Why does Co-op Bank need rescuing?
The Co-operative Group merged its banking arm with Britannia Building Society in 2009 and was lumbered with a large number of poor-quality property loans that Britannia had made.Co-op Bank had also made some poor-quality property loans of its own.
Concerns grew that these would leave it with a hole in its balance sheet, potentially requiring a bail-out from the government, which would mean losses for bondholders. This led Moody's, the ratings agency, to downgrade Co-op Bank to junk bond' status in May.
The Bank of England's Prudential Regulation Authority (PRA) then insisted that Co-op Bank should boost its capital by a £1.5bn top-up, of which £1bn had to be in place by the end of this year and a further £500m in 2014.
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What was the original rescue plan?
The Co-op initially responded by announcing a plan under which it would contribute £1bn, including proceeds from selling the group's insurance business. However, Co-op Bank bondholders would have to cough up the rest by having around £1.3bn of existing bonds converted into a mix of new bonds and shares.
Bonds being debt owed by the bank can't be used to offset losses on bad loans, whereas shares count towards the bank's capital. The Co-op Bank would then be listed on London Stock Exchange, but the Co-op would retain a controlling interest.
However, this deal was opposed both by US hedge funds who owned a large chunk of Co-op Bank bonds and by small private investors in the bonds.
Hedge funds argued that the Co-op was being left with too large a stake in the bank given the circumstances, while private investors who had bought bonds for guaranteed income were opposed to swapping them for the less certain returns offered by shares.
What's happened now?
The Co-op's chief executive Euan Sutherland initially insisted there was "no Plan B" and the only alternative to the initial offer was that the Co-op Bank would be seized by the Bank of England under its powers to take over failing banks.
But after the hedge funds increased their holdings to more than 40% of the outstanding bonds, the Co-op was forced to negotiate. This week it announced a revised plan that will be more favourable for bondholders and less attractive for itself.
What's the new deal?
Institutional bondholders including the hedge funds will be given more shares in compensation for their bonds. The main result of this is that the Co-op will only own 30% of the bank when it lists on the stock market, instead of the 70% stake that it originally planned.
Private investors are likely to receive new bonds rather than having part of their holding forceably converted into shares. However, full details of the restructuring have yet to be announced, so investors don't yet know exactly what they will receive.
Trading in the existing bonds listed on the London Stock Exchange was suspended due to the high level of uncertainty and is expected to resume when the Co-op publishes detailed proposals.
Will private investors be better off?
The exact number of retail bondholders is unclear, but there are estimated to be around 5,000-15,000, controlling around 5% of outstanding bonds. That means they have little direct influence over what they're offered.
However, forcing small investors to accept a bad deal can be very controversial, as we saw when Bank of Ireland was accused of doing so during its recapitalisation. With that in mind, retail bondholders are likely to be offered a relatively favourable deal certainly better than originally proposed under the June plan.
But in the circumstances, they can't expect everything will go back to how it was they are still likely to receive less income than they anticipated when first buying the bonds.
Will Co-op Bank be an ethical bank going forward?
Co-op Bank claims to have a tradition of being an ethical bank and maintains that that will continue, with these principles being embedded in its constitution. However, as a listed, for-profit company, it will have obligations towards its shareholders and these may come into conflict with some ethical objectives.
The Co-op will not have absolute control and two of its biggest shareholders will be large US hedge funds, so potentially there could be some significant shareholder disputes over this.
That said, there is probably little commercial sense in abandoning the one thing that differentiates it from other banks, so some form of ethical approach will probably continue.
Will this drive away Co-op Bank's customers?
Agreeing a final deal to shore up Co-op Bank's finances should make it appear safer to savers, although in practice the Bank of England's bankstop mean there was never a risk in continuing to bank there.
The saga may prompt some customers to switch especially those with concerns over its ethical future but British consumers are notoriously reluctant to switch banks, so a mass exodus seems unlikely.
Does Co-op Bank offer a better service?
Aside from its professed ethical stance, it's not easy to distinguish Co-op Bank from its rivals. The online arm, Smile, has won several awards over the years for customer service, while the main bank sometimes runs special deals for new current-account customers.
But the bank has still been fined and forced to pay hundreds of millions of pounds in compensation for its part in the Payment Protection Insurance (PPI) mis-selling scandal.
Ed has been a private investor since the mid-90s and has worked as a financial journalist since 2000. He's been employed by several investment websites including Citywire, breakingviews and The Motley Fool, where he was UK editor.
Ed mainly invests in technology shares, pharmaceuticals and smaller companies. He's also a big fan of investment trusts.
Away from work, Ed is a keen theatre goer and loves all things Canadian.
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