Hedge funds target June deal to salvage Co-op Bank's future

The American hedge funds in talks to take full control of the Co-op Bank is racing to secure backing for a deal by the middle of next month.

Sky News has learnt that a committee of bondholders - which also owns the majority of the Co-op Bank's shares - is close to presenting the terms of a new deal to the struggling lender's board and its regulators.

Regulatory sources said this weekend that the hedge funds, led by GoldenTree Asset Management and Silver Point, were targeting the outline of a deal to inject new funds into the Co-op Bank in little more than a fortnight.

The development will raise hopes that a consensual private sector solution can be found to safeguard the Co-op Bank's future, despite the disappearance of prospective buyers such as Virgin Money.

It comes just a week after the bondholder and its advisers held their first talks with officials from the Prudential Regulation Authority (PRA) last week about the level of new capital required to secure a financial restructuring of the Co-op Bank.

Sources said the hedge funds - which also include Blue Mountain Capital Management and Cyrus Capital Partners - had used the meeting with the PRA to argue that the Co-op Bank needs a lower sum than the company has previously indicated.

It emerged this month that the hedge funds had tabled a proposal to the Co-op Bank that would involve pumping substantial sums into it.

Details of their proposal remain unclear, although it would involve the provision of a smaller sum than the £300m of new equity that the Co-op Bank had previously signalled it would require.

In March, the Co-op Bank said it would require between £700m and £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 - between £250m and £300m - would come from issuing new shares.

There is no formal deadline for a rescue deal to be stitched together, and people close to the Co-op Bank pointed out that it continued to meet key regulatory capital and liquidity requirements.

The hedge funds hold important cards during the talks to stabilise the Co-op Bank's finances following the failure to find a buyer through a conventional sale process.

The Co-op Group recently wrote off the remaining value of its 20% shareholding in the Co-op Bank - incurring a £140m hit which plunged the supermarkets-to-insurance mutual to a statutory annual loss.

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 £1.5bn bailout in 2013.

The Co-op Bank's huge pension liabilities, and their joint 'ownership' with the Co-op Group, remain among the major obstacles to a deal to resolve its future.

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

If new capital is not forthcoming, regulators would have little choice but to put the Co-op Bank into a resolution process, which would involve an orderly wind-down of the company's operations.

At that point, the likes of Nationwide or Virgin Money could be asked to step forward to take on some or all of the Co-op Bank's four million customers.

A number of other parties, including OneSavings Bank (Stuttgart: 2OS.SG - news) and Santander UK (LSE: 44RS.L - news) , are more interested in acquiring individual loan portfolios from the Co-op Bank.

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) .

A spokesman for the bondholders did not return calls seeking comment.