Mutual respect

13 February 2012 | By Samuel Dale

At last year’s Building Societies Association conference there were some blunt questions about the performance of the mutual sector.

Former BSA chairman David Webster, asked whether the sector had missed an opportunity in the wake of the financial crisis. Current chairman Peter Griffiths accepted this to be the case and cited slowness in product innovation as the primary reason.

Despite the open public contempt for banks, societies saw their market share dip in 2009 to under 15% while banks jumped as high as 82%, according to BSA figures.

In 2010 the trade body changed its reporting structures to include all mutuals, such as Co-operative Bank, and not just societies. Even accounting for the extra lenders, gross lending by mutuals stood at just 15.2% in 2010 while banks remained high on 76%.

But 2011 was the year the sector bounced back from the financial crisis as gross lending rocketed by 16%, compared with growth of 3.7% in the whole market.

Societies lent £23.6bn last year, up from £20.4bn in 2010, while the entire market grew from £135.3bn to £140.7bn. The BSA figures also show a 1.6% rise in market share for mutuals from 15.2% in 2010 to 16.8% last year.

By contrast, specialist lenders saw an even bigger increase in lending of 44% and although this is clearly impressive, it needs to be seen in the context of coming from a low base. As a result specialists saw their share rise from 5% in 2010 to 8% in 2011, a steep increase from the nadir of 2009 when they recorded just 3.5%. These rises came at the expense of banks - their share of gross lending fell by 3.6% to 75.2% in 2011 from 78.8% in 2010.

Mutuals’ net lending also began to recover dramatically from a worrying -£6.3bn in 2010 to -£2.2bn in 2011.

Such impressive figures for societies show they are finally making inroads into the major banks. It’s a sector on the up so the big question is why has it been such a good year and how have they managed to lend more?

Savings grace

The simple answer is that retail deposits were up by £4bn last year, compared with a rise of just £200m in 2010, giving societies a major shot in the arm through their primary funding channel.

With more deposits there is more money to lend and the correlation is clear with £4bn more savings and £3bn more lending in the sector. Reasons for the boost are a mixture of competitive ISAs, failures in wholesale funding and a flight to safety by investors.

Adrian Coles, director-general of the BSA, says fear in the stock markets is pushing investors to the safety of building societies.

“Previously people had taken the view that in such a low interest environment they were happy to expose their money to some risk,” he says.

“Last year some of these risks crystallised and many came looking for the safety of a boring building society to place their money. Products have also been attractively priced to bring in savers.”

Coles adds that the mutual sector has virtually no exposure to the eurozone crisis and the southern European economies facing debt crises.

Graeme Yorston, chief operating officer at Principality Building Society, agrees that the exodus to safe havens is lucrative for the mutual sector.

“More people are choosing to invest in societies than elsewhere,” he says. “One reason is nervousness in the equities market, which is making investors look for safe havens. Ongoing trouble in the eurozone means safety is a priority and societies can provide that.”

But while trouble in the eurozone has had a positive impact on societies’ funding it has had a negative impact for banks.

Ray Boulger, senior technical manager at John Charcol, says societies have also benefited from troubles in the wholesale markets.

“Banks are more reliant on the wholesale funding markets than societies,” he says. “This has inhibited banks’ access to funding and has made it more expensive if they do get it, as LIBOR is high.”

Banks are more exposed to the eurozone crisis than societies, which means they only have to worry about the indirect problems a crisis would pose.

“Societies have little exposure to the southern European economies of Greece, Italy, Portugal and Spain,” says Coles. “It is an area that societies don’t have to manage, whereas banks do. Obviously it is in no-one’s interest to see trouble in the eurozone as there are huge knock-on effects for the economy.”

An unstable Europe and rocketing LIBOR creates the fear of another banking collapse but without a government rescue this time around.

Some argue it is prompting investors to protect their money across numerous accounts under the government guarantee scheme. The scheme, amended after the run on Northern Rock in 2007, means the government protects savings up to £85,000 in each financial institution.

“Most societies are awash with cash because of the government guarantee scheme leading many savers to spread their savings across numerous accounts,” says Rob Jupp, managing director of BrightStar Financial. “It has been a major factor in boosting their savings which has allowed them to lend more.”

Slow to adapt

But societies have also been criticised for struggling to cope with the radical drop in interest rates and general fall out from the financial crash in 2008. As member-focussed entities, many had difficulty adapting to market shocks such as a low interest rate environment.

Chris White, chief executive of Hinckley & Rugby Building Society, concedes that it has taken mutuals time to adjust to the post-crisis environment.

“We have aligned our business models to the new order of low base rate,” he says. “When the base rate fell it took us all a while to adjust but we are back in the game now with competitive rates. We had a one-off adjustment to a world with less wholesale funding and more competition for retail funds.”

