Building societies' cash flow squeezed

BUILDING society finances came under intense pressure last week because of a continuing net outflow of money from depositors' accounts, raising fears that mortgage rates will have to rise sooner than expected.

The net outflow of funds from societies in July is almost certain to have been even more acute than the pounds 314m outflow in June, the worst monthly figure for six years. Competition with National Savings, withdrawals by people applying for the Wellcome share issue, seasonal factors such as holiday payments and borrowers paying off outstanding debts have all led to the loss of retail deposits for the societies.

Building societies are concerned that inflows to National Savings hardly appear to have slackened last week, despite the cut in the interest offered on the highly competitive First Option Bond last Monday. The bond, the first time National Savings has targeted lower-rate taxpayers, took in more than pounds 100m of retail savings within five days of its launch two weeks ago.

Mortgage rates are now almost certain to rise, probably by about 0.5 per cent, as the societies are forced to make their investment rates more attractive. Some societies believe the move could come within the next few days, although they say they may be able to hold off for two or three weeks.

An early mortgage rate move is likely to come first from one of the medium-sized societies, which are under the greatest financial pressure. These include Cheltenham & Gloucester, Bristol & West, Bradford & Bingley, National Provincial, Alliance & Leicester and Northern Rock.

They depend on wealthier depositors and the wholesale money markets for most of their funding. Given the lack of retail deposits, they have sharply increased their borrowing from the markets. Although there is a 40 per cent ceiling on the proportion of their funds that can come from the money markets, most societies have a lower limit closer to 30 per cent imposed on them by the Building Societies Commission.

Many middle-ranking societies are already approaching this limit, forcing them to turn to the retail market for extra funding. But the only way they can reverse the outflow of retail funds will be to raise investment rates, which will mean a simultaneous rise in mortgage rates.

'The warning light is already on for some societies over their money market borrowing,' one senior society official said.

The Building Societies Association, which represents the industry, has been lobbying the Government for an increase in the money market funding limit to 50 per cent.

Because it would require primary legislation to do so, however, the BSA does not believe a change is likely in the foreseeable future.

Societies emphasised that although pressure from their wholesale funding limits might mean higher lending and savings rates, it did not imply that their finances were in any way insecure.

Society chiefs complained last week that Monday's half- point cut in the National Savings First Option Bond to 9.67 per cent was merely cosmetic and had done little to reduce the bond's competitiveness. 'They needed to knock one percentage point off the rate to make a difference,' John Bayliss, general manager of the Abbey National, Britain's second largest mortgage lender, said. 'And that does not take account of the fact that National Savings has a raft of other extremely competitive savings products.'

In deciding their interest rate strategy, the societies have to take account of the traditional drop in deposits during the summer months. Money tends to flow out of savings accounts during June, July, August and much of September. With the prospect of another two and possibly three months of retail outflows, some societies may decide there is no point waiting any longer before putting up interest rates.