Around 7000 retail investors owning permanent interest bearing shares (Pibs), which pay dividends of between 5.5% and 13%, will be affected by the plan.
The group admits that bond holders will lose out in the short term, but the exchange will give them a significant minority stake in the bank which will enable them to share in the upside of the bank’s transformation.
The number of shares and bonds offered in exchange for current holdings would be finalised in October, when it is expected to officially launch the offer.
Parent company the Co-operative Group is also providing extra capital.
Earlier in the year the bank pulled out of a deal to purchase 631 Lloyds Bank branches, and two days later its debt was downgraded to junk status by ratings agency Moodys, which warned it may need external help in tackling its balance sheet deficits.
The move announced today will not involve help from taxpayers.
At the end of May the bank appointed HSBC’s Niall Booker as its new chief executive and reports suggested there would be further reshuffles at senior level as the group looked to turn around the fortunes of the flailing lender.
In a statement, Euan Sutherland, chief executive of the Co-operative Group, said: “"The Group is confident that, under the bank’s strengthened management team, this plan offers the best way forward. We believe it is the right approach to ensure that we continue to provide great service for our 4.7 million Bank customers, while safeguarding the interest of other stakeholders.
“The plan that we have announced means that the whole Group can now look to the future with confidence."
