Co-Operative Bank Ltd.’s former managers performed “cursory” due diligence when they took over Britannia Building Society and its troubled real-estate loans, the main cause of the lender’s near-collapse, according to a report commissioned by its former owner.
“The severity of the problem was magnified by failures of management, lack of capability, a fallible culture and weak governance,” according to the report by Christopher Kelly, the former chairman of the U.K.’s Financial Ombudsman Service. He reviewed the years before the £1.5 billion ($2.5 billion) capital shortfall as discovered.
The report also blamed a failed information-technology project and the costs of compensating customers who were mis-sold payment-protection insurance for increasing the shortfall. Executives were distracted by their effort to buy 630 branches from Lloyds Banking Group Plc, Kelly said.
The capital hole, which came to light after Co-Operative Bank’s failed attempt to buy the branches last year, forced the lender’s parent, Co-Operative Group Ltd., to give up control of the bank after more than a century. The affair has also led to the departures of Len Wardle as Co-Operative Group’s chairman and Euan Sutherland as chief executive officer.
Regulators and the Treasury are probing the company amid claims from the bank’s ex-chairman, Paul Flowers, that the government encouraged both deals. Kelly found no evidence of government pressure, and said regulator Andrew Bailey had written repeated letters expressing alarm over the Lloyds plan.
Drugs, Supermarkets
Flowers was the only executive who declined to speak to Kelly, according to the report. The methodist minister is due to appear in court in Leeds, northern England, next week to face charges of drug possession.
Kelly’s report, based on more than 130 interviews with current and former employees, was commissioned by Manchester, England-based Co-Operative Group and Co-Operative Bank in July. The 151-year-old, mutually owned Co-Operative Group’s remaining businesses include supermarkets, funeral homes and pharmacies.
“I would like to apologize for these past failings,” Niall Booker, CEO of the Co-Operative Bank, said in a statement. “The report is about the problems of the past.”
Co-Operative Bank bought Britannia in 2009, creating a company with 70 billion pounds of assets. Britannia was led at the time by Neville Richardson, who subsequently became the CEO of Co-Operative Bank before leaving in July 2011.
Richardson criticized the Lloyds talks that occurred after his departure and told Parliament last year that the lender was in “good shape” when he left, an assertion disputed by Bank of England Deputy Governor Andrew Bailey and in Kelly’s report.
Risk Appetite
Kelly said Co-Operative Bank gained assets “well outside its risk appetite” when it acquired Britannia for its branch network and individual customers. The building society came with a 3.7 billion-pound corporate loan book, mostly in commercial real estate, that accounted for as much as half of its lending, he wrote.
“Though the board does not seem to have been aware of it at the time, the due diligence performed on what turned out to be the most risky part of the acquired assets - the corporate loan book and in particular the commercial real estate lending - had been cursory,” Kelly wrote.
In Britannia’s last seven months as an independent entity, “most of its profits came from a one-off repurchase of some of its subordinated liabilities and debt securities,” he wrote.
Capital Neglect
Kelly said the Co-Operative’s managers failed to focus on raising capital levels early enough, even though they should have recognized that regulators were going to impose stiffer capital requirements in the wake of the financial crisis. The bank’s mutual ownership structure meant it was more constrained in its fundraising ability than publicly traded banks, he said.
“A tendency towards being inward-looking, arguably not helped by being based outside London,” also contributed to the “debacle,” Kelly wrote. “The bank appeared to be largely unaware of the limitations on its own capability.”
What capital actions were taken “had the deliberate effect of pushing issues into the future, presumably in the hope that profitability would have improved by then,” he wrote.
Paul Myners, a former UK Treasury minister, is stepping down as a director next month after calling on Co-Operative Group, which is owned by its members, to take “urgent steps’’ to overhaul governance or risk running out of capital.
Bloomberg
