What a difference a couple of months makes. In early October, the Building Societies Association assured the News that despite the oncoming recession there would be no more forced mergers following the rescue by Nationwide of the Cheshire and Derbyshir societies. Time has proved them wrong.
In normal times, eight weeks passes so quickly you hardly know its gone. These are not normal times. In the current circumstances all sorts of assumptions can change overnight, let alone in two months. In fact, apparently good assets turn bad in the flicker of a computer screen.
For building societies, there have been three groups of assets that have caused them severe problems. One is Icelandic banks, the second is buy-to-let mortgages and the third – well just mortgages generally, in the current market conditions.
According to the BSA, building societies held about £200m in Icelandic banks that have been unable to repay deposits. It sounds like a lot of money, but it needs to be put in context – it is about a fifth of the sum that UK local authorities held in the same banks and a mere 0.5% of total building society assets.
But reassuring though this sounds, this is a bit misleading. Most societies lost little if anything. Some lost, propotionately, rather a lot. Specifically, the Barnsley Building Society has had to be absorbed into the Yorkshire Building Society because of Barnsley’s £10m exposure to Icelandic banking. So although the Icelandic banks represented just 0.5% of all UK building society assets, some 5% of all societies deposits with Icelandic banks were made by one, small, society.
Barnsley has said that the potential loss of the £10m does not threaten the viability of the society, but does significantly reduce its holdings of reserves. Consequently, they say, a merger would be a better option. Barnsley told the News that despite even with the £10m hit (which may yet be reclaimed) that it remained within its regulatory capital limits.
Even before Barnsley’s problems were revealed, another Yorkshire society had been forced into a merger. The strong Skipton society – the sixth largest in the country, which has 19 subsidiary businesses – is taking over the Scarborough society. “Scarborough Building Society has seen difficult trading conditions leading to a substantial impact on profit and a resultant weakening capital position,” according to a statement from the two societies.
“In addition, the board of Scarborough has considered the possible impacts of continuing house price falls and the impending recession in the UK, and has concluded that the effect would be an unacceptable reduction in its capital resources and that, to fully protect the interests of its members, it should approach Skipton Building Society as its preferred merger partner.” It, too, told the News that it had not breached its regulatory requirements for capital.
But, despite the sense of optimism in the sector just two months ago, some societies have reached worryingly low levels of capital adequacy. The fact that societies – and, consequently, the BSA – have changed their minds about their capital adequacy positions in such a short period of time is, in a sense, no surprise. The level of crisis across the financial sector continues to catch people out. Another example is that the former society Bradford & Bingley issued a rights issue, suggesting that this would prop-up its capital adequacy position, but within days of completion it was recognised that this did no such thing and the bank had to be nationalised.
Impossible though it may seem, things are even worse in Ireland. Yes, we have had five large UK banks, including three of the very largest, nationalised or part-nationalised, but there are now fears that several Irish banks may have to merge if there is to be any domestic, Irish-owned, banking sector left. As part of the shake-out of the Irish banking sector, the EBS building society is in discussions with the Dutch mutual Rabobank and with Irish Life & Permanent (itself the remnant of a demutualised society) about one of them taking it over in a rescue deal.
Nor are the UK sector’s problems over. The credit ratings agency Fitch has just downgraded three building societies on the basis of a higher perceived risk exposure in the current market conditions. Both the Chelsea and Newcastle societies have been downgraded from A to A-. And, most worryingly, Britannia was similarly downgraded – putting a question mark against the proposed merger with Co-operative Financial Services. To put the credit ratings in context, these are still investment grade – but Fitch still had the Icelandic banks on an A rating at the beginning of this year.
Just how healthy the building society sector as a whole is depends fundamentally on how strong the housing market is and how quickly, if at all, prices recover and default rates return to normal. At present, we can assume that prices have not reached their bottom – that is certainly the assumption made by the Treasury in its Pre-Budget Report. And it is likely that there will be an increased rate of repayment defaults, which is where the real damage will come from. This is especially true in the buy-to-let mortgage sector, where some societies are exposed to a worrying degree.
So how bad is it? We just do not know – and predictions can turn wrong very quickly. Just ask the BSA.