It should be clear by now to the directors of Britain’s 70 remaining building societies that a majority of their members are not interested in promises of cheap mortgages – they can obtain them elsewhere. What their members are interested in, however, is windfalls. The Building Societies Association argues that the current generation of investors and borrowers “are gathering to themselves the benefits of the reserves built up over many previous generations”. It warns that by voting for demutualisation, members will deny cheap mortgages and high-interest savings accounts to future generations. But it is the industry-wide strategy of boosting reserves and the resulting increase in asset value that has made the building societies such a tempting target for conversion. In a way, the building societies have wasted their opportunity, because they enjoy two advantages over the banks: they do not have shareholders breathing down their necks demanding ever higher returns, and they do not have to service external capital. They should have exploited this position to undercut the banks. Instead, they grew fat. The building societies’ claim to be cheap mortgage providers does not stand up to scrutiny. They are being undercut by aggressive new entrants in the financial services market, such as Standard Life, which has a banking operation that offers variable rate mortgages at 4.55%. Standard Life Bank reports that since it started its telephone marketing operation in January it has been receiving about one mortgage application per minute. “Each of our telephone operators is transacting as much business as 11 building society branches,” says Jim Spowart, Standard Life Bank’s managing director. There are now more than 2,000 different mortgages available from some 100 lenders, and whatever happens to the remaining building societies, that alone will almost guarantee a high degree of competition in the home loans market. “The building societies do not offer the best rates on deposits or mortgages and we have seen how competitors such as Egg can operate on much finer margins,” says Philip Middleton, director of banking strategy at KPMG. “An Internet transaction costs less than 1p compared with 40p to 60p for an identical transaction in a branch.” The pressure on the remaining building societies is increasing. In the past two years, five of the largest have converted into banks, showering their members with £30bn in windfall flotation bonuses. And in April, for the first time, the wishes of a mutual’s board of directors were ignored, when 62% of Bradford & Bingley members voted for conversion, despite a £5m advertising blitz urging them to vote the other way. Given the current deluge of mortgage lenders, it is increasingly difficult for building societies to survive. Their rates are low and their networks small – and the result is a level of profitability well below the standards of the UK financial services industry. In the case of B&B this translates into a 10% return on equity, less than half the banking sector’s average ROE. Plc status allows the building societies to diversify and expand into profitable new areas of business – at least that is the theory. The reality is that more banks is what the UK least needs, and players like B&B, starting afresh with nothing to bring to the party but a 3% share of the mortgage market, are hardly in a position to compete with the likes of a Lloyds TSB or a Barclays. Even before the dust settled on B&B’s conversion vote, the City’s rumour mill had swung into action, speculating on whether Halifax or Abbey National was the future bank’s most likely suitor. Royal Bank of Scotland’s bitter battle to take over Birmingham Midshires Building Society, which it lost to Halifax, stands as an example of the banks’ keen interest in expanding their mortgage businesses. “Bradford & Bingley would make an interesting acquisition for someone looking to expand their mortgage book or grow their customer base, particularly after the recent success we’ve seen at Standard Life in this sector,” says Ben Dutton, financial services analyst at Datamonitor, a market research group. The market gives Halifax a better than average chance of remaining independent, but sees little chance of the other recent arrivals holding their own against the big banks. “Of the others that have converted (Woolwich, Alliance & Leicester, and Northern Rock) it is unlikely that any will be independent in five years’ time,” says Hugh Pye, banking analyst at Robert Fleming Securities. “Their management is alive to the potential advantages to be gained by becoming part of a bigger group or of merging amongst themselves.” The building societies that have become banks will be looking carefully at ways of becoming bigger and more diversified, according to KPMG’s Middleton. “Many may come to the conclusion that they are too small to do it alone,” he says. “They may form alliances with others, merge with overseas partners or decide to sell out at a premium.” Datamonitor’s Dutton believes that the remaining second- and third-tier societies could have a future as mutuals – provided they came to grips with their cost base. “The combined building societies are about the same size as Halifax, but their average cost base per employee is a lot higher,” he says. “The building societies’ survival will depend on their ability to rationalise their back-office functions and improve efficiency. This is the stumbling block, because many are archaic organisations and refuse to give way to reform.” The steps taken by some of the larger societies – Nationwide, Yorkshire, Norwich and Newcastle, for instance – to insulate themselves against conversion, in some cases by changing their statutes to raise the voting minimum to a 75% majority, and in others by requiring windfall beneficiaries to donate their profits to charity, is evidence of a tenacious reluctance to give up the status quo. Jules Stewart is a freelance journalist.
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