Good day for the building society sector?

Friday last week was on the face of it a good day for the building society sector, with West Bromwich saved from the wolves have been hounding it for what seems like weeks now and an announcement that building societies will have access to a new method of capital raising that evens out some of the structural disadvantage they have against the banks.

I am genuinely pleased for West Brom, not just because it is a large society with a strong regional franchise, but because everyone had effectively written it off as the next Dunfermline and yet it has managed to prove its critiques wrong.

What they did was swap subordinated debts for new profit participating deferred shares (PPDS). The first question my wife asked me is what is subordinated debt?
Well they are long term loans usually with a fixed rate of interest payable. The loans cannot usually be recalled before their end date and they are used by companies to boost capital to use for growth. Whilst they are long term, they do at some point get repaid and therefore can only be treated as secondary capital. Primary tier 1 capital or permanent capital has to be actual funds with no repayment date in the future, such as retained profits and this is where the PPDS come in. They have no repayment date, the capital that pays for the PPDS is therefore permanent, so better quality than subordinated debts. This permanency has had the effect of increasing the capital ratios of West Brom and therefore suring up its balance sheet for the future.

So everything is great then? Well as I have said I am genuinely pleased, however for me personally there is one issue with this scheme. As a mutual we are not driven to maximise profits for shareholder return and can therefore return some of our profits to members by way of quality products and also through building up capital which earns a return that again gets ploughed back into product development and other member initiatives.

However a society which has issued PPDS, now effectively has a perverse anomaly in its objectives. One group of investors want profits maximised so that they receive a strong profit share on their deferred shares and the other group (saving and borrowing members) want better returns and service that detract from profit.

This balancing act will requires skill from the relevant board. For me serving only one master (our members) is what makes mutuality come alive, so maintaining that mutual advantage will be key for those societies that issue PPDS.