The announcement by Lloyds Banking Group at the end of last year that LBG were in exclusive talks with Co-operative Financial Services (CFS) for the sale of the bundle of 632 branches and brands that is referred to as 'Verde' raised the question of whether this is good for UK banking and consumers. Clearly Gary Hoffman, Chief Executive of NBNK and former CEO of both Northern Rock and Barclaycard, didn't think so. “Lloyds has made the wrong decision. There is no question that the execution risk with the Co-op is much more significant, and over a very short period of time this will be proven". It could be argued that this is just sour grapes, given that Gary Hoffman's NBNK (a vehicle with significant institutional backing set up to buy one or more banks) was also bidding for Verde and didn't make the cut, however Gary Hoffman is one of the most experienced retail bankers in the UK and led Barclaycard to be one of the most successful credit cards businesses in the world, so he does know what he is talking about. With the expiry of the exclusivity agreement and the invitation of NBNK back into discussions, Gary Hoffman may yet prove to be right.
Merging Verde with the Co-operative ticks all the boxes for the ICB (Independent Commission on Banking) in that it will create a competitor with around 7% market share in current accounts and is building on an established player, both recommedations made in the ICB report. However that still doesn't answer the question of whether it will really become an alternative to the Big 5 banks.
Unlike Virgin Money (see http://www.itsafinancialworld.net/2011/12/is-northern-rock-decision-good-for.html ), the existing Co-operative Financial Services is largely undifferentiated from the Big 5 banks. Whilst it makes a lot of its ethical stance it was still caught up in the Payment Protection Insurance (PPI) misselling scandal, writing off £90m, which, in fairness, is a lot less than the major high street banks, but is still significant. CFS is hardly the most customer centric organisation. Until very recently the payment terms on its many charity-branded cards were so tight that unless you opened the credit card statement on the day you received it and made payment within a couple of days it was impossible to avoid charges for late payment. Hardly a customer friendly or ethical way to operate. This has now been addressed.
If you look at the high street presence of the combined CFS and Britannia branches (CFS acquired Britannia Building Society in August 2009), the offering and customer experience is dated and certainly no better than the major high street banks. With the addition of the Verde branches CFS will have around 1000 branches.
In the digital space CFS has in the past won many awards for its direct bank, Smile, but the lack of investment in this operation has meant that it has not kept up with what customers are looking for from a digitally-enabled bank and is not sufficiently different to attract customers away from more traditional players. The same could be said of Intelligent Finance, the brainchild of Jim Spowart, which CFS acquires as part of the Lloyds Banking Group Verde bundle.
For CFS to really become the challenger that the ICB is so keen for it to be then CFS needs to significantly invest in fundamentally changing the branding and customer proposition that the combination of Co-Operative Financial Services, Britannia, TSB, Intelligent Finance and Cheltenham & Gloucester brings. With such a diverse group of brands with different values and attracting different segments it will not be clear to customers what it stands for and why they should engage with it. CFS will need to simplify, move to a single brand with a strong customer proposition which is more than just being an alternative to the other banks. It needs to design a customer-centric bank where branches are but one part of the overall way that customers can engage, digitially enabled and fit for 21st Century Customers. That requires a lot of investment, above and beyond the capital required to acquire Verde, the hundreds of millions required to integrate Verde whilst still keeping the lights on, and ensuring the Verde customers don't defect before they are transferred. With no shareholders to turn to and the wholesales markets still not working efficiently finding the funding at an affordable price is an enormous challenge for CFS.
Over the following few months as the negotiations continued with Lloyds Banking Group, CFS got to understand more about what it is undertaking, but still has to establish whether it can raise the funding and only then will it become clear whether CFS is going to be able to close the deal. If they do, but don't invest in the transformation, then what the UK consumer will get is just another high street bank and the hopes of a challenger that the ICB had will be just that, hopes. If CFS embraces the challenge then the re-born CFS could be a really exciting, ethical, customer-focussed challenger and the Big 5, as they wrestle with implementing ring-fencing, should be seriously worried.
The concerns don't only lie with the Co-op. For Lloyds Banking Group having just come off the back of spending nearly £4bn on the integration of Lloyds TSB and HBoS, the question of just how much it will cost to separate what constitutes Verde from the mother ship is concerning. Anything over £1bn would be a real challenge for LBG given everything else they have on their agenda. The Co-op target systems are not ideal, particularly as they still haven't completed the integration of Britannia, so increasingly the deal may be looking less attractive to LBG.
As is increasingly looking likely they reverse their existing banks into Verde sticking with the LBG systems, they will end up with superior systems than they have today. Unlike RBSG, the Lloyds Banking Group systems, based on the original TSB systems are real-time and not significantly batch-based. This gives them significant advantages in dealing with customers demanding real-time banking. However CFS will end up with the suboptimal LBG systems as Lloyds is spending significantly on 'simplifying' their systems, but only for the LBG version not the ones going to Verde. This means that Verde will be disadvantaged to LBG, so may not be as competitive.
The FSA (Financial Services Authority) is now demanding that, assuming the Verde deal goes through, given that Financial Services will be around 40% of the Co-op's business that the governance appropriate to a bank is put in place. This would mean having a board made up of executive and non-executive directors that would need to be FSA approved. Given the time it is currently taking for the FSA to approve executives is measured in months not weeks and that the Co-op doesn't currently have a CEO for its Financial Services business (though interestingly Gary Hoffman has allegedly had conversations about filling this role) this could be a deal breaker. However Lloyds Banking Group could sweeten the deal by providing a team of seasoned managers to run the business. Whilst this might put the FSA's concerns about leadership experience to bed, how radical will this new competitor be if it is being run by the same people who ran Lloyds Banking Group?
On top of that the Co-op as a co-operative is currently governed by its members. The FSA's requirements fundamentally challenge the way that the Co-op wants to run its business.
The possibility of CFS walking away from Verde is looking increasingly unlikely.
There is still the chance that an IPO is the more attractive solution for LBG given how cleaner and simpler that will be for the bank, however with bank asset prices at an all time low at what price would the IPO get away?
It looks like CFS may have got their deal, but will they suffer from buyers' remorse?