LONDON Britain's Co-operative Group CWSGR.UL will force bondholders to help plug a 1.5 billion pound ($2.4 billion) capital hole, avoiding a repeat of unpopular taxpayer-funded bailouts made during the financial crisis.
Using a "bail-in" rescue model, bondholders will have to swap their debt for new bonds and equity in the bank, which will be listed on the London Stock Exchange.
The Co-op Group, Britain's biggest customer-owned business, will also provide financial support for its banking unit CPBB_p.L, the Co-op said on Monday.
Europe is pushing ahead with plans to implement a "bail-in" regime that would force bondholders and depositors, rather than taxpayers, to bear the cost of failed banks and the Co-op's approach could become a blueprint for future rescues.
"We have put in place a detailed and comprehensive solution to meet the current and longer-term capital requirements of the bank. In doing so we have agreed a plan to ensure its future," said Co-op Group Chief Executive Euan Sutherland.
Co-op Group, which runs supermarkets, pharmacies and funeral services, will retain a majority stake in the Co-op Bank, which has 4.7 million customers. Sources said bondholders are likely to end up with at least a quarter of the bank's shares.
Sutherland said he was confident a "good proportion" of bondholders would support the move, given that coupons on their debt will be canceled making them effectively worthless. If they refused, the bank would face the threat of nationalization.
The bank's future has been in question since ratings agency Moody's cut its credit rating to junk status and warned it might need taxpayer support - something the bank denied.
Its capital position had come under scrutiny since it pulled out of a deal to buy hundreds of bank branches from Lloyds Banking Group (LLOY.L) in April.
Analysts have blamed Co-op Bank's problems on its takeover of the Britannia Building Society in 2009.
Industry sources say Britannia, which had lent aggressively on commercial property, was likely to have required a taxpayer-bailout had it not been bought by the Co-op.
Co-op said it would hive off toxic assets worth about 14.5 billion pounds into a 'bad bank,' most of which are from Britannia, as part of a restructuring.
Sutherland has overhauled Co-op's management since joining from retailer Kingfisher in May.
He declined to comment on whether former chief executive Peter Marks, who led the Britannia acquisition, or other former executives should have past pay rewards clawed back. Marks received a 103,000 pound long-term performance bonus in 2012 and a 490,000 bonus for 2011.
Co-op said the bail-in plan will generate 1 billion pounds of new capital this year and 500 million pounds in 2014.
This includes a debt-for-equity exchange with the bank's subordinated bondholders.
Co-op's debt holders all have 'subordinated', or 'junior' bonds that pay higher interest than 'senior' debt, but carry a higher risk. These kinds of bonds suffered heavy losses in bank rescues in Ireland and Spain.
The bank's subordinated bonds took another hit on Monday following significant declines in recent weeks. <ID:L5N0ET1YF>
The plan applies to about 1.3 billion pound of outstanding Co-op Bank bonds. Co-op said about 7,000 private retail investors will be affected, the majority of whom have invested around 1,000 pounds.
Britain's financial regulator said it would "hold the Co-operative to the delivery of its plans" which incorporate the previously announced sales of its life insurance business for 220 million pounds and a planned sale of its general insurance business. One banking source said there were around 10 to 15 parties interested in the general insurance business.
The Prudential Regulation Authority has said banks must raise 25 billion pounds of extra capital by the end of the year to absorb any future losses on loans.
Taxpayer-funded rescues during the 2008-09 crisis, particularly of RBS (RBS.L) and Lloyds (RBS.L), were highly unpopular with Britons and authorities have been trying to avoid any more.
Co-op said its core tier 1 ratio, a measure of the bank's financial strength, was expected to be above 9 percent by the end of 2013 and to increase in the following years. The PRA wants banks to hold at least 7 percent.
Co-op will provide details of the plans via a prospectus after its results in August and before the planned stock market listing of shares in October.
($1 = 0.6379 British pounds)
(Additional reporting by Laura Noonan; Editing by David Stamp and Erica Billingham)