While the large UK lenders enjoy the benefits of national coverage and can send out business development managers to contact and support local brokers, many regionalised lenders with mutual status risk being squeezed and now have to look in other directions in order to maintain profitability.
As has already been mentioned, carpet bagging has died down and building societies are again free to concentrate on serving their members, but are borrowers still interested in local lending and does it result in a better service for borrowers? And will finding new niches allow them to remain mutual?
The composition of the mutual building society movement has changed dramatically since Abbey National decided to become a plc in 1989.
Although there were no further developments until 1994 when Cheltenham & Gloucester announced it was to become a subsidiary of Lloyds Bank, by the time Bradford & Bingley floated in December 2001, 10 societies had demutualised, representing over two-thirds of the total assets of the sector in 1994.
Seven of these former building societies have merged into, or been purchased by, larger banks and the remaining three, B&B, Alliance & Leicester and Abbey National are still occasionally linked with take-over speculation. The remaining societies, led by Nationwide, have so far been able to resist the pressure from carpet baggers and the media to follow suit and also demutualise.
Building societies differ from banks and other plcs in that they are both owned by, and run for, their members. Accordingly societies have no external shareholders expecting to receive dividends; any profits are retained to allow the society to develop for the benefit of its members.
Because profit maximisation is not the principal goal of the societies and they are able to run on lower costs by not paying a dividend, they are often able to offer cheaper mortgages and better rates of interest on savings than their competitors.
There have been several arguments put forward for conversion to plc, and it is in considering these in turn that it is possible to see whether there are likely to be further conversions within the sector, and whether building societies have a viable future.
Freedom to diversify
One major reason given for conversion was that they were looking to diversify in order to secure a stronger position to participate in the ongoing and accelerating pace of change in the financial system.
The Building Societies Act 1986 was prescriptive in terms of what activities a building society could undertake, and therefore in order to diversify, building societies had to convert. However, due to the rapid changes within the financial services market during the 1990s it was recognised that the constraint within the 1986 Act was inappropriate, and accordingly it was largely removed by the Building Societies Act 1997. Following this legislation a society can undertake any activity as long as it is not expressly prohibited by legislation, and is approved by the members. This has paved the way for societies to diversify into new markets.
It has been suggested that plcs are more accountable to their shareholders than mutuals, and accordingly shareholder pressure forces institutions to be more efficient. There is little evidence to support this proposition; building societies are fully accountable to their members, and margins at the converted institutions tend to be much wider than at continuing building societies.
Converters claimed they needed access to increased capital, however some converted institutions have since returned capital to shareholders.
Over many years reserves have built up within building societies and members realised conversion was an opportunity to unlock this embedded value, and enjoy the resulting ‘windfalls.’
While all organisations need reserves to protect themselves from adversity, it can be argued that by building up excessive reserves the mutual is not acting in the best interests of its members as it is not passing its profits back to the members by lowering mortgage rates or increasing interest rates on deposits. Conversion gave an opportunity for some societies’ reserves to be returned to members, although many of the beneficiaries had contributed little to the build-up of reserves in the first place.
However, to their credit, the remaining societies have acknowledged their obligation to members by returning profits through lower mortgage rates and higher savings rates.
Whatever the merits of conversion it appears clear that apart from the windfalls, existing and potential borrowers and investors of the converters are not better off as building societies consistently outperform the banks in best-buy tables for both mortgages and savings.
Furthermore there is no evidence of greater efficiency at the quoted institutions. KPMG noted in its Building Society Database 2001 that: ‘Increased competition in the market has driven down margins in the building society sector and created greater cost-efficiencies.’
This performance is supported by public opinion. In a survey of over 100 personal finance journalists, only 3% felt that: ‘The conversion and takeover of building societies will result in a better service for customers.’ Over one-third ‘ 65% ‘ of journalists agreed: ‘In the long run customers of building societies that remain mutuals will gain more benefits than customers of building societies that convert.’
Challenges still exist
Although it is clear that building societies still have a valid role to play in providing a financial service, and that some of the pressure for conversion has lifted, significant challenges remain that have to be faced. It might be trite to say, but the societies that recognise and embrace the challenges will have the best chance of prospering and outperforming their peer group.
The internet has been viewed as a huge threat to traditional businesses and a way for products, such as finance, to become commoditised with business going to the cheapest provider. To an extent this is true, and certainly information is readily available to consumers to allow them to shop around for the ‘best deal.’
The internet is an important means of capturing data and applications from customers, and can provide an extremely cost effective delivery mechanism. However, many borrowers remain averse to technology, and prefer to deal with ‘real people.’ Also where products become more specialist, and manual intervention is necessary, then the threat from the internet diminishes.
Quality of service is important and the expertise of mortgage brokers is increasingly recognised and valued by both borrowers and lenders. Building societies’ local knowledge and flexibility make them ideal partners to work with brokers rather than to poach business and cross-sell other financial products.
As with any financial services business, building societies have to work to very fine margins, and constantly target improvement. Accordingly it is important that operating costs are kept to a minimum, without compromising quality of service.
In his paper, The Economics of Mutuality and the Future of Building Societies, Professor David Llewellyn noted that ‘whether building societies are justified, and whether they have a viable future, will be determined not by whether consumers can be convinced about the philosophical basis and nature of mutuality, but by their efficiency, pricing and service.’
Small is bountiful
To this end a number of smaller building societies have already moved into new areas that should allow them to compete on both price and service with those larger players that operate in these areas but for whom it is not a key aspect of their business.
One of the most recent moves was taken by Kent Reliance when it set up a subsidiary company, Jersey Home Loans Limited, in September last year, to meet the needs of the residents of this Channel Island. Until then residents had only been able to choose mortgage products from a handful of multinational brands, none of which were really concentrating on tailoring the deals to the local populous.
The Ecology Building Society has a more established, if unique offering. It was set up 20 years ago to provide mortgages for properties which give an ‘ecological payback,’ and it uses the money deposited by its savers to grant mortgages on properties and projects that help the environment. It was one of only a handful of lenders to pass on the full base rate cut recently and is now one of the fastest-growing building societies with assets in excess of £42m.
A final move, designed to strengthen the position of smaller mutuals, is Mutual One. Formed in 1998 it is a joint venture company involving eight societies with combined assets of more than £1.7bn. It allows its members to pool resources and share services to reduce overheads.
This spirit of co-operation has been mirrored by the recent launch of the Mortgage Distributors Co-operative, which will allow smaller lenders to offer niche products and again benefit from economies of scale. The implications of this are discussed in further detail in the next feature on page 25.
The mutual movement has proved flexible and willing to adapt to changing markets. While it may be overshadowed in size by the many of the plcs it has reacted to changing market needs and many have valid offerings that have cemented their place in the market.
The Building Societies Act 1997 allows societies to move into most areas as long as members do not disapprove.
In the more complex areas of the mortgage market, the threat of the internet on brokers is lessened.
Mutuality is no longer the issue. Borrowers care more about efficiency, pricing and service.