Media Centre
Introduction
When we reviewed the 2008 conference we agreed that we needed a keynote speech at the start of the conference. The aim was and is to give upbeat messages about the sector. Of course, such a decision has risks – and boy have those risks come to pass this year.
You don’t need me to tell you that we have been through an extraordinary year. Indeed, in Adrian Coles’ words on the BBC website at the end of September 2008 – and repeated in our Annual Report – “It has been utterly, unbelievably, astonishing”. Adrian is not normally given to exaggeration and I do not believe he has exaggerated on this occasion. Little did I think that when I agreed to undertake the BSA chairmanship for a second time, the job of being Chairman would be so different from my experience of Chairman in 2003/04. In those days, quite frankly, it was sinecure; today it is anything but – busy does not begin to describe it!
I would like to divide my thoughts into three. First a brief review of the past year covering some of the things that have not gone so well for building societies, as well as those many things that have. Secondly, to talk about the underlying strength of building societies and thirdly to look at the challenges we face – and some possible solutions. I make no apology for highlighting those challenges. No sector is immune from the recession, and institutions that concentrate their business on the UK financial and housing markets have clearly been affected. We need to face up to those challenges and collectively work out how to face them.
But first, to the past year.
2008 and 2009
The difficulties in the banking sector, for many, began with the run on Northern Rock in September 2007. One of the initial reactions of many people to this development was to transfer their savings funds to building societies. In the 16 months to August 2007, building societies attracted £11.5 billion in new funds (net of withdrawals) from savings. In the16 months from September 2007 this figure increased by 70% to £20 billion. For some time it looked as though building societies were substantial net beneficiaries of what it is now clear was merely the opening phase in the UK of the banking crisis.
Typically, however, building societies generally did not take advantage of the substantial savings inflow to increase their lending into the housing market – although some did. Rather, conditions in the markets made it more appropriate for societies to increase their holdings of liquidity – both because they felt it was a good idea and encouraged by the FSA – and to repay wholesale funding following the virtual closure of many of the wholesale markets.
At the beginning of 2008, some had expressed the hope that those markets would return to normality with trust and confidence gradually re-emerging. However, a stream of events from March onwards made this an extremely unlikely development. Just to remind ourselves let me list some of those.
In March, Bear Stearns suffered a collapse in confidence and was acquired by J P Morgan, for what would previously have been seen as a knock-down price.
In April, Nationwide Building Society recorded the first annual fall in house prices for 12 years.
Also in April, the Bank of England unveiled its special liquidity scheme.
In July, the US authorities were forced to step in and assist Freddie Mac and Fannie Mae.
Also in July, HBOS’s £4 billion rights issue was subscribed to by just 8% of its shareholders.
In September, the pace quickened. Fannie Mae and Freddie Mac were rescued by the US government, and at about the same time, the first signs emerged that building societies were not immune to the crisis, with the announcement that Nationwide was merging with both the Derbyshire and Cheshire Building Societies; in neither society was there a members’ vote or a payout, a clear indication of very changed market conditions.
Only a week later, Lehman Brothers collapsed and almost simultaneously, the US government put together a rescue package for the insurance company AIG. The day after that it was announced that HBOS would be taken over by Lloyds TSB. A week later the American lender and deposit taker Washington Mutual – a quoted plc despite its name – was closed by regulators, while a few days afterwards Fortis was part nationalised by the governments of the Netherlands, Belgium and Luxembourg. Two days later Bradford & Bingley was part nationalised in the UK. The day after that the Irish Government decided to fully guarantee all the deposits – irrespective of the currency in which they were denominated - in the country’s main banks for two years. Simultaneously Dexia Bank was bailed out by the Belgian, French and Luxembourg governments.
In October, the FSA raised the limit on guaranteed bank deposits from £35,000 to £50,000. A few days later the Icelandic government completed its takeover of the three largest banks in that country leading to a significant call on the UK deposit protection scheme. In the middle of the month, the UK announced plans to inject £37 billion into various banking groups and the Dutch government injected €10 billion into ING. In late October and November there were announcements of more building society mergers involving the Yorkshire and Barnsley, and Skipton and Scarborough respectively, while in late November, London Scottish Bank went into administration. In January 2009 a further set of measures, including the Asset Protection Scheme, was announced to strengthen further the UK banking system.
