Bill Jamieson: Why there are deeper questions at Dunfermline

Published on Monday 23 March 2009 20:47

ONLY yesterday, it seemed, small, local, mutually owned financial institutions were being tipped as the new banking model in post-crash Britain – just like the Dunfermline Building Society.

Think again. For the Dunfermline, Scotland's oldest and last remaining independent financial institution, looks to be the latest in need of a bail-out. It is poised to announce losses reckoned at around 26 million and needs to find additional finance to meet the Financial Services Authority requirements on capital reserves.

Hardly reassuring news for the Dunfermline's 312,000 customers with 3.2 billion of deposits, or for the society's 390 employees. Some sources have estimated a potential write-down on the society's commercial loan portfolio of up to 90m.

The society, being advised by Edinburgh-based investment bank Noble & Co., has held exploratory talks with other bigger building societies such as the Britannia and the Nationwide, but without, so far, any success..

Now there seems almost a race between Westminster and Holyrood governments to get in first with a bail-out plan. The Scottish Government is understood to have come up with various ideas including, it is understood, an offer to purchase the society's loans to housing associations that might help free up capital.

And over the weekend there was growing speculation of a Westminster government solution in the form of a bail-out extending to 60bn.

Opinion has now quickly coalesced round the view that the Dunfermline should not be allowed to fail.

But there are searching questions longer term as to what sort of business we are seeking to rescue. Can it really grow out of the crisis through bumper profits in future years? It made just 2m in 2007. Does it have a viable business model that can withstand intense competition from the big banks – crippled as they are?

The society did not casually alight on commercial property lending as some optional sideline. It was driven to this sector by intensifying competition in the residential mortgage market, with the big banks building huge mortgage market shares.

Consider the position now.

Two of its major competitors are Lloyds Banking Group and RBS. Lloyds, with a 30 per cent plus share of the UK mortgage market, is majority owned by the government and has some 260bn of its "toxic assets" now insured by the taxpayer.

RBS, 68 per cent state-owned, has some 325bn of its toxic assets underwritten. Both banks are under intense pressure from their majority shareholder to step up their lending to the housing market. Indeed, the Royal recently announced that it was making 9bn of mortgage lending available this year, with 1.7bn earmarked for Scotland. In addition, the bank will consider mortgages of up to 90 per cent of house value.

How can a small society like the Dunfermline hope to compete without help against this state-supported onslaught? It has really no immediate alternative but to join that very large part of the UK banking system now under state control and either have its problem loans taken over under the government's asset support programme or have the government underwrite a capital injection by way of, for example, Permanent Interest Bearing Shares (PIBS).

The society has recently been coy about its lurch into commercial property lending. The 2007annual report had virtually nothing to say about these loans, to what developments and projects they were extended, what form they took and why.

The big leap forward in commercial lending occurred in 2006 under the chairmanship of Sir John Ward.

In the 2006 accounts he reported that while gross residential lending had jumped 30 per cent to 512m, "the biggest surge was in commercial lending which recorded a rise of 173 per cent to 235m."

Put another way, the society's commercial lending jumped to within 60 per cent of the total lent in residential mortgages the previous year. "We are now established", wrote Ward, "as a mainstream lender to the Scottish commercial property sector, competing with plc banks on transactions."

It hardly seemed a fitting purpose for a mutual building society. And if it was struggling to see a long-term future then, what prospects does it have now?