Review of the year
What a year it has been. We knew it would be tough, but it was worse than that. The recession has been the most severe since the Great Depression. Inevitably, many mutuals went down with the wider economy.
The mutual sector most badly hit has been the building societies. The reasons for the decline of the Dunfermline, Chelsea, Barnsley, Derbyshire and Cheshire have been various – but they have formed something of a pattern.
Many were too determined to chase high interest rates and got caught out by the failure of the Icelandic banks. Others were engaged in sub-prime lending and mortgage securisations. Some committed too much of their loan books to commercial property and paid the price. One got hit by very high levels of mortgage fraud.
A director of a building society who I know socially told me of the vigorous conversation they had on his board. “We want to know why our earnings are not as good as other building societies,” the independent directors said, with a touch of anger. “Other societies are getting higher returns, lending more in the commercial sector!”
“They are wrong and we are right,” replied the chief executive. “Other societies are chasing returns by adopting high risk strategies. Ours is conservative and prudent. I do not believe that property prices will remain at this peak and we must ensure our mortgages are affordable and sustainable.”
And, of course, the chief executive was proven right. If only more building societies had the same sort of exchanges, with the same results, the sector would now be in a more healthy state. As it is, more enforced building society mergers are predicted by many people within the financial services industry.
We have also learnt more about the collapse of the Presbyterian Mutual Society. The judgement of an investigation into its failure from the Treasury was very critical of those who ran the society. “It seems clear …… that members had no idea their money was at risk… an impression that may have been underlined by the fact that the society offered financial products for which it should have sought authorisation”, said the Treasury. It added that the FSA had decided not to prosecute those in charge of PMS “at this stage”.
Like some building societies, the PMS had bet the business on property prices remaining high and loaned too much for speculative commercial property development. Moreover, too much of members’ deposits was put into fixed assets, making it impossible to repay them when there was a run on the society as rumours grew and confidence disappeared. I hope the lessons from this will be learnt more widely.
There is a wider resonance here – and one that could inflict lasting damage on the mutual sector. One element of the global financial crisis was the extent to which businesses were financed by lending, often very highly leveraged. The policy response has been to increase the extent to which businesses are financed by equity.
At its most extreme, this is demonstrated by the much more demanding capital adequacy rules imposed on banks. Several of the banks have had to make rights issues – calls for extra capital from existing shareholders – in order to meet these demands.
Mutuals clearly cannot make rights issues and the capital squeeze on various forms of mutuals is likely to be a recurring problem in the next few years. The Treasury and building societies have been working together on how best to overcome the problem. The preferred solution involves a variant on the traditional PIBS – permanent interest bearing shares – and involves the transfer of loans into a form of equity if the society cannot pay interest as specified.
This arrangement is clearly preferable to a building society ceasing trading or demutualising – but it is a slippery slope that could become more widely used and create a new type of semi-demutualisation.
Despite this gloom, there has been good news as well. Credit unions actually have had a pretty good 2009 – none have gone into default and needed rescuing by the Financial Services Compensation Scheme. That is the first time this has happened in several years.
However, it is very unfortunate that the Treasury has stepped back from its intention to transfer responsibility for regulation of Northern Ireland credit unions to the Financial Services Authority. And there is growing concern in the credit union movement about what would happen under a Conservative government if credit union regulation is moved from the reasonably sympathetic and knowledgeable FSA to the rather drier atmosphere of the Bank of England.
I am even less sanguine about the microcredit sector internationally. Increasingly the microcredit sector is being led by large banks, which are entering the market. While it might be said that the capital available for lending will increase substantially, I have no confidence that mainstream lenders will display the right levels of sensitivity or discretion in their debt collection processes.
One truly excellent piece of news during the year was the appointment of Ed Mayo as the new Secretary General of Co-operatives UK. Ed is a very impressive person, who had a strong record at both the New Economics Foundation and Consumer Focus. He has skills and perspectives to sell the co-operative movement into a wider arena.
On the retailing front, we have seen a very strong year for the Co-operative Group, which completed the Somerfield acquisition at the beginning of the year. Group revenues in 2009 were up by 27% and profits by 17%. And while the building society sector has struggled, the distinctive arrangements that lie behind Co-operative Financial Services have meant that it has avoided the structural problems facing building societies, while also benefiting from increased deposits as confidence in the big banks slid.
The merger with Britannia seems to be going well, as does the takeover of Somerfield. This lies behind some very confident remarks Peter Marks, the Group’s chief executive, who himself had a very good 2009 – having been named ‘Leader of the Year’ in the Orange National Business Awards.
In a recent Radio 4 interview, Marks indicated that more acquisitions are possible in the future. While Marks accepted that it was unlikely that the Group could get merger approval for more supermarket purchases, he suggested that CFS would be keen to do more deals to expand into a major player.
Marks was asked if wanted to make further acquisitions. “Not right now,” he said. But when the time was right, would the Group like to purchase Northern Rock? “Further down the line, when we have digested Britannia and Somerfield, absolutely,” responded Marks. Questioned further, Marks explained that he would not commit himself to a bid for Northern Rock, clarifying: “We would look at any opportunity like Northern Rock, when we have completed the integration of Somerfield and Britannia.”
It sounds as if 2010 will be a year of consolidation for the Co-operative Group, while planning for further growth opportunities in the years after that. There is a very real chance that the next few years will be much better than the last one.