Savings Banks Tied To Housing Markets

There is a popular perception in the U.K. and the U.S. that savings banks ("building societies" or "thrifts") will emerge relatively unscathed from the financial crisis, because most have little or no exposure to the most problematic asset-backed securities. Yet the "monoline" nature of their businesses means that the prospects for the sector depend, crucially, on the outlook for the residential housing market--where recent data suggest there is cause for concern.

Potential risks. U.S. thrifts and U.K. building societies are vulnerable during housing corrections for three key reasons:

--They are largely monoline businesses with activities heavily concentrated in the residential mortgage sector. In the case of U.K. building societies, this concentration is nearly total. U.S. thrifts are somewhat more diversified--according to the Office of Thrift Supervision (OTS), only about 46% of loans were for home mortgages. Nevertheless, in both cases, steep property-price corrections can quickly lead to a surge in impaired assets.

--As smaller institutions, savings banks tend to have trouble raising funds on the capital markets--a problem that is particularly acute for U.K. building societies due to their mutual ownership structures. A thrift with liquidity problems must either raise money on the wholesale market or attract more retail deposits, which are both limited and expensive options in the current economic climate.

--Building societies and thrifts are hardly immune to poor risk-management, particularly the temptation to extend ever-more generous loans to home buyers in the context of a housing-market bubble. Most followed the lead of other banks in requiring only a 5%-10% deposit by buyers at the peak of the cycle in 2006-07; these new homeowners are now in 'negative equity' situations that frequently precede default and foreclosure.

Current situation. There are indications that the downside risks facing the sector in the U.K. and U.S. are rising:

-- Moody's last month downgraded seven big U.K. building societies and signaled a negative outlook for the sector. Although the Nationwide, easily the largest society with 180 billion pounds ($274 billion) in assets, was not among them, pressure on the sector is increasing as housing prices continue to fall. The largest building society in Scotland, the Dunfirmline, collapsed on March 30.

--In his speech to the ICBA, Treasury Secretary Timothy Geithner promised that further government capital would be made available to community banks and thrifts through the Troubled Asset Relief Program (TARP), primarily through capital repayments from institutions that had already received TARP funds, such as Goldman Sachs .

--The latest OTS industry report revealed in February that in 2008, troubled assets (mortgages more than 90 days in arrears, or in repossession) as a percentage of total thrift assets had reached their highest level since the Savings and Loans crisis of the late 1980s-early 1990s.

Housing-market prospects? Recent month-on-month upward blips in the most widely watched U.K. housing-market indexes and a slowing in the year-on-year rate of decline of the broadest U.S. Case-Shiller housing price index (to -18.6% in February from -19% in January) have led some market observers to conclude that a near-term rebound is possible. However, this is probably incorrect:

--U.K. housing prices relative to gross domestic product, equities, price-to-rent ratios and first-time buyers' incomes remain near historic highs (much higher than in the U.S.). Although "affordability" measures have increased due to recent declines, required mortgage deposits have risen to an average of nearly 25% of loan value from 11% in 2007--making purchases more difficult.

--In the U.S. there is evidence that price declines in some of the worst-hit markets, such as California, are moderating. However, previously resilient regions, such as the New York metropolitan area, are experiencing accelerating slumps.

Outlook. Savings bank prospects appear poor--particularly in regions that are only beginning to experience major housing-price declines. The U.S. mortgage foreclosure rate hit a 50-year high during the first quarter. However, the economic headwinds facing U.K. building societies may be more severe, as the U.K. housing market seems to have further to fall.

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