Co-op Bank board to set seal on hedge funds’ £700m rescue deal

The board of the Co-operative Bank will gather on Tuesday night to apply the finishing touches to a £700m rescue deal led by a handful of American hedge funds, potentially ending months of uncertainty for the struggling lender's four million customers.

Sky News has learnt that directors of the ethical lender are meeting to finalise an agreement which appears to have secured the backing of the Co-op Group, removing the final major obstacle to a financial restructuring package.

A formal deal is likely to be announced on Wednesday morning, although people close to the situation said it was conceivable that it could yet face new delays, with talks expected to continue late into the evening.

The agreement, which would come more than four months after the Co-op Bank was formally put up for sale, follows growing pressure from banking watchdogs on the Co-op Group and other stakeholders to reach a compromise.

Tensions over the division of the £10bn pension scheme shared by the Co-op Group and Bank, and the ongoing relationship agreement between them, had prompted several weeks of delays.

Sources said, however, that the key elements of a deal had now been approved by pension trustees, with the Group also close to agreeing its key terms .

One said that the Bank and bondholders had agreed to a request from the Group to inject substantial annual sums into the new Bank pension scheme for the next decade which would be in excess of the demands of the trustees.

If the deal is confirmed, the Co-op Group - once the sole shareholder in the lender that carries its name - will see its stake reduced to around 1%, with the Co-op Bank becoming almost entirely owned by a consortium of Wall Street financiers.

The hedge funds will also guarantee to provide more than £200m for the acquisition of new shares in the Co-op Bank.

Under the plans, the existing Pace (LSE: 4031.L - news) scheme will be sectionalised, leaving each side of the Co-op responsible only for its own employees' retirement savings.

The current arrangement includes a 'last man standing' provision which means that each is liable for the whole scheme if the other side goes bust.

Insiders said the 'last man standing' arrangement would be dissolved over a period of time approved by the pension trustees.

In total, Pace counts nearly 90,000 Co-op Group and Bank workers as members.

The Group pays £20m into the scheme each year, with the Bank contributing £5m, with a new triennial valuation of the scheme deficit due to take place this year.

The pension trustees have been insisting that Co-op Bank bondholders commit to funding their standalone scheme over a multi-year period, while the Co-op Group has ruled out providing new funds to the scheme.

The bondholders had offered to inject £62.5m in cash over five years to eliminate an actuarial deficit, with the scheme gaining rights to Co-op Bank assets in the event of a future crisis.

Sources said the sum invested in the scheme would now be higher than that.

In a statement issued on Monday, the Bank said it was at an "advanced" stage of talks about the Pace separation - and that other commercial elements of the rescue deal for the Co-op Bank had been "substantially agreed".

The PRA, which is expected to issue a public statement once the deal is announced, declined to comment.

The attempts to resolve the stalemate come as a fifth hedge fund - Anchorage Capital Group - joined the consortium of Wall Street financiers seeking to finalise the rescue of the Co-op Bank.

"The (bondholder) proposal, if implemented, would enable the Bank to meet the longer-term‎ capital requirements applicable to all UK banks and to continue as a standalone entity," the lender said on Monday.

"The proposal would also safeguard the Bank's values and ethics."

The Co-op Bank also said it had been informed by banking regulators at the weekend that its long-term capital requirements would be lower than previously expected.

It added that it saw the potential to pay a dividend to shareholders in 2021 if its business plan was delivered over the coming years.

Monday's statement raised hopes that a deal to save the Co-op Bank - and avoid it becoming a test-case for the Bank of England's powers to wind down failing lenders - can be struck well before a September deadline for repayment of a £400m bond.

The Co-op Group, which is one of the UK's biggest food retailers and funeral care providers, would see its stake in the Bank slashed to less than 5% under the bondholders' plan.

The scramble to rescue the Co-op Bank has been triggered by its need to find more than £700m of new capital.

In March, the Co-op Bank said it would require up to £750m of new top quality capital, the majority of which would be generated by exchanging some of its debt for equity - a process known as a liability management exercise.

The remainder would come from issuing new shares, which the five hedge funds would 'backstop' or guarantee to buy if there is insufficient demand from other existing investors.

The Co-op Bank's total capital requirement has been marginally reduced to just under £700m by the regulator's revised guidance, a source said.

The Co-op Bank has been hit by a string of legacy issues, as well as the challenge posed by ultra-low interest rates, since its original £1.5bn bailout in 2013.

The lender announced an annual loss this year of £477m, taking its total losses since its rescue in 2013 to well over £2.5bn.

The Co-op Bank's balance sheet ballooned following a disastrous merger with the Britannia Building Society, and then ran into trouble when it tried to buy more than 600 branches from Lloyds Banking Group.

Its former chairman, Paul Flowers, brought it into disrepute when his drug-taking and sexual proclivities were exposed by a tabloid newspaper, while his financial competence was questioned by MPs (BSE: MPSLTD.BO - news) .

The Co-op Group, Bank, bondholders and pension trustees all declined to comment.