It’s the epitome of a difficult sell. The UK’s Co-operative Bank put itself on the market on Monday, citing progress on its turnaround plan. But this is a lender in a ferociously competitive market, likely to fall short of capital requirements, and whose erstwhile ethical brand was tarnished by media revelations that its former chairman – then a Methodist minister – binged on rent boys and crystal meth. Prospective buyers will need fortitude – and a low enough price tag.
In theory, the lender is worth a bit more than 700 million pounds ($877 million), based on the member-owned Co-operative Group conglomerate’s latest valuation of its 20 percent stake. However, that would be excessive. The Co-operative Bank’s own half-year numbers suggested that the underlying business might make 34 million pounds in operating profit for 2016. Assume a tax rate of about 25 percent and a zero fair-value adjustment of the Co-op Bank’s debt. Using a historic price-to-earnings multiple of 9 times – the average of four listed UK challenger bank peers – would mean its equity might be worth around 230 million pounds. A backward-looking return on equity calculation which uses the same earnings input produces a similar price tag.
There are sound reasons for a further discount. The Bank of England reckons Co-op Bank’s capital position should be measured in months not years. Lenders almost never shrink to a position of greatness, as the cautionary tale of Royal Bank of Scotland has shown. And the conditions that make it hard for Co-op to build capital through earnings – low interest rates, high restructuring costs, and charges for previously failing customers – may well persist.
The fragmented nature of UK retail banking could prompt another so-called challenger bank to overlook these worries and snap up Co-op Bank’s 28 billion pounds of assets. Put nine of them together and their combined asset base would fall short of that of Nationwide, the smallest of the top half a dozen, with its 225 billion pound balance sheet. A leap of faith may be what it takes to propel one of the minnows closer to the big league.
Request a free trial of Breakingviews here.