Are building societies in danger of crumbling?
Are building societies becoming an endangered species? That may seem a strange question given that, in comparison to most of our high street banks, they are in pretty good shape.
Just one building society – the tiny Dunfermline – needed to be rescued by the government and the cost of that was miniscule in comparison to the £100 billion-plus cost of bailing out our banks.
Building societies have had to make write-offs on ill-judged loans, but these are insignificant compared with the billions wasted on property, private equity and the like by the big banks. Indeed, Leeds Building Society recently reported record profits for 2009.
Yet even Graham Beale, chief executive of Nationwide, the UK's largest building society, and chairman of trade body the Building Societies Association, admits that many societies will have suffered falling profits, or even losses, in 2009.
Credit-rating agency Moody's goes even further. "Many societies will find it increasingly difficult to survive," it warns, while other commentators also predict a further wave of takeovers and mergers in the industry.
Hit by the credit crunch
The problem is that the sector's very conservatism means it has been disproportionately affected by the fallout from the credit crunch, and the threats are coming from all sides.
Take deposits: building societies have stuck most closely to the traditional banking model of taking in deposits from savers and lending them out to borrowers, leavened with only a small amount of the kind of wholesale funding that was embraced so enthusiastically by the big banks.
But getting those deposits has become much harder. First, plunging interest rates mean bank and building society deposits are far less attractive to savers – the £30 billion taken in across the industry last year was the lowest for a decade, and building societies actually suffered a net £9 billion of withdrawals by savers.
Sales of collective investment funds and other investment-based products, by contrast, were at a 10-year high.
Competition for deposits
Competition for this dwindling pool of deposits is intense. The wholesale markets, which were so extensively used by banks in the run up to the credit crunch, are now all but closed.
That means retail savings are once again one of the main sources of finance for banks as well as building societies and that is pushing up rates.
While savers may think the 3.5% or so available on a few accounts is poor, it is some seven times more than the Bank of England base rate.
Building societies are hampered even more in the fight for savings for two reasons.
First, Northern Rock savers have had an explicit government guarantee, and the other state-owned banks an implicit one, that they will not lose any of their deposits while other banks and societies can offer protection for only the first £50,000 of savings.
The Northern Rock guarantee is to be lifted from 24 May 2010, which should help a bit.
Second, regulators are demanding that building societies set aside more capital to protect against future crises.
Adrian Coles, director-general of the Building Societies Association, reckons that between 20 and 25% of all new deposits must go to bolstering reserves rather than mortgage lending.
Nationwide's Beale warns that the rising cost of deposits and increased regulation means profit levels for most retail-funded institutions will fall. He adds: "The current level of retail pricing for savings products is not sustainable.
"That means at some point savings rates will fall in relative terms or, more likely, the cost of borrowing will increase. Neither outcome will be popular, but it is a basic commercial reality."
Mortgage lending down
The lending side is also suffering. Ray Boulger, senior technical analyst at mortgage broker John Charcol, points out that gross mortgage lending last year was £1.44 billion, which is little over half the level of 2007.
And remortgaging, Boulger adds, "created turnover as borrowers paid off one lender and borrowed from another". It also created fee income for lenders.
Societies' profits are also being squeezed by the fact that many of them offered borrowers variable rate mortgages that tracked base rates.
With interest rates now at 0.5%, the cost of providing these guarantees is prohibitive, particularly when savings rates are rising to attract deposits.
Lower savings, reduced remortgaging and a lack of wholesale finance means that the societies, as well as banks, are still having to restrict mortgage lending, and Coles warns that the recovery in house prices is making the problem worse as the small lending pool has to be spread among more expensive houses.
But Moody's warns that the shortage of mortgage finance could send the housing recovery into reverse: "The contraction in the mortgage markets will put pressure on house prices," which could also lead to more write-offs on existing loans.
Already, however, the disconnect between savings rates, base rates and mortgage rates is putting pressure on margins and forcing societies to become even less competitive than their banking rivals.
Statistics from Moneyfacts show that, since last April, 12 lenders have increased their standard variable rates – all of them building societies, including Nationwide, Skipton and Norwich & Peterborough.
Picking up the tab
Societies are also having to pick up what they claim is a disproportionate share of the cost of insuring against future bank collapses.
Coles points out that organisations which rely heavily on retail deposits have had to pay substantially more in to the Financial Services Compensation Scheme (FSCS) than those that finance themselves mainly through the wholesale markets, despite the fact that, barring a Northern Rock-style calamity, these deposits are far more 'sticky' than the funds provided by a handful of institutional investors.
Nationwide's Beale insists: "The sector is not in crisis. There may be individual issues, but the building society sector as a whole is far better placed than other financial sectors in the UK to tolerate current conditions."
Analysts at Moody's agree that some societies are better placed than others to cope with the crisis.
Moody's also says that lenders which have no, or only a small, exposure to mortgages that track close to base rates, such as the Leeds or the Principality, have been able to pass on the higher cost of funding to borrowers more effectively.
"Cost-cutting has been particularly effective for some lenders, such as Coventry and Leeds, helping to ease pressure on margins."
But Moody's adds: "We expect to see more consolidation in the sector in 2010 and 2011, with continued divergence among lenders based on the strength of their balance sheet and the scale necessary to compete in a tough operating environment."
There have already been plenty of these and after the Chelsea and Yorkshire merger there will be just 50 building societies left, with total assets of £335 billion.
Other such deals are inevitable. In February, we saw the UK's oldest building society, the Chesham, agree to be taken over by the Skipton.
Already, Nationwide accounts for around half of the assets of the sector. Boulger says: "A very large number of building societies are doing very little – lending in very restricted markets, such as a 30-mile radius of their offices."
He adds that mergers and takeovers will only be a solution for weaker societies if they find a stronger partner. "If you take over an organisation which is struggling, you have to be strong yourself."
But Coles insists the sector should not be written off. "There are challenges, but we are confident we will meet them. There is no question of worrying whether societies will survive."
This article was originally published in Money Observer- Moneywise's sister publication - in April 2010
Changing mortgages without moving home. Property owners chiefly remortgage to get a better deal but some do so to release equity in their homes or to finance home improvements, the costs of which are added to the new mortgage. Even though you’re not moving house, you still need to engage solicitors, conveyancing and the new lender will require the property to be surveyed and valued.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.