Adapting to interest rates was only one aspect of the new world order as the recession ripped through balance sheets and crunched credit.

Nottingham Building Society went through a planned reduction to its balance sheet during the crisis and it was not alone.

David Marlow, chief executive of Nottingham Building Society, says the sector has experienced a turbulent time.

“A number of societies have now dealt with the issues of the crisis and rebuilt their balance sheets,” he says. “We took a planned decision to reduce our balance sheet, which is now complete, and we can now turn our focus to rebuilding that position. I believe this is the situation with many societies.”

Dick Jenkins, chief executive of Bath Building Society, says societies hunkered down after the crash.

“Following the crisis societies went into a conservative mode,” he says. “In the past year they have realised there is good business out there that they must compete for. Societies are now more confident about their savings models and this gives them confidence to lend.”

The mutual way

Mutuals are certainly popular with politicians with everyone from the Prime Minister downwards embracing co-operative models in finance and beyond.

Yorston believes the mutual model is back in vogue and there has been a mutual renaissance.

“Savers are recognising it is a model that has been around for hundreds of years and can offer a stable place to invest,” he says. “Through talking to members we know the community high street presence is becoming an attractive feature. Societies have a clear connection with the communities in which they operate.”

White speculates that poor service levels at major banks could have caused customers to leave for the mutual sector.

“I can only guess at the service levels of major banks but there are advantages to using societies,” he says. “You can speak to one person who will call you back, which makes us easier to deal with.”

All this means the political situation for societies has long been superficially favourable with warm words from all parties. But the messages have been mixed with, Northern Rock sold to the private sector amid calls from the BSA and more than 100 MPs to remutualise the bank.

But the Independent Commission on Banking’s proposals, which have been adopted wholesale by the government, praises societies. The BSA is clear this is a vote of confidence in societies, and combined with capital requirements from Basel, gives them a huge advantage over banks in the coming years.

“The ICB highlighted that societies were well regulated and could be used as a model for ring-fenced retail operations and the government seems to have accepted these recommendations,” says Coles. “Banks are facing huge reorganisation costs whereas societies don’t face higher capital buffers and ring-fencing.

“They don’t face that huge diversion of management time on splitting themselves up and can instead focus on customers. I am confident that all building societies’ activities will fall within the ICB ring-fence.”

Reinvention

With more cash, relatively favourable conditions in Europe and regulatory and political backing, societies are well placed to lend more. As the big banks have focussed on prime, vanilla customers societies have reinvented themselves as boutique specialists in areas such as shared ownership while still offering flexible underwriting and the human touch.

Sally Laker, managing director of Mortgage Intelligence Holdings, says the amount of building society mortgages it distributed rose by 57% in 2011.

“This year-on-year increase is a direct result of their flexible stance and willingness to look at new ways in which to grow their product offerings by reaching out to people who don’t necessarily fit the standard criteria, but are otherwise good quality borrowers,” she says. “The mutual sector has come into its own in the past year. We have seen a wave of innovative products and a focus on competitive pricing and a personalised approach to underwriting.”

Boulger says societies have been more innovative than banks with some interesting products in niche areas.

“Finding ways to lend money is not difficult right now but societies have certainly been more innovative than the major banks,” he says. “Societies have proven far better at finding niches and also operate a more common sense approach to underwriting in contrast to the computer says no approach at some major banks.”

Since the demise of self-cert mortgages the self-employed have struggled to access mainstream mortgages without extensive records. Such a niche is exactly the type of area that societies have been able to move into during the past year.

“The societies we deal with show a flexibility and an understanding of what makes a good loan,” says Jupp. “They have been particularly good at self-employed mortgages and can make decisions on information such as management accounts.”

John Eastgate, sales and marketing director at Saffron Building Society, says it takes a more practical approach to self-employed mortgages than banks and doesn’t require such an array of documentation.

“We also take a more practical view of company directors and owners obtaining mortgages,” he says. “Buy-to-let is another big area for us and while we are not doing the volumes we had before the crisis we are active in that space.”

Jenkins says societies recognise the need to lend in niche areas such as buy-to-let and shared ownership.

“These are important considering where the mortgage market is right now, especially for smaller societies,” he says. “More societies are getting into different types of lending.

“For example, self-build was probably offered by two or three lenders in 2008 and now there are around a dozen. The vacuum left by the exit of specialist banks has created an opportunity for societies.”

Eastgate says Saffron has targeted the self-build market during the past few years.

“We have definitely established a market for self-build mortgages,” he says. “We went from a limited offering and operating only through BuildStore, the established self-build broker, to a wider approach. We have underwritten some interesting projects on everything from garage conversions to homes being knocked down and rebuilt on a grand scale. There is a broad spectrum on what self-build does.”

