Oh dear, oh dear.
Nationwide may have reported the first annual gain in UK house prices since March 2008, but that won’t offer much respite to UK building societies, seven of which on Friday had their lower tier 2 subordinated notes (LT2) and permanent interest bearing shares (PIBS) downgraded between one and two notches by ratings agency Fitch.
Fitch said the downgrades reflected the risk that building societies would exchange or convert their LT2 debt and PIBS into more equity-like instruments, following the introduction of profit participating deferred shares (PPDS) in June 2009, designed to provide societies with a tool by which to create regulatory core tier 1 capital.
As the ratings agency explained:
This is because building societies, given their mutual status, are unable to raise common equity which, together with retained earnings, is the main constituent of regulatory core tier 1 capital, placing them at a structural disadvantage to most banks in terms of their access to capital.
In other words, Fitch believes the mutuals are not done capital raising and because of their mutual state have no option but to go down the controversial PPDS road — a measure which in effect throws them into quasi-demutualisation.
One of the negative consequences of this sort of quasi-demutualisation, say the critics, is the need to payout dividends to outside investors. That can reduce business and future potential windfalls for building societies, by leading to less competitive rates for savers and borrowers.
Nevertheless, as the FT pointed out back in September the PPDS option still appears a better one to the main alternative: demutualisation. As they wrote:
…one thing seems certain – few, if any, of Britain’s building societies will take the obvious route to fresh equity and a more flexible future through a stock market listing. Demutalisation – chosen by eight of the 10 largest building societies in 1992 – proved a disaster. By 2008, all had been taken over or nationalised, following a dash for cheap debt and quick profits.
Related links:
Societies mull controversial share deals – FT
Mutual suspicion – FT