The Paul Gosling Column
A ‘United Co-operatives’ moment for Co-operative Financial Services may be looming. The impetus for growth and renewal in the retail sector provided by the merger of the Co-operative Group and United Co-operatives could be replicated by the possible amalgamation of CFS with the Britannia Building Society.
Following the media leaks of discussions between the two mutuals, it is important to stress that merger remains a possibility, not a done deal. Talks are taking place and there is shared agreement that there are grounds for pushing ahead – but there is no certainty that a full merger will be the result. Other options are a partnership in which each side sells products on behalf of the other, or even that they just walk away from any arrangement. CFS says that it would then be willing to discuss linking-up with other building societies.
Britannia’s and CFS’s books are each currently being assessed by the other, evaluating the assets, liabilities and scope for improved efficiencies resulting from a merger. In particular, each side needs to be confident that the looming recession and continuing global financial crisis will not have a particularly nasty impact on a merged entity.
There has been speculation that Britannia could have difficulties with above-average lending for a building society in buy-to-let mortgages through its Britannia Capital Investment Group subsidiary. But this interpretation is dismissed by Britannia, which points out that its bad debt and write-off levels in the recent period have been below those of CFS. It says that its buy-to-let business has avoided high risk investments and focused on loans that are sustainable, whatever happens in the property market.
On its side, CFS is emerging very well from the global financial crisis, with a significant increase in deposits and a benefit from the perception that mutuals are more reliable and trustworthy than the main banks. As David Anderson, chief executive of CFS, says, its status encourages a more cautious approach to risks and customer service. “We are a mutual and maybe think more about our customers,” he says. He adds that mutuality has ensured it did not get involved in high risk activities. “We don’t have the same access to external capital, so you think harder about the capital you have got,” he explains.
CFS is inherantly more cautious in its approach than the investment banks have been. “We have a very clear principle that any new instrument goes through a very strong process of approval,” says Anderson. This means that derivatives and other financial instruments would have to be explained to an approvals board, including lay people. If an instrument cannot be explained clearly, it won’t be approved. The complex derivatives that have generated global losses are beyond the understanding of seasoned bankers, let alone lay directors.
A merger with Britannia as the second largest building society would make sense for CFS, not least because there is little direct competition between the two bodies. Rather there is what is termed ‘synergies’ – the two bodies would dovetail neatly if joined together. “It’s a terrific opportunity to create a new large mutual force,” says Anderson. “But it’s in its early days. We haven’t reached a point where we have said it could be done.”
In fact, press speculation about a merger is an embarrassment for CFS – the possibility of doing a deal has not even gone to the CFS or Co-operative Group boards. Consequently, there are many approval hurdles to be overcome yet.
Together, the two bodies would have around £70bn of assets, with CFS contributing nearly two thirds of this. CFS has about 8,000 staff, but only 90 or so branches, whereas Britannia has 5,000 employees and about 250 branches. One benefit of a merger from the CFS point of view is that it would instantly gain a much larger branch network – an existing ambition – reducing its dependence on the use of the internet and telephone banking and on intermediaries selling its insurance products.
Expanding the sale of CFS insurance products is one of the main drivers for a possible deal on the CFS side. Britannia sells Legal & General and Axa insurance products, while CFS ‘manufactures’ its own insurance products. If Britannia could be persuaded to sell CFS products in place of L&G and Axa, there would be a strong gain for CFS – whether or not this involves a merger. “There is an obvious opportunity to work together,” says Anderson.
But one of the peculiar facts about the proposed link-up is that it would firm-up the position of CFS as a ‘bancassurer’ – a multi-product financial services institution. This was the model widely expected a decade ago to become dominant in the industry, but was essentially an unsuccessful strategy for Lloyds TSB and NatWest. CFS believes bancassurance makes more sense for it, because of its position as an ethical provider of financial products – it needs to reassure customers of the provenance of financial products, which it can only do if it writes as well as sells those products.
Britannia is a far more attractive potential spouse than is the largest building society, the Nationwide. Specifically, it is felt that the cultural approach of Britannia is closer to that of CFS than is that of the Nationwide, whose current board appears to see mutuality as a commercial opportunity rather than necessarily a principle that they are committed to for its own sake. And Nationwide would dwarf CFS, making the Co-op effectively the junior partner.