FTB focus

First-time buyers have also seen some innovation from building societies notably from the big beast of the sector, Nationwide, and its Save to Buy scheme.

Andrew Baddeley-Chappell, head of mortgage strategy and policy at Nationwide, says Save to Buy allowed first-time buyers to access a range of mortgages with just a 5% deposit. He points out that it is one of only a handful of lenders offering mortgages at 95% LTV.

“Throughout 2011, we continued to bring innovation to the sector, particularly in the first-time buyer market,” he says.

Such high LTV deals herald a return to the traditional role of societies to collect savings and then lend to the community. Coles believes the focus on first-time buyers means societies are now becoming recognised as specialising in this area.

“There has been particular attention by building societies to niche areas such as shared ownership, self-build and high LTV loans when appropriate,” he says. “Many now recognise that 95% LTV loans is what building societies are for.”

Brokers highlight other noteworthy schemes such as Accord Mortgages’ hybrid fix and track mortgage, long-term fixes from the likes of National Counties and Saffron’s affordability calculator, although it must be said the list is not exhaustive.

Small fish

The specialist lending provided by certain societies is welcomed by the industry but the amount of overall lending in the mutual sector is still small beer when compared with the wider market.

The money involved is insufficient to tackle the problem of good mortgage customers being turned down or to effectively service niche areas, and far too low to give a real boost to the entire mortgage market.

For example, Saffron increased its lending by 10% in 2011 but only to £145m while Hinckley & Rugby more than doubled its lending but only from £35m to £77m. Even Principality only reached £1bn after a 6.5% increase between 2010 and 2011.

While others such as Yorkshire Building Society, Skipton Building Society and Coventry Building Society have a larger presence in the billions, Nationwide dominates the sector.

Providing well over half of all mutual lending, Nationwide increased its lending by 48% in the six months up to September 30 2011 to £8.9bn. It makes more than half of all mutual lending and the fluctuations in its business can have a major impact on the figures for the sector.

Apart from Nationwide the small volumes of many societies’ deals can be a source of frustration for brokers. Dominik Lipnicki, director at Your Mortgage Decisions, says the amount of funding at mutuals can be filled before brokers have a chance to grab it.

“It is difficult for building societies because they can’t compete with the big banks so they try to specialise with quirky criteria such as long-term fixes or first-time buyers,” he says. “But we have seen deals such as the 10-year fixed rate from Norwich and Peterborough fall away quickly due to high demand.

“We are seeing good ideas and products but the funding is so small that they get taken up quickly. It is the biggest problem for brokers as they try to be an expert on niche products but as soon as they recommend something it has gone. It is made worse as sourcing software isn’t geared up to deal with these short-term deals.”

The billions involved at major banks make the fluctuations in their lending appetites the most important factor to the mortgage market.

Consolidation

It isn’t all good news for mutuals as the sector has gone through an enormous shake-up in recent years. Mergers and consolidation have been a regular occurrence with the likes of Nationwide, Yorkshire and Coventry all bailing out a number of failed institutions.

Dunfermline Building Society needed state aid to survive while Cheshire Building Society, Chesham Building Society, N&P, Derbyshire Building Society, Scarborough Building Society and Chelsea Building Society, to name but a few, are all examples of institutions that couldn’t survive alone.

Mergers mean the total number of building societies has fallen below 50 for the first time in decades.

“In some ways it is surprising there hasn’t been more consolidation in the past few years,” says Boulger. “It’s not just funding problems but the regulatory burden too that falls harder on small lenders. It is unlikely there will not be any more mergers but I don’t expect the trend to change and see a rush of them.”

The expectation is that the sector will not halt its declining numbers but as the UK recovers and the fortunes of societies and banks improve, the nature of mergers will change. Rather than desperate bailouts by Nationwide or the government, consolidation may be positive in the future.

“The trend to consolidation and a smaller number of societies will continue but the quality of mergers will change,” says Marlow. “Whereas the consolidations of 2008 and 2009 were effectively rescue acts, now mergers will be positive moves to build better businesses.”

Eating into banks’ market share

But the future appears bright for mutuals especially with the boost to savings and lending in 2011 following a stagnant period since the crunch. The increase in market share at the expense of banks will be particularly pleasing for those in the sector.

The mutual sector is well placed to continue eating into their market share as banks face the eurozone crisis and mountains of regulation causing their businesses to face issues reflected in rising LIBOR.

Building societies escape largely unscathed from these problems and enjoy the reputational advantages of simply not being bankers.

Rather than being bashed like the banks, politicians are jumping over themselves to hug mutuals and praise the model.

All this bodes well and shows that mutuals have bounced back from the crisis but have plenty of space to climb further.

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