It is one of three inquiries into the bank’s downfall – another is being led
by Sir Christopher Kelly for the Co-op Group, and an internal probe is being
carried out by the Prudential Regulation Authority (PRA) – and, to date, it
has been the most high profile.

Although there has been much disagreement over the causes of the collapse –
most notably between former bank chief executive Neville Richardson and PRA
head Andrew Bailey over whether Britannia’s corporate loan book was really
to blame – each has appeared to agree it is a bank worth rescuing.

On Monday morning, at 7am, the full detail of what that rescue will entail
will be disclosed for the first time.

It will herald the beginning of the end for the bank’s 141-year history as a
mutual entity, and a very different future as equity control passes to a
series of largely unknown vulture and hedge funds, whose primary interest is
financial return rather than mutuality.

When Euan Sutherland, the former Kingfisher chief operating officer recruited
to replace Marks at the helm of the group, confirmed the size of the
shortfall in mid-June, he set out a plan that he believed would fill that
hole. It involved raising about £1bn from the Co-op itself, while the
remaining £500m was to be provided from enforcing losses on the bank’s
bondholders. Of the £1bn, Co-op would provide a capital injection of £500m
through the issue of a new bond, with a further £500m expected to be raised
by the end of next year from the sale of two insurance businesses.

As part of the exchange offer with bondholders, the Co-op proposed that the
15,000 or so institutional and largely retail owners of the bank’s junior
debt would be offered a mixture of new bonds with a face value of half their
existing holdings, as well as shares in a newly-listed Co-op Bank.

The Co-op’s £1bn capital injection was, however, to be contingent on enough
bondholders agreeing to the terms. Of the £1.3bn of junior debt, at least
80pc of the holders by value of the bonds had to have consented to the
exchange for the deal to go ahead. Had the threshold not been met, it would
have left the Co-op Bank with a £1.5bn capital shortfall and no way to meet
it. The structure, although somewhat vague, was designed to ensure the Co-op
Group would be left owning at least 50pc of the bank, with some 20pc to 40pc
floated on the London Stock Exchange.

But within days, it was clear that reaching that 80pc threshold was not going
to be easy. Sir John Ritblat, the former British Land chairman and a Co-op
bondholder, was one of the first to put his head above the parapet, calling
the bond-for-shares suggestion “absolutely outrageous”.

By early July, Mark Taber, who had success lobbying on behalf of junior
Bristol and West bondholders affected by the Bank of Ireland’s problems, had
corralled 1,300 retail bondholders together to speak out. Writing to Bailey
at the PRA, he warned that the Co-op Bank faced nationalisation, arguing
that the PRA’s insistence on rapidly filling the black hole had caused an “unavoidable
stand-off”.

But despite the noise from the retail bondholders – who had purchased the
bonds due to their substantial dividends of up to 13pc – it was the
institutional holders who had the upper hand.

By mid-July, it emerged that Moelis, the Wall Street boutique advisory firm,
had been drafted in by an unspecified group of hedge funds to advise them in
relation to the Co-op situation.

It later emerged that the leading lights of the group – known as the LT2
Group, because they own what are known as lower tier two bonds – were
Aurelius Capital Management and Silver Point Capital. The others – believed
to total seven – have not been made public, but The Sunday Telegraph
can disclose for the first time that their number includes Monarch
Alternative Capital. Together, the seven account for about 40pc of the
bank’s junior debt. A stand-off between Sutherland’s advisers at UBS and the
bondholders ensued over the summer, and by early September, Moelis felt it
was time to be vocal. Managing director Caroline Silver publicly branded the
mutual “irresponsible” for not engaging with her clients. That
seemed to work.

By mid-September, intense negotiations began between UBS and Moelis as to how
some form of agreement could be carved out, but only after boutique advisers
Greenhill were called in to advise an independent committee of the bank’s
directors, chaired by bank chairman Richard Pym, to ensure the bank’s
interests were being served as well as the Group’s. UBS, led by financial
institution specialist David Soanes, and Greenhill, led by co-founder James
Lupton, went into those talks safe in the knowledge that Aurelius and Silver
Point have past experience of playing hard ball. Aurelius, led by Mark
Brodsky, is involved in a long-running court battle to extract $1.3bn from
Argentina in relation to its 2002 default. Silver Point, meanwhile, has made
money investing in the spoils of several stricken financial institutions,
including Lehman Brothers and MF Global. Monarch profited handsomely from
investing in European sovereign debt.

Co-op sources indicate Sutherland knew that this form of tough, drawn-out
negotiation was always the most likely outcome, suggesting that the plan set
out in June was merely a “Plan A”. Partial details of the
negotiations emerged a fortnight ago after an agreement in principle was
reached with the vulture funds. The Co-op Group confirmed that it would end
up owning 30pc of the bank, but remain the largest single shareholder.
Sutherland released a short video to customers and staff to try to reassure
them the mutual would still be in control, and that its ethics, based on the
Rochdale Pioneers’ values of co-operation, would remain intact.

But with vulture funds used to aggressive tactics, will that still be so?
Sources close to the negotiations said that despite the “full-on”
stance adopted by the LT2 Group, the funds are unlikely to be “throwing
their weight around” when it comes to the bank’s day-to-day running.

“In terms of the way it will be run, the bank will still be led by the
Co-op and its decision-making. Our guys don’t want to be active managers –
they want it to be well capitalised.” The sources also pointed to the
fact that, despite the formation of the LT2 Group, each fund has its own
objectives, and once the deal is finalised, will revert to acting as
individuals.

It is unclear how many of the seven funds will have notifiable positions of
more than 3pc, which will force them to be made public in the bank’s listing
prospectus. However, no one fund will own more than 10pc of the shares.

What is also unclear is the fate of thousands of retail investors, and what
proportion of shares they will receive.

In addition to the details of how the equity will break down – The
Sunday Telegraph reveals today that the Co-op Group will now inject £400m,
rather than the originally assumed £1bn – the mutual will provide
bondholders with the timetable for votes and listing. Even with agreement in
principle, a vote will still need to be held, with 80pc of all tiers needing
to agree in order to avoid a public bail-out.

Sources indicated that the timetable will ensure the vote, and therefore the
recapitalisation, will be completed by the end of this year – but the stock
market listing of Co-op Bank is not likely until early 2014.
Institutional investors are unlikely to flood to the stock given the likely
illiquidity from the outset, and concerns about the bank’s future viability.

Although the £1.5bn capital hole will have been plugged, real concerns remain
about the bank’s independent future. “It will start off with an unusual
shareholder register,” argues Ian Gordon, Investec’s banking analyst. “I
think it would not be utterly dissimilar to where Lloyds and RBS were in
2008, if it makes it to listing.” Gordon believes that as a result of
its weaker profitability and its lack of scale e_SEnD the Co-op has just 300
or so branches e_SEnD it has several “commercial disadvantages”
which could make the quoted entity rather a lame duck. “Even if I put
on my rose- tinted glasses, and say UK retail returns are going to be
sustainably high, the returns available on the Co-op will be sub-optimal,
which does lead you back to a consolidation debate – either looking for more
opportunities, or, more likely, the Co-op becoming a target,” he
continues.

If the latter is true, although the eventual take-out price could replenish
some of the capital the Group has spent, Sutherland may be left thinking:
has it all been worth it?