Co-op Bank Learns Debt Can Cost Your Soul

NEW YORK (TheStreet) -- While on a recent visit to England I frequently passed branches of the Co-operative Bank in ragged city centers. I got a feeling of nervousness as I walked by these places, and upon my return found out why.

England's Co-operative Bank was founded in 1872 by a membership co-operative called Co-operative Group Ltd. in Manchester, with seven million members. It operates under a 20-year-old set of ethical principles and it's said to be losing its soul over a mountain of debt.

The bank saw the financial crisis as an opportunity to grow. In 2009 it agreed to acquire the Britannia Business Society; then, in 2011, it agreed to take some 632 Lloyds Bank branches. The lefty bank seemed to be on its way into the big leagues, the Big Four of British banking.

But Britannia had a ton of bad loans, some 1.7 billion British pounds worth (over $2.7 billion). These were mainly loans on commercial property. The result, for Co-operative Bank, was a 1.5 billion-pound capital shortfall, announced this year.

Enter two hedge funds, Silver Point Capital of Greenwich, Conn., and Aurelius Capital Management of New York, stage right. They bought 43% of the bank's Lower Tier 2 debt, at a price The Telegraph newspaper estimated at 300 million pounds ($480 million).

The hedge fund then organized the remaining bondholders, who held a total of 940 million pounds ($1.4 billion) of debt, and blocked a deal that would have allowed the Co-op to retain 75% of it.

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