I list out those events, not to demonstrate what a tremendous memory I have – they were all mentioned in the timeline going across the bottom pages of the BSA’s Annual Report – but just to remind you all at this stage – the Spring of 2009, just how frantic everything was last Autumn, and also to make the point that during those weeks the financial world utterly changed. There is a lot about building societies, as I will say in a few minutes, that is truly worth preserving, but building societies cannot be immune from such fundamental developments.
The Policy Reaction
The nationalisations, recapitalisations and provisions of liquidity involving mind boggling amounts of taxpayers’ money were nevertheless, in my view, a sensible reaction to these momentous developments. Various commentators have suggested that the banking system was on the verge of collapse. There was a risk of catastrophic meltdown in economic activity and building societies should not criticise the actions taken by the government to deal with the crisis in the banks.
We were and are, however, critical of two aspects of the authorities’ response. First, it seemed wrong to us to reduce interest rates so sharply, so quickly. Of course, building societies had little choice but to follow the downward trend, but many did not follow it to the full extent dictated by the base rate reductions. Many societies were sympathetic to the plight of savers and felt it appropriate to look after the interests of, especially, their elderly investors who had saved for years in the expectation of living off their interest income, but found this income rapidly plummeting towards zero as the Bank implemented an aggressive rate cutting policy. We also questioned whether this policy would benefit the mortgage market or, rather, restrict the flow of funds available for mortgage lending even more than was likely to be the case as a result of other developments in the economy.
Savers clearly save for a number of reasons. Many people save for precautionary reasons, especially as the unemployment forecasts increase. Others will continue to save for a “sunny day” – weddings, holidays, car purchase. Nevertheless extremely, unprecedentedly, low interest rates clearly do not provide an incentive to save. In our view the interest rate cutting policy did not have to be quite so savage.
Clearly the Government and the tripartite of FSA, Bank of England and the Treasury forgot basic principles which are especially important to lenders which retain loans on their balance sheets. You can only lend the money you can raise from savings. The days of securitisation – lend and let someone else worry about it - are over. They show no signs of returning in the medium term. So we are where we are. Mortgages are too cheap and savings rates are too low – with no sign that this policy will change in the short term.
We were also extremely concerned about the Financial Services Compensation Scheme arrangements as they applied to building societies. The arguments here are well known to you so we will not dwell long on this subject. Nevertheless, it seemed to the many low risk, prudently run, building societies utterly unfair that they and their members should face a bill for bailing out the far less prudently run banks from Reykjavik and Bingley. We need to find a fairer mechanism for funding the Compensation Scheme and we need to put in place arrangements that give longer term certainty to institutions so that they are not faced with huge additional burdens on their profit and loss account at very short notice. We also need to ensure that the Government recognises the risk from a shortfall of collections from Bradford & Bingley and Iceland. It would be appalling if building societies were placed at any sort of risk as a result of the failure of the authorities to realise the maximum amount from the Bradford & Bingley loan book. Although there may be different approaches between banks and building societies to this issue, I am sure that we will all agree that some lender representation in the Bradford & Bingley run-off process would be sensible – given that it is the banks and building societies that have to pick up the bill if there is a shortfall at the end of the day.
The Government should clearly state now what it intends to do when such a shortfall arises. The potential cost to the members of all building societies is significantly larger than the fiasco of MP’s allowances.
