If we were living in less ‘interesting times’ – as the Chinese proverb puts it – the Butterfill Act would quite possibly now be fundamentally restructuring the mutual sector, particularly those mutuals providing financial services.
The Butterfill Act – named after the sponsoring Conservative MP, Sir John Butterfill – enables mutuals of different types to merge. They were previously unable to do this, unless they demutualised. Clearly the measure is a very helpful one for the movement and we should thank Sir John and also the Mutuo think-tank and its chief executive Peter Hunt for their work in supporting Sir John to get this on the statute book.
As readers will be aware, the first merger to take advantage of this Act will be that between CFS and the Britannia Building Society – assuming the latter’s members endorse its management’s recommendation for the two organisations to come together.
But the original bill was not formulated with CFS and Britannia in mind. Various mutual organisations lobbied Sir John, encouraging him to put forward the measure. Sir John will not say who these mutuals were, but his constituency is Bournemouth West. One of the largest local employers is the Liverpool Victoria Friendly Society – or LV=, as it chooses to brand itself these days – which is also one of the biggest mutuals in the country.
Assumptions that Liverpool Victoria is keen to embark on mergers with, or takeover, other mutuals may be wrong, according to its director of communications, Nigel Snell. “We have no current plans,” he says. He adds that even if it had, “we wouldn’t talk about it”. But, unlike most people in the financial services, even in mutuals, Snell is clearly up to speed on the Act. “It is a sensible piece of legislation,” he says when contacted without prior warning. Whether his knowledge should be taken as inferring anything of significance it is difficult to judge. “I’m not saying we would not ever do it,” he adds.
Superficially, there would be enormous attractions in bringing together a large friendly society with a large building society – it could create comparable synergies to that of the merger between CFS and Britannia. A friendly society such as LV would instantly have a massive distribution operation, potentially increasing sales, without adding overheads. Again, says LV, this assumption is misleading.
“It would be a massive step for us to become a high street retailer,” says Snell. “It is not part of our plans to become a high street retailer. I could not talk about whether we would use that legislation. That is something we would talk about only when the time came.”
My interpretation of the conversation is that LV is clearly aware of the opportunties presented by the Butterfill Act, but, unlike CFS and Britannia, does not believe that the time is right. Indeed Snell points out that the collapse in talks between the two life mutual insurers Royal London (which owns Scottish Life) and Royal Life highlights the difficulties in conducting mergers and acquisitions in the current economic climate. That reality is true across the business world, with M&A activity noticeably down at present.
In fact, it is easy to see why a merger would be unattractive in existing circumstances. Confidence in the building society sector is at a low point. This has been emphasised by a report from credit ratings agency Moody’s, in which they downgraded nine of the UK’s largest building societies, including the very largest, Nationwide.
The exercise undertaken by Moody’s should be respected, but not given excessive credence. Moody’s evaluated societies’ ability to withstand a much more severe collapse in residential and property prices than is actually likely to happen – it asked whether the societies would cope with a fall in house prices of 40% and 60% from peak prices. While prices could, just conceivably, drop to something approaching 40% below peak before they bottom out, a 60% fall is extremely unlikely. There are signs that falling prices are now levelling out, at about 20% below their 2007 heights.
But it is nonetheless worrying that many of the giants of the sector have been fingered – Coventry, Skipton, Yorkshire, Newcastle, Norwich & Peterborough, Principality and Chelsea, as well as Nationwide. In fact, some of those now rated by Moody’s as weak – Chelsea, Yorkshire, Skipton and Nationwide – have stepped in to rescue failing societies. The list includes some societies that were regarded as the stars of the sector – Yorkshire (which David Anderson headed, before moving to CFS), Skipton, Norwich & Peterborough and Principality.
One name in the list that is not a surprise is that of the West Bromwich Building Society. Its profile is worryingly similar to that of the now collapsed Dunfermline Building Society. West Bromwich (like Chelsea) has been downgraded to a Baa3 credit rating by Moody’s. The good news is that it remains investment grade and is not regarded as ‘junk’. But it ‘may be… unreliable’ and ‘have speculative characteristics’. If it is downgraded one level further, its future could ‘not be considered well secured’.
Members should not be over-concerned by the downgrade, said West Bromwich society. “The West Brom wishes to stress that it remains a safe and secure home for members’ savings, as evidenced by strong capitalisation and a high and increasing proportion of retail funding,” it said in a statement. “In fact, over the last year we have attracted 90,000 new members and have grown our retail savings deposits base by £1 billion.”
However, it would be wrong to skip over the reasons why West Bromwich and Dunfermline weakened. Both moved away from their traditional business models and bought mortgage loan books from other lenders, which now seem to have higher default rates than their own loans. At the time the loan books were bought, the societies apparently believed that they were high grade debts, when their status may not have been very good.
According to an ‘FSA whistleblower’, interviewed by the Financial Times, “We had unearthed incontrovertible proof that societies had been paying big prices for what were ostensibly the safest residential mortgages, but were in fact risky self-certification loans.” He added that societies had been “eaten alive by investment bankers”.
Incidentally, it is this occasional evidence of naivety in the ranks of the management of mutual societies that means I never subscribe to the campaign regularly voiced in the Daily Mail and Mail on Sunday to try to reduce the pay of senior management in building societies and other mutuals. Our sector needs to strengthen the capacity of its executive officers, even if that means competing (to an extent) with City salaries.
In the case of the West Bromwich Building Society, its involvement in the purchase of portfolios of other lenders’ loans was conducted through an arms length company, the West Bromwich Mortgage Company. People who took out mortgages with one lender found themselves debtors to another. One borrower told me that when he went to talk to the West Bromwich society, its staff were not even aware that it had set-up an arms length company to own and administer another lenders’ mortgages.
What I fail to understand is the rationale for the West Brom to venture out in this way, just as I cannot understand why Dunfermline got involved in the commercial, buy-to-let and self-certified lending that brought it down. In the case of West Brom, the society was also unable to come up with an explanation within the timetable of putting together this column. Readers may also wonder why the regulator, the Financial Services Authority, failed to put a stop to this type of higher risk lending. The FSA – quite reasonably, in my view – points out that it was not its job to stop societies making loans that Parliament had explicitly approved in legislative changes made in 1986 and 1997.
All of which brings us back to the issue of whether more mutuals will now take advantage of the latest piece of relevant legislation, the Butterfill Act. The good news from the Moody’s downgrades is that, contrary to predictions by some commentators, there is nothing negative said about the Britannia Building Society. But until all the bad news is out of the way from other mutuals operating in the financial services sector, there is unlikely to be any rush towards further mergers.