Sep 2011 – Mutuals recover

The health of the mutual sector is getting stronger and gross mortgage lending has risen by 20 per cent in six months. Adrian Coles, director-general of the Building Societies Association, reports

Evidence of a strong recovery in the building society and wider mutual sector has become ever more evident in recent months; the results declarations for 2010 published in the early part of the year showed a doubling of profits (as a proportion of assets) across the building society sector compared to 2009.

That good work has been built upon by the strong results shown by many members of the sector for the first half of 2011 - a continued growth in profits, and rising capital ratios, accompanied by an increase in mortgage lending. Indeed, mutual sector gross mortgage lending has risen by 20% in the first half of the year compared to a zero increase across the entire market.

On the savings side, despite intense competition, including from National Savings & Investments’ new index linked bonds, it seems likely that mutual sector savings balances will increase a little this year, after falling in 2009 and 2010.

Recovery

What have been the key elements of this recovery? The market environment within which mutuals operate, including very sharp falls in the overall size of the mortgage and savings markets and a prolonged reduction in the level of owner-occupation, have hardly been conducive to business success in recent years, and mutuals’ still face a range of challenges. Nevertheless, the strengths of the sector have helped to deliver the recovery.

Mutuals enjoy wide political and regulatory endorsement. There is no room here to include the many supportive analyses from political commentators, the regulatory authorities and the media, although snapshots of these can be found on the BSA website at http://www.bsa.org.uk/whatpeoplesay/2011.htm They are seen as very distinct and separate from the banking sector.

Second, mutuals have, and had, a lower risk appetite than their competitors in the mortgage market and therefore their provisions have been less marked during the recessionary years (and fell in 2010 compared to 2009).

Third, new forms of capital have been introduced and the BSA continues to work towards further innovations in this area that would be consistent with the recently published draft Capital Requirements Regulation. Generally, capital ratios have increased in recent years as has the amount and quality of the liquidity held by the sector (albeit at some cost).

Fourth, the mergers that have taken place within the mutual sector have resulted in weaker institutions being removed and stronger institutions and managements consolidating their positions.

Finally, the absence of shareholder pressure has meant that many mutuals have been able to “hibernate” in terms of maintaining or shrinking their balance sheets, while at the same time undertaking rapid restructuring of their cost base and business processes.

Successful mutuals

So what are the features of a successful mutual? First, successful mutuals are clear about the strategy that they are adopting, but are still able to react (possibly opportunistically) to individual events.

Second, the top mutuals know how to implement the strategy. This normally involves cost and procedure control, the acquisition of high quality assets, appropriate pricing for, and management of, risk (a feature missing from much of the financial system in the run up to 2007), and improvement in the high quality of service for which mutuals are already well known.

Successful mutuals don’t take their corporate governance procedures for granted and make changes as appropriate, where these have been found lacking. The BSA will be leading a major exercise on conducting board effectiveness reviews during the autumn of 2011 and the winter of 2011/2012, which will help mutuals go even further in correcting any weaknesses that are found.

A final feature of a successful mutual is involvement in the local community – mutuals are well known for being a part of their communities, and apart from the obvious benefits this brings to communities, it can mean that mutuals can rely on local loyalty at times of stress in the financial markets.

Size doesn’t matter

None of these strengths and actions is dependent on the size of the mutual. There are clearly very large, very successful, organisations in the mutual sector, Nationwide and Co-operative Financial Services, are obvious examples, as well as a number of other significant sized building societies.

However, it is notable that size does not guarantee success. The Halifax, part of HBOS, was the largest mortgage lender in the UK; Northern Rock was the most rapidly growing; Royal Bank of Scotland was (on some measures) the biggest bank in the UK; and Bradford & Bingley was the biggest buy-to-let lender – all failed to survive the credit crunch without state support.

In contrast, many small building societies have been able to play to their strengths and remain in business without external support, sticking to their tried and trusted methods. Mutuals will continue to thrive in the future even if the market conditions they now face are more hostile than those they have been used to in the 50 or so years before 2007.