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Co-op Bank bonds take a tumble on wind-up report

The Co-operative Bank Plc's senior and subordinated bonds all fell to record lows Jan. 30 after a Sunday Times report the day before questioned the long-term viability of the Manchester-based lender.

The falls took the price of the Co-op's £400 million 5.125% senior bonds due in September to roughly 86% of par from 94%, according to Bloomberg data. On the subordinated side, the bank's £206 million 11% bonds due in 2023 were quoted at 58% of par, down from 76%, while the £250 million 8.5% bonds fell to 56% of par from around 69%.

The falls compounded losses that came in the wake of an update Jan. 26 in which the bank admitted it was likely to miss previous capital guidance, keeping its common equity Tier 1 ratio below 10% in the medium term until 2020. In a prior third-quarter trading review, the Prudential Regulation Authority revised the bank's Pillar 2A capital requirement to 14.1% of risk-weighted assets.

The Sunday Times reported that the Bank of England is considering an intervention that could see the Co-op wound up before the end of the year. The bank had enough liquidity to meet this year's senior bond redemption but would struggle to raise a new bond to top up its finances, the article added.

Co-op representatives declined to comment on the report when contacted by S&P Global Market Intelligence. The Bank of England also declined to comment.

Falls greater than expected

The scale of the bond fall took observers by surprise given the more muted response to the initial statement last week. "The bank is solvent," said Otto Dichtl, a credit analyst at Stifel Nicolaus Europe. "The drop in capital is more than what they were expecting and therefore their recovery will take a bit longer."

The Co-op had expected to meet its individual capital guidance set by the U.K. regulator before 2019.

The failure to achieve this target highlights the difficulty of turning around troubled banks in the U.K. while interest rates remain low and the economic outlook remains uncertain, Fitch analysts led by Claudia Nelson said in a Jan. 30 note. In particular, the Co-op is struggling to return to profitability as it focuses on residential and buy-to-let mortgage lending where yields are tight. In this context, the U.K.'s post-Brexit rate cut is likely to have hit the bank's recovery plan and the Co-op is not expected to return to profitability by 2018, Fitch added.

But Fitch analysts agreed that the lender does not face a funding issue. The Co-op mainly funds itself through deposits, and as senior bonds do not form part of its regulatory capital base, it should not matter if it opts to roll them over through a new issue or not. "[W]e believe that access to funding and liquidity is correlated with banks' capital positions," the Fitch analysts wrote.

Nevertheless, there are unanswered questions about whether the bank will need to take further steps to meet its capital targets, Dichtl said.

"The bank needs to give some clarity to the market on whether the PRA is still on board with its plans or otherwise say what it plans to do about it," he told S&P Global Market Intelligence, adding that the bank is not a resolution case.

The lender is expected to present its full-year 2016 results in early March.