Page last updated at 12:51 GMT, Friday, 12 June 2009 13:51 UK

Q&A: What now for building societies?

The West Bromwich building society has secured its independence, for the time being.

West Bromwich Building Society
The West Bromwich should now be safe, the authorities believe

For weeks there had been speculation that worries about its financial strength would force the authorities to take it over or organise some sort of rescue.

Now the society, and the Financial Services Authority (FSA), have come up with a novel way of propping it up.

It involves getting rid of some of its long term debts but creating a new type of investor and shareholder.

What is the deal all about?

The society has revealed it plunged into the red in the past financial year, recording a loss of £49m.

That is bad because, as it is owned mainly by its savers, it has limited scope to raise new money to rebuild its reserves.

But what was really worrying the authorities was the society's ability to withstand further falls in property prices.

The FSA has been "stress testing" the finances of all societies.

This has involved assuming, among other things, a 50% fall in house prices from peak to trough, and a 60% fall in commercial property prices too.

The FSA was clearly not sure that the West Bromwich could withstand this, so it has come up with a cunning plan.

Professional investors who were due to be repaid £182.5m of the society's notes (glorified IOUs) in the coming years have agreed to abandon their claim to that money.

In exchange they are getting a new fangled type of share in the West Bromwich called a Profit Participating Deferred Share (PPDS).

Is the society safe now?

It should be, because the deal makes the society much more solvent than it was before.

If we had not done this we would have had to have looked at other options
Jonathan Westhoff, West Bromwich finance director

It no longer has to repay that £182.5m at all.

And there is a double benefit - the £182.5m value of new PPDS shares counts immediately as an extra financial cushion against any future losses, in addition to the society's existing reserves.

The holders of the new shares are entitled, in theory, to up to 25% of the society's post-tax profits in the future.

But payments will be entirely at the discretion of the board.

So the plan at the West Bromwich is similar to someone having a large chunk of their mortgage written off.

"If we had not done this we would have had to have looked at other options," said Jonathan Westhoff, the finance director of the West Bromwich.

What does it mean for savers and borrowers?

It means there should be no threat of the society being declared in default.

That would have meant it being either closed down, carved up (like the Dunfermline building society earlier this year) or being frog-marched into a takeover by a larger society such as the Nationwide.

Thus savers' money is safe and home buyers can still look to the society for a mortgage.

"We are still here for the long term - we have no other agenda or objective," said Mr Westhoff.

So who does it affect?

The institutional investors who held the West Bromwich's notes may be a bit peeved, as their IOU's were guaranteeing them a return of between 5.625% and 6.625% a year.

Dunfermline Building Society headquarters
The Dunfermline had to be bailed out because of its debts earlier this year

That is a very good rate of return at the moment.

But they might have lost everything if the society had been declared in default as they were way down the order of preference for creditors in the event of the society being declared insolvent.

They would not have been protected by the Financial Services Compensation Scheme, nor necessarily been bailed out by the government if the West Bromwich had failed.

On a wider view, maintaining the solvency and security of a large building society affects everyone because financial stability is undoubtedly a good thing.

What does it mean for other building societies?

If other societies now wish to raise extra money from new shareholders to bolster their finances they can now do so by issuing PPDSs.

They could not go down this route before.

"Other building societies should consider whether PPDS could be useful for their own capital management," the FSA said.

A spokesman for the Building Societies Association said: "This has to be a good thing as all the extra capital makes their society safer."

Nine societies have now revealed losses for last year, so some may well be interested.

Doesn't this undermine the idea of mutuality - societies being owned by their members?

The deal pioneered by the FSA and the West Bromwich looks like a half-way house to full demutualisation.

This does not compromise a society's mutual status
BSA

But that is not quite the case.

For some years societies have been able to create new shareholders when issuing IOUs known as Permanent Interest Bearing Shares, or PIBs.

The point here is that each investor, whether they own a PIB or PPDS, will only have one vote, no matter how many bits of paper they have bought or their face value.

So a big financial institution would have one vote, just like a member of the public with a savings account.

"This does not compromise a society's mutual status, they [investors] do not have greater powers than ordinary savers," said the BSA.

But surely a very large investor would call the tune and demand some return at the expense of other members?

So you might think.

The UK's biggest building society the Nationwide has long made much of its mutual status.

It has proclaimed loudly that by being owned by its members, and not by conventional shareholders, it can give savers better interest rates and offer borrowers cheaper mortgages.

But Jonathan Westhoff at the West Bromwich argues that in future it will still be he and fellow directors, not any new shareholders, who will decide how to use the society's future profits.

"Will there be a shift from one set [of members] to another? I don't think so. We have to focus on all the shareholders and keep them satisfied," he said.

The BSA says there will still be a big difference between a shareholder-owned company, and a mutual owned by its members, even if some of them now look like conventional shareholders.

"Building society's don't have to maximise profitability and this [PPDS] doesn't change that," the BSA says.



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