With a record year for mortgage lending in 2002, increased competition caused margins to narrow further and lenders had to strive for ever higher volumes in order to realise profits. However, in the midst of this, some of the fears over the future of mutuality were put to rest as the remaining building societies stood toe to toe with the plcs and many emerged stronger than ever.
Figures from the Council of Mortgage Lenders (CML) show mortgage lending totalled £219bn in 2002, the strongest year ever for lending. And rather than fading against the brand might of some plcs and the financial power of the international conglomerates, the building society sector more than held its own with £35.4bn of the total market, up from just under £30bn in 2001.
While the bulk of the market share still rests with the plcs, the remaining 65 building societies are obviously offering something that is maintaining them as such a healthy sector of the market.
Adaptation is key
The last few years have shown this is partly due to their willingness to adapt, form link-ups with other societies and enter niche markets.
John King, group marketing manager at Coventry Building Society, says: ‘The ongoing commoditisation of the mortgage market shows little sign of abating and this will continue to cause lenders to develop non-interest-based income streams and to develop into new and possibly niche areas where attractive.’
A number of societies have now ventured into non-standard lending this way with key examples including Portman Building Society with its acquisition of Sun Bank, Nationwide’s acquisition of UCB, and Britannia’s acquisition of Platform. In other areas, Yorkshire has set up Accord Mortgages to deal with intermediary business, and others such as Norwich & Peterborough (N&P) are prepared to lend to people with unconventional employment, such as contract workers and on properties of unusual construction even if they are subject to agricultural restrictions.
John Malone, national mortgage manager at Prudential Mortgage Services, says: ‘Some of the big lenders are either setting up their own niche operation or acquiring it; it is not due to capital constraints, but because they do not have the experience in these niche markets. But if you look at some of the smaller building societies such as Ipswich and Dunfermline, they do not have the expertise in some niche markets and therefore need to call in other lenders and use their abilities.
The mutuals are also establishing a wider range of products to compete with the plcs, with the latest example being Britannia, which has signed a deal with Liverpool Victoria that will allow them to sell each other’s products outside of mortgages.
Then there is the mutual’s much-vaunted claim to operate on lower margins, taking advantage of the low interest rate environment. Theoretically mutuals can operate on narrower margins because they do not have to pay dividends to shareholders, and some have estimated the plcs have to distribute between 30% and 40% of their annual profits in dividend payments.
Alison Rolls, head of communications at N&P, says: ‘This gives mutual building societies an in-built competitive advantage. We then use this money ‘saved’ by offering lower mortgage rates and higher savings rates than the banks. These benefits are truly appreciated by our borrowers and there is increasing evidence to show they recognise the benefits mutuality can bring. Just look at the tables that show the best value mortgage lenders. They are dominated by building societies.’
Chris Holland, senior press and PR manager at Leeds & Holbeck Building Society, agrees: ‘Our own interest margin of 1.15% in 2002 was one of the lowest in the industry and enabled us to offer some market-leading products and provide our members with £35m of tangible benefits through better rates for borrowers and savers.’
The advantages of this were highlighted following the recent base rate cut when more building societies passed the full base rate on than plcs. Roy Boulger, senior technical manager at Charcol, says: ‘Somewhere between 15 and 20 lenders passed on the full quarter percent cut, but a substantial majority of these were building societies, so on that count building societies did better. ‘
Cause for celebration
It seems the days of carpet bagging are gone (at least for the time being), and as we move into what had traditionally become a nervous time for some mutual societies, as their annual general meetings approach, it is now a time to celebrate their successes. The last lender to convert from a building society to a plc was Bradford & Bingley in 2001. Since then their numbers have held firm and the top six building societies have increased their market share and strengthened their position.
These top societies have moved to the forefront of innovation in the UK market and have reaped the benefits. However, while the threat of carpet bagging appears to have receded, a new heavyweight threat has emerged and is threatening the future of many small lenders in the UK. This threat is the Basel Capital Accord, or Basel II, which will have varying degrees of impact across the spectrum of UK mortgage lenders.
Back to Basel
The Basel Committee on Banking Supervision is an organisation set up to improve capital transactions by lenders to prevent bank failures. Basel II will significantly decrease the current risk weighting on mortgages of 50% for those lenders that can prove the soundness of their back books. Proving this should not be a problem for larger lenders and building societies, but could prove expensive for the smaller societies. They have to prove they have modelled their credit and understand their credit experience and will need to develop systems to demonstrate this. If they cannot they will have to hold more capital in reserve by the end of 2006 when it comes into force, and so there are concerns that if smaller building societies have to operate on higher risk weightings they will be competitively disadvantaged.
However, Adrian Coles, director general of the Building Societies Association, says: ‘There are a lot of things we still do not know. It is conceivable that smaller lenders will be disadvantaged but that is by no means inevitable.’ However, he admitted: ‘Even if a few of the smaller building societies come together they might not necessarily produce the size of mortgage book that you need to go onto Internal Rating Basis (IRB).’
A recent survey conducted by credit risk management specialist, Scorex, revealed that 71% of lenders intend to meet the requirements for the IRB approach by 2007, but over half have not yet started implementing the necessary processes and software. The survey found 60% have not yet finalised their strategy and 50% have not yet set up a dedicated compliance team.
Keith Hale, head of sales at Scorex, says: ‘It seems a large proportion of organisations have not yet considered how they are going to meet compliance by 2007 and the longer organisations leave putting such strategies in place, the more expensive it is likely to become. It is clear organisations need to start talking to systems suppliers now.’
While Holland says there is still time for lenders to prepare, he admits the extra costs will come at an inopportune time.
He says: ‘The Basel II Capital Accords are not due to be introduced until 2006 and will not fully come into force until two years after that, so there is time for lenders to prepare. To get the most from the new Accords will mean significant extra investment both in financial terms and in ensuring people have the right expertise. For smaller societies this could present a considerable burden at a time when all societies are facing up to various new regulatory requirements.’
But is this an issue that transcends mutuality? Rolls says that Basel II and getting a risk model approved to be able to calculate regulatory capital is not an issue of mutuality.
She says: ‘Essentially this is an issue of resources and skills. A small lender, be it a bank or building society, may not have the time, money or sufficient data to build statistically robust models that will pass the tests to be applied for use in internal ratings compared with a larger bank of building society. However, it is still early days and there are ways in which they might overcome these potential disadvantages.’
Boulger disagrees: ‘On the basis that it will clearly affect small lenders more than most, and by definition these are building societies, then it will affect building societies. One of the key factors is the asset risk of the portfolio they have got. If some of the smaller building societies can work together without amalgamating for this purpose then it would be helpful. I think that of the extremely small societies, many are of the size where they will have to give a lot of thought as to how they will deal with Basel II.’
Many societies have formed link-ups with other groups and entered niche markets to remain competitive.
71% of lenders intend to meet the requirements for the IRB approach.
Basel II will decrease the risk weighting on mortgages for lenders that can prove the sound- ness of their back books.