Phil Lee, group FD of Britannia Building Society

Having discovered a still-living prehistoric ice-man in the sleepy suburbs of
his home town, Kyle, the star of sardonic hit US cartoon, South Park, was aghast
at suggestions he should be put on show as a tourist attraction. “Little boy,
sometimes what’s right isn’t as important as what’s profitable,” he is soon
told.

At Britannia, the UK’s second-largest building society, however, the opposite
holds true – sometimes what’s profitable isn’t as important as what’s right. As
group finance director Phil Lee explains: “In the member part of the business,
we’re only seeking to make sufficient profit to maintain the capital ratios. So
we’re not driving to maximise profit and we’re not targeting,” he says. “There’s
always a minimum level below which it’s not reasonable to go, but, as an
example, the bonuses for the guys in the member business are for hitting the
minimum level. They don’t get extra bonuses for generating extra profit.”

It’s an odd concept. But building societies, by their very nature, are odd
organisations and not ones that mirror the ethos of a capitalist society – they
are, rather, a by-product of capitalism, borne out of a community’s need to look
after the less well-off members of the population.

It is a sector that has gone through a huge amount of change over the past
two decades – Abbey, although often still referred to as a building society, was
the first to de-mutualise when it listed on the London Stock Exchange in 1989.
There followed a spate of de-mutualisations until last year the circle was
completed and the UK saw its first re-mutualisation when Britannia acquired
Bristol & West from the Bank of Ireland. Today, there are just 63 societies,
Britannia being the second largest, after Nationwide, with group assets of
£23.3bn.

Lee has had perhaps the most unique view of the de-mutualisation process,
having been at Bristol & West when it was de-mutualised and then at
Britannia when it re-mutualised it. “It’s actually quite a tough process. It’s
tough in a range of ways. You’ve got to go through all the Stock Exchange rules
for a listing, so you’ve got all the corporate finance stuff to go through,”
says Lee. According to Lee, that and the “huge” data cleaning process required
to meet robust regulations are the “big two” of the de-mutualisation process. At
one point, 15% of the organisation were working on the project.

Mutually beneficial

Because of this, it’s fair to assume that Lee would not support a return to
plc status, both because of the work involved and because he seems to genuinely
believe that running Britannia as a mutual is better for its clients. “I’m a
strong believer that we can deliver far better for our customers as a mutual
than we ever could if we had shareholders and customers to balance,” he says. He
also believes that the mutual sector helps keep mortgage prices in check.

It seems his members agree – almost 400,000 of them voted overwhelmingly to
remain as a mutual at the society’s annual general meeting on 30 March. (An
indication of how involved in the business members feel is evident in the voting
figures – 27% returned their forms).

Among those were 69,000 clients of the newly acquired Bristol & West, who
also seemed keen to benefit from Britannia’s mutual status. This should probably
come as no surprise. Britannia has a unique profit-share programme, which it
calls the Britannia Membership Reward scheme where members are allocated points
depending on the products they hold. These are then converted into hard cash
and, in February this year, £48m was distributed among 900,000 eligible
Britannia members.

The acquisition of Bristol & West is a fascinating case study.
Britannia’s investment bank was aware that the Bank of Ireland wanted to get rid
of the retail side of the business, yet wanted to keep hold of the goodwill to
allow it to carry on marketing and selling mortgages. Britannia, on the other
hand, needed the retail funds offered by the Bristol & West customer
accounts in order to grow its own mortgage business.
“It gave us more than £4bn of retail funds – with the rules we’re under, we
can’t have more than 50% of the funds from the wholesale markets,” says Lee.
“Once you get in above 40%, your headroom gets restricted. So to get £4bn of
retail means that we could, in theory, get £4bn of wholesale funds to match it
and have £8bn more than we could [to offer as mortgages].”

Not only that, the acquisition also handed Britannia 97 new branches and, as
a result – and after conflicts with existing Britannia branches were taken into
account – the building society gained 65 new towns. It was, by all accounts, a
marriage made in heaven and a £150m deal was thrashed out and signed in May
2005.

Keep costs in check

Running a mutual society where profits are certainly not the panacea brings
its own set of challenges for Lee. Driving the bottom line of a business brings
with it a certain clarity of thought that he and Britannia do not enjoy. So how,
for example, does Lee ensure that costs are kept in check?

“It comes through our givens, the second one to be financially strong,” he
says, describing one of six pledges the society holds as the core to its being.
“Within that financial strength is [a number of] components and cost efficiency
is a strong one. So across executive teams we’ve all got joint objectives for
group efficiency ratios and cost asset ratios and cost income ratios. And
they’re built into our bonuses.” The other five “givens” are: to remain mutual
and act in the membership’s best interests; to be ethical, socially responsible
and a model of compliance; to be a great place to work, grow and develop; to
reward members through the loyalty scheme; and to maintain an extensive branch
network. They are the cornerstone of Britannia’s philosophy and look down on
directors from a plaque mounted in the boardroom at its Staffordshire-based he
adquarters.

