Presentation given at the CML\'s MICE conference in November 2011. View on current arrears, arrear issues and what next.

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. and borrowing easy
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
Page 4

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

6. Slow growth sets in for the long run...
20%
GDP & BoE Rate 1.8
Gross & Net debt 100%
£ Trillions
87.2%
1.6 90%
15%
80%
71.1%
1.4
70%
70.9%
10% 1.2
52.7%
60%
1.0
5% 50%
0.8
0.9% 1.3%
40%
0% 0.6
0.5% 30%
0.4
20%
-5%
0.2 10%
-10% 0.0 0%
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Real GDP Growth BoE Rate Net debt Gross debt Net debt/GDP Gross debt/GDP
Sources: ONS, HM Treasury, Office for Budget Responsibility 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
Page 6

7. Mortgage lending has plummeted...
90
Mortgage Lending 80% > The impact of the credit
GBP Billions
Gross Advances - LTVs -Rates crunch on banks’
80 70% balance sheets, Basle III
requirements, and the
70
60% high level of uncertainty
in the global economy
60
50% means it will be a long
50
time before lenders return
40% to 2007 lending levels, if
40 ever
30% > Lending criteria have
30
tightened substantially
20% with close to 75% of new
20
mortgages at LTVs <= 75%
10 10%
0 0%
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
Gross mortgage advances Mortgages with LTV <=75%
Sources: BoE, FSA
Page 7

8. ...as write-offs remain surprisingly low.
Household Sector Write-off Rates > Constrained by capital
% 2.50 -Secured Debt- and with liquidity tight,
banks in the Eurozone
and UK have yet to
2.00 recognize the full extent
of their problems
1.94%
> By default and
1.50
reluctantly, governments
are becoming “investors
1.00
of last resort”
> The strongest banks will
look to drive down risk
0.50
assets (ie curtail lending)
0.12%
0.06%
to shore up capital ratios
0.00
Jan-1993
Jan-1995
Jan-1997
Jan-1999
Jan-2001
Jan-2003
Jan-2005
Jan-2007
Jan-2009
Jan-2011
United Kingdom United States Euro Area
Sources: BoE, ECB, Federal Reserve
Page 8

9. Average house prices have held up...
250
UK House Prices > Still well above pre-2000
GBP Thousands
(Monthly Average) historical trend despite
the 19% drop from 2007
200
peak
> House prices grew at a
165
CAGR of 5.2% from 1987
150
to 2010 as number of
households grew only
107
0.89%
100
> In 2004 the ratio of house
prices/borrower’s income
50
(per CLG) peaked at
5.21x, the highest in 25
years. At YE 2010 it had
dropped to 4.96x
0
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
Lloyds/Halifax Nationwide
Land Registry Lloyds/Halifax Trendline '83 - '99
Lloyds/Halifax Trendline '00 - '10
Page 9

10. though equity has been wiped out for some
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%
Page 10

11. Consumer debt is among highest in OECD...
% 180
Household Debt/Income > From 2000-2007 UK
consumers went on a
160
borrowing binge which
put UK households
155
amongst the most
140 indebted in the western
world
120
> As a result and despite
123
the substantial drop in
interest rates, household
100 interest load is similar to
99 levels experienced in the
early 90s
80
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
United Kingdom United States Euro Area
Sources: ECB, BoE
Page 11

12. unemployment is on the rise...
3.0 30% 1.4 25%
Unemployed Youth and Long term
Millions
Millions
21.30%
& 1.27
Unemployment
2.5 Unemployment Rate 25% 1.2
20%
17.8%
1.0
2.0 20%
0.87
15%
0.8
1.5 15%
0.6
10%
1.0 10%
10.6%
0.4
8.1%
0.5 5% 5%
0.2
0.0 0%
Oct-93
Oct-96
Oct-99
Oct-02
Oct-05
Oct-08
Apr-92
Apr-95
Apr-98
Apr-01
Apr-04
Apr-07
Apr-10
Jul-94
Jul-97
Jul-00
Jul-03
Jul-06
Jul-09
Jan-93
Jan-96
Jan-99
Jan-02
Jan-05
Jan-08
Jan-11
0.0 0%
Oct-93
Oct-96
Oct-99
Oct-02
Oct-05
Oct-08
Apr-92
Apr-95
Apr-98
Apr-01
Apr-04
Apr-07
Apr-10
Jul-94
Jul-97
Jul-00
Jul-03
Jul-06
Jul-09
Jan-93
Jan-96
Jan-99
Jan-02
Jan-05
Jan-08
Jan-11
Unemployed <6 months Unemployed >6 & <=12 months
Unemployed >12 months Unemployment rate Unemployed >12 months Unemployment rate age 18-24
Sources: ONS Sources: ONS, BBC
> 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
Page 12