Building Society Strengths
In all this doom and gloom it is easy to overlook the fundamental strengths of the building society model. Building societies – and I hardly need to say this to this audience – do not need to pay dividends to shareholders. Despite all the difficulties of recent months, they continue to head some of the most important best buy tables. Earlier this year, for example, Moneyfacts research showed that building societies occupied 11 of the top 12 places in the tables for the six best paying cash ISAs over the last 18 months and the six best accounts for the previous 36 months. Similarly, market research undertaken by the Association shows that consumer perceptions of standards of service in building societies are much more favourable than their perceptions of the service they receive from banks. On treating customers fairly, trust, offering value for money and customers’ willingness to recommend their institutions to their friends and family there is a substantially better performance by building societies than banks. We have a much better record of keeping branches open than do banks; we have a much lower level of residential mortgage arrears than the banks and our competitors in the market. Generally, societies have followed a much more prudent business model.
Societies are based all over the country and provide employment in many regions of economic stress. Their economic effect on other service businesses in their regions is immense and one the Government should seek to enhance.
And let’s not overlook the process of what those who like to talk in jargon call “democratic engagement” and what I like to call “talking to members”. Building societies are accountable to their customers because their customers are members. There are no external shareholders. We have just come out of a series of encouraging building society annual general meetings featuring significant support from members for building societies’ recent actions. The building society model allows that process to take place and societies are healthier as a result.
Challenges……..|
Let’s not pretend, however, that while generally building societies are in a relatively good position to face current market conditions, that this statement applies to every single building society. It may well be the case that the recession has a much greater impact on particular institutions than on generalities of institutions. We have seen, for example, the very different experiences of say, HSBC and Standard Chartered in the recession, compared to Royal Bank of Scotland and the HBOS group. Similarly, in the building society sector we saw mergers towards the end of last year involving weakened societies.
In the 200 year celebration of Darwin’s birth it is a stark business example of survival of the fittest and we need to recognise the challenge.
More recently, the Dunfermline episode shook all of us in the building society world. Clearly, that society had expanded unsustainably in certain areas that it did not fully understand and as a result at great cost to the reputation of the sector as a whole. . The development of the sector over the next 18 months will be challenging. No one can foretell that similar episodes will not happen again. However, we can all commit to the principle that all societies wish to see a strong mutual sector and will individually and collectively work to avoid any further failures.
I am also convinced that such a commitment is needed from Government and regulators. The time for only nice words by the authorities about mutuals is over. We need to see action, support and a desire to build a better future gaining traction in the minds of the Tripartite. Equally, it is time to remove any lingering sense of complacency in building society boardrooms; it is very important, that we face up to the issues for societies. So what are these challenges?
First, by way of general background:
- The period of very strong savings inflows into building societies may have come to an end with the February data – which was the best ever February savings performance by societies. There was an outflow in March and this seems likely to be repeated in April – normally, seasonally very strong months as a result of ISA inflows.
- On the other side of the balance sheet, there are significant net monthly repayments of mortgage loans outstanding. Loans outstanding declined in the first quarter. A number of societies are indicating to the Secretariat that they do not expect to grow this year and may well contract their balance sheets – albeit in most cases modestly.
Against this background -
- Low rates of interest affect societies’ margins significantly – because of the immovable minimum interest rate payable on savings accounts.
- In contrast to the recession of the early 1990s, societies this time do not have the cushion of the “endowment effect” – the income earned on their free reserves – also because of the very low level of interest rates.
- Other income - such as insurance commissions - based on mortgage transactions, is reduced.
- Societies face intense, and I would say unfair competition, especially on retail funding, from the range of fully nationalised, or majority Government –owned banks, together with National Savings, all of which are perceived to have, explicitly or implicitly, a total Government guarantee. At the same time the government’s Debt Management Office is replacing building societies in the wholesale market, especially with local authorities.
- We have to generate profits to pay the FSCS levies.
- Credit losses (or provisions for such losses), especially on commercial and purchased books, are becoming more significant in some societies and add to pressure on profit.
- There is intense competitive pressure in the retail savings market.
- Tracker and fixed rate products on both sides of the balance sheet make it more difficult for societies to manage their margins.
- Societies are being required by the FSA to hold extremely high levels of liquidity in the form of very low-yielding assets.
- External capital in the form of PIBS or subordinated debt is expensive, and may not be available to all societies – especially those whose capital may not be adequate for the nature of the recession we are now experiencing.
