Consolidation has become a relatively common word within the mortgage market in recent years, especially within the building society community. Recently, Yorkshire Building Society and Chelsea Building Society announced that they had agreed to merge, creating the UK’s second largest building society.

The enlarged society will be known as Yorkshire Building Society and have a total of £35bn in assets with 2.7 million members and a national network of 178 branches. The future for the broker brands of the societies remains unclear, as a decision is yet to be made over the future of Accord Mortgages and Chelsea Intermediary Services, and obviously the sooner this can be cleared up for the intermediary market the better.

Of course, consolidation is inevitable, especially in challenging economic times. Looking back through the history books – or at least the Building Societies Association (BSA) website – it is difficult to believe that there were 1723 authorised societies in 1910 with total mortgage assets of £60m. By 1950 this number had dropped to 819 but mortgage assets had risen to £1.06bn.

In 1970, the levels of mortgage assets rise eight-fold to £8.75bn and authorised society numbers fell to 481. By 1980, mortgage assets were up to £42.4bn as society numbers continued to decline to 273.

It is fair to say that building societies really prospered until the early 1980s when there was little competition in way of savings accounts and of course mortgages. This led them to being in control of the majority of their customers’ financial requirements as many remained loyal to their branches in terms of savings and help with their mortgages. At this time building societies were restricted on their mortgage lending however, as lending was funded in the most part through retail savings which led to the simple equation that individual institutions could only lend from what they took in via savings.

Sponsored

Aldermore Insights with Jon Cooper: Edition 9 – Why lending strategy is becoming more central in buy to let

Sponsored by Aldermore

It was during the late 1980s and early 1990s that UK banks and foreign entrants really began to stir up the distribution horizon and competition was further fuelled by increasing house prices. This was also the time when the intermediary market started to impose itself and begin its domination of all things mortgage related. As the market grew, so did opportunity levels and for many building societies demutualisation swiftly became the best option as funding for mutual lending began to emerge from the money markets which resulted in the previous monetary control on lending being swept away.

By 1990, the number of authorised building societies had shrunk to 101, but the total amount of mortgage assets had reached the heady heights of £175bn. The following period saw more competition with banks in the sector, with many diversifying into a range of other market areas including estate agency, commercial lending and secured loans in order to boost their lending pots. But this transition was far from plain sailing. For years, building societies had been trying to squeeze costs to create efficiencies.

These historic inefficiencies proved difficult to manage, because of long standing legacy issues and systems that were in place. As consolidation and mergers became commonplace, the downside was that they put extra pressure on this infrastructure as they often had to run several separate platforms resulting in huge cost implications to incorporate new complete systems. In terms of diversification, while this had become a necessity, it also resulted in some players getting into difficulties through a number of factors including fraud and risky underwriting on top of market downturns.

During this period of time, it also seemed that a new breed of chief executive and their senior teams took over. The societies then earned big money based on increased profit indicators, and there is an argument that it was this drive for increased profit that led to the downfall of many institutions. While all this was going on, the conflict remained over the tradition of the branch network within communities. Many of these branches were not able to produce the required levels of activity and income, which left head office with the dilemma of how to make these branches profitable, which led to the arrival of dual pricing in its infancy.

In the current market, it is evident that due to credit crunch implications and government bailouts, the FSA is now taking a greater interest in the way financial institutions are being run.

There is also increased pressure on societies to lend, while at the same time bolstering balance sheets and liquidity in the event of many stress test situations. What would happen to any building society if there was another Northern Rock extreme run on funds for example? In essence, the modern market revolves around the managing of margins between high savings rates to attract savers and low mortgage rates to be competitive on mortgages.

The most recent figures from the BSA show that gross lending by building societies rose by 15% in December to £1.8bn. But for 2009 as a whole, gross lending was half the levels seen in 2008, going from £37.5bn in 2008 to £18.6bn last year.

This is not great news for the sector, as mortgages, generally speaking, constitute the main income generator for building societies. This is made worse if an individual society has a low standard variable rate which will also result in even lower income levels from its back book in addition to low levels of current lending.

As we have charted the course of mutual history, it is evident that this is a sector that has seen its fair share of ups and downs but the recent economic turmoil has certainly seen a good number of reputable institutions fall by the wayside. Indeed, looking at the current statistics – with balances updated with data to end of November 2009 –  the number of building societies stands at 52 with total assets amounting to £335bn including mortgage assets of £235bn.

The sector’s future is difficult to predict. There are a number of variables such as how long funding issues last, how strong individual building society’s business models are and how healthy the balances sheets are. The largest player in the market, Nationwide, firmly believes in the building society sector which is a positive sign and it has already taken several regional mutuals under its umbrella. Unfortunately there are now very few left with the capability of Nationwide to take on others who may be in trouble.

This conjures up an interesting situation as no Government would wish to see a pillar of the community and bedrock of the financial structure fall to its knees. This would be a delicate situation, and while it hopefully does not come to this, it remains to be seen how the Government will handle such a situation. As with all firms operating in the mortgage market, the mutual sector will have to manage the ongoing pressures and cycle of how to make sustainable income whilst running branches and improving the business infrastructure – not even to mention rebuilding balance sheets and trying to squeeze costs to pacify all stakeholders including the FSA.

Of course, there are many who do things right. Coventry Building Society immediately springs to mind, but there are many more. However, as is evident from the Yorkshire and Chelsea talks, more mergers and consolidation seem likely as the stability of being part of a bigger group is a strong pull.

While it would be good for institutions to retain their local names and identity, to benefit their local regions and communities, it is difficult to say whether this will happen. It almost seems inevitable that we will be left with just a handful of well run and stable building societies, which is certainly a far cry from the huge numbers trading over 100 years ago.

Phil Whitehouse is head of The Mortgage Alliance