Building & Life Societies - Our Mutual Friends
By Nick Funnell
Thursday 22nd September 2007
“They give then take away, repossess and crucify… NatWest-Barclays-Midlands-Lloyds.” Manic Street Preachers- NatWest-Barclays-Midlands-Lloyds (1992).
Yes, it seems as though the big high street banks will never be able to fully shake off their poor public image, no matter how hard they try to ramp up on their ‘green’ and ‘ethical’ credentials. The Financial Ombudsman recently reporting up to 1000 new complaints every day concerning banks’ charges and poor service, and a recent survey showed two-thirds of Brits saying they had ‘lost all faith’ in their bank. Could a mutual building society offer a better home for your money?
Members Only
Mutuals have no shareholders, only members. Becoming a member means either saving or borrowing in the case of a building society- the largest, Nationwide, has a £100 hurdle either way before membership status is confirmed. Each member has one vote at the company’s AGM, regardless of the size of their account.
The first known building society was formed in 1775 in Birmingham, swiftly followed by many others all over the country. Their purpose initially was to manage a central fund to pay for the housing of all members, who would save regular amounts each month- the society being wound up once all were housed. Later in the 19 th century permanent building societies were formed, many accepting savings from customers who weren’t necessarily potential homeowners. Today there are 59 mutual building societies in the UK, managing total assets of £315bn- £160bn (51%) by the market giant Nationwide, now over five times the size of its nearest mutual rival Britannia. Total savings balances stand at £200bn- compared with £700bn at the banks.
Mutuals often boast of their lack of shareholders in their PR- with no dividend payments to finance, all profits can be used within the business. On their website, Nationwide claims to have calculated a figure of £5bn as being the cumulative benefit to customers of staying mutual over the last ten years.
Mutual Life insurers and pension providers are much thinner on the ground in the UK, especially since the conversion of Standard Life to a PLC in 2006. Standard, with its 2.6m policyholders, was seen as something of a last bastion for large-scale mutual insurance, having seen off two previous attempts by members to force a conversion vote in 2000 and 2003.
Bagging a Windfall Payoff
The Standard vote was the last in the line of large demutualisations that has seen virtually all life and pensions providers, and many building societies convert into PLCs. Beginning with the Abbey National in 1989, but really picking up steam after 1995, mutual members were often tempted by the large windfall payments (in the form of shares in the new company or cash) on offer to them if the conversion vote went through.
In many eyes, the demutualisation process was marred by carpetbaggers- people who became members of mutual organisations simply to pick up a quick windfall. Most waited passively for conversion to occur- seen as inevitable in their late 1990s heyday- but some aggressively used their membership rights to push for demutualisation votes at AGMs.
Demutualisation- The Case For and Against
The decision that members face in a demutualisation vote has both short and long-term consequences, both for the company and their personal finances. There are several arguments for and against:
For - Windfall payments: without doubt the juiciest incentive of all. Members’ valuable rights are crystallised in the form of payments in cash or shares in the new PLC. For example, Scottish Widows’ demutualisation in March 2000 triggered average payments of £6,000 for each former member.
- Access to capital: being a PLC creates more growth opportunities with greater access to capital markets. This could raise the share price, making members’ windfalls even more valuable.
- A change in culture at the top: ‘best practice’ corporate governance and accountability are encouraged through enhanced transparency and regulatory and shareholder oversight (see Equitable Life below).
- It should also be mentioned that the directors will inevitably start to compare their salaries with those at other PLCs- and that usually means the start of a significant shift upwards.
Against - Relinquishes membership rights for shares: the ‘one member, one vote’ culture of mutuality is abandoned. Inevitability, shareholder influence will come to be dominated by City fund managers with their own agenda.
- Dividend payments and other additional corporate costs: yes, those shareholders will demand their cut of the profits every half-year. This, coupled with extra compliance costs of PLC status, eats away at the value the company can offer customers in terms of products and services. According to the Building Societies Association, management and dividend costs in PLCs are on average 30-35% higher than the management costs of mutuals.
