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Categorized | Banks, Financial

Much at stake for Co-op as talks teeter

Posted on March 30, 2012

Just before Christmas, Lloyds Banking Group was confident the sale of 630 branches would be stitched up by this weekend.

While the business had not attracted the level of interest it was hoping for, Lloyds had selected the Co-operative Group as its preferred bidder – a popular choice in government and consumer circles – and said that it expected to secure terms for a deal in the first quarter.

Three months later the talks are hanging in the balance, with both sides playing down expectations that a deal will be reached.

At stake is not only a straightforward exit for Lloyds from the business it must sell to meet state aid rules but also a rare opportunity to create a serious competitor to the big five banks, say consumer groups.

Should the Co-op fail to agree a deal with Lloyds, the mutual would return to slower organic growth, picking up branches where it can and extending banking services in its grocery stores.

Reaching the kind of scale it would instantly achieve through the Lloyds purchase – 1,000 branches compared with its current 340 – without a big acquisition could take decades.

Meanwhile the Lloyds business would either be floated or sold off to NBNK, an investment vehicle that would be keen to reopen talks after its bid for the branches was rejected last year.

Either way, without an existing banking arm to merge the Lloyds branches into, hopes are fading that this business could create a viable competitor for consumers.

A review by Sir John Vickers’ banking commission last year said that to compete effectively banks need at least 6 per cent of the current account market.

As a standalone business the Lloyds branches would have about 4.6 per cent, less than Santander UK and Nationwide but more than other building societies.

“It’s clear this is the deal everyone wants,” says someone familiar with the process. “But the government can’t force it.”

While the Co-op’s bid has the support of ministers and consumer lobbyists, the regulator is taking a tougher stance.

Anxious that it does not wave through any more banking deals that blow-up shortly after they are approved, the Financial Services Authority is considering whether it should regulate the Co-op’s entire business if it buys the Lloyds branches.

This would pose stringent capital requirements on not just the mutual’s banking arm but also its grocery chain, funeral parlours, pharmacies and other smaller businesses.

For a group that is already struggling to compete with large retailers such as Tesco and Boots, this would be a disaster.

Having to hold a larger capital buffer would restrict the funds available to the Co-op for expanding its other businesses and could put further pressure on already squeezed profit margins, according to people close to the situation. Simply put, if the regulator does take this view, it is likely to kill the Co-op’s plans.

The mutual’s chief executive said on Thursday that discussions were continuing and a final decision would be made in the coming weeks.

He made clear that he would only push ahead if the deal was beneficial for members who have a stake in the whole organisation, not just the bank.

Should the talks collapse, Lloyds would probably resort to its back-up plan of floating the branch network – an option analysts say carries more risk that a clean sale.

This would make Lloyds solely responsible for carving out the branch network as an independent business, ensuring it had fully-functional systems and a robust management team and board.

Lloyds would also face the uncertainty of pricing a float in a difficult market and convincing private investors to back a bank that had failed to attract a buyer.

“It’s an issue of valuation,” says Robert Law, an analyst at Nomura. “The fewer options Lloyds has to choose from, the lower the price is likely to be.”

Also, he says, without a firm bidder Lloyds may have to improve the asset package, by including better quality mortgages, for example, to attract private investors.

Lloyds’ priority throughout the process has been to limit the execution risk of a deal rather than extract the highest price.

Analysts warn that failing to agree terms with the Co-op would leave the bank in a weak negotiating position and having to shoulder all the risk.