For Louise Hyams, Lord Mayor of Westminster, last Wednesday night was a sad but significant occasion. Having completed her year in office, the seven o’clock council meeting in Old Marylebone Town Hall was the last she would address as chairman. Wearing the mayoral chain over her ceremonial blue and gold brocade robe and escorted by an attendant with the council mace, she strode into the chamber where Westminster’s 60 councillors rose to thank her for a job well done. She did not linger over the farewell. There was business to attend to before handing over to her successor, Duncan Sandys, the great-grandson of Sir Winston Churchill. After a few opening comments, Ms Hyams quickly turned to the meeting’s agenda. Buried amid items on policing, council housing and further education was a small and technical issue on treasury management. The resolution, “Item 4”, was passed unnoticed with barely a murmur. For building societies across the UK, though, it was “Item 4” that was significant. Westminster City Council had decided “since the collapse of the Icelandic banks”, with which it had placed £16.2m, there was a “need for the investment strategy to be refreshed”, the paper stated. As a result, the credit rating criteria for viable deposit-taking institutions was raised from A to AA-. “This limits the placement of any new cash deposits to either AAA rated liquidity funds or the eight UK banks and building societies that have access to the Government’s rescue package,” Item 4 read. Forty-two British building societies have access to the so-called “Government rescue package”, but of the eight Westminster meant, the only mutual is Nationwide. Westminster is not alone among local authorities in tightening its investment criteria. Barnet has whittled down the societies it will accept as counterparties from 12 to two – Nationwide and Britannia. Dorset and Haringey councils also plan to withdraw deposits from societies as the three, six or nine-month fixed terms expire in the weeks ahead. According to a source at one specialist consultancy that advises local authorities, such action is now commonplace. “In light of the Icelandic debacle, authorities have been keen to tighten up their lending lists,” the adviser said. The recent collapse of Dunfermline Building Society has exacerbated the unease that most local authorities feel, the adviser added. “The last thing they want is ... to have to explain themselves all over again.” For building societies, it is a worrying development. Local authorities had £10.1bn invested in the sector at the end of 2008, according to the Building Societies Association (BSA), which accounted for 3pc of overall funding – and 10pc of wholesale funding. On their own, the council withdrawals would be manageable but, as bankers pointed out, the trend is unlikely to stop there. As disappointed as the societies are with the local authorities, it is Moody’s, the credit rating agency, that has attracted their ire. Last month, the agency slashed the ratings of nine leading societies, seven of them below the all-important A-standard, in a single announcement. The decision was taken despite the fact that every society had passed the Financial Services Authority stress tests. The downgrade plunged them into crisis. Many local authorities planning to invest in societies, so long as they had an A credit rating, will now withdraw their funds. Braver institutions will demand a better interest rate, hitting societies’ profits. Worse still was the effect the downgrade had on the Bank of England’s Special Liquidity Scheme (SLS), the state-backed emergency funding vehicle all UK lenders have been using to finance mortgages since the wholesale markets slammed shut at the time of Northern Rock’s collapse. Following the ratings cut, they are in breach of the SLS terms, which has led to frantic discussions with the Bank. “Moody’s gave us just one hour’s warning before publication,” said one furious society director. “And we pay them for that service.” Moody’s has since had several awkward meetings with society bosses. The main gripe is with the agency’s assumptions of a 40pc fall in house prices and a worst case scenario of 60pc. “A worst case is going to test far more than just building societies,” Adrian Coles, director-general of the BSA, noted. Moody’s may well be overplaying the crisis but, even ignoring that, sentiment towards the societies has soured. The Dunfermline’s collapse in March shocked the markets. In 140 years, no society had ever needed before taxpayer support. The sector, famous for “looking after its own”, had always merged its way out of crises. Not this time. “Every rescue dilutes capital and potentially harms existing members,” another society director said. “Nationwide and Yorkshire were tapped up to take on the Scottish society but they had already done their bit for financial stability – Nationwide swallowing Derbyshire and Cheshire, and Yorkshire absorbing Barnsley. Strong as they are, Dunfermline was a step too far.” It was a watershed moment. Dunfermline was put into administration and the good assets handed to Nationwide alongside a £68.5m taxpayer bung. In the eyes of the unnamed whistleblower who days later went to Vince Cable, the Liberal Democrat treasury spokesman, the fact that the sector had washed its hands of Dunfermline was proof that “the mutual movement is no longer strong enough to take care of its own problems”. He warned: “I believe the problems at the Dunfermline will soon be mirrored by similar difficulties at societies... No other society can swallow other bad balance sheets whole, so in future there will be no mergers ... taxpayers will take the strain of ensuring the survival of the building society movement.” If