Lloyds Banking "Stitched Up" As Co-op Buys Bargain Branches

LONDON -- Shareholders in Lloyds Banking (LSE: LLOY.L  ) , the company that was formed in 2009 when Lloyds TSB ruined itself by buying HBOS, were kicked in the teeth last week after the Co-operative Bank bought 632 of its branches in a deal worth up to 750 million pounds.

In a stroke, the Co-operative Bank has dramatically expanded its existing branch network, thus increasing its economies of scale, and it has done so at a bargain price. Lloyds, on the other hand, has been royally stitched up as it was forced to sell to the authorities' preferred bidder in spite of there being more lucrative offers on the table.

Three negatives for Lloyds
Lloyds was forced by the European Union to sell these Project Verde branches because the EU felt that the bank's market share was too large. Oddly enough, the EU was happy for the original deal to buy HBOS to go ahead when it could have easily vetoed it for the same reason.

Lloyds has also been forced to accept a much lower price than was offered by other bidders and it has had to guarantee the 350 million pounds of debt that the Co-operative Bank is issuing to pay for the first installment.

So Lloyds is effectively lending money to the Co-operative Bank, which it will then use to buy the Project Verde branches. That isn't exactly what you'd call a good deal.

People will come
The Co-operative Bank's profile has risen strongly during the last few months as many people have moved their accounts from those larger rivals embroiled in yet another wave of scandals.

A good example prompting people to shift to the Co-operative Bank was the computer problems that recently hit Royal Bank of Scotland (LSE: RBS.L  ) , where NatWest, RBS, and Ulster Bank customers were unable to access their money for a couple of weeks. Applications for accounts with the Co-operative Bank have risen by about a quarter since this news hit the wires.

To say the banking industry has a public-relations problem is a mild understatement. The Co-operative, helped by its ethical image and not having to be bailed out by the government in 2008-09, is well-placed to capitalize upon its competitors' misfortunes.

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Investing in the Co-operative
If you were thinking of buying shares in the Co-operative Bank, you're out of luck. That's because it's owned by the Co-operative Group, a mutual organization that is in turn owned by its 6 million or so members, which include depositors at the Britannia Building Society and people who regularly shop at 'Co-op' shops.

The Co-op is best known for selling groceries, funerals, and insurance but in the last few decades its other financial services interests have increased quite dramatically.

The Co-operative Bank should be able to use its newly acquired branches as a springboard to turn itself into a major player in the British banking market, possible even making inroads into business banking, which has been poorly served in recent years.

Things get worse for the other banks
Three weeks ago I decided that bank shares would no longer be on my list of acceptable places to invest new money.

The final straw was the revelation that Barclays (LSE: BARC.L  ) had been manipulating the London Interbank Offered Rate (LIBOR), even though this appears to have been done with the tacit approval of the Bank of England.

Since then, the banking news has become worse, with HSBC Holdings (LSE: HSBA.L  ) having admitted its role in laundering money for drug cartels, terrorists, and rogue states.

With the modern banking industry seemingly having gone out of its way to actively recruit sociopaths, Barclays and HSBC won't be the only ones to have broken the law.

It used to be the case that lawyers, traffic wardens, and estate agents were the most despised of professions. But nowadays the investment bankers are giving them a good run for their money.

Not as ethical as you might think
However, the Co-operative isn't quite as squeaky clean as its ethical image suggests. For example, many of its own funds own shares in companies that contravene its ethical investment policy.

They're not alone in doing this because many other ethical fund managers are happy to invest in companies they say are unethical. The Co-operative has argued on many occasions that it does so in order to get these companies to change their policies and that it is easier to do this as a shareholder.

For example, here is the most recent summary for the CIS Income With Growth Unit Trust.

Among the unit trust's 10 largest holdings are British American Tobacco, Royal Dutch Shell, which has interests in the Canadian oil sands, the exploitation of which is something the Co-operative intensely dislikes, and HSBC. Does the Co-op seriously think that it can persuade BAT to get out of the tobacco business?

That said, it's isn't too hard to argue that any company in the FTSE100 index is unethical if you look closely enough and have very strict criteria.

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Tony owns shares in Lloyds Banking Group but he doesn't own shares in any of the other companies mentioned in this article. Unlike many ethical investors he won't invest in tobacco companies. The Motley Fool has a disclosure policy.
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