Why Co-Op may be front runner for Lloyds’ branches

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I may have under-estimated, by more than £1bn, the loss that Lloyds is likely to incur from the forced sale of branches, loans and deposits that collectively it has christened Verde (see Wednesday's post for more on this).

My probable error was to be too sanguine about the capital that regulators at the Financial Services Authority will force Lloyds to inject into Verde prior to the disposal.

I had been told that Verde's net equity capital would be around £2.5bn. So on that basis, NBNK's £1.5bn offer for Verde would - if successful (quite a big if) - crystallize a loss for Lloyds of £1bn (it would be paying £1.5bn for a business with a net value of £2.5bn; welcome to the wonderful world of banking in a period of endemic gloom among investors).

But here's the thing (as I am wont to say): the regulatory requirement for Verde to hold £2.5bn of capital, as a buffer against potential losses, would only be true if the new owner of Verde was a large, long-established bank (like Lloyds itself) which has what is known as advanced regulatory status.

But NBNK, as the new kid on the block, does not have advanced status and might not get it for years: it would have standard status.

With standard status, Verde would have to hold £3.6bn of capital - which, to repeat, would be capital initially provided by Lloyds.

So a bid of £1.5bn for Verde from an outfit with standard status would create a colossal loss for Lloyds of more than £2bn. Yikes.

Now of the three potential bidders for Lloyds, two - NBNK and Sun Capital - would find it hard to escape standard status, because (to state the obvious) neither of them have been giants in banking for the past 20 plus years.

That said, both have been talking to National Australia Bank about buying its UK operations, Yorkshire and Clydesdale banks - which have £3bn of capital - in an attempt to acquire more market share and credibility as potential owners of Verde's more than 300 branches and £36bn in deposits and liabilities.

But any takeover of NAB's UK banks, or any partnership with NAB, would not solve the regulatory status problem, because NAB does not have advanced status in the UK.

That said, there is one wannabe bidder for Verde with advanced status: Co-operative Banking Group, owner of the Co-operative Bank, Smile and Britannia.

In theory, a bid from the Co-Op would be worth about £1bn more to Lloyds than a bid from either NBNK or Sun Capital.

Which explains why bankers close to Lloyds have been making very positive noises about the Co-Op's chances of winning the auction for Verde, even though the Co-op is yet to make a bid.

There are a couple of caveats, however.

First, it's not that long since the Co-op bought the Britannia building society, and the FSA would have to be persuaded that the Britannia had been properly and safely integrated before giving the Co-op the green light to make a much bigger takeover.

Second, it's not immediately clear where the Co-op - as a co-op - will get the money for this every substantial deal.

So there remains a realistic possibility that Lloyds will not receive any realistic offers for the bank.

Nor does Lloyds' official fall back position, of floating Verde on the stock market, look particularly appealing, because stock-market valuations of banks are lower in relative terms than even what NBNK has offered for Verde.

Finally, there is another potential obstacle to any successful sale, which is that Lloyds has been told by one of the bidders, Sun Capital, that it has chronically underestimated the computer and systems costs of separating Verde.

As I understood it, Lloyds believes the systems costs would be of the order of £800m or £900m. whereas Sun - on the basis of extensive research - believes the bill for creating a new independent computer network to service Verde's 5m customers would be as great as £1.2bn.

The sheer size of these separation costs, if they become accepted, will further depress whatever bids Lloyds ultimately receives for Verde.

For Lloyds' board, what will be incredibly galling is that there is no scope for it to kill the sale and keep Verde: Lloyds will have to grin and bear whatever losses it eventually faces on a deal that has been ordered by Brussels.

Update 1740: I've received a bit more information on this fascinating and complicated auction.

First, NBNK is hopeful that the FSA - with possible encouragement from Lloyds - may award it advanced status, putting it on a level playing field with the Co-op in the bidding.

It is immensely difficult to know whether that optimism is misplaced - although I wouldn't expect NBNK's chief executive, Gary Hoffman, a lifelong banker (who reconstructed nationalised Northern Rock for the government) to be naive about this.

Second, NBNK is many hundreds of millions of pounds below Sun in its estimate of the cost of creating independent computer systems for Verde: NBNK believes the cost will be nearer Lloyds' calculation of £800m than Sun's estimate of £1.2bn.

All of this needs to be nailed down fairly fast, because NBNK won't be able to issue a prospectus to raise the money to buy Verde unless it has certainty on whether it will have advanced or standard status and also what the realistic IT and hardware expense will be.

Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 1.

    I don't see why Lloyds should sell any branches. It's as big as it is thanks to the gov-brokered shot-gun HBOS wedding. The gov should be hanging its head in shame or stamping on europe.

    Still it'll be nice to be able to get my groceries at the bank.

  • rate this

    Comment number 2.

    This is madness. Surely letting Lloyds sell in 24 months when conditions are better wouldn't hurt anyone, least of all UK taxpayers who own much of Lloyds.

  • rate this

    Comment number 3.

    Bigger fish to fry RP, looks like there may be a silent run on French banks in progress.

    ''El-Erian noted that the ratio of market capital to total assets for the sector has fallen to 1% to 1.5% — far short of the range of 6% to 8% typically seen for healthier banks.

