2.1.4 Building societies – their numbers decline further
In September 2015 there were 44 building societies in the UK. The table below shows the top five building societies in terms of total size of the assets on their balance sheet. The figures show how the industry is dominated by Nationwide, with an asset size that exceeds the combined size of all the other building societies (£130 billion).
The financial well-being of the building societies is very strongly related to the UK housing market, given that the majority of their assets are mortgages that are secured against residential properties. The UK housing market went into decline from autumn 2007 with average house prices falling by 20 per cent by spring 2009 (Nationwide, 2015). This was, to a major degree, a further consequence of the ‘credit crunch’ that affected the financial markets in the wake of the collapse of the US sub-prime mortgage sector. In this environment, mortgage lenders found it difficult to raise funds in the wholesale markets to support their lending business. Additionally, they became more cautious about those to whom they would lend money for home purchase. These factors, in turn, reduced the demand for property, thereby resulting in downward pressure on house prices. Since spring 2009, average house prices have recovered steadily. In August 2015, the average house price in the UK was £195,279, 5 per cent higher than in October 2007, at the start of the financial crisis (Nationwide, 2015).
The economic environment that followed the financial crisis took its toll on the sector – particularly the smaller ones – resulted in a number of takeovers of weaker building societies by those in a stronger financial position. The Derbyshire and Cheshire building societies were taken over by Nationwide, and the Scarborough Building Society was taken over by Skipton Building Society. Additionally, the branch network, the good-quality loans and the retail and wholesale deposits of Dunfermline Building Society were acquired by Nationwide in 2009. The rest of the Dunfermline’s assets – the loans of weaker quality – were either taken on by the Treasury or placed into a special fund to be managed by the accounting and advisory firm, KPMG.
In December 2009, a merger was announced between Yorkshire Building Society and Chelsea Building Society, the latter having previously incurred material financial losses as a result of poor lending decisions and mortgage fraud. The merger was completed in April 2010. These and other mergers and takeovers further reduced the total number of building societies and reinforced Nationwide’s domination of the sector.
Is the core business of building societies really any different to the banks – particularly those banks that have previously converted from building society to banking status? One difference the building societies would point to is their mutual status and how this status affects their business model. Building societies, as mutuals, are owned by their members – including both savers and the mortgagors. In the ‘plc’ sense of the term, building societies do not have shareholders. So, with no need to run the business in the best interests of the shareholders, building societies are free to maximise member value – i.e. operate in the best interests of their customers.
Until the mid-1990s, there was arguably not much to distinguish between the banks and the building societies in terms of the treatment of their customers. However, in response to the rush to conversion in the 1990s, certain of the leading societies – including Nationwide and Britannia – sought to demonstrate their mutual approach to business by providing overt benefits to their members. Nationwide did this through changing its product pricing – cutting its mortgage rate and raising savings rates. Britannia, prior to its merger with Co-operative Financial Services, used to pay a form of dividend to its members. Other building societies adopted similar schemes to demonstrate the value that mutuality brought to members – although the evidence from market data indicated that the schemes were also useful in boosting the building societies’ share of the mortgage and savings markets, at the expense of the banks.
The vast majority of the lending business undertaken by building societies is in the form of mortgages on residential property.
What are the strengths and weaknesses of this part of the business model of a building society?
The key strength is that the lending is secured against property. If a borrower defaults, their property can be repossessed by the building society and sold to recoup the original mortgage sum that had been lent. Until autumn 2007, rising property prices meant that the average value of the mortgage debt as a proportion of average property prices was falling – reinforcing the security that building societies had against the mortgages advanced.
The key weakness is that the financial health of building societies is largely tied to one sector only: the UK housing market. Societies’ asset portfolios are less well diversified than those of the banks. This makes them vulnerable to poor financial performance in periods of weakness in the housing market – for example, between 1990 and 1993 and from 2007 until 2009.