Building societies are, by definition, long-term players in the mortgage market – regardless of the economic climate. These organisations are now run by highly experienced professionals, many of whom are battle-hardened veterans of previous recessions. Societies tend to take the long view and benefit from strong capital bases, the accumulated profits of generations. As long-term players, they have a huge investment in their brand equity and they guard jealously their reputation for fairness, honesty and consistency.
It has to be conceded that, culturally, building societies are rather a conservative breed and are not natural innovators. Specialist lending, however, is now a well established and growing part of the market and is, for a building society, a natural extension of its business model. Building societies have not been immune to the savage margin compression which has occurred in the prime mortgage market so specialist lending represents an increasingly attractive and logical diversification.
A number of leading building societies including Nationwide, Britannia, Portman and Yorkshire already own thriving specialist lending subsidiaries but this trend is now developing momentum with other societies including Coventry and Norwich & Peterborough more recently following suit.
Augmenting skill sets
Building societies have existing sales, marketing, compliance and regulatory resources as well as service infrastructure in place. While they may need to augment their skill sets, societies do not face the entry costs of a new player which is setting up from scratch. Yorkshire Building Society is an example of a society which has built its franchise in the specialist markets from a standing start and today Accord is a well regarded and established player.
Some societies have entered the specialist market through acquisition, which creates the opportunity to exploit the economies of scale this produces. Britannia originally entered the non-conforming market with a start up venture, but only really achieved critical mass when it acquired Platform. Since then Platform has grown to become a leading operator in its chosen market space. In a variation on this theme, Portman acquired Sunbank in 2001, relocated it from Stevenage to the Society’s headquarters in Bournemouth, transformed its business model and rebranded the business as The Mortgage Works.
Key driver
A key driver for the formation of a subsidiary is the additional flexibility afforded to a society by owning mortgage assets which do not confer membership rights on the borrowers. These non-member mortgages can be more easily securitised or traded which opens up new funding options for the controlling society as well as allowing it to manage its accumulations of higher risk lending. Up to now, only Britannia’s subsidiary has employed securitisation extensively but it seems likely that, as societies increase their share of the specialist lending market, more will be trading assets. This could include selling whole loans to other building societies, for example.
One of the reasons for the limited use of securitisation to date by societies is, quite simply, a lack of need. Most have strong, well capitalised balance sheets and stable, diversified funding bases encompassing both retail and wholesale markets. This lack of dependency on a securitisation conduit is a big strategic advantage. Global demand for mortgage backed securities can be volatile – the appetite of investors, for example, has unquestionably been adversely impacted by the crisis in the US non-conforming market. A specialist lender owned by a building society can securitise tactically when market conditions are propitious, and revert to other cheaper funding sources when the economics of securitisation are less compelling.
By the same token, the existence of substantial on-balance sheet capacity can enable a specialist lender to do a proportion of lending which might not be readily securitised. It can also optimise the use of its balance sheet by holding assets for months or even years after origination. The de-risked loans can then be sold on even more profitably. This also means that society subsidiaries should be able to offer their borrowers and business partners a greater degree of flexibility. In an increasingly over-crowded market this may become a key competitive advantage.
Not without challenges
Earlier, I touched upon the fact that most building societies are naturally customer orientated with fairness written into their corporate DNA. In practice, this culture naturally percolates into a society’s lending subsidiaries. In the non-conforming market in particular, this equality of treatment is a major selling point.
Today’s specialist lending market is not without its challenges. The proliferation of new players, fierce competition and falling margins will be challenging for all concerned. The growing engagement of the mutual sector in the specialist lending market, however, is inevitable. Building societies and their specialist subsidiaries will remain stable, committed lenders in the market which can only benefit brokers and borrowers alike.
