Lloyds 'knew of Co-op deal doubts'

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File photo dated 07/08/13 of a Co-operative Bank branch sign as the bank has launched a new fight to win back customers and re-build its ethical reputation with a ?125 current account switching offer which includes a donation to charity. PRESS ASSOCIATION Photo. Issue date: Tuesday February 4, 2014. Customers who switch their current account to the Co-op will get ?100 and they will also be able to donate a further ?25 to one of seven charities, including Action Aid, Oxfam, Water Aid and Amnesty International. See PA story MONEY Coop. Photo credit should read: John Stillwell/PA Wire

Lloyds Banking Group was told about regulators' concerns over an abortive deal to sell more than 600 bank branches to the Co-op months before the transaction was agreed, according to evidence put before MPs today.

The concerns over the so-called Project Verde transaction were set out in a letter in December 2011 from Andrew Bailey of the Financial Services Authority to now-disgraced Paul Flowers, then chairman of the Co-operative Bank.

It spelled out doubts about whether it could "transform itself successfully and sustainably into an organisation on the scale that would result from acquiring the Verde assets".

The letter, published by the Treasury Select Committee today, said: "I am aware that you, with our agreement, have already communicated elements of our concerns to Lloyds Banking Group ahead of their decisions on a preferred bidder.

"To avoid any possibility of ambiguity I would be grateful if you could also provide them with a copy of this letter and include us in the circulation."

Mr Bailey's letter detailed a series of concerns that would need to be overcome before regulatory approval could be granted to the deal, including the need for suitable plans for the integration and senior management team.

It also referred to the need for "a feasible and sustainable capital plan".

Lloyds announced a £750 million agreement to sell 632 branches to the Co-op in July 2012 but the deal collapsed the following year after a huge shortfall in the mutual's capital level was discovered.

MPs on the Treasury select committee are investigating the deal and the subsequent collapse of the Co-operative Bank, which had to be rescued by bondholders including US hedge funds after a £1.5 billion black hole was found in its finances.

Mr Bailey, who is now deputy governor of the Bank of England and head of the Prudential Regulation Authority, told the committee the prime reason for the collapse had been the Co-op's earlier merger with the Britannia building society.

MPs were told that the Britannia had moved away from its traditional mortgages market and was pursuing "racier" lending, and would have collapsed, dragging down much of the rest of the mutual
sector, without the tie-up with the Co-op.

Mr Bailey also pointed to the impact on the Co-op of a £598 million write-off on an IT transformation programme, expressing incredulity at the amount that was "hugely larger than anybody could have expected".

The committee has previously heard claims from the head of a rival bid that state-backed Lloyds was "swayed by political considerations" when it chose the Co-op as its preferred candidate to take over hundreds of branches.

Lord Levene, former chairman of NBNK Investments, said he had handed Lloyds chairman Sir Win Bischoff a paper setting out "key risks" to the Co-op.

But in a letter to the committee, Sir Win said there had been no record of the document Lord Levene said he had handed over.

He added that the document itself contained no reference to the capital shortfall facing the Co-op which ultimately scuppered the bid, which was not known about in the markets at the time.

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