Lloyds plans IPO as Co-Op sale collapses

June 2013 | FEATURE | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

In late April, after nearly 12 months of negotiations, the Co-Operative Group (Co-Op) announced it was withdrawing its interest in acquiring 360 branches of the Lloyds Banking Group. The deal, which was agreed in July 2012, would have seen the UK’s largest mutual pay Lloyds £750m for the business. Lloyds will now float its network of branches on the stock exchange.

According to a statement released by the Co-Op, the company’s board felt that the deal was no longer feasible due to the continued economic downturn in the UK and the increasingly stringent regulatory requirements being placed upon the entire financial services sector. Industry regulators in the UK have identified a £25bn capital shortfall across the sector which will need to be addressed.

Peter Marks, the Co-Op’s outgoing chief executive, said“We have decided, at this time, that it is not in the best interests of our members to proceed with the transaction. Having worked closely and constructively with Lloyds we are naturally disappointed to have reached this conclusion. However, against the backdrop of the current economic environment, the worsened outlook for economic growth and the increasing regulatory requirements on the financial services sector in general, the Verde transaction would not currently deliver a suitable return for our members within a reasonable timeframe and with an acceptable level of risk.”

The sale of the branches, which has been progressing under the code name ‘Project Verde’, was imposed upon Lloyds by European Commission competition rules. Regulators decreed that Lloyds must sell branches by November as a condition of the group receiving a state bailout during the 2008 financial crisis. Controversially, the British government provided Lloyds with £20.5bn of funding, leaving UK taxpayers with a 39 percent stake in the group.

The Royal Bank of Scotland (RBS) is in a similar position with regard to 300 of its own branches. RBS was due to sell off the business in 2012 before the Santander Group reneged on their deal. European regulators had insisted that RBS also sell off the branches after it required government bailouts in 2008 and 2009.

Lloyds will now divest itself of branches via an initial public offering (IPO). However, analysts suggest that any proposed spinoff and flotation of the branches – which will be rebranded as TSB on the UK high street from August onwards – is unlikely to occur before the second half of 2014. The UK government and Lloyds, therefore, would need to seek an extension to the original deadline from EU regulators. It is expected that an IPO could value the branches at twice the price agreed with the Co-Op, reaching in the region of £1.5bn.

The Co-Op’s decision to pull out is also a blow to the government which saw the transaction as an opportunity to create a legitimate competitor to the oligopoly of the UK’s five largest high street banks – Lloyds, HSBC, Barclays, RBS and Santander UK. This group currently holds 83 percent of all UK current accounts, while the Co-Op’s banking business – which is over 150 years old – holds just 2 percent of deposits. Once completed, the Co-Op’s share of current accounts would have increased to 7 percent.

The government had hoped to revitalise the UK’s credit starved economy by creating ‘challenger’ banks which could lend money at more competitive rates, which in turn would hopefully force the industry’s bigger players to follow suit.

Uncertainty had surrounded the future of the Lloyds / Co-Op deal for some time. The Co-Op announced losses of £674m last year, as well as a capital hole of up to £1bn – the equivalent of half of the group’s capital. The group also agreed to sell its life and general insurance units in March, in order to help facilitate the TSB purchase.

Despite the ongoing uncertainty surrounding the feasibility of the deal on the Co-Op’s part, in February Chancellor George Osborne continued to champion the selloff, telling MPs and peers that he was “very keen” to see the deal completed. A spokesman for the Treasury Department noted that the failure of the sale was a “a commercial matter” but that “the government remains determined to promote greater competition in the banking sector in order to provide consumers with more choice”.

Lloyds, which is Britain’s biggest retail bank, expressed its frustration that the deal had collapsed via a statement. Chief executive António Horta-Osório noted “We are disappointed that The Co-Operative Group is unable to complete this transaction. However, we are well advanced in our plans to bring the Verde business to the UK high street during the summer through the TSB Bank.”

Lloyds made an underlying pre-tax profit of £2.6bn in 2012, with the Verde branches contributing around £200m profit a year. It is estimated that the cost of the collapsed deal to Lloyds is around £1bn.

On 10 May Moody’s rating agency downgraded the Co-Op bank’s debt rating to junk, warning that the group may need “external support” if it was unable to strengthen its balance sheet. Moody’s calculates that the Co-op Bank’s “problem loan ratio” had increased by the end of 2012 to 10.9 percent from 8.1 percent 12 months earlier, reflecting a deterioration in the bank’s commercial real estate portfolio. In a statement the Co-Op noted that it was “disappointed” with Moody’s decision.

Richard Summerfield