The Paul Gosling column
For an event held amidst a global economic crisis, this year’s Building Societies Association conference in Manchester was an upbeat affair. And that was how it should be. While a building society failure is not impossible, the sector has so far shown much ruder health than have some former societies that converted into PLCs. We all know about Northern Rock, but, in addition, Bradford & Bingley is now asking shareholders for extra cash; and analysts are worried about Alliance & Leicester.
“The last few months have been uncertain times for consumers and for anyone in the financial services sector,” said Adrian Coles, director-general of the BSA, with extreme understatement. “Building societies have been able to weather the storm partly because they are not as reliant as banks on the international money markets, nor have they been exposed to investments linked to the US subprime market to the same extent as other institutions. As such, savers have been turning to building societies as a safe haven for their money and [building society] CEOs expect this to continue.”
The truth of these comments can be seen in the most recent figures for deposits and loans. In March, societies received £1.26bn in savings, against £700m the year before. Societies took more than twice the amount in deposits that they loaned – net lending was £580m, down from £1.8bn the previous March. As savers moved their money to more trusted institutions, they transferred money away from the converted societies and into the real thing. It is a strong vote of confidence in the mutual sector in times of trouble.
Optimism within the sector was emphasised by John Goodfellow, chief executive of Skipton Building Society, who is chairman of the BSA for the coming year. “The turmoil in the financial services market and the impact of the credit crunch provide an ideal opportunity for the building society movement,” he said. “The fairness of mutuality and the inherent strength of our business models position us as the providers best placed to weather this storm.”
Iain Cornish, chief executive of Yorkshire Building Society and outgoing chairman, made a similar point. “We entered troubled waters in a fundamentally sound vessel. Societies generally are well capitalised, highly liquid and prudent businesses.” He added: “The sector dominated the best buy tables again last year and collectively we delivered more than £1bn worth of member benefits, and we consistently outscore the banks when it comes to quality of service.”
Speakers at the conference included Hector Sants, recently appointed chief executive of the Financial Services Authority. Recognising the importance of the sector, he told the conference: “Mutual building societies add a welcome element of diversity within the financial sector and, whilst we at the FSA do not endorse any specific model, we certainly encourage diversity as a way of adding strength and stability to the system and to encourage beneficial competition.”
Sentiment in the sector is generally positive. According to Coles, society chief executives believe that there will be a tough housing market correction, but that societies are well placed to resume lending when immediate pressures ease. Societies’ CEOs regard the “underlying economic factors” as still sound. Some 70% of chief executives said they felt optimistic about the year ahead. What is more, the Northern Rock has not merely reinforced customers’ trust in society – it has also strengthened the sense of mutual identity amongst societies, which is now stronger than at any time since demutualisations.
It is reassuring that one of the named priorities for societies over the next year is to emphasise the concept of membership and to provide even greater member benefits, stressing the gains achieved by mutuality.
Societies have reacted to the crisis environment by cutting back on loans and introducing more restrictive conditions. One hundred per cent loans have become a thing of the past: Nationwide will now only lend 75% loan to value for new customers, or 95% for existing members. Lending on buy-to-let is particularly subject to scrutiny, though the building society bosses say they retain confidence in the sector. There is also, understandably, a desire to increase lending margins in the current climate. This is, in any case, a requirement for many societies, given the need to meet higher solvency obligations imposed by banking regulations.
Despite this, the mood is positive. The BSA survey found that societies believe they have the reserves to meet a likely downturn – according to the leaked internal memo for housing minister Caroline Flint, house prices are expected to fall by at least 5% to 10% this year.
However, the health of the building society sector cannot be taken for granted. The current wellbeing is to a large extent the result of regulatory restrictions on their borrowing on the inter-bank market: at least half of mortgage lending must be financed from members’ deposits. The BSA has previously asked for that limit to be raised to 70%. BSA’s Adrian Coles tells us that this request is unlikely to be resurrected in the near future, while the FSA says that it regards the restriction as a fundamental mark of building society identity.
Another issue challenging societies and the rest of the mutual sector is how to retain its show of difference from the PLC sector, while operating effectively and efficiently. PLCs are increasingly perceived as excessively greedy, as they feed the often unrealistic demands of shareholders and executive directors. The bonus culture amongst executives is widely regarded as being a key factor that has driven unsustainable – and occasionally fraudulent – profit declarations by PLCs, while there is also disquiet that major banks such as Citigroup are continuing to pay dividends, even while needing massive capital injections. The mutual sector has, mostly, avoided serious ethical pitfalls, even though they must pay competitive salaries to attract top executives.
But the FSA’s Hector Sants provided the conference with a welcome warning on corporate governance. “If a building society is to survive, prosper, and bring real benefits to its members, it must have a good quality board,” said Sants. “A board, together with the senior management team, has to lead their society through these challenging, competitive and more complex times.”
Sadly, parts of the mutual sector failed to follow this approach in the past. If mutuals’ directors ever repeat past mistakes, motivated by greed or over-optimism, we could yet have another generation of Northern Rocks and Equitable Lifes.