Societies banking on a merger: Size can offer critical advantages in the competitive UK market for lending and savings. John Willcock reports

THE REAL motive for the mega-merger between the Leeds and the N&P building societies is likely to be more specific than all the spin about synergy and economies of scale. It is that the two managements are planning at some point to convert the newly merged entity to plc status.

Critical mass is needed for the new society to compete with the clearing banks in an increasingly competitive market for British savings and lending. The management of both the Leeds and N&P said conversion to plc status was an option, when they announced their merger plans last week, although they claimed that they had no current plans to do so.

Ditching mutual status appeals to building society managements for a number of reasons, not least because it will make them considerably better off - the lure of share options, pension schemes and the like should not be underestimated.

Already there have been rumblings from customers that the merger will benefit the management at the expense of the members.

More generally, banks can be far more ambitious than a building society in growing their business. To increase profits, they need to widen margins and that means enlarging the balance sheet. And a bank can raise money at keen rates on the international money markets.

Conversion also enables a society to escape the heavy hand of the Building Societies Commission (BSC), a staunch enforcer of caution and prudence.

The BSC is, in effect, an outpost of the Treasury, and has a reputation within the industry of being something of a nanny. Smaller societies are discouraged from developing complicated new products, which the BSC judges they may not have the ability to manage properly.

And if any society, heaven forbid, makes a loss, the BSC quietly ushers it into the arms of one of its larger brethren, such as the Cheltenham & Gloucester.

This attitude is in stark contrast to the Bank of England's approach to regulation.

The clearing banks are viewed as grown-ups that can lose hundreds of millions of pounds with relative impunity. The banks' shares may take a caning, and journalists may give them a roasting, but the Bank of England will not push them immediately into a merger.

The impetus for loss-making societies to merge may be slowing anyway, as the UK economy splutters into patchy recovery. The weaker societies, such as the Bristol & West and the Skipton - which industry observers had pencilled in as merger candidates - are now reporting respectable profits.

The public reason given for the Leeds/N&P merger is the need to take advantage of economies of scale. The sceptical will remember Nationwide Anglia's botched attempt to amalgamate its two founding societies' computer systems and smile. But there are some genuine gains to be had from size, particularly if the new Leeds wants to convert itself into a bank.

The new Leeds will have a strong presence in the North of England and total current assets of over pounds 30bn, putting it on a par with Bank of Scotland and TSB. The old Leeds had assets of only pounds 18bn, making it a vulnerable tiddler in clearing bank terms.

So the merger - which seems to be arousing plenty of opposition from vociferous small investors, if not from the City - should qualify the Leeds/N&P management for membership of the big clearing banks club should it opt for plc status. This matters because it will be able to borrow money more cheaply.

The new entity should be big enough to gain recognition on the international money markets, if it were to convert into a bank. The financial performance of both merging societies should be enough to win a healthy AA3 credit rating from agencies such as Moody's, according to City sources.

Last week's announcement, therefore, is likely to herald further building society mergers - to be followed rapidly by conversion to plc status. City corporate financiers are already running their slide rules over the likes of the Alliance & Leicester and Cheltenham & Gloucester. The BSC's nursery may soon be looking bare.

Through the 1990s, the desire of managers for more freedom, the advantages of size in access to the money markets, and the benefits of spreading overheads such as marketing and back office systems will all force the pace of concentration. Britain's high-street savings market is changing fast.

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