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Western EuropeJune 5 2005

Building societies retain resilience

The building society sector has survived demutualisation and clung on to sizeable shares of the mortgage and savings markets. But could there be more mergers in the pipeline? Michael Imeson reports.The day after Tony Blair was returned as UK prime minister for a third term last month, the outcome of a markedly different sort of election was announced. Philip Williamson, chief executive of the Nationwide Building Society, was voted chairman of the Building Societies Association (BSA) for 2005/6.
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Although Mr Williamson’s election was little more than an automatic elevation from his previous position as deputy chairman, it presents the building society movement with an opportunity to re-state its case as a significant player in the financial services sector.

A few years ago, pundits were predicting the eventual disappearance of mutually-owned building societies, as most of the biggest had converted to bank plc status. Today, the demutualisation threat is over, and the societies that remain have a healthy share of their chosen markets.

Commenting on his election, Mr Williamson said there were “some real opportunities” for the building society sector. “Without shareholders, we have an inherent advantage which we must continue to drive home. People like doing business with organisations that they can trust to put them first.”

Mutual status

A building society is a mutual institution: it is owned by its savings and mortgage customers – the “members”. These members have rights to vote and to attend and speak at meetings. Each member has one vote, regardless of how much money they have invested or borrowed, and the society is run by a board of directors.

Building societies are different from banks and other companies in that they have no external shareholders requiring dividends. They therefore run at a lower cost than banks, purely for the benefit of their customers/members, which allows them to offer cheaper mortgages and better savings rates.

There are now 63 societies, down from 80 in 1995, 167 in 1985, 382 in 1975 and 2286 in 1900. They were set up in the 19th century to finance home ownership at local level. Their decline in number has been mainly due to mergers, but in the 1980s and 1990s some of the larger ones – such as Halifax, Northern Rock and Woolwich – converted from mutual to plc status.

Considerable clout

Today, they may be small in number, but not in clout. The societies that remain have combined assets of more than £240bn. They have 15 million savers, 2.7 million borrowers, 33,000 full-time staff and just over 2000 branches. Since the 1980s, many have diversified from their core mortgage and savings products to provide current accounts, credit cards, cash machines, unsecured loans, insurance and estate agency services.

A recent report from ratings agency Standard and Poor’s (S&P) concluded that building societies will continue to provide a competitive alternative to banks in the mortgage and savings market. But it cautioned: “The sector will likely shrink further as margin compression and increasing regulatory costs cause the smaller societies to seek scale economies through mergers.”

Any shrinkage is likely to be in numbers, not market share. Adrian Coles, the BSA’s director-general, told The Banker that building societies have “huge confidence” in their future. “They suffered a loss of confidence in the 1990s because of carpetbaggers [opportunistic small investors who became members so that they could vote for demutualisation and benefit from windfall pay-outs] but have recovered,” he says.

“They account for 20% of personal deposits and about 20% of mortgages outstanding. The Financial Services Authority, in its January outlook report, noted that the asset quality of building society mortgages was better than the banks’.

“There have been no building society mergers since December 2003. To say there will be no more mergers would be ridiculous, but they are resilient. They saw off the recession of the early 1990s. They saw off the carpetbaggers in the late 1990s and they have coped with the burden of financial regulation in the first part of this decade.”

Mr Coles makes the point that the number of plcs on the London Stock Exchange has fallen more sharply recently than the number of building societies. “In the five years to 2003, plcs on the main exchange and AIM declined by 40% , whereas societies declined by only 11%.”

He says that the risk of further demutualisations is “extremely low” because “societies have worked out what they are for”. In the late 1980s and 1990s, they compared themselves to banks. “But those left have sharpened up and realised they are different from banks and are closer to their roots. They operate on narrower margins, which keeps customers – their owners – happy. Banks by law have to put their shareholders first, not their customers,” he says.

If banks are not as competitive, why do they have such a big market share? One answer is that much of that share is held by former societies that have held on to their base for many reasons. “It’s not just price that determines what people buy; it’s where the branches are, their advertising, image and inertia,” says Mr Coles. “These are all important factors in allowing banks to keep customers, even if they don’t have the most competitive rates.”

Show of commitment

Mr Williamson told The Banker there was only a “slim chance” of more demutualisations because “those institutions that are left genuinely want to be building societies, behave like building societies and differentiate themselves from banks. They are more committed to the sector than before.”

Most societies have put in place arrangements that would make conversion to a plc more difficult and less attractive. Nationwide, for example, introduced “charitable arrangements” that apply to all new members from November 3, 1997. This means if it became a plc, any potential financial gain made by new members would go to charity. “This charitable structure has been mimicked by other societies,” says Mr Williamson.

Nationwide is the second largest retail deposit taker in the country, after Halifax (a former society, now part of HBOS), with 10 % of the market. It is the fourth largest mortgage lender, after Halifax, Abbey plc and Lloyds TSB/Cheltenham and Gloucester. With assets well in excess of £100bn, Nationwide accounts for about half of all building society assets. Mr Williamson accepts that its size distorts the sector to some extent, “but our principles are the same as any other society.

“Our core strategy is to continue as a society, while looking to improve the effectiveness of our organisation and to broaden our product portfolio. We now have one million credit card customers, a growing market share of personal loans and 7% of the new current account market.”

Regulation affects the sector slightly differently from banks. “Societies do not have to comply with some of the governance issues with which a plc has to comply,” says Mr Williamson. “But in terms of best practice, we at Nationwide will do everything that a plc would do.”

Respectable ratings

Michelle Brennan, an analyst at S&P, says the credit quality of the three societies it rates is good: Nationwide (A+, stable outlook), Yorkshire (A, stable outlook) and Britannia (A, stable outlook).

“They compare well with the top 50 financial institutions across Europe, for which the average is about A+,” says Ms Brennan. “The rated societies are strong entities with good business positions. They have strong balance sheets, and compare well with traditional banks.”

Their strength is due to their focus on mortgages and savings. But this focus brings risks. “They are both competitive markets and there are signs the mortgage market is decelerating ,” says Ms Brennan.

“Building societies don’t generate as high a level of profits as plc banks. This is partly through choice. They don’t have shareholder pressures, and Nationwide and Yorkshire have chosen to return profits to customers/owners by more competitive pricing. Britannia has taken another route, which is to pay a bonus to members, like a plc would pay a dividend.

“These mutual pricing and bonus policies mean the profits tend to be lower than for quoted companies. This can at times create challenges to finance growth and fund the balance sheet.”

Simon Walker, a KPMG partner, says that because societies are facing falling margins and a tougher market, they can no longer rely on their “traditional strategies” of growing their asset base faster than costs. “They are having to follow credit diversification strategies” – which means more buy-to-let mortgages, more light-weight sub-prime lending and more commercial lending. “The better and wiser managements are looking at cost cutting, too.”

Mr Walker believes that building society managers should undergo a culture change. “If they really want to succeed, they need to get out more and talk to their staff, customers and intermediaries. They should do the equivalent of what [supermarket] ASDA’s executives do: go out for a few days every year and stack shelves.”

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