Preaching to the converted

Manna from heaven, or fool's gold? As the big players dangle cash handouts and the mutual movement

Building societies are an endangered species. While the value of mortgages lent and the number of customers have soared, the number of societies has plummeted from 1,723 in 1910 to just 77 today.

The industry is dominated by the top 10 societies, which together hold 85 per cent of building society assets. But consolidation means that if plans for five of the leading societies to demutualise go ahead during the next year, the size of the sector will shrink by more than half. At the same time its share of the mortgage market will fall from nearly two thirds to just 20 per cent.

Societies have moved a long way from their original purpose, gathering money from those who have a surplus to lend to those who do not. While savings accounts and mortgages still feature strongly among their services, so do banking, estate agency, stockbroking, credit cards and insurance services.

Although building societies are mutuals, that supposedly exist only for the benefit of their members who also comprise most of their customer base, they now worry as much about profits as the banks and other financial organisations (even if for some the claim is that they want to cut profits).

As their businesses have diversified and developed, building society managers argue that the legislation governing societies has become increasingly restrictive. For example, the 1986 Building Societies Act limits the amount of money they can raise on the financial markets to fund mortgages, the bulk having to come from deposits lodged with a society. Shedding mutual status and converting to a public limited company with shareholders is seen as the only way to escape such shackles.

Northern Rock is one of five societies that has announced its intentions to convert. Adam Applegarth, the executive director, says: "Conversion to a bank will enable us to benefit from less constraining regulation. We will benefit from easier access to capital and to the wholesale money market. We believe it's the best chance we have to be able to compete."

Conversion also means windfalls for members. Abbey National started the trend for conversion in 1989, paying out pounds 560m in free shares to 5.5 million qualifying members. Each member received 100 shares worth 130p each. Today Abbey National shares are selling for 600p or more.

Cheltenham & Gloucester converted in 1995, becoming part of the Lloyds Bank group. Rather than issuing shares, the new company paid qualifying members cash totalling pounds 1.8bn. And this year Abbey National bought National & Provincial, paying 665,000 members an average of pounds 1,300 each in shares or cash.

The sight of so many people apparently receiving something for nothing has made it relatively easy for societies to convince their members of the virtues of demutualisation when it is put to the vote. Thousands of savers have rushed to open qualifying accounts with those societies they believe will convert. The bigger societies have even been forced to raise the minimum opening requirements of their shareholder accounts - those with membership rights - to as much as pounds 5,000 to deter the opportunists.

Halifax, Alliance & Leicester, Woolwich, Northern Rock and Bristol & West have all announced plans to convert.

Nationwide, the UK's second biggest society, was widely rumoured to be planning the takeover of National & Provincial, followed by conversion to a bank. However, foiled by the unexpected and successful bid from Abbey National, Nationwide has since come out in favour of mutuality.

Rob Thomas, building societies analyst for UBS, says that while most members do not appreciate the benefits of mutuality, they do understand the quick-fix payout.

"The man in the street, including me, would rather have money in a society and keep their fingers crossed that it will convert," he says. "It's manna from heaven."

However, he believes that savers and borrowers will lose out once the larger societies have converted. He argues that once building societies become banks, their main concern must be providing dividends for shareholders. This means they will need wider profit margins, resulting in lower rates of interest for savers and higher rates for borrowers.

The Consumers' Association found that when the Halifax and Leeds Permanent merged, new accounts offering lower rates of interest were introduced to replace most savings accounts. It also noted a similar decrease in rates paid by National & Provincial prior to its takeover by Abbey National.

Those that are planning conversion, or have converted already, insist that their customers benefit from a bank's financial strength and a wider range of products and services. They also argue that customers will vote with their feet if services and interest rates fall below the standards expected.

So who is next? Nationwide has to be a good bet for conversion at some stage and Mr Thomas also expects medium-sized societies such as Yorkshire, Skipton, Portman and Chelsea to follow suit. He says: "By the end of the century there will probably be about 50 societies, but these will mostly be the small ones. And there's a question mark over whether their rates can be sufficiently enticing to draw people."