UK Capital Investments adequacy is a mutual headache for UK's building societies group

Back in February of last year, Adrian Coles, director general of the Building Societies Association, declared that his members were "definitely not" suffering the acute agony of the banks, a fate which I had predicted a few days previously.

People have said that UK Capital Investments adequacy is a mutual headache for UK's building societies group.

Two years since, it's obvious who was right and who was wrong in that argument and yesterday saw further evidence of the ongoing problems the building society sector faces.

Yorkshire's willingness to consider absorbing the Chelsea Building Society is just one more rescue, albeit with a substantial capital restructuring as a condition. That said, it's not a done deal. Yorkshire is talking about a "possibility" of a merger and both sides' customers will vote. Such democracy is a far cry from the secret loans used by the Government to prop up HBOS while it merged with Lloyds TSB.

As with the banks, capital adequacy continues to be a headache at a time when the folding stuff is at a premium. Names such as Barnsley, Britannia, Chelsea, Cheshire, Derbyshire, Dunfermline, Scarborough and West Bromwich have all either been dismantled, rescued, recapitalised or merged since Coles made his assertion.

The proposed salvation of Chelsea borrows from recent bank recapitalisations, such as the one undertaken by Lloyds Banking Group.

At its heart is a proposal to swap £200m of Chelsea's subordinated debt for £100m of new debt convertible into core tier 1 capital if losses mount in future at the enlarged group. The deal is sweetened for Chelsea bondholders by the payment of a whopping 13.5pc annual coupon.

The new securities are a form of contingent core tier 1 capital – otherwise known as CoCos. It is at least a market solution to a market problem, which is progress. But the issue of capital is not going away.

Losses from recession, fraud and downright poor lending have eaten into capital reserves at the lenders. The Financial Services Authority (FSA), however, wants capital ratios to be increased but mutuals don't have shareholders to provide new equity.

Previous forms of building society capital, such as permanent interest bearing shares, are not "loss bearing" so don't count as far as the FSA is concerned. The regulator invented profit participating deferred shares to recapitalise the West Brom but the problem with this issue was that it was small and illiquid and was only taken up by investors because the alternative was complete wipe-out.

I expect we will see a further refining of new building society capital instruments to more closely resemble the large scale CoCos issued by banks. This needs to be authorised by the FSA so that the likes of Nationwide, by far the biggest and strongest building society, can tap the markets to replenish its capital.

There's no suggestion that Nationwide has a problem. But at the moment the only way it can rebuild capital is through retained earnings which means less competitive rates for customers. Its margins have already shrunk drastically as the official Bank rate has hit 0.5pc. Its ability to provide consumers with credit, to help get the housing market and wider economy going next year, is severely constrained given the combination of losses on bad loans and increased regulatory demands on capital.

This is true for all and a general lack of credit will prove a major brake on recovery next year.

Laffin and crying in M&B bar brawl

I need a stiff drink after absorbing the latest machinations at Mitchells & Butlers, the All Bar One pub chain whose boardroom resembles one of the worst bar brawls in stockmarket history.

It was announced yesterday that four directors would be leaving the board. One, Richard McGuire, had been appointed by the company's biggest shareholder, Piedmont, which is an investment vehicle of Joe Lewis.

In the ascendancy is Simon Laffin, who was yesterday appointed chairman. Laffin and his allies on the board have expressed concern at the strained relations between the board and a small number of large shareholders, especially Piedmont which, through McGuire, has vetoed key board appointments. M&B made its concerns public on Monday and plans a representation to the Takeover Panel.

Laffin is using the spotlight of publicity and disclosure to test the motives and resolve of the shareholders which the company says are undermining M&B's board. He's going to consider further appointments to the board, all of which will be voted on (including his own re-election) next month. His career as chairman could be short-lived. But at least all shareholders now realise how dysfunctional the company's governance has become and can buy and sell shares with more clarity. They have only Laffin to thank for that development.

UK Capital Investments Group News, December 2009