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Arrears: What next?

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A view on arrears in the UK mortgage market and what will happen going forward.

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Arrears: What next?

  1. 1. Arrears: What next? November 2011 Page 1
  2. 2. Agenda Case study: A family of five 1. A Perfect Storm... again? 2. Regulation has added costs and complexity 3. Pre-arrears management may help 4. So, how does the future look?
  3. 3. 2007, times were good... Let’s go back in time to early 2007: The economy is strong Pay raises are on the cards, Real estate prices always go up... Jack and Mary decide to buy a £155,000 house for their family of 5... Page 3
  4. 4. It is a stretch, the £15,000 down payment is all the savings they have... Mortgage amount £140,000 90% LTV interest only variable rate no repayment vehicle ...but times are good and borrowing easy Page 4
  5. 5. Fast forward to 2011, a perfect storm... again? Page 5
  6. 6. Slow growth sets in for the long run... Page 6 Sources: ONS, HM Treasury, Office for Budget Responsibility > Growth to be modest at best... with heightened risk of a double-dip in 2012 > Governments have lost ability to stimulate the economy or mitigate effects of another crisis > Eurozone hubris carries seeds of a crisis worse than fall of Lehman in 2008 0.9% 1.3% 0.5% 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 -10% -5% 0% 5% 10% 15% 20% GDP & BoE Rate Real GDP Growth BoE Rate 52.7% 70.9% 71.1% 87.2% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 £Trillions Gross & Net debt Net debt Gross debt Net debt/GDP Gross debt/GDP Sources: ONS, HM Treasury, Office for Budget Responsibility
  7. 7. Mortgage lending has plummeted... Page 7 Sources: BoE, FSA > The impact of the credit crunch on banks’ balance sheets, Basle III requirements, and the high level of uncertainty in the global economy means it will be a long time before lenders return to 2007 lending levels, if ever > Lending criteria have tightened substantially with close to 75% of new mortgages at LTVs <= 75% 0% 10% 20% 30% 40% 50% 60% 70% 80% 0 10 20 30 40 50 60 70 80 90 Q1-87 Q1-88 Q1-89 Q1-90 Q1-91 Q1-92 Q1-93 Q1-94 Q1-95 Q1-96 Q1-97 Q1-98 Q1-99 Q1-00 Q1-01 Q1-02 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 GBPBillions Mortgage Lending Gross Advances - LTVs -Rates Grossmortgage advances Mortgageswith LTV <=75%
  8. 8. ...as write-offs remain surprisingly low. Page 8 Sources: BoE, ECB, Federal Reserve 0.06%1.94% 0.12% 0.00 0.50 1.00 1.50 2.00 2.50 Jan-1993 Jan-1995 Jan-1997 Jan-1999 Jan-2001 Jan-2003 Jan-2005 Jan-2007 Jan-2009 Jan-2011 Household Sector Write-off Rates -Secured Debt- United Kingdom United States Euro Area % > Constrained by capital and with liquidity tight, banks in the Eurozone and UK have yet to recognize the full extent of their problems > By default and reluctantly, governments are becoming “investors of last resort” > The strongest banks will look to drive down risk assets (ie curtail lending) to shore up capital ratios
  9. 9. Average house prices have held up... Page 9 165107 0 50 100 150 200 250 Jan-83 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 GBPThousands UK House Prices (Monthly Average) Lloyds/Halifax Nationwide Land Registry Lloyds/Halifax Trendline '83 - '99 Lloyds/Halifax Trendline '00 - '10 > Still well above pre-2000 historical trend despite the 19% drop from 2007 peak > House prices grew at a CAGR of 5.2% from 1987 to 2010 as number of households grew only 0.89% > In 2004 the ratio of house prices/borrower’s income (per CLG) peaked at 5.21x, the highest in 25 years. At YE 2010 it had dropped to 4.96x
  10. 10. But for Jack and Mary the drop is enough to put them into negative equity... House value: £131,750 Mortgage is still £140,000 106% LTV Interest rate is now 3% though equity has been wiped out for some Page 10
  11. 11. Consumer debt is among highest in OECD... Page 11 Sources: ECB, BoE 155 123 99 60 80 100 120 140 160 180 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Household Debt/Income United Kingdom United States Euro Area % > From 2000-2007 UK consumers went on a borrowing binge which put UK households amongst the most indebted in the western world > As a result and despite the substantial drop in interest rates, household interest load is similar to levels experienced in the early 90s
