Smaller lenders are circling Co-operative Bank looking to pick up bargains as it emerged that the stricken institution could have to raise almost £1 billion in order to bolster its finances.

Their interest was sparked yesterday by the Co-op saying that it was searching for a solution to its problems, either through a sale or an injection of capital.

The bank, which is based in Manchester, is taking the action because low interest rates, high restructuring costs and charges for items such as mis-sold payment protection insurance have been higher than expected. The Co-op said that it would announce another “significant” annual loss next month after saying this month that its capital had deteriorated.

OneSavings Bank, created by JC Flowers, American private equity firm, and Paragon, the buy-to-let lender, are interested in parts of the Co-op.

However, the Co-op is seeking a buyer for all of its business. Potential buyers could include Clydesdale, Banco Sabadell which also owns TSB, Santander or private equity firms such as Cerberus. Several parties have taken a close look at the Co-op and decided it was facing with too many problems. t

The Co-op is also considering converting its bondholders into equity. Analysts believe that the most likely option is for the bank to force junior bondholders to convert bonds into shares to strengthen its capital base.

That could raise about £450 million of high-quality capital for the bank. On top of that, the Co-op may need to raise £300 million to £400 million, according to analysts. To restore the bank comfortably to its position two years ago when it had enough capital to meet all the Prudential Regulation Authority’s (PRA) standards, it might have to aim for about £1 billion, analysts added.

A deadline for reaching a conclusion is likely to be the summer, as the Co-op is due to repay a £400 million senior bond in September. The bank has said that it has the liquidity to do that but may have to bail in that group too if it cannot find other solutions.

Subordinated bonds in the Co-op are trading at about 50p in the pound, almost 40 per cent lower than a few weeks ago when worries started to intensify. Senior debt was priced at about 88p, indicating traders do not believe it will be bailed in, or caught up in a rescue in a way that would mean bondholders would have to take a hit on their investment. However, these securities could be converted into a riskier form of debt.

The Co-op is 80 per cent owned by investors including Silver Point and Perry Capital, two US hedge funds, which may have to decide whether to put more money into the bank despite making heavy losses on their existing holdings. Perry is thought unlikely to do so as it is winding itself down.

Several new hedge funds have expressed interest in the situation, but are unlikely to invest unless subordinated bondholders are bailed in first to strengthen the bank, sources said.

The PRA, which ensures banks’ safety, said that it “welcomes the actions” of the Co-op. It added: “We will continue to assess the bank’s progress in building greater financial resilience over the coming months.”

A key factor will be what the Co-operative group decides to do. The group, which encompasses supermarkets to funeral care, once owned the entuire bank but its holding has shrunk to 20 per cent in the past four years as the bank has been through several restructurings. The group may now have to decide whether to put up more cash despite the fact that it is investing in its own turnaround, or suffer its stake falling even lower.

That would not automatically lead to the bank losing its ability to use the Co-op name. But it will be for the Financial Conduct Authority and the business secretary to decide whether customers are being misled about its true identity.

The Co-op bank’s ethical approach remains important, its management said yesterday. They also pointed out that the lender had made “considerable progress” in the past few years, shrinking its costs, selling non-core businesses and, this weekend, transferring its IT system to a new IBM one.

In a step forward, the Co-op said that it had resolved its argument with Capita over its £325 million mortgage servicing agreement.