Although admirable, the six “givens” could potentially make running the
business very difficult indeed, as there are so many stakeholders to keep happy.
Lee says he has two tasks: “to understand where we are and to understand where
we are going”. But in order to do that, his key performance indicators are
likely to be very different from your average plc. “I use the customer and staff
satisfaction scores in terms of where I think we are going,” he says. But,
again, he points to costs. “The easiest thing in the world as a finance director
is to cut costs. To cut costs in a way that doesn’t damage the business is the
challenge. That’s what we’re forever looking at.” Something that will ring true
with every finance director in the land.

Britannia’s sixth “given” is to maintain an extensive branch network, which,
on the face of it, may seem a little passé – especially in an era of internet
banking where the trend has been to close branches to cut costs and market the
benefits of online. But Lee insists that is 4 what his members want and points
to the fact that Halifax has committed itself to opening 100 further branches in
the south east as vindication. “We have many more branches than comparably sized
competitors and the reason is that our members tell us they want the branches.
As long as the membership wants the branches, subject to at least breaking even,
then we will have those branches,” he says.

Fast integration

Integrating the acquisition of Bristol & West is at the top of Lee’s
current agenda, followed by the adoption and interpretation of international
financial reporting standards (see box, page 34). “To give you some feel for the
scale of it, I have 150 people directly working on the [integration] programme
at the moment. They’re the ones who are full-time. In addition, we have dozens,
if not hundreds, working some or most of the time around the rest of the
business on areas relating to the acquisition,” he says. Lee is the board-level
director responsible for the integration and that includes the technology
systems.

“We have until the end of June – nine months from the time we bought it,”
says Lee. “I don’t believe you’ll find anybody that’s done it any quicker. It’s
a tough challenge for the guys. Bristol & West had just under 2,000 products
and we’ve had to understand the nature of all 2,000.” Although Britannia will
absorb only a fraction of those 2,000 products, it is still a massive task to
rationalise and harmonise the ones they want onto one common system.

With any systems integration of this size there are two distinct
responsibilities and challenges. Mapping customers’ products across to existing
product lines (Britannia has made a pledge that no customer will be financially
worse off as a result of the transaction) and meeting the stringent regulatory
compliance burden associated with such sensitive data. “It’s the toughest
programme I’ve had in my experience,” says Lee, describing the two IT systems as
being “not the least bit compatible”.

“The drive is to do it as fast as possible so you’ve then got a lot of
inter-related things that need to be done at the same time. A key part of my
role has been keeping rating agencies informed on what we’re doing and why, and
keeping the Financial Services Authority up to speed.”

The FSA keeps a beady eye on proceedings. As well as Britannia’s normal
supervisor, who keeps up with the integration, and the reports that Lee sends to
the FSA at the same time as he passes them to his board, an external reviewer
comes in every two months to measure how the process is going, reporting
directly to Britannia’s chief executive, Neville Richardson.

But all things going well, by the summer there will be no sign of Bristol
& West and Britannia will be a 265-branch network building society. Lee says
that maintaining the culture and strategy of the business through the
acquisition and into the future is another one of his key challenges and
priorities. He says the level of staff satisfaction that Britannia currently
enjoys is as high as in any company in the UK – 95.8% are either satisfied or
very satisfied with working there, apparently. And judging by the voting figures
and AGM results, it seems that the society’s members are also similarly
satisfied.

There is, however, always one. In a letter to the Independent newspaper on 16
March, Britannia member Robin Graham vented his frustration. “The highest paid
director is shown as receiving total remuneration and other benefits of £603,000
and the board as a whole have received £1.973m,” he wrote. “As a ‘mutual’
building society, do members not have a reasonable expectation that the board
will reward themselves at an appropriate level?”

You can please some of the people…

STANDARDS LIFE

Although not a listed company, Britannia must comply with IFRS because it has
listed debt securities. However, finance director Phil Lee insists the group
would have adopted them anyway, as part of its compliance undertaking.

That is not to say that Britannia is particularly happy with them. Even the
group’s chairman Ian Adam has something to say on IFRS in the 2005 annual
report. “I do question the complex approach currently being adopted and the
value of some of the extensive disclosure requirements that we are required to
make,” he says. The chairman is one of four accountants that sit on the
Britannia board.

Lee admits that adoption put “huge” amounts of pressure on his team and
points to reporting income and swaps as areas where problems may arise. “My view
is they’re mixing up principles with detailed rules. They talk about the
standards being based on principle, well you go into it and they’re not,” he
says.

Pensions is another area of concern. “I had to take a budget to the board in
November for the following year and I [didn’t] know what the pension costs
[were] going to be because you can’t evaluate them until 31 December when you
have the interest rates, because the standard is so prescriptive that you have
to use the values on that day to then compute your pension costs,” he says. “So
we’re a month into the new year before I know the pension cost that’s going to
hit the P&L.” Lee estimates that Britannia will have a pensions deficit of
about £10m on an actuarial basis, on assets of about £330m.

Another problem he found is that everything takes so much longer. He says
that, previously, 95% of queries could be settled through a conversation with
the audit partner, but now “almost everything” has to be referred back to
technical committees.

“It’s a new world. We’re making sure we understand the consequences of it,
and that’s quite a challenge. If you’re in marketing quite rightly you haven’t
got accounting standards at the top of your mind, but these standards change the
actual product design,” he says.