June 20 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has downgraded The Co-operative Bank PLC’s (CB) Long-term Issuer Default Rating (IDR) to ‘BB-’ from ‘BBB-', Short-term IDR to ‘B’ from ‘F3’ and Viability Rating to ‘bb-’ from ‘bbb-'. The Long-term IDR and VR have been placed on Rating Watch Evolving (RWE). The bank’s Support Rating has been downgraded to ‘5’ from ‘3‘and its Support Rating Floor revised to ‘No Floor’ (‘NF’) from ‘BB+'.
Fitch has also downgraded the bank’s long-term senior debt to ‘BB-’ from ‘BBB-’ and placed it on RWE, and downgraded its subordinated debt ratings to ‘CC’ from ‘BB+’ (Lower Tier 2) and ‘BB-’ (Upper Tier 2) and placed them on RWE. A full list of rating actions is at the end of this rating action commentary. The rating impact, if any, from the rating actions on the bank’s covered bonds will be detailed in a separate comment.
The downgrade of CB’s IDRs and VR reflects Fitch’s concerns that the bank’s capital requirements are greater than originally anticipated. CB has indicated that it requires GBP1.5bn of additional capital. This is sizeable in relation to the bank’s reported equity. CB’s recapitalisation plan includes an injection of capital from its parent and a liability management exercise. Full details of the liability management exercise have not yet been disclosed but Fitch’s understanding is that an exchange offer to junior subordinated bondholders will result in GBP1bn of additional common equity Tier 1 (CET1) capital by end-2013. A further GBP500m of CET1 capital will be injected by the Co-operative Group in 2014, conditional on the exchange offer becoming effective.
The Prudential Regulation Authority has stated that the need for higher capital reflects expected future losses and an assessment of the future cost of conduct redress. CB has indicated that the targeted fully-loaded Basel III CET1 ratio is at least 9% at end-2013 and to increase in the following years. The downgrade of the IDRs and VR also considers Fitch’s view that the bank’s franchise is likely to have been damaged given negative sentiment surrounding the bank since April 2013. There are signs that confidence among some depositors and investors may be weakening and execution risks associated with new management’s objective of addressing the various operational challenges within the bank present a considerable challenge.
The ratings have been placed on RWE, indicating on the downside the presence of execution risks in the recapitalisation plan but also upside ratings potential if the plan is achieved. Various corporate and investor agreements need to be put in place before the plan can proceed. Furthermore, the exact details of the plan have not yet been announced.
Depending on the outcome of the liability management exercise and the amount of fresh equity received by the bank, as well as impact of the lower debt servicing costs, the bank’s IDRs, VRs and senior debt may be upgraded. If the plan is implemented as outlined, Fitch considers that the outcome should be positive for senior debt holders. The RWE would result in an upgrade if CB can raise the full amount of capital targeted and stabilise its franchise combined with new management setting down a sustainable, credible longer-term strategic plan. CB’s IDRs, VRs and senior debt may be downgraded further if regulators require additional actions, if the market uptake of the planned debt for equity exchange offer is lower than expected or if the plan to recapitalise the bank to an acceptable level within an acceptable time frame fails.
KEY RATING DRIVERS - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
CB’s Upper and Lower Tier 2 Instruments (subordinated debt) have been downgraded to ‘CC’/RWE from ‘BB+’ and ‘BB-', respectively. The downgrade reflects the plan to redeem these bonds at rates below par value and to exchange them into a combination of bank shares and Cooperative Group debt. As a result, these bondholders are expected to suffer losses. Fitch considers that sufficient pressure exists for most junior debt holders to accept the offer and thus avoid more adverse consequences in the event that they do not take up the offer. Given the outline terms of the offer, Fitch considers this constitutes a distressed debt exchange on those securities under its criteria.
RATING SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings of the Upper and Lower Tier 2 Instruments could be downgraded further or upgraded by one notch once additional details of the exchange are announced. At that time, Fitch will be in a position to undertake a meaningful assessment of recoverability.
KEY RATING DRIVERS - SUPPORT RATING AND SUPPORT RATING FLOOR
The downgrade of the bank’s Support Rating and revision of the Support Rating Floor is consistent with Fitch’s view of a clear political intention to ultimately reduce implicit support for banks in the UK. In addition, Fitch believes CB’s systemic importance is reducing given the scaling back of the bank’s scope and ambition. Fitch considers CB to be more of a niche player, positioned as an alternative to the UK’s major banks.
The rating actions are as follows:
Long-term IDR downgraded to ‘BB-’ from ‘BBB-'; placed on RWE
Short-term IDR downgraded to ‘B’ from ‘F3’
Viability Rating: downgraded to ‘bb-’ from ‘bbb-'; placed on RWE
Support Rating: downgraded to ‘5’ from ‘3’
Support Rating Floor: revised to ‘NF’ from ‘BB+’
Senior unsecured notes Long-term rating: downgraded to ‘BB-’ from ‘BBB-'; placed on RWE
Senior unsecured notes Short-term rating: downgraded to ‘B’ from ‘F3’
Lower Tier 2 subordinated notes: downgraded to ‘CC’ from ‘BB+'; placed on RWE
Upper Tier 2 subordinated notes: downgraded to ‘CC’ from ‘BB-'; placed on RWE