A panacea for Building Societies?

West Bromwich Building Society, the eight largest mutual in the UK, has been particularly hard hit by the current financial crisis, with a March full year loss of £39.3m, mostly incurred from property loans gone bad.

Building Societies face the problem of not being able to access external sources of tier one capital that would enable them to absorb these type of losses. West Bromwich has however managed to overcome this hurdle by converting £182.5m of subordinated debts into profit participatory deferred shares (PPDS), which are designed to qualify as tier one capital, thus improving the mutual’s core tier one ratio to 11.6% Not bad for a building society that was on the verge of collapse!

This new instrument pays a dividend, at the society’s discretion, of up to 25% of post tax profit made. PPDS seems to provide benefits all round; West Bromwich building society gains tier one capital without sacrificing its building society status and UK Insurers (the main investors in West Bromwich) asset quality improves. A good piece of financial engineering, however, in and of itself, insufficient to support the re-emergence of a strong, vibrant and sustainable mutual sector the UK economy needs right now.

Sustainable value creation will arise when the sector starts to punch its combined weight in the UK FS Sector. It must act in consort, aided and abetted by the Building Society Association, under the admirable leadership of Adrian Coles. Lobbying government to reinstate tax breaks for the sector would be a start. VAT relief on scalable ‘third party delivery’ of operational support services, sized to optimise cost efficiency supported by a robust enabling technology infrastructure, would be a real catalyst for change. 

These changes would allow societies to focus on building their regional customer franchises, without the burden of trying, in vain, to compete with the scale economies that make the UK banks such a force, especially when price continues to be the primary factor driving customer choice. 

The sector has a potentially significant role to play, as the UK economy continues to battle with recession, but only if it recognises that most aspects of each society are, and will remain, sub-optimal. In the absence of action from societies, which suffer, not unreasonably, from partisan behaviour that continues to colour the judgement of many management teams,should the government intervene? It has a unique opportunity, arising from the systemic problems in the FS sector highlighted by the current recession, to make a huge and lasting difference.

We look forward to the outcome of the government’s consultation on its white paper into the future of the Financial Services sector and urge it to consider the promotion of the type of structural changes that we, and others, consider necessary.