  12. 12. unemployment is on the rise... Page 12 Sources: ONS 1.27 0.87 17.8% 21.30% 0% 5% 10% 15% 20% 25% 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 Apr-92 Jan-93 Oct-93 Jul-94 Apr-95 Jan-96 Oct-96 Jul-97 Apr-98 Jan-99 Oct-99 Jul-00 Apr-01 Jan-02 Oct-02 Jul-03 Apr-04 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Millions Youth and Long term Unemployment Unemployed >12 months Unemployment rate age 18-24 Sources: ONS, BBC 10.6% 8.1% 0% 5% 10% 15% 20% 25% 30% 0.0 0.5 1.0 1.5 2.0 2.5 3.0 Apr-92 Jan-93 Oct-93 Jul-94 Apr-95 Jan-96 Oct-96 Jul-97 Apr-98 Jan-99 Oct-99 Jul-00 Apr-01 Jan-02 Oct-02 Jul-03 Apr-04 Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Millions Unemployed & Unemployment Rate Unemployed <6 months Unemployed >6 & <=12 months Unemployed >12 months Unemployment rate > From peak of 10.6% in April 1993 it took 8+ years to get back below 5% unemployment > Unemployment this time around has not exhibited V shape of the 90s and is now trending upwards again > Highest in 17 years
  13. 13. Saving grace –for now-: low interest rates Page 13 Sources: CML, BoE, FSA, Crown Mortgage Management > With interest rates at all time lows, arrears have been kept in relative check, well below 90s levels > A mortgage rate increase of 1% adds roughly £90 a month to the average mortgage > The “normalization” of arrears levels took over 9 years from 1989 352 160 140 8.98% 3.96% 3.55% 1.41% 1.23% 0% 2% 4% 6% 8% 10% 12% 14% 16% 0 50 100 150 200 250 300 350 400 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Thousands Arrears >6 months Arrears >6 months Mortgage rates Arrears >6 months as % of all Mortgages
  14. 14. The crisis has brought with it more regulation Page 14
  15. 15. with major new directives a continuous flow... Page 15 Mar Apr Dec Jan Oct Nov Dec Jan Jun Jul Nov Dec Jan Feb Mar Oct Nov Dec 2008 2009 2010 2011 2012 2013 Mortgage Effectiveness review – Stage 2 Discussion Paper 09/3 - MMR CP 10/2 MMR: Arrears & Approved Persons PS 10/9 MMR: Arrears & Approved Persons CP 10/16 MMR: Responsible Lending CP 10/28 MMR: Distribution & Disclosure European Commission - Mortgage Credit Directive Forbearance & Impairment Provisions - Mortgages MMR- Final Consultation Paper FSA split: Financial Conduct Authority (FCA) Prudential Regulatory Authority (PRA) Economic Crime Agency Alignment of MMR & MCD? Basle 3 phase-in begins European Parliament & Council of Ministers pass MCD
  16. 16. > Higher capital ratios > New liquidity buffers > New mortgage affordability rules > Increased reporting further tightening lending… Page 16
  17. 17. > Impairment indicators > Forbearance > Pre-action protocol > Increased reporting and lengthening arrears resolution… Page 17
  18. 18. Arrears management is now more complex... > Ongoing monitoring of mortgage book and policies and procedures to ensure compliance with existing and proposed regulations > Success depends on  Keeping ahead of regulation  Continuous staff training  Transparency  Proper support and additional resources for the regulatory and compliance team > …meaning additional costs  Systems development  Additional reporting requirements  Increased work load  Training ... and costly Page 18
  19. 19. Page 19 Pre-arrears management may help borrowers,
  20. 20. and is now a key element of servicing > Portfolio/borrower stress testing to identify borrowers at risk  Substantial system enhancements  Inclusion of credit reference agency information  Development of meaningful, workable reports Heavy demand on lender/servicer resources > What to do with the information? > Staff awareness can help identify borrowers where difficulties will be encountered shortly  Challenge the Income and Expenditure information  Identify other triggers: request for change in payment type, consent to 2nd charges...  Understand long term sustainability to assist borrowers to exit amicably before arrears reach litigation levels Page 20
  21. 21. Early identification is important... For Jack and Mary though, net income barely changed and inflation reduced available income significantly Page 21 Current I&E (Monthly) Net income £2,018 Expenses 91.5% £1,847 Mortgage 17.3% £350 Council tax 6.2% £125 Water rates 1.7% £35 Fuel & lighting 7.1% £144 Car lease 11.6% £235 Motoring costs 6.6% £134 Food 22.3% £450 Cigarettes/drinks 7.9% £160 Clothing & footwear 2.5% £50 Other child expenses 2.0% £40 TV/Internet 1.9% £39 Other debt repayment 4.2% £85 Available income £171
