Before you say 'I do' to a cash crisis

BRITAIN'S biggest building society, the Nationwide, last week stepped in to rescue two smaller mutuals, as the property crisis deepened, leaving small savers to wonder just how safe is their money.

The Nationwide threw a life-line to the Derbyshire after it emerged it was heading for a pre-tax loss of £17m for the first half of the year. Similarly, the Cheshire was reeling after an £11.5m loan turned sour, pushing the society £10.5m into the red.

Closer to home, the Dunfermline last week announced job losses at its head office and a major management shake-up. This follows the £9m provision it was forced to make over a bungled IT project which squeezed last year's profits from £11m to £2m.

The tiny Catholic society has already given up the ghost and announced a merger with the Chelsea. So consumers could be forgiven for questioning whether the writing might finally be on the wall for Britain's 59 surviving mutuals, particularly if house prices continue to fall and repossessions rise.

During the last housing slump, four out of 10 societies disappeared. If that pattern is repeated it will spell the end for around 20 mutuals. To put all this into perspective, though, no saver with a UK building society has lost money through a collapse since before the First World War. Furthermore, the first £35,000 with one institution is protected by the Financial Services Compensation Scheme.

Nevertheless, there are times when this guarantee will not be enough. If you have inherited a lump sum that you need to distribute with others, you could have a cash mountain in your account for a short while. Similarly when you are buying and selling property unusually a minor treasure chest could be drifting through your hands.

Should your bank or building society go down that day, you might never recover.

In theory, building societies should be better protected than banks against the squeeze of the credit crunch, because they have always raised the lion share of the money they lend in mortgages from ordinary savers.

Their constitution prevented them participating in the weird and wonderful financial derivatives, and asset-backed securities, which have caused such damage to the banking sector.

Furthermore they operate in a low-risk environment and, unlike the banks, societies must always be seen to make healthy profits to survive. Any hint of a loss and the regulators pounce, normally followed shortly by a shotgun marriage with a stronger or wiser cousin.

Mark Durling, banking analyst at Brewin Dolphin, believes we will see widescale mergers among the mutuals. He said: "The problem facing all savings institutions is the cost of money, and some small societies are crying out for funds. They will increasingly struggle to compete."

The key to pinpointing those who will survive is size, strength of savings brand, reserves, business-risk profile, overall profitability and the quality of its management, according to Simon Walker of KPMG.

Walker said: "We don't believe there are any other immediate problems in the sector, but there could be further consolidation. Those with low profitability or who have moved into higher risk lending are the ones to watch."

So how do you spot the winners?

The strongest society is Nationwide, which is bigger than the rest of the other 58 societies put together. Its only question mark is what would happen if it did hit the skids. No other society is strong enough to rescue it. However, as one of our major institutions, it is unlikely any Government would allow it to fail.

The next richest is National Counties, whose members might expect an average windfall of £2,800 if it merged or demutualised. Although just outside the top 20, its free capital ratio (one measure of financial strength) is 9.2% compared with a sector average of 5.9%.

The Yorkshire, Coventry and Chelsea are also seen as winners in the current climate, financially strong, well managed, attracting new inflows of savings and in the acquisition business.

The Skipton, though strong, has a more diverse business mix than its close rivals, owning Connells the UK's second biggest estate agent, a mortgage administration business and a credit reference agency.

However, the Fitch rating agency, which judges all the above as strong companies with no concerns, has down-graded the Britannia, Westbromwich and Principality.

Britannia has already announced a £40m provision against bad debts for the first six months of the year, compared with £14m for the whole of last year, largely connected with its subsidiary Platform which specialises in buy-to-let and higher risk lending. However, its free capital ratio, at 5.9% , is still in line with the sector average. The Westbromwich also has a buy-to-let exposure, but its capital position is slightly below average at 5.4%.

Another to watch is the Dunfermline, after its £9m provision on the IT project which cut its to £2m. The society's free capital is also the lowest in the top 20 at 4.4%.

Outside the top 20, almost any society is vulnerable, as size becomes a problem. Kevin Mountford, of moneysupermarket said: "Changes are afoot, and more mergers are on the cards. The current difficult climate will exhaust the will and ability of many small mutuals to continue."

How to bag a windfall

The disappearance of societies is not necessarily bad news as windfalls of around £1,000 are usually paid to members if their society merges or demutualises.

No bonuses are to be paid as a result of the Derbyshire and Cheshire deals announced last week, as they were forced marriages following bad debts. However, Catholic members are to receive a bonus when their merger with the Chelsea is completed.

The lure of bonuses can get out of hand. During the last round of consolidation, carpetbaggers stormed some societies in a bid to enjoy a free bonanza.

To see them off, many societies set up charitable trusts and required new customers to assign any rights to a windfall to it, thereby removing the lure of a giveaway and protecting themselves from carpetbagger disruption. However, some have recently rescinded.

At Kent Reliance and the Saffron, for example, you can still become a full member with windfall rights by depositing £100. Some others, such as the Cambridge, give full membership rights to new customers but only if they live locally.

At the Nottingham and Scarborough, you can become a full member if you invest more than £2,500.

The majority of the rest, ask you to sign away the right to a windfall but only for five years, which could still make it a reasonable long-term investment.

How does the guarantee work?

If your bank or building society collapses, the first £35,000 per person is protected, irrespective of the number of accounts held there. This also applies to joint accounts, so in theory two people can claim £70,000.

It therefore makes sense to spread your money around in £35,000 pots. However, it is all a bit more complicated than that. For example, recompense is only payable in respect of nest eggs held with institutions which have a separate banking licence.

Beware different savings brands within one group, as only the first £35,000 invested in each of these accounts will be protected. At the HBOS group, for example, several brands are covered by just one licence, so only a maximum £35,000 would be paid out.

Ironically, Britain's biggest savings institution, the Halifax, is not itself authorised, although savers would be covered by the group's Bank of Scotland registration.

The FSA is currently investigating the whole area of compensation and whether it should be increased to £50,000. But it is also known to be concerned about this snake pit of banking licences.

Another problem area is foreign banks, some of which repeatedly top the best buy tables. If a bank authorised by the FSA in the UK fell over, compensation would be paid by the Financial Services Compensation Scheme (FSCS) writing a cheque within weeks.

However, other institutions such as Anglo Irish and Icelandic bank IceSave are registered in another European state. Savers still enjoy the equivalent £35,000, but first they would have to claim compensation from the local authority, which may only pay out a fraction of the UK guarantee. A top-up will then have to be claimed from the FSCS.