    “These are all signs of an institutional run on French banks,” he wrote.

    Better get busy Robert.

  • rate this

    Comment number 4.

    > Now of the three potential bidders for Lloyds, two - NBNK and Sun Capital -

    They are mostly tainted by connections to The City, thus obvious non-starters.

    The Co-Op (headquarters in Manchester.) is the only one that we could ever trust. The rest are run by horrid London spivs.

  • rate this

    Comment number 5.

    I'd hold on for 12 months. In this economic climate, anything could happen. The US is in serious trouble and Europe is faced with an insoluble problem. China is stalling. Global growth is moribund and unlikely to improve whilst everyone is in austerity mode.

    Who knows - maybe Brussels will receive its comeuppance.

  • rate this

    Comment number 6.

    Europeans don't follow silly EU rules so why should we? Why should a English company pay for a competitor to buy part of it's business? This is madness, maybe we should have Nick's referendum on the EU and see how much appetite the English public have for being shafted by Europeans.

    (I deliberately exclude Scotland from this as they want to be in the Euro and have an economy like Ireland).

  • rate this

    Comment number 7.

    This is madness. Surely letting Lloyds sell in 24 months when conditions are better wouldn't hurt anyone, least of all UK taxpayers who own much of Lloyds.
    Deluded - no way will confditions be better .
    The end is coming. The banking leeches/spivs have won. Just make sure we meat out proper justice to them when the system collapses.

  • rate this

    Comment number 8.

    The Co-Op have got no chance of buying these branches. The reason is that the Co-Op supports Labour and the London Spivs are mates of Cameron and Osborne. Politics does not come into it, Ha Ha.

  • rate this

    Comment number 9.

    Co-op stay away from this madness.

  • rate this

    Comment number 10.

    Is there sufficient evidence for the government to tell the EU cant be done - get lost. Anyway if the government took a bigger share in Lloyds the sell off would not be necessary because of greater control and accountability implied in the large public sector interest (except so far the Government have shown no interest in guiding the banks to be more responsible and user cuddly).

  • rate this

    Comment number 11.

    So the last government persuaded Lloyds to rescue the moribund HBOS by offering to overrule any Monopolies & Mergers objections. This overly-ambitious takeover further weakened Lloyds, which then had to be rescued by the government. Finally EU bureaucrats decided that Lloyds had become too big anyway and insisted it sell many of its branches.

    What as mess!

  • rate this

    Comment number 12.

    hmm why can't I post a comment - if this appears I know I can - then the question would be why can't I post the comment I'm trying to post?

  • rate this

    Comment number 13.

    Why shouldn't either UKGov or the Bank of England buy Verde?

    Afterwards, should they not want or know how to run Verde, they could pay Lloyds to do it for them ... .

  • rate this

    Comment number 14.

    What is to stop Lloyds's customers (in credit) from moving their assets back to Lloyds if they want to do so?

    Only debts can be sold - not deposits (unless term deposits). So whoever 'buys' the branches will need to buy the locations NOT the credit customers.

    So the buyer will be stuck with the debts without any means of financing them! A terribly difficult problem these day's for any bank!

  • rate this

    Comment number 15.

    6. Lindsay_from_Hendon

    You really do write bigoted nonsense and everyone should regularly be reminded that YOU LIVE IN SWITZERLAND and not in either of the Hendon's in England! Your views are anti-European and against the general benefit of every citizen of the EU. All you seek to do is to destroy Europe for your own personal selfish benefit - if not, return to the UK and pay our TAX!

  • rate this

    Comment number 16.

    12. G.UP..N..77 "then the question .. why can't I post the comment I'm trying to post?"

    The system if flaky or perhaps the daft 400 ASCII character count says your post is OK when you have included a Unicode character which counts as 2 characters - so the idiotic character count JavaScript says your post is OK buy the host checking system sees over 400 characters!

    Badly written code by the BBC!

  • rate this

    Comment number 17.

    I fail to understand the import of your recent blogs.
    Verde concerns a private company getting bids to offload some of its assets.
    No decision will be made until December and no account of public opinion will be taken (a bit like bombing Libya for 9 months).

  • rate this

    Comment number 18.

    If a colossal loss for Llyods as indicated in the article was £ 2bn then we as tax payers holding 41% of Llyods would lose £ 820M. That would be an act of gross mis conduct by the EU in wasting public money and if it happened UK citizens should take the EU to the European Court of Law for compensation.

  • rate this

    Comment number 19.

    It's really galling that the EU can impose this when the only reason the company became so large was under pressure from politicians et al,at a time of crisis. Having to sell now rather than at a time when taxpayers will be rewarded for their investment is execrable
    If assurances were made of a sale when we are through this crisis that should suffice for now
    We could do worse than the co-op though

  • rate this

    Comment number 20.

    Now I'm not a fan of bankers, but I actually have some sympathy for Lloyds. they were shafted by shifting goalposts (government: buy, buy, please buy... erm, actually no, sell), and now they have the prospect of capitalizing a business that's going at the same time they need to improve their own situation.

    Still, we'll be bailing them out either way. So not too much sympathy.


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