Newcastle strengthens position with debt conversion agreement

The mutual said in return for offering investors a better rate of interest, it will convert 46m of its subordinated debt and permanent interest bearing shares (PIBS) into profit participating deferred shares (PPDS) if its capital levels come under severe stress.

Newcastle said the debt would only convert into PPDS if its core tier one capital – a key measure of financial strength – drops below five per cent.

Building societies have been forced to strengthen their capital ratios after the FSA toughened the rules on the type of capital that counts as core tier one – ruling out the use of PIBS.

The conversion gives Newcastle an extra 2.2 per cent slug of core tier one capital. The deal includes a reversible feature, meaning the instruments will cease to be convertible and the interest increase will fall away if the society's core tier one capital ratio exceeds 12 per cent.

Jim Willens, chief executive of Newcastle, said: "This initiative represents a significant enhancement to the quality of our capital base and provides further underpinning to our financial strength. It puts us on a very solid footing and will support our strategy of providing long-term member value as a strong, traditional and independent building society."

West Bromwich Building Society last year bolstered its finances when it was allowed to convert 182.5m of subordinated debt into PPDS.

However, the use of PPDS has been criticised by some in the sector for diluting the mutual model, as building societies have a duty to act in their members' interests, rather than external shareholders.

A Leeds-based team at law firm Addleshaw Goddard, led by banking partner Mark Thomas and corporate finance partner Ian McIntosh, worked on Newcastle's capital strengthening.

Mr Thomas said: "This has been a great opportunity to continue to be at the cutting edge of building society capital enhancement and the addition of the 'reversibility' feature has minimised the level of coupon uplift necessary to secure the agreement of investors for the Newcastle Building Society.

"This agreement was sought by the society in order to underpin its financial strength, involved active negotiation with investors in the society and will enable Newcastle to continue as a stro-ng, independent society."