- Potential conflicts of interest: shareholders and policyholders/customers may have differing views of the company’s best way forward. An obvious bone of contention is the size of the dividend payment. Also, between 1995 and 2000 newly demutualised building societies responded to shareholder pressure to cut costs by reducing their branch network by 24%- with an obvious knock-on effect for customer service.
- Potential increase in risk: pressure from the City has a tendency to force PLC directors into adopting ambitious growth targets, rather than simply focussing on the customers they already have. This can always backfire if not managed properly (see Northern Rock below).
Case Studies- Equitable Life and Northern Rock
Equitable Life (Mutual)
The financial failings of Equitable Life look set to cast a dark shadow over the UK life and pensions market for many years to come. Equitable, the world’s oldest life assurer, was forced to close its doors to new business in December 2000 after losing a protracted high court battle concerning guaranteed annuity promises made to certain classes of policyholders over a number of years.
In his 2004 report on the affair commissioned by the government, Lord Penrose was scathing about the lax oversight culture that operated within Equitable Life during the 1980s and 1990s. Highlighted in particular was the imperious 15-year regime of Roy Ranson, who straddled the roles of Chief Actuary and Chief Executive between 1982 to 1997. His controversial ‘maximum distribution’ policies left Equitable without sufficient reserves to cover all their commitments, eventually leaving thousands of policyholders facing hugely reduced pensions to see them through retirement.
Penrose described Ranson as a highly “idiosyncratic and autocratic” character, who was allowed to run the main £30bn with-profits fund "without significant control by his colleagues, his board, the auditor or the regulator". Ouch. Indeed, other members of the board were only told about the fatal annuity guarantees in 1993, a full ten years after they were first instigated.
Would things have been different if Equitable Life had been a PLC? While there are certainly numerous examples of poor leadership within publicly traded companies, it could be argued that the extra scrutiny offered by shareholders would have meant that Ranson’s regime would not have gone on unchallenged for so long. Shareholders may be ‘greedy’ but, as Gordon Gekko said in the film ‘Wall Street’, greed can be good if it keeps the board of directors on their toes. Unlike long-term pension policyholders, they demand their dividend payment every half year, and will raise hell at the AGM if any cut is made.
Northern Rock (PLC)
UK newspaper headlines in mid-September 2007 were dominated by the crisis at Northern Rock, a former building society demutualised to a PLC bank in 1997. With other banks cutting their lines of credit, NR was forced to turn to the Bank of England in its role as ‘lender of last resort’, the first time a UK bank had done so since the early 1970s. News of this sparked panic among NR’s savers, leading to a dreaded ‘run’ as many thousands queued around the block to withdraw their money. Only a full guarantee from the Chancellor saying the Treasury would cover all savings calmed the situation sufficiently to stem the flow.
The root cause of the problems at NR lay in its overly aggressive and high-risk lending model. The bank ramped up its mortgage lending at the beginning of 2007, when most economists were forecasting a slowdown in the housing market and interest rates were rising, squeezing its profit margins. NR’s interim report of June 2007 boasted that its net lending rose 47 per cent during the first six months of 2007, to just under £11bn, with a further £6.2bn pipeline of loans agreed with customers.
Chief Executive Adam Applegarth, once regarded as something of a ‘golden boy’ by the City, now looks to be the villain of the piece for chasing his dream of making NR the third largest UK mortgage lender within just a couple of years. Such ambitious leadership plans bear the hallmark of modern PLC status, with its attendant growth demands from shareholders, fund managers and City analysts. The less fevered world of mutuality may be relatively staid and unexciting, but at least customers know their money is unlikely to put at risk by an overly aggressive lust for expansion.
In these days of instant online price comparison, the ownership structure of the product provider may seem to some a matter of little importance. However, to those seeking a more long-term relationship with a financial partner, mutual membership could prove an attractive option.
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