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

1. Arrears: What next?
November 2011
Page 1

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. 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. 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. Fast forward to 2011, a perfect storm... again?
Page 5

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. 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. ...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. 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. 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. 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. 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. 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. The crisis has brought with it more regulation
Page 14

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. > Higher capital ratios
> New liquidity buffers
> New mortgage affordability rules
> Increased reporting
further tightening lending…
Page 16

17. > Impairment indicators
> Forbearance
> Pre-action protocol
> Increased reporting
and lengthening arrears resolution…
Page 17

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. Page 19
Pre-arrears management may help borrowers,

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. 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. 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. > 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. So how does the future look?
Page 24

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. 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. 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. 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. ?
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. 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. Thank you!
Page 31