As I write this article this morning – 18 May 2012 – my Financial Times main headline tells me that “Spain calls for calm after bank downgrade”.  The main item for political debate is the crisis in the Eurozone, the future of Greece within the Euro and the risks of contagion spreading across the Northern Mediterranean and to other peripheral Eurozone states.

So there is not much in the financial markets currently to engender cheerfulness.  Indeed, the UK economy will suffer if the Eurozone implodes – not of course because the UK is a member of the Euro, but because of the very important contribution that the Eurozone makes to the demand for UK products.

Against that depressing background, where do building societies stand in the UK?  They hold relatively little of their assets with Southern European based banks and their business is almost exclusively UK based.  They would not be immune from a Euro crisis, but appear relatively well placed to cope with what the external world throws at them.

In the recent short-term they have done well.  Mutuals’ gross mortgage lending was up 40% between the first quarter of 2011 and the equivalent period of 2012 compared to an increase of just 11% across the entire market, for example.  Post-tax profitability, which fell to an aggregate all time low of eight pence per hundred pounds of assets in the sector in 2009 recovered to fifteen pence in 2010 and probably edged up a little further to perhaps seventeen pence in 2011 – a satisfactory rate of return for a sector that does not need to deliver dividends to shareholders.

Looking longer term building societies, like banks, face the whole panoply of regulatory change that could revolutionise the banking sector over the next five years – the disappearance of the FSA, the creation of the new Prudential Regulation Authority, as a subsidiary of the Bank of England, the new Financial Stability Committee of the Bank, and the new Financial Conduct Authority.

We are also expecting the imminent publication of an HM Treasury White Paper on how to implement the recommendations of the Vickers Commission on banking. This envisaged the creation of a ring-fence around the consumer and small business parts of banks to separate them fully from their wholesale market investment banking operations.  In this context, building societies were encouraged by the latest Standard & Poors’ report on their sector published on 19 April 2012 entitled “Back to Basics – Banking Keeps UK Building Societies on Solid Ground”.  The report makes the point that:

“Building societies have generally emerged from the difficulties of the financial crisis in better health than the UK banking industry as a whole.”

“Standard & Poor’s believes that what keeps the building society sector on solid ground are its franchise stability, adequate capitalisation, focus on prime residential lending, and customer deposit-based funding profiles.  Furthermore, because building societies focus mainly on lending and deposit-taking, we view them as good examples of “back to basics” banking.  And as the business models of larger banks evolve in response to regulatory and market developments since the financial crisis, building societies could claim, with some justification, that they are already further along the road to maintaining sustainable franchises in the new financial landscape.”

“We believe this solid business model will continue to support relatively stable credit profiles through macroeconomic cycles.”

Building societies face the future with confidence.  Customer satisfaction levels – on a very wide range of measures – remain above those of banks; as noted above, their credit ratings seem stable for the time being at least; mortgage volumes are increasing and they are already well positioned, compared to the banking sector, to cope with the regulatory reform that is going to sweep through the financial markets over the next few years.  Local authorities and other public sector entities would be well advised to at least examine the terms and conditions offered by societies when considering where to invest their surplus balances!