Building societies confident on capital shake-up

Europe is finalising rules which will govern the capital that financial institutions must hold as a backstop in a crisis, under its Capital Requirements Directive (CRDIV), part of the Basel III global banking deal.

Unlike banks, building societies, owned by their members, cannot raise capital by issuing shares. Instead they must rely on retained profits to boost capital, which can limit their ability to lend.

Now mutuals believe Europe is close to sanctioning the creation of new instruments – as early as next month – which would allow them to raise fresh funds from external investors but not dilute their mutual status.

“We’re very confident that the final text of the European legislation will allow for an instrument that our members would be able to issue,” said Jeremy Palmer, head of financial policy at the Building Societies Association.

“There’s excellent recognition (in Europe) that mutuals and cooperatives are different (to banks), and that their capital instruments are different. It’s about recognition.”

Cost and increasing regulation have stifled the creation of new building societies, while mergers, demutualisation and the odd collapse have reduced their number to 47.

Green lender the Ecology Building Society was the most recent building society to launch when it started trading in West Yorkshire 1981 with just £5,000. Establishing a new society today would require funds of at least £1m.

“It means quite clearly that establishing a new building society is possible because there’s a definite recognition of ways to raise the necessary foundation capital,” said Mr Palmer.

The instrument will allow mutuals to raise fresh funds for growth from external investors, rather than solely profits – which have proved harder to come by in the ultra-low interest rate environment. This could mean more firepower to compete with banks, added Mr Palmer.

“If you’re a bank, you just go out and do a rights issue. If you’re a mutual, you’re stuck.

“It means that building societies will have an equal ability to plc banks to raise common equity tier one capital from an external source rather than being completely dependent on internal capital – without compromising their mutuality.”

Earlier this year Nationwide Building Society won members’ approval to issue core capital deferred shares (CCDS) – widely seen as the blueprint for the sector’s new capital instrument.

Should Nationwide’s CCDS be issued they will pay investors – such as pension funds and insurers – a percentage of profits, capped at £15 per share. In a crisis, investors’ interest could be reduced or fall to zero. Each CCDS holder will also only have one vote.

The UK’s biggest building society said in statement: “We want to ensure we have flexibility going forward to grow the business for our members and to meet the capital requirements.”

CRDIV also limits the type of instruments that contribute towards core tier one capital – the purest form of capital. Permanent interest-bearing shares (PIBS), popular among building societies, will no longer count towards core tier one capital.

Yorkshire Building Society recently bought back £228m of this “old-style” capital, which pays external investors a fixed rate of interest.

“Going forward, PIBS are not going to be worth in capital what they are now,” said the Yorkshire’s director of corporate development, Andy Caton. “Instruments that we have got at tier one get faded out. The regulators are focusing just on core tier one.”

In June the Yorkshire had a 12.9 per cent core tier one capital ratio.

“We won’t be issuing this new instrument next year – we just don’t need to,” said Mr Caton. “Our future capital will be generated by retained profits.

“That’s not to say societies shouldn’t issue it, because they may want to grow faster, or might want to do acquisitions or mergers. It’s good that they have that flexibility.”

The new instruments will be permanent – meaning issuers cannot recall them.

“It’s not the first time building societies have raised external capital,” said Mr Palmer. “The important thing is not that anyone needs more capital right now. It’s the flexibility.”

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