13. Saving grace –for now-: low interest rates
400
Arrears >6 months
16% > With interest rates at all
Thousands
time lows, arrears have
350 14% been kept in relative
check, well below 90s
300 12%
levels
352
250 10%
> A mortgage rate increase
8.98%
of 1% adds roughly £90 a
200 8% month to the average
mortgage
160
140
150 6% > The “normalization” of
arrears levels took over 9
3.55%
100 4% years from 1989
3.96%
50 2%
1.41%
1.23%
0 0%
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Arrears >6 months
Mortgage rates
Arrears >6 months as % of all Mortgages
Sources: CML, BoE, FSA, Crown Mortgage Management
Page 13

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

15. with major new directives a continuous flow...
FSA split:
Financial Conduct Authority (FCA)
Prudential Regulatory Authority (PRA)
Economic Crime Agency
PS 10/9 MMR: European European
Arrears & Commission - Parliament &
Approved Mortgage Council of Ministers
Persons Credit Directive pass MCD
CP 10/2 MMR: Forbearance &
Mortgage CP 10/16 MMR:
Arrears & Impairment Alignment of
Effectiveness Responsible
Approved Provisions - MMR & MCD?
review – Stage 2 Lending
Persons Mortgages
Discussion CP 10/28 MMR: MMR- Final
Basle 3 phase-in
Paper 09/3 - Distribution & Consultation
begins
MMR Disclosure Paper
Mar Apr Dec Jan Oct Nov Dec Jan Jun Jul Nov Dec Jan Feb Mar Oct Nov Dec
2008 2009 2010 2011 2012 2013
Page 15

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

17. and lengthening arrears resolution…
> Impairment indicators
> Forbearance
> Pre-action protocol
> Increased reporting
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. Pre-arrears management may help borrowers,
Page 19

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 Current I&E
income barely changed (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
and inflation reduced available income significantly
Page 21

22. as is a thorough grasp of circumstances
Practically eliminating their ability
to absorb any shock... Rate
25-year
amortizing Inflation of
Current I&E increase of at a rate 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
Page 22

23. in order to devise solutions where possible
> 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
Page 23

24. So how does the future look?
Page 24

25. Despite low rates, the consumer is hurting
12%
RPI vs. Total pay growth > High inflation and low
wage growth putting the
10%
squeeze on consumers
8% > Low income families
experience higher
5.60%
6% inflation. Fuel and water
account for 7.7% of their
4% budget vs. 3.4% for high
income families
2%
> Institute for Fiscal Studies
2.2%
0%
notes real income after
Gas bills +22.3% y-o-y tax fell 3.5% in tax year
-2% 2010/2011, biggest drop
Electricity +12.9% y-o-y since 1981 and predicts
-4% continued pain through
Food +6.5% y-o-y
at least 2013/14
-6%
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
Sources: ONS
Page 25

26. Savings rates have increased for now...
14%
> Household savings rates
dropped to all-time lows
12% in 2008
> But have since climbed
10% as households attempt to
put cash aside for “rainy
8%
days”
> Rate reached 7.4% in Q2
2011
6%
4%
2%
0%
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
UK USA Germany
Sources: OECD Economic Outlook
Page 26

27. Mortgage balances have barely budged...
60
Mortgage Balance/Household
60
> Mortgage debt per
£ Thousands
Millions
household is at an all time
£46,148
high
50 50
> ...and deleveraging will
take a long time
CAGR: 7.69%
40 40
30 30
26.9
CAGR: 0.89%
22.9
20 20
£8,393
10 10
0 -
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Households Mortgage Balance per Household
Sources: BoE, CML , CLG
Page 27

28. For how long can the BoE hold rates?
1.4
Mortgage Lending by Payment Type 45.0% 80%
Variable rate mortgages 20%
£ Trillions
69.24%
18%
1.2 70%
16%
60%
1.0
14%
42.5%
50%
0.8 12%
40% 10%
0.6
8%
40.0% 30%
0.4
6%
20%
2.87%
4%
0.2
10%
2%
0.0 37.5%
0% 0%
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
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
Repayment Interest only
Combined Other
as% of Total mortgages Weighted average variable rate
Interest only as % of Total mortgages
Source: FSA 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
Page 28

29. Arrears will outpace ‘90s levels over the cycle...
500 4.5% 500 4.5%
Total Arrears Total Arrears
Thousands
Thousands
450 4.0% 450 4.0%
? ?
400 400
3.5% 3.5%
350 350
3.0% 3.0%
300 300
2.5% 2.5%
250 250
2.0% 2.0%
200 200
1.5% 1.5%
150 150
1.0% 1.0%
100 100
50 0.5% 50 0.5%
0 0.0% 0 0.0%
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Arrears >3-6 months Arrears >6 months Arrears as % of all Mortgages Arrears >3-6 months Arrears >6 months Arrears as % of all Mortgages
Source: CML, Crown Source: CML, Crown
...but how will it happen?
Page 29

30. Hard times ahead...
> 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...
Page 30

31. Thank you!
Page 31