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Rating Action:

Moody's affirms Co-operative Bank's ratings following proposed liability-management exercise

12 Nov 2013

London, 12 November 2013 -- Moody's Investors Service has today affirmed the Co-operative Bank plc's Caa1 senior unsecured debt and deposit ratings, and changed the outlook on the rating to negative from developing. The bank's standalone bank financial strength rating (BFSR) was also affirmed at E, which is equivalent to a baseline credit assessment (BCA) of ca.

The standalone ratings at the E/ca level reflect Moody's view that the liability-management exercise (LME) outlined by the bank on 4 November constitutes a default under Moody's definition, given that the new set of securities offered in exchange to shareholders amount to a diminished financial obligation compared to the original. The affirmation considers the increasing likelihood that the LME will be accepted by the required minimum of bondholders of each affected bond class. Moody's notes that some uncertainty will remain until the vote of bondholders is finalised and the results are published on December 12. Absent a successful outcome of the LME, it is likely that the bank will face resolution and, in which case, it is highly probable that investors in securities that would otherwise have been subject to the LME exercise will face greater losses than envisaged in the exchange offer. The rating agency will reassess all ratings again once the result of the voting on the LME by investors is disclosed.

The standalone ratings at E/ca also reflect the significant challenges that the bank faces in restoring its franchise -- winding-down its significant non-core portfolio and increasing the very low efficiency and profitability of its core operations via a multi-year cost reduction and restructuring plan. The plan outlines a restructuring to last four to five years, which envisages that the Bank will cure its breach of the regulatory Individual Capital Guidance (ICG) by the end of the plan period, giving it little flexibility for any further unexpected losses. While the plan has been discussed and agreed with the Prudential Regulation Authority (PRA), the PRA does retain discretion to revisit the Bank's non-compliance with its ICG.

The outlook change to negative from developing on senior unsecured debt and deposit ratings balances the positive impact of the likely capital injection via the LME (the likely receipt of which Moody's had reflected in the bank's ratings in its previous rating action) against the heightened execution risk posed to senior unsecured bondholders by the multi-year cost reduction and restructuring plan. Moody's considers that execution risks have either increased (e.g. conduct risks) or become more visible (e.g. asset impairments, IT costs, minimal regulatory capital headroom) since the last rating action.

The negative outlook also reflects Moody's view that the likelihood is diminishing that the UK authorities will be prepared to provide further systemic support may be less likely in the future, should the proposed investments in and restructuring of the business model prove insufficient to return the Co-operative Bank to sustainable profitability.

Concurrently, Moody's affirmed the Co-operative Bank's subordinated debt and 5.5555% perpetual junior subordinated bonds at Ca and Ca (hyb) respectively, and changed the outlook to stable from negative. Bondholders of the subordinated bonds have been offered a combination of ordinary shares and new Tier 2 notes issued by the bank in exchange for their current holding. In addition, they will have the chance to to subscribe for an additional 25% of the Bank's equity for GBP125 million. Investors in the bank's 5.5555% perpetual junior subordinated bonds would receive exclusively new Tier 2 notes issued by the bank if the LME is successful. Should the LME be accepted by the required amount of bondholders and all the bonds exchanged, then Moody's expects to withdraw these ratings.

The rating of the 13% perpetual junior subordinated bonds has been affirmed at Ca (hyb), and the outlook changed to positive from negative since these bondholders have been offered subordinated notes issued by the Co-operative Group (not rated), which has a more diversified business structure than the bank. Moody's also expects to withdraw the ratings of these bonds upon successful LME, as it does not rate the Co-operative Group.

RATINGS RATIONALE

--AFFIRMATION OF STANDALONE AND LONG-TERM DEBT AND DEPOSIT RATINGS

The affirmation of the standalone ratings reflects Moody's view that the proposed exchange offer under the LME constitutes a default under Moody's definition because it requires creditors to accept a new set of securities that amounts to a diminished financial obligation compared to the original obligation, with the effect of allowing the issuer to avoid becoming insolvent. Moody's will reassess the BCA of the bank following the announcement on 12 December. If, as Moody's expects, the LME proceeds as intended, the current ratings and outlooks would likely be reaffirmed. While not a likely outcome, failure to proceed with the LME would likely entail resolution which would be negative for all bondholders.

