The marrying kind: For the banks, buying a building society is more of a necessity than merely an opportunity. John Willcock reports

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The Independent Online
THE long-term attraction of building societies as acquisition targets for banks has increased since a court ruling in June that appeared to put a brake on Lloyds Bank's pounds 1.8bn takeover of Cheltenham & Gloucester. Despite the court's decision that C&G members of less than two years' standing would not be eligible for cash payments and might therefore vote against the deal, banks are still keenly interested in buying societies.

There are two reasons why: first, the court decision makes the process of buying a society in an agreed deal longer and more difficult but not impossible. C&G will announce its revised proposals for the merger, aimed at winning the vote, in a fortnight.

Second, the bank results reporting season, currently under way, shows that banks are finding it hard to make money out of branch banking in an increasingly competitive, low interest rate, low-margin environment. The good news on tumbling bad debt provisions has been replaced by a nightmarish margin squeeze.

For instance, Lloyds announced a large half-year fall in bad debt provisions from pounds 272m to pounds 184m, yet revenues rose by just 5 per cent. Lloyds has prospered through the recession under its chief executive, Sir Brian Pitman, by keeping a firm hold on costs, but the bank now needs new avenues for growing the business.

This goes for all the banks. Some, like National Westminster and Barclays, are building up their investment banking. TSB, Bank of Scotland and Royal Bank of Scotland are all considering a building society acquisition. Abbey National says it will think about it when societies look cheaper.

Buying a building society delivers millions of new customers cheaply. Taking over C&G will put Lloyds in the top five mortgage lenders in the UK, for instance.

Banks face a series of hurdles in an acquisition, beginning with finding a society that wants to be taken over. Those, like Woolwich, that cherish their mutual status, are quite safe under the protection of the Building Societies Act.

By contrast, Andrew Longhurst, chief executive of C&G, sees becoming part of a bank as more attractive than merging with other societies and believes that C&G would be too small to survive as a plc on its own.

The society must receive approval from its members. At least 50 per cent of those eligible must vote, and of those 75 per cent must say yes. When C&G announces its new proposals it is likely to delay the deal from its planned completion day next spring to December 1995, so that most of the 27 per cent of C&G members who are of less than two years' standing pass the two-year threshold and qualify for a cash bonus.

For the banks, choosing a society means going for either a national network, which would need rationalising, or a regional society that would complement the bank's existing network. The two Scottish banks are therefore obvious candidates for English societies.

Both banks would probably need to issue equity in order to afford a top 10 society. The broker Smith New Court has estimated possible prices for the top 10 societies based on the price Lloyds is paying for C&G. SNC has assumed a price for each society based halfway between 2.1 times book and 13.6 times earnings.

Interest in societies is not limited to the UK. National Australia Bank has acquired Yorkshire Bank and Clydesdale Bank, and analysts suggest a society in the South-west would make a good geographical fit while Continental banks are still looking.

But some of the strongest interest in buying UK societies comes from Ireland. Financial institutions have reached the same level of domestic saturation that their food industry colleagues reached five years ago, and want to take the same path and venture abroad. The first stop and best-known market is the UK. Irish banks and building societies are planning to buy a series of medium-sized UK building societies. But they are holding back to see how the C&G/Lloyds deal will be resolved.

Bank of Ireland and Allied Irish Banks, which have 40 per cent of the Irish market, are probably the strongest candidates for making a purchase. Three building societies, Irish Permanent, First National and Educational, are also in the frame.

Shane Nolan, analyst with the Dublin broker NCB, said: 'Bank of Ireland and Allied Irish Banks have little scope left to grow in Ireland. They are very profitable and looking for a home for their surplus capital.'

Bank of Ireland already has a successful UK subsidiary, Bank of Ireland Home Mortgages, with a pounds 2bn UK mortgage book. A spokesman said: 'Our UK mortgage business has been profitable even in the depths of the recession and if a suitable opportunity to buy a bank or building society came up we would consider it.'

Tony Shanahan, group finance director of First National Building Society, said: 'We remain open- minded. We are interested in diversifying into the UK either by buying mortgage portfolios or deposit takers, such as banks and building societies. The problem is the legal obstacle.'

The Irish Permanent is converting to plc status in October and it may expand in the UK, where it already has two London branches, by buying a mortgage portfolio rather than a society.

It is now a question of when, not if, another society agrees to be bought out by a bank, UK-based or not. Competitive pressures and a low interest rate environment make such deals a necessity for the banks rather than merely an opportunity. They will be willing to pay prices that will be attractive to society members and the C&G court ruling has merely delayed the process, not stopped it.

------------------------------------------------------------------------ Top 10 building societies by reserves ------------------------------------------------------------------------ 1993 1993 profit Possible reserves after tax acquisition pounds m pounds m price pounds m Halifax 3,649 574 7,735 Nationwide* 1,841 250 3,633 Woolwich 1,243 137 2,237 Alliance & Leicester 1,023 132 1,972 Leeds Permanent 982 127 1,895 Cheltenham & Gloucester 864 132 1,805 National & Provincial 640 80 1,216 Bradford & Bingley 633 87 1,256 Britannia 446 54 836 Yorkshire 313 46 641 ------------------------------------------------------------------------ *Estimate Source: Smith New Court ------------------------------------------------------------------------