Bank deal may be a step too far

The Co-op group is preferred bidder for Lloyds' branches but the move is proving complex and there are doubts that it is equal to the task

If Lloyds is getting queasy about the sell-off of "Project Verde" what about its preferred bidder? Last week's unscheduled announcement that the EU-mandated sale of 632 branches had been delayed, together with the insistence that a flotation of Verde is being actively pursued, was widely seen as a shot across the bows of the Co-operative, which yesterday published its annual results.

The Co-op's results statement only made a passing reference to Verde alongside the figures which showed that the society's banking operations returned flat profits of £201m.

But Co-operative group chief executive Peter Marks admitted that the transaction was proving "complex" for a number of reasons, not least regulatory. Heads of agreement were due to have been signed yesterday. Lloyds last week said an announcement was now not expected until the second quarter.

Mr Marks yesterday mounted a robust defence of the Co-op's position: "This is a carve-out of a very big business. That means we need to take time.

"I think we've all seen what happens when banks don't take enough time to do things. We are not going to be bullied or harassed by anyone into doing this quickly."

All the same, a decision is still going to have to be made within weeks, not months, and the regulatory complications are not encouraging. Co-op Bank has 345 branches as well as the online bank Smile and is still integrating Britannia building society, two years on from its acquisition. Mr Marks said that the society is "ahead" based on a three-year integration plan.

A deal to buy Verde, however, would be of a different order, more than doubling Co-op Bank's size and potentially creating a genuine challenger to the existing high street players. The new-look Co-op Bank would also account for more than 50 per cent of the Co-operative Group, which could be a problem. The Co-operative board is made up of ordinary individuals elected by regional societies; they include a plasterer, a nurse, a retired publisher. That might not be such a bad thing given the lamentable performance of more conventional non-executive directors in overseeing British companies.

But are they the sort of people who would get through the FSA's "intrusive" screening of directors of banks? The bank has not publicly settled on a chief executive. Or a finance director. Acting boss Barry Tootell, the former finance director, and James Mack, acting finance director, may have to be replaced if the deal goes ahead.

Mr Marks is not best pleased about such questions, which are being raised in City circles. He pointed out that Co-op Bank has its own board, made up of more conventional bank directors. And he added: "We have run a bank for over 100 years. It is also profitable. During the financial crisis a lot of banks governed by professional bankers collapsed and ran to government for a bail-out. Co-op came through the crisis without any crisis. To question our ability is patent nonsense. This is a major deal and it would be a major step-up for us.

"Therefore the Financial Services Authority are quite rightly scrutinising it closely. If we can't satisfy the FSA then I don't want to do this deal. So we are taking our time and doing a very thorough job."

Financially, the Co-op's banking arm is in reasonable health. The company has an enviable loan-to-deposit ratio of 94 per cent, meaning for every £1 in deposits taken in the bank lent out 94p. So, in theory, no requirement for any wholesale funding. That is an improvement on last year's 103 per cent. Its tier one capital ratio of 9.6 per cent is a shade lower than the big high street banks, all of which have more than 10 per cent.

What the bank does not have is the ability to tap the equity markets for cash if funding gets tight although Mr Marks says Co-op is closely involved in discussions with mutuals across Europe about the creation of a new funding vehicle that could rectify the situation.

But he refused to comment on how the purchase of the Lloyds branches might be paid for. Using debt could prove controversial. Mr Marks insists Co-op remains "well within our lending covenants" and is proud of the fact it was able to secure £2bn to fund the acquisition of Somerfield, the grocer, and refinance the group in the middle of 2008 with the financial crisis in full swing. But with £1.4bn of debt on its books, having to take more on might concern the FSA.

The EU deadline to get this done is the end of 2013. Beating it could prove sticky. Royal Bank of Scotland's more conventional sale of just over 300 branches to a more conventional bank (Santander) is a year behind schedule.

Analysts are beginning to bet on that flotation. Nic Clarke, at Charles Stanley, said: "I think the FSA is worried not only about the depth of management experience at the Co-op but also whether the Co-op will have the systems to cope with the transfer and running of the additional branches and customers. I don't think it is a big negative for Lloyds as it has other options (IPO etc)."

Meanwhile, NBNK, the Aim-listed vehicle created to run a new simple bank by former Lloyds chairman Lord Levene, is watching closely. It has a board in place, and equity. But Lloyds made Co-op the preferred bidder claiming it posed less "execution risk" as an established operator. NBNK could surely match its price. Its problem might be Lloyds' pride.

Co-op blames economy and computers for dip

The chief executive of the Co-operative Group insisted its food business has turned a corner after its profits tumbled last year.

Alongside unveiling its full-year results, Peter Marks said its grocery operation had built up "around two weeks" of fuel stocks on fears over the tanker-driver's strike. He blamed "arguably the worst economic downturn in living memory" and an updating of its IT systems for a 20 per cent fall in grocery operating profits to £309.4m for the year to 31 December. The changes to supply chain systems led to lower product availability in its food shops in the first half.

Mr Marks described 2011 as a "challenging" one for the UK's fifth biggest grocer, which has 2,801 shops, following its acquisition of Somerfield's 600 shops in 2009.

Mr Marks said: "It is the first time in my long career that I have seen food volumes fall – people are having to spend less on food."

Its grocery unit suffered a 2.1 per cent fall in like-for-like sales over the year, reflecting a 3.6 per cent fall in the first half and a 0.4 per cent dip over the final six months.

Its full-year sales were lower than Sainsbury's, Morrisons, Asda and even Tesco, which has suffered a fall in UK underlying sales recently. But Mr Marks said it had been a "game of two halves", citing "a massive... and continued improvement" after it addressed its availability issues in the first half.

Overall, the Co-operative Group posted a fall of 5.8 per cent to £373m in pre-tax profits, on revenues up 1 per cent to £13.3bn.

While its banking division's profits slipped by 0.5 per cent to £200.9m, the star performer was its portfolio of specialist businesses. This division's profits jumped by 10.4 per cent to £99.4m, driven by strong results at its funeral care and legal services operations.

The Co-op reduced its dividend per point earned by members to 1.75p from 2p.

James Thompson