• Co-op bank must reach agreement with Lloyds within weeks
• Profits fall 5.8% to £373m
• Chief executive: 'toughest economic backdrop for 40 years'
• Co-op bank waiting for permanent boss
• Analysts think Lloyds may float branches instead
Co-operative Group warned on Thursday of "some very material regulatory issues" before it can proceed with its formal bid for 632 branches being sold by Lloyds Banking Group.
As the group announced profits had fallen 5.8% across its operations which unite banking, grocery, pharmacies and funeral care, Peter Marks, the chief executive, said the results should be "set against the toughest economic backdrop I have seen in more than 40 years in business".
The banking arm – where profits were flat at £201m – has been granted "preferred bidder status" for the Lloyds branches and was supposed to have reached "heads of agreement" with Lloyds by tomorrow under the original timetable. But, Lloyds admitted last week that an agreement was still to be reached and the bailed-out bank delayed an announcement until the second quarter of the year.
Marks said that a decision on whether to proceed would be taken in "weeks rather than months" and admitted: "I can't predict whether we'll get to the end on this."
He declined to detail precisely what the regulatory issues were, but took issue with any suggestion of "governance" concerned at the group level where board members are "ordinary" individuals, including a plasterer, a nurse and a Methodist minister.
The banking arm is being run by acting chief executive Barry Tootell, and Marks said there was a permanent appointee "waiting in the wings" who could be named if the bid were to proceed.
Marks stressed that the bank was conducting proper due diligence before making a binding offer and wanted to avoid a repeat of the humiliation suffered by Royal Bank of Scotland, which needed a taxpayer bailout after buying ABN Amro.
"What is not in question is our ability to run a bank," said Marks
If Co-op can submit an offer it would transform its existing 345-branch network and give it a 7% share of the current account market. This would make the enlarged Co-op a major competitor to the "big four" banks - Lloyds, Royal Bank of Scotland, HSBC and Barclays. Lloyds has to sell the branches by November 2013 to meet EU state aid rules and is still treating Co-op as a preferred bidder.
"Our current bid is non-binding and we would only proceed if we could reach an agreement that was in the interests of our members and other stakeholders. Any transaction would be subject to regulatory approval," the group said.
Gary Greenwood, analyst at Shore Capital, said that Lloyds might need to embark on a stock market flotation of the branches instead. "We think it is increasingly possible that this deal could fall through and that Lloyds will need to pursue a more costly IPO," said Greenwood. "In the Co-op's results statement we note comments from the Co-op group CEO, Peter Marks, that the deal is 'complex and that there can be no certainty it will reach a final agreement'. We also note that the Co-op Bank's core tier 1 ratio remains relatively weak compared to other mutuals, at 9.6% (other large mutuals are in the 12%-14% range), which is unchanged from the level at the interim stage," said Greenwood.
A fall in profits across the Co-op group forced a cut in the dividend to members to 1.75p per point from 2p a year ago. Profits before tax and payments to members were down 5.8% to £373m while operating profits were flat at £585m.
The food business, which has expanded rapidly since the acquisition of Somerfield business, was knocked by a "increasingly tough market" reporting a fall in operating profit to £309m, down £389m.
Like-for-like sales in the food sales were down 2.1%, but an improvement on the 3.6% fall in the first half of the year.
Marks cited "aggressive" promotional offers for the decline in sales.
"2011 was a time of severe challenge for the UK economy and for our millions of customers and members. Consumers have been assailed by rising costs, credit squeeze and uncertainty about the future to an extent unparalleled in recent times. Against this background, I believe that this is a creditable performance. We have delivered profitability in-line with expectations, while maintaining our financial strength and resilience," Marks said.
He stressed that the group would continue on its three-year £2bn investment programme, despite the economic backdrop.
"Our ownership model means that we can take a long-term view and we are as driven, determined and ambitious as ever to modernise our business. We will not allow the current economic downturn to knock us off the course we have set," said Marks.
"Looking ahead, I do not expect to see any significant recovery in the UK economy during 2012, with little hope of an improvement in disposable income for our customers. If anything, it is quite possible that things will get worse before they get better," said Marks.
The specialist businesses – which include funeral care and pharmacies – enjoyed the largest rise in profits to £99m from £90m.