Group’s debt puts it in the hands of banking syndicate

Just how crucial were the banks in driving the reform process at the Co-operative Group? Very, is the simple answer. The background to the Group’s debt owes more...

Just how crucial were the banks in driving the reform process at the Co-operative Group? Very, is the simple answer.

The background to the Group’s debt owes more to the unwise acquisition of Somerfield than to that other disaster at the Co-op Bank, which was caused to a large extent by a similarly mistaken acquisition of Britannia.

But at least the Britannia takeover was without a purchase price. By contrast, the Somerfield acquisition came with a big upfront cost – and continuing financial pain.

Somerfield was bought in 2009 for £1.57bn. The purchase enabled the Group to double its market share, achieved by borrowing heavily on the markets – but most of that debt has not yet been repaid. Lord Myners observed, perfectly reasonably, that there was “nothing to show for that deal”.

Or rather, there was nothing positive to show; there was in fact a considerable amount negatively to display. The Somerfield grocery empire was based on a disparate collection of stores, of different sizes and in many cases with inappropriate locations for the Group’s strategy of growth in the convenience store sector. Many of those stores came with very expensive leases.

As a result, the Group still holds leases on more than 600 stores that are lying empty. That represents an annual lease cost of nearly £500m. Somerfield turns out to have been an extremely expensive mistake.

But the debt problem lies not only with the impact on profits. It also relates to damage in the control of the business. Debt of this level cedes control of the business, to a significant extent, to those who lend the business money.

And so we come to the syndicate of banks, to whom the Group owes a very large fortune.

The role of those banks in pushing reform of the Group was made clear in a video posted on the Group’s website, in which the now-permanent chief executive Richard Pennycook advocated the reform proposals, subsequently adopted by the special general meeting on governance reform.

“Throughout this crisis, we have been working very closely with our banking syndicate,” Mr Pennycook explained. “From time to time, we have needed permission from them to do certain things. They have been very supportive.”

But the banking syndicate’s role in promoting governance reform – and, it could be argued, in penalising the Group if reform did not take place – is particularly significant.

“They have incentivised us to ensure that the governance reform goes through,” said Mr Pennycook. “We will receive money back from the disposals that we have recently announced [ie, the farms and pharmacy chain, and now also Sunwin] – money that we can use to invest in our businesses.

“That will only come back to us at the point where the governance reforms have gone through and the rule changes have been accepted by the Financial Conduct Authority.

“Those disposals are very important – they have allowed us to reduce debt, but they are also important because we can use some of that money to reinvest in our businesses. I can’t get that money until these reforms have been concluded.”

In truth, we should not be surprised that the banking syndicate has adopted this very hard-nosed approach – after all, it is the way bankers operate. The Group was placed in this situation of vulnerability by the scale of its borrowings to achieve the Somerfield takeover, which created unsustainable debt, serious damage to Group profitability and, it turns out, loss of ultimate control of the business.

It is in the public domain that one of the bank lenders is RBS. The Financial Times reported that RBS took the leading role on behalf of the banking syndicate in negotiating with the Group. This was denied to me by both RBS and the Group. However, we know that RBS has taken a very tough line in its negotiations with other debtors. RBS has been accused of preventing many businesses in trading difficulty from getting back into financial health, including by holding on to businesses’ income once they have entered the RBS ‘recovery’ unit.

This unit was called the Global Recovery Group, or GRG, and it has been slammed in a report by a then-advisor to government, Lawrence Tomlinson. RBS strenuously denies any wrongdoing – but has recently announced that it is closing GRG.

It is worth noting, irrespective, that in certain situations banks will prevent their clients from accessing funds received if that income is less than the debt owed to their bank.

Group CEO Richard Pennycook
‘Throughout this crisis, we have been working very closely with our banking syndicate’ – Group CEO Richard Pennycook (Image: VisMedia)

By coincidence, the Group has another problem with its ability to access capital from a disposal. It turns out that Royal London has not yet completed payment for its acquisition from the Group of its life insurance and asset management business. This is why the Group still owes the Co-operative Bank
a promised £163m. A further £180m to £200m may become payable by Royal London, once a court case is completed.

CIS operated two core businesses, general insurance and life insurance, which, I understand, operated a shared reserve. It is not yet clear how much of that reserve is owned by each of the two insurance businesses. Until that is resolved, the final payment by Royal London cannot be transferred.

A spokeswoman for Royal London confirms: “Part VII of the Insurance Companies Act sets out a process to follow for the transfer of an insurance business to another insurance company.

“The process requires the appointment of an independent expert who looks at the impact of the proposed transfer on the various groups of affected policyholders and submits a report to the financial regulators [the Financial Conduct Authority and the Prudential Regulation Authority] and the Court, primarily considering the fairness of the terms of the transfer to all affected policyholders.

“This process is governed by law and must be approved by the High Court. The final payment from Royal London not part of what is being approved by the court, but is a contractual obligation arising from the terms of the sale to Royal London of Royal London (CIS) by Co-op.

“However, the payment is dependent on Royal London being able to release certain shareholder funds and the proposed release of those funds is one of the issues which is considered by the independent expert, and in turn by the financial regulators and the Court. The transfer is required to be approved by the High Court of England and Wales before it can proceed.”

I understand a court hearing will take place very soon that will indirectly determine the size of, and approve, the final payment from Royal London to the Group. While these matters are very technical, they are also very important.

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