  22. 22. Practically eliminating their ability to absorb any shock... as is a thorough grasp of circumstances Page 22 Current I&E Rate increase of 25-year amortizing at a rate of Inflation of (Monthly) 1% 4% 5% Net income £2,018 £2,018 £2,018 £2,018 Expenses 91.5% £1,847 £2,064 £2,336 £1,902 Mortgage 17.3% £350 £467 £739 £350 Council tax 6.2% £125 £125 £125 £125 Water rates 1.7% £35 £35 £35 £35 Fuel & lighting 7.1% £144 £144 £144 £151 Car lease 11.6% £235 £235 £235 £235 Motoring costs 6.6% £134 £134 £134 £141 Food 22.3% £450 £550 £550 £473 Cigarettes/drinks 7.9% £160 £160 £160 £168 Clothing & footwear 2.5% £50 £50 £50 £53 Other child expenses 2.0% £40 £40 £40 £42 TV/Internet 1.9% £39 £39 £39 £41 Other debt repayment 4.2% £85 £85 £85 £89 Available income £171 -£46 -£318 £116 New boiler £1,200 7.02 N/A N/A 10.35 ABS car brake repair £667 3.90 N/A N/A 5.75
  23. 23. > Gas and electricity hikes have yet to hit the budget > Arrears are an unforeseen event away > With the account already on interest only, there are no options available to reduce the payment amount... > Unless income increases or expenses reduce, the borrower will go in arrears in order to devise solutions where possible Page 23
  24. 24. So how does the future look? Page 24
  25. 25. Despite low rates, the consumer is hurting Page 25 Sources: ONS > High inflation and low wage growth putting the squeeze on consumers > Low income families experience higher inflation. Fuel and water account for 7.7% of their budget vs. 3.4% for high income families > Institute for Fiscal Studies notes real income after tax fell 3.5% in tax year 2010/2011, biggest drop since 1981 and predicts continued pain through at least 2013/14 5.60%2.2% -6% -4% -2% 0% 2% 4% 6% 8% 10% 12% Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 RPI vs. Total pay growth Gas bills +22.3% y-o-y Electricity +12.9% y-o-y Food +6.5% y-o-y
  26. 26. Savings rates have increased for now... Page 26 Sources: OECD Economic Outlook > Household savings rates dropped to all-time lows in 2008 > But have since climbed as households attempt to put cash aside for “rainy days” > Rate reached 7.4% in Q2 2011 0% 2% 4% 6% 8% 10% 12% 14% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 UK USA Germany
  27. 27. Mortgage balances have barely budged... Page 27 Sources: BoE, CML , CLG > Mortgage debt per household is at an all time high > ...and deleveraging will take a long time 22.9 CAGR: 0.89% 26.9 £8,393 CAGR: 7.69% £46,148 - 10 20 30 40 50 60 0 10 20 30 40 50 60 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 £Thousands Millions Mortgage Balance/Household Households Mortgage Balance per Household
  28. 28. For how long can the BoE hold rates? Page 28 Source: FSA > 40+% of mortgages are on an interest only basis (vs. 13% in 2002) with a majority having no repayment vehicle > Variable rate mortgages represent close to 70% of all mortgages... > ...and rates are at an all-time low 37.5% 40.0% 42.5% 45.0% 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 Q1-07 Q2-07 Q3-07 Q4-07 Q1-08 Q2-08 Q3-08 Q4-08 Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 £Trillions Mortgage Lending by Payment Type Repayment Interest only Combined Other Interest only as % of Total mortgages Source: FSA 69.24%2.87% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 0% 10% 20% 30% 40% 50% 60% 70% 80% Q1-07 Q2-07 Q3-07 Q4-07 Q1-08 Q2-08 Q3-08 Q4-08 Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Variable rate mortgages as% of Total mortgages Weighted average variable rate
  29. 29. ? 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 0 50 100 150 200 250 300 350 400 450 500 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Thousands Total Arrears Arrears >3-6 months Arrears >6 months Arrears as % of all Mortgages Arrears will outpace ‘90s levels over the cycle... Page 29 Source: CML, Crown ...but how will it happen? Source: CML, Crown ? 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 0 50 100 150 200 250 300 350 400 450 500 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Thousands Total Arrears Arrears >3-6 months Arrears >6 months Arrears as % of all Mortgages
  30. 30. Hard times ahead... Page 30 > A stalled economy, > Leverage well beyond previous downturns, > Limit government’s ability to help. > Inflation and low wage growth squeeze the consumer, > As unemployment is set to rise further with public sector redundancies continuing. > Low interest rates have helped but for how long? > Arrears are likely to test levels seen in the 90s though possibly spread out over a longer term > As are possessions which totalled over half a million during the 90’s cycle and amount to 124,000 from 2008 through 2010 > Unless a Black Swan event occurs...
  31. 31. Thank you! Page 31

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