Just what the name and governance arrangements for a merged Britannia and CFS would be are undecided. But the option of decoupling CFS from the Co-operative Group to create a new and independent mutual is firmly ruled out by the Co-operative Group. In part, the governance arrangements to be put in place would depend on the legal requirements, which are as yet unclear.
There is also the issue of whether Britannia’s members should be entitled to a merger bonus. The logic of why members of a mutual should expect to receive a bonus for merging with another mutual is lost on this writer, but it seems certain that the Mail on Sunday and the Saturday edition of the Financial Times will argue in favour of one – just as they did for members of the Cheshire and Derbyshire building societies, whose members should actually feel relief and thanks for Nationwide rescuing their organisations. Any merger between Britannia and CFS would have to be approved in a vote by Britannia’s members.
It needs to be stressed that the possible merger between CFS and Britannia is a sign of strength, not weakness. It arises from a recognition of the opportunities. Britannia and CFS insist the society is not in distress and the regulator, the Financial Services Authority, has not been an instigator of talks, as it has been with other recent banking mergers. Indeed, Britannia worries that the market environment may at present be too volatile to complete a merger for the moment.
Britannia Group chief executive Neville Richardson declines to be drawn on the prospects of a full merger taking place. “It’s really hard to say,” he says. “I would not like to predict. The likelihood of co-operation in some way is high. But that could be on a product level.”
For Britannia, it would have the expectation that CFS would market Britannia mortgages in place of those currently offered by The Co-operative Bank – which is only a small part of its business at present. Joint working would preferably go beyond this, says Richardson. “We need better internet capability. CFS has that through Smile. We need better transactional capability and the bank has its current account. We outsource loans and credit cards. CFS does those. There’s a lot in it for Britannia.”
However, Britannia sees the relatively strengths of the two institutions in slightly different terms from the CFS perspective. In particular, Britannia stresses that each organisation has about three million members. Richardson also focuses on the relative independence of CFS within the Co-operative Group structure, rather than seeing it as part of the Group. “CFS operates within the co-opertive movement, but with appropriate levels of autonomy, as are required by the Financial Services Authority,” he says. “Second, the view we have taken is that we would only look at it if it was a merger of equals.”
There is no timetable for a possible merger, not least because it is dependent on new regulations being put into place by the Treasury that would permit the coming together of two different types of mutuals. It is thought that the new regulations are unlikely to be effective until the end of this year or the beginning of next, meaning that no merger is probably feasible until well into next year. However, continued discussions could lead to a framework agreement earlier than this.
The merger is only conceivable because of measures contained in the Building Societies (Funding) & Mutual Societies (Transfers) Act, 2007 – known as the Butterfill Bill, after its sponsor Sir John Butterfill MP. Sir John told Co-operative News that the CFS and Britannia link-up is “absolutely the type of thing we are looking at”. He adds: “I don’t think you will find them alone.” He believes that other mergers are likely to follow – in particularly involving friendly societies merging with building societies and industrial and provident societies.
Sir John’s Act was the result of a long-term involvement with supporting mutuals, which in part results from the significant role of mutuals as employers in his Bournemouth constituency – the former Portman Building Society had its headquarters there and Liverpool Victoria Friendly Society is one of the largest local employers. “I have been an officer, deputy chairman, of the All Party Group on Building Societies and Financial Mutuals,” explains Sir John, “and was a founder member of the [earlier] All Party Group on Building Societies. We extended it to all types of financial mutuals because of the common interests.”
He says there was dissatisfaction across the mutual sector about the old legal controls and framework. Sir John says: “A lot of people in the industry said: ‘This is a bit silly. We are all covered by different bits of legislation. We can’t merge with each other unless we give up our mutual status. That is absurd. It is much better if we can merge and retain our mutuality.’”
This lobbying led to the Butterfill Bill, after Sir John won a place in the ballot for private members’ bills, and he was supported by Peter Hunt and Mutuo in drawing up draft legislation. Sir John believes that his Act could play a very important part in the modernisation, consolidation and future success of the mutual sector. The long-standing Conservative MP says: “Given that the corporates have rather cocked things up recently, the mutuals will be looking more and more attractive to the general public.”