- External perceptions of the sector are deteriorating – Moody’s, the FSA whistleblower quoted by the FT, and subsequent press coverage are questioning - but by no means undermining - the benign view of societies that has so far been a feature of the recession.
- More generally there is a rising regulatory burden. However, I am pleased to report that the Association’s working relationship with the FSA has improved significantly.
- The FSA is now stress testing the largest societies in the light of the action by Moody’s. We are not, as the BSA, told what the proposed stresses are. What is clear is that they wish societies to have sufficient capital to withstand proposed shocks. So far, so good, but there is two observations I wish to make –
- Any good risk system judges probability – every institution would fail if every entry on its risk register comes to pass.
- Greater harm can be done by extreme stressing – to find the failure point. Whilst clearly the FSA under its powers can deal with an institution it decides is failing – this is a long way from taking similar actions if it judges that an institution will fail if a set of extreme conditions arise at the same time. Diversity of supply is one of the financial services strengths of the country. Do not weaken that strength merely to avoid a potentially future embarrassment. The age of embarrassment passed when cash was showered at the bankers like confetti.
……… and some solutions
- So what is to be done? There are two groups of actions. The first is to persuade others to do things; the second is to do things ourselves. In the first
- group – • Convince the authorities of the potential for unfair competition from the nationalised banks. We need framework agreements in place similar to that governing Northern Rock.
- Convince the authorities that a different funding mechanism is required for future contributions to the FSCS.
- Seek a more balanced solution from the FSA on the liquidity issue – current and likely future regulatory requirements go too far on quality and amount of liquidity, and not far enough in recognizing the impact of this policy on earnings capability.
- Similarly we need to get a more sensible balance between TCF and prudential requirements. Some TCF requirements can prevent sensible prudential improvements being put in place.
However, let’s not forget that the primary responsibility for determining the future of societies lies with societies themselves –
- Effective cost control is more important than ever before –the trick is to cut fat while developing muscle. Just cutting costs - at any cost - is not likely to be effective.•
- We need to look in more revolutionary ways than we have about the long-term benefits of working together.
- We need to reduce even further reliance on the wholesale markets – while still recognizing the benefits of a diversified funding base
- Increasing the proportion of administered rates, thus giving societies flexibility to manage margins in the future. I recognise that this may be something societies can do only slowly.
- Be even more vigilant in improving our corporate governance. Assess ruthlessly the performance of directors – both executive and non-executive
- Looking at previously unthought of restructuring opportunities in the sector. I welcome the fact that we have just changed the BSA’s rules to maintain our close relationship with Britannia when it merges with the Co-op later this year. There could be other Butterfill mergers; there could be more building society mergers. What sort of structure in the sector do we want?
- Looking at new forms of capital raising
- Retail Pibs
- Conversion of sub-debt to Pibs
- Profit related capital
And lastly, Government support. So far every scheme for capital or liquidity is designed for the bankers and is more expensive for mutuals to use. Lets have a scheme designed for mutuals.
- So my message to HMG is
- It costs less to support mutuals than plcs
- It achieves more across the country
- The general public will praise you for such support.
Conclusion
It’s important that, while recognizing the challenges, we don’t drown in gloom! Building societies have seen tough times before. We complain about the impact of low interest rates, but we should recognise that the strain on borrowers is much less in this recession than in the early 90s. We should note that it is a perfectly viable strategy for many societies to “stand still” for a year or two – just as the Lex column in the FT suggested last week was a good strategy for HSBC. Remember that your members would not see a policy of restraint as a failure – rather a prime example of prudency in this age of difficulties. Some were wrong to assume a few years ago that the good times would last forever. It is equally wrong now to believe that we are in never-ending recession.
I am coming towards the end of my time in this speech, and in the building society sector. I’ve enjoyed the last 30 minutes, and over 40 years! My final message is that we must hold on to the traditional values of building societies - not least putting the customer first - while at the same time not closing our mind to what might be seen as some revolutionary change in the current extraordinary circumstances.
Thank you for your attention.