it comes to that, the Government seems willing. There is huge political support for the societies. “The Government has a longstanding aim of enabling the mutual sector to grow and serve a wider section of the community,” the Budget Red Book said. The influential Treasury Select Committee (TSC) last week in its report on the financial crisis went further, calling for new rules to make it easier to create a society or remutualise. “Building societies have generally been shown to have operated a safer business model [than banks],” the report said. “The Government should examine whether any legislative or regulatory changes are required to facilitate building society start-ups and remutualisation.” To get there, though, the mutual sector – all £400bn of it – is likely to need short-term support. As one-trick ponies, societies’ mortgage exposure has left them extremely vulnerable to house price falls and unemployment in the recession. They may not have had the banks’ exotic structured instruments but lending has not always been of the cautious calibre expected. Several societies will make a loss this year, eating into precious capital – the reserves that underpin financial strength. Management will not survive unscathed as poor lending practices are exposed. “Societies ... were unsophisticated and inexperienced, and when they bought commercial loans or acquired mortgage books, it was obvious they were “fools in the market” being exploited by Wall Street and the City of London,” the whistleblower claimed. “I witnessed trusting and naive provincial building society executives, who had no real understanding of any aspect of the workings of global capital markets, being eaten alive by cynical, rapacious and short-termist investment bankers.” Although some societies may fail like The Dunfermline, many are strong businesses simply having to tough out the difficult conditions. To ensure those survive, the Treasury is planning some form of lifeboat to help societies rebuild capital. The Budget Red Book hints at the plans, saying the Government is taking “actions relating to the development and design of capital instruments and the potential for shared services between mutuals”. With no access to the equity markets, societies can only rebuild vital capital by generating profits or through clumsy “Permanent Interest Bearing Shares”. Back office “shared services” to pool the cost of administrating mortgage and savings customers as well IT systems will help profits by shaving costs. But more dramatic measures will be needed. Paul Somers, a director of Collins Stewart ISTC, has proposed “collective covered bonds” – an idea he picked up from the Norwegian saving banks who are too small to access the markets individually. Mr Somers suggests societies pool their resources by issuing bonds from a “special purpose company” into the market. The company would be backed by the sponsoring societies’ cash flows, each receiving a share of the funds relative to how much cash they put in. At the very least, his proposal could be a source of potentially cheaper funding, particularly if the bonds are wrapped with a Government guarantee. Though all societies can access it, only Nationwide and Yorkshire have so far used the guarantee to raise funds in the markets – of £1.5bn and £750m respectively. Capital needs to be addressed but, following the Moody’s downgrade and the local authorities’ planned withdrawals, funding is now societies’ number one priority. Despite being skewed towards more secure retail deposits, 30pc of the sector’s funding – or around £100bn – comes from institutions, who may think twice following the Moody’s downgrade, and the wholesale markets, which remain effectively closed. Without funding, mortgage lending will dry up. “To the extent that funding is restricted, it will restrict our ability to lend,” Nationwide chief executive Graham Beale told the TSC. The BSA’s Adrian Coles reckons “it is quite conceivable that lending will fall this year” as funding evaporates. It is already happening. So far this year, societies – which provide £250bn of Britain’s mortgages in total – have pulled £2.2bn out of the market. Last year, the sector managed to replace much of its lost wholesale funding with £9.9bn of retail deposits. But the story now is mixed. With rates at almost zero, savers are moving their money into different investments and societies suffered overall retail withdrawals in both January and March. In total, though, they have attracted £1bn this year due to a strong February. So severe are concerns about funding, in fact, that the Bank of England is said to be considering revising the terms of the SLS or creating a society-specific vehicle to ensure mortgage obligations can be financed. But because the pricing may be punitive to reflect their reduced credit ratings – and in doing so erode capital, bankers reckon Nationwide, which can still fund, will have no choice but to continue absorbing smaller players. Regulatory reform may also be on the agenda. Dunfermline collapsed in part because the rules governing societies were progressively relaxed, allowing it to originate more buy-to-let mortgages and acquire books of loans from investment banks. In addition, the maximum permitted commercial lending was raised from 10pc to 25pc between 1986 and 1993, which Dunfermline took to the extreme. The FSA has been warning the societies about the risks since 2003, and may now choose to act.Mutuals are no longer as safe as houses
Britiain's building societies face up to the prospect of losing capital as a result of changed credit status and must adjust to the new reality.
Sunday, 3 May 2009
Then comes Pension Funds!
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