Building societies are angry – and no wonder. The collapse of former society Bradford & Bingley has left them facing massive financial contributions, significant reductions in their profits and a cost to their members through less favourably priced products.
Bradford & Bingley went bust, provoking its nationalisation by the Treasury. To put it in the formal words of the Treasury, “Bradford & Bingley was unable or likely to be unable to satisfy claims against it”, as determined by the primary regulator, the Financial Services Authority.
As a result, the Treasury, the FSA and the Bank of England had to work-out a rescue deal for Bradford & Bingley customers, which also did not have a devastating impact on the financial markets. That rescue involved the Treasury nationalising part of the bank, while B&B’s retail deposit business and branch network were transferred to Abbey – the former building society that is the UK arm of Spanish banking giant Banco Santander, which is also in the process of undertaking a rescue merger with Alliance & Leicester.
But Santander had to be given a guarantee to take over parts of a failed business. This led to the Treasury authorising £14bn to be paid to Abbey, backing the transfer of the retail deposits. That £14bn is being financed by a short-term loan from the Bank of England, to the body that underwrites banking deposits – until now, to a maximum of £35,000 per customer, per institution – the Financial Services Compensation Scheme (FSCS).
This is not the end of the FSCS’s involvement in the B&B rescue. It will have to pay interest on the Bank of England loan of £450m, due in September next year. Further contributions from the FSCS will be required if substantial losses are incurred on the B&B loan book. The book value of the B&B loans is £42bn, but it has arrears of around 3% – much higher than most other lenders. This explains why, just before the rescue, B&B announced it would take on more debt collectors, while it was making workers in some other parts of the business redundant.
B&B loaned mortgages at the high risk end of the market – sub-prime, self-certified, buy-to-let and high loan-to-value. We can therefore expect significant levels of bad debt on those loans. If the write-offs exceed £3bn, then the FSCS will have to provide further funds.
Of course, the FSCS does not have ‘free money’ – it comes from somewhere and ultimately it is not from the Government. While the short-term funds come from a Bank of England loan, income for the FSCS is provided by the industry itself – and this is where the building societies’ anger comes in. The costs will be met by additional, and very substantial, contributions from banks and building societies.
The irony is unmistakeable. Building societies have a safe business model, they are well managed, their losses from high risk loans have been small. In the history of the FSCS, it has never been required to bail-out a building society or its customers. It has, though, had to support several credit unions – since the establishment of the FSCS in 2001, every single FSCS rescue had been of a credit union, until B&B collapsed. Several small banks, plus BCCI and Barings, had to be rescued prior to the creation of the FSCS.
“There’s quite a significant cost here for societies,” says BSA spokeswoman Rachel Le Brocq. “It is very annoying that institutions that have behaved very responsibly are being asked to pick-up a bill for those institutions that have behaved less responsibly.” While the BSA is sure this will damage societies’ profitability, it has not yet been able to produce an estimate of the actual cost.
The BSA is confident that societies and their members will not have to rely on the FSCS for the foreseeable future, either – despite the current market turmoil. Societies have a low-risk business model, which limits their exposure to inter-bank lending difficulties.
It is true that the Derbyshire and Cheshire building societies had to be rescued by the Nationwide. But the BSA does not believe that any more rescue mergers will be required. And, of course, this problem within the movement was solved within the movement, without recourse to outside financial support.
When KPMG published its annual Building Society Database in August it predicted that the property downturn and related financial stress would push more societies into merger. Richard Gabbertas, author of the Building Society Database and a KPMG partner, said: “It is inevitable there will be more consolidation as market conditions worsen.”
In a sense, KPMG has already been proved right with the circumstances of the Derbyshire and Cheshire societies, but the BSA believes that future mergers will take place from positions of strength, not weakness. “Maybe there will be more mergers,” says Le Brocq, but not as a result of crisis, she suggests.
“Only connect,” wrote novelist E.M. Forster. It is the connections of bad lending decisions with the whole of the global financial decisions that has brought the world’s markets to their knees. And in the UK, connections from the depositors’ guarantee scheme continue to bind the renegade building societies to the real thing.
One lesson that can easily be drawn is that it is in the interests of all financial institutions that regulation is sufficiently tough that we can honestly say about Bradford & Bingley, Northern Rock, Alliance & Leicester and Halifax – never again!