As in the previous rating action, the three notch gap between standalone and debt rating primarily reflects the benefit senior unsecured creditors are likely to receive from the additional capital the LME will generate, supplemented with some moderate expectation of systemic support from the UK authorities. Moody's decision to limit the uplift to three notches reflects the rating agency's concerns over the damage the bank's franchise has suffered, its impaired profitability and the consequent uncertainties to bondholders.

-- CHANGE IN OUTLOOK TO NEGATIVE ON LONG-TERM DEBT AND DEPOSIT RATINGS

The negative outlook reflects the combination of (1) the challenges the bank faces in re-establishing its franchise and viability, which Moody's believes have either increased or become more visible since the last rating action; and (2) the likelihood that the UK authorities' willingness to provide systemic support to senior unsecured bondholders in the bank will diminish over time.

In Moody's view, the bank faces significant execution risk in achieving the cost savings and business restructuring planned over the coming years. The bank faces significant challenges to become a viable, profitable institution. The reduction of its non-core portfolio will likely take a long time given unfavourable market pricing, high levels of impairments and differences between the bank's assets' carrying value and their fair value, especially related to Optimum, a book of predominantly interest-only intermediary and acquired mortgage book assets (as at 30 June 2013, GBP7.3 billion). Moreover, there is also uncertainty regarding the point at which the bank will be able to generate sufficient earnings to rebuild its capital buffers, since it is expected to report losses for a number of years, and will require between GBP 400 - 500 million investment in IT infrastructure to comply with regulatory requirements and deliver its new strategy.

In consequence, the bank will remain vulnerable to further shocks, and potentially reliant on regulatory forbearance, for a sustained period of time. Even now, the breach of the Individual Capital Guidance level -- whose cure is envisaged in the Co-operative Bank's 4-5 year business plan -- indicates that the bank has very limited room to absorb unexpected losses, including conduct-remediation costs and additional impairments caused by adverse economic and market conditions. Moody's believes that the bank's ability to generate meaningful additional capital in such instances will rely heavily on both the Co-operative Group and on the new shareholders, both of whom need to be able and willing to inject new capital against an uncertain, challenging earnings perspective for the bank.

The negative outlook also reflects Moody's view that the likelihood of the UK authorities being willing to provide systemic support to the bank may decrease over time should further problems arise in the execution of the LME or of the restructuring plan. The negative outlook is consistent with that applied to the debt ratings of other major UK banks, and reflects the UK authorities' increasingly uncompromising stance on systemic support.

--CHANGE IN OUTLOOK TO STABLE ON SUBORDINATED DEBT RATINGS

The outlook change to stable reflects Moody's view that bondholders will likely accept the initial proposal given that they would potentially face higher losses if the bank is subject to a resolution, which may be the most likely alternative in case the LME fails.

Moody's notes that the Co-operative Group announced an agreement on 21 October with 48% of holders of LT2 securities and received support from representatives of retail investors in the perpetual subordinated bonds and preference shares. Although it will remain difficult to provide an accurate estimate of the bank's future share price, Moody's believes that the initial recovery for investors of lower Tier 2 bonds and 5.5555% perpetual junior subordinated bonds is in line with the Ca rating, which is reflected in the stable outlook.

--CHANGE IN OUTLOOK TO POSITIVE ON 13% PERPETUAL JUNIOR SUBORDINATED BONDS

The outlook change on the rating of the 13% perpetual junior subordinated bonds reflects Moody's expectations of a better recovery rate for the bonds issued by the Co-operative group given its diversified business structure.

WHAT COULD CHANGE THE RATING - UP

Upward pressure on the long-term debt and deposit ratings of the Co-operative Bank could develop in the medium term as we see evidence of the successful execution of (1) the LME; and (2) the full recapitalisation plan in 2014; together with (3) significant progress being made in the bank's restructuring, deleveraging and cost-saving initiatives.

WHAT COULD CHANGE THE RATING - DOWN

Negative pressure on the senior unsecured debt and deposit ratings would stem from either (1) the bank's inability to fully execute the proposed recapitalisation or insufficient progress on the cost saving and restructuring plans; or (2) a significant deterioration of its liquidity and (3) higher than expected impairments or conduct related costs.

The principal methodology used in this rating was Global Banks published in May 2013. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Carlos Suarez Duarte
Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Johannes Felix Wassenberg
MD - Banking
Financial Institutions Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's affirms Co-operative Bank's ratings following proposed liability-management exercise
No Related Data.
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