Last year saw a rampage of conversions and flotations among UK building societies and, at the risk of sounding ingenuous, one is tempted to wonder why they opted for a life of looking over their shoulders at the company share price and having to justify their strategy to investment analysts to the much cosier status of mutuality. Greed may have been a factor. Around £35bn in special dividends to savers was dumped into the economy, and surely this must in part account for today’s irritatingly high interest rates. Halifax, Alliance & Leicester, Northern Rock and Woolwich all cited pretty much the same reasons for conversion; mainly access to external capital and expanded operating powers. But Halifax, for instance, largest among the new plcs, is planning to return £1bn to shareholders through a buy-back programme. Woolwich had a huge extra dividend and will buy in their own shares at some stage, as will Alliance & Leicester. The main debate at these new banks is how to return capital to shareholders, a strategy that has not caused the City to sit up and shout “gee whiz”. “I’m not sure if Halifax is doing anything differently, apart from publishing more copies of its annual report,” says John Leonard, European banking analyst at Salomon Smith Barney. “Halifax has done some slightly odd things and we’re a bit unsure about their strategy,” says Hugh Pye, head of bank research at Robert Fleming Securities. Britain’s remaining 71 building societies have essentially the same powers as banks. They are certainly unrestricted within the personal finance sector, the business that provides the real returns. Unlike Barings, of course, building societies cannot trade in commodities, foreign exchange and derivatives. Looking at last year’s results, the range of pre-tax profit increases of 7% to 20% for the four new plcs looks pretty paltry compared with the 41% achieved by Nationwide, now the country’s biggest building society and a hotly debated candidate for conversion. However, it would be wrong to suggest that conversion was entirely a mistake. The move towards a more fixed-rate orientated mortgage market, for instance, is clearly to the benefit of those that converted given that the plc structure is an advantage in raising fixed-term debt or doing swaps. All of them have been more successful in making the transition than might have been suspected. Commitment to shareholder value and understanding of it is certainly a management feature at Woolwich and Alliance & Leicester. “Northern Rock is the name we see as having the most potential to develop extra value for its shareholders as a public company,” says Leonard. “It has raised national awareness of the name. Their ability to leverage and grow the business more quickly as a plc is significant.” Indeed, with about a 3% market share Northern Rock could be compared with Bank of Scotland in the retail banking sector – a comparatively small and efficient organisation with lots of potential for quick growth. For Alliance & Leicester and Woolwich the principal benefit is that the market now has a reasonably objective reference point on what the franchise is worth, and the risk that they would be sold too cheaply in a private transaction has been very much reduced. “They aren’t easy targets but I do see the franchise characteristics of the medium size ones as a transition either to become a successful acquirer and to build up a larger national franchise or as a transition towards an eventual sale of the company,” says Leonard. It would seem likely that the four new banks and others to follow in their footsteps may simply be “passing through”. In a world where consolidation and globalisation are becoming a matter of survival, the building societies-cum-banks are obvious add-on targets for banks or other financial services organisations seeking outlets for their surplus cash. “I would not expect Alliance & Leicester and Woolwich to be independent in their present form in five years time,” says Pye. “I think they will have chosen their best partner to merge with. The management of both banks is alive to the potential advantages to be gained by becoming part of a bigger group, or even merging between themselves.” The current rumours of merger talks between Alliance & Leicester and Woolwich would appear to prove Pye correct. The last thing the UK banking industry needed was four new players in a year, with people such as HSBC Holdings and Lloyds TSB having shown their determination to remove capacity from the system. The market is over-banked, but as Royal Bank of Scotland’s chief executive George Mathewson once remarked: “We continue to make record profits in a supposed over-banked market. Funny, isn’t it?” In an ordinary manufacturing sector where there is real competition, a glut of producers would cause price pressure and companies would go bust. That doesn’t happen in banking. Instead, capital builds up and because of the sector’s semi-monopolistic nature the banks are reluctant and slow to compete on price. If one bank cuts its price to gain market share, rest assured that in three nanoseconds the rest of the market has adjusted its prices downward. So the result is the same market share with lower profitability. The bottom line is that the UK mortgage market is a relatively slow growth area that is becoming more competitive and less profitable. Future strategy has to be diversification into other product areas. Abbey National, which in 1989 became the first building society to convert, now has more than 50% of its products in businesses such as life assurance and unsecured personal lending, which are growing faster than mortgages. The logical way forward for the societies is to become the mortgage arm of one of the large UK or foreign banks, because none is in a position to develop its own full-service business. Jules Stewart is a freelance journalist.
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