Arrears: What next?
November 2011
Page 1
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?
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
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
Fast forward to 2011, a perfect storm... again?
Page 5
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
£ Tr
illio
ns Gross & Net debt
Net debt Gross debt Net debt/GDP Gross debt/GDPSources: ONS, HM Treasury, Office for Budget Responsibility
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-
87Q
1-88
Q1-
89Q
1-90
Q1-
91Q
1-92
Q1-
93Q
1-94
Q1-
95Q
1-96
Q1-
97Q
1-98
Q1-
99Q
1-00
Q1-
01Q
1 -02
Q1-
03Q
1-04
Q1-
05Q
1-06
Q1-
07Q
1-08
Q1-
09Q
1-10
Q1-
11
GBP
Bill
ions Mortgage Lending
Gross Advances - LTVs -Rates
Gross mortgage advances Mortgages with LTV <=75%
...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
Average house prices have held up...
Page 9
165
107
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
GBP
Thou
sand
s UK House Prices(Monthly Average)
Lloyds/Halifax NationwideLand Registry Lloyds/Halifax Trendline '83 - '99Lloyds/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
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
Consumer debt is among highest in OECD...
Page 11
Sources: ECB, BoE
155
123
99
60
80
100
120
140
160
18019
8719
8819
8919
9019
9119
9219
9319
9419
9519
9619
9719
9819
9920
0020
0120
0220
0320
0420
0520
0620
0720
0820
0920
10
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
unemployment is on the rise...
Page 12
Sources: ONS
1.27
0.87
17.8
%
21.3
0%
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-
93O
ct-9
3Ju
l-94
Apr
-95
Jan-
96O
ct-9
6Ju
l-97
Apr
-98
Jan-
99O
ct-9
9Ju
l-00
Apr
-01
Jan-
02O
ct-0
2Ju
l-03
Apr
-04
Jan-
05O
ct-0
5Ju
l-06
Apr
-07
Jan-
08O
ct-0
8Ju
l-09
Apr
-10
Jan-
11
Mill
ions 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-
93O
ct-9
3Ju
l-94
Apr
-95
Jan-
96O
ct-9
6Ju
l-97
Apr
-98
Jan-
99O
ct-9
9Ju
l-00
Apr
-01
Jan -
02O
ct-0
