Outlook bleak for building society

THE clock is ticking on talks aimed at plugging a black hole in the Dunfermline Building Society, and preventing a third Scottish financial institution from collapsing, after other mutuals stonewalled its pleas for help.

Executives and regulators have been forced to turn to the Government for a lifeboat, to avert a major run at the troubled mutual after it announces the biggest loss ever to hit a building society later this week.

Hundreds of thousands of savers and borrowers have been horrified to learn that the society is expected to announce a 26m loss primarily because commercial loans turned sour. It is now seeking a cash lifeline from the taxpayer.

Uppermost in savers' minds is the question of how safe is their money? Some have already voted with their feet and removed their savings. The Scottish Building Society, one of the financially strongest, confirmed it had received a wave of deposits coming from the Dunfermline.

The crisis at the Fife-based home lender is a turning point for the building society movement, which has always taken pride in its record that it has never required a government bailout and no saver has lost a penny for nearly a century. Where a society did face difficulties, another mutual would ride to its rescue.

Building Societies Association chairman John Goodfellow is eager to quash suggestions that the Dunfermline is being abandoned and allowed to fail by the rest of the sector. He said: "It is a simple question of numbers. Over the past 12 months we have digested five big mergers, and there comes a point where you have to say that for the time being enough is enough.

"We always recognised that there might come a moment when we needed to examine other mechanisms for supporting societies, and that is what we are doing. As a sector we have always tried to solve our problems, and we are working with the Dunfermline to ensure that is what we do now."

Investors have traditionally felt safe when depositing their nest-eggs with mutuals, because they are owned by and run for the benefit of their customers, and thus are not driven by profit alone.

The activities that societies can undertake are also restricted by law, which they claim has left them less exposed to the credit crunch. Some are rich organisations sitting on fat cushions of capital. On the rare occasion a society has run into difficulties in the past, another mutual has stepped in to take it over.

You have to go back to the 1970s to find the last major building society scandal of any significance. The chief executive of the Grays committed suicide after leaving a note for his wife telling her "not to go into the bathroom alone". Inquiries discovered he had been embezzling funds for 40 years. This was followed a decade later by the New Cross, which got its sums horribly wrong.

Both were rescued by the Woolwich and no one lost any money.

In the last property recession, societies tumbled like a house of cards, with nearly half disappearing before green shoots of recovery emerged, and the current economic crisis has already taken a significant toll.

To date, the Britannia is merging with the Co-op, Derbyshire and Cheshire have been swallowed by the Nationwide, the Scarborough by the Skipton, the Barnsley by the Yorkshire and the Catholic by the Chelsea.

Yet no one has stepped in to prop up Dunfermline, whose financial position looks considerably bleaker than the position that triggered the demise of the Derbyshire and Cheshire. The Derbyshire was taken over when it was poised to announce a loss of 17m, while the Cheshire was rocked by a single 11.5m bad debt.

Regulators have an unwritten rule that societies are not allowed to make a loss because they are owned by ordinary savers, rather than sophisticated shareholders.

But the debacle at Dunfermline has torn up the rule book. At its last annual results it came close to making a loss after announcing a 9.5m writedown on a failed computer project, leaving it earning a 2m return on more than 3bn of assets.

Such a close shave would normally have prompted regulators to swing into forced merger mode. Its capital ratio at 4.4 was also thin, compared with the society average of 5.9, or more than nine at the strongest institutions, such as the much smaller Scottish.

But the Dunfermline was given a second chance, only to be driven onto the rocks again by bad debts on commercial loans, an area into which it had expanded aggressively, and disproportionately for a society of its size, until they represented 15% of its lending or 260m. The larger Yorkshire, for example, has no commercial debts.

Finally, it has been hit by new rules from the Financial Services Authority requiring it to set more capital aside, leaving it with liquidity constraints.

Chief executive Jim Willens has said in a statement that the society continues to meet its regulatory capital requirements and has strong liquidity.

This may bring cold comfort to the society's 300,000 savers and 35,000 borrowers, given that almost all institutions have given brave assurances about their financial strength shortly before they imploded.

So should you be worried about your savings? The first 50,000 of any investment is guaranteed by the Financial Services Compensation Scheme. On top of this, Prime Minister Gordon Brown has pledged that no UK saver will lose deposits. He has even taken the measure of compensating savers who decided to move offshore to Iceland.

It seems unlikely, therefore, that the Dunfermline would be allowed to fail. But it makes sense to spread your investments and never hold more than 50,000 in a single institution.

Borrowers have less to worry about. Their bigger concern will be what happens to their mortgage payments after a rescue. If the society needs to get back into profitability, their mortgages may become less competitive, and homebuyers may find themselves with few options other than remortgaging when their deal comes to an end, which can push up costs.

The Dunfermline offered 100% and other high loan-to-value deals. These borrowers are unlikely to find it easy to move elsewhere and could face much higher repayments.

Ten tips to keep savings safe

Don't worry. The Prime Minister has promised that no UK depositor will lose money.

Be sensible. If an interest rate looks too good to be true it probably is.

Know who you are investing with. Check their credentials out on www.fsa.gov.uk.

Only invest with UK-authorised banks and building societies.

Spread your money around. Make sure you invest a maximum of 50,000 with any one group.

National Savings & Investments is state-owned and therefore the safest UK savings organisation.

Failed institutions such as Royal Bank of Scotland, Northern Rock and Bank of Scotland are guaranteed by the taxpayer.

Be wary of putting your money into an organisation you have never heard of.

Keep up with the news.

Don't be greedy. A good return that lets you sleep at night is better than the top rate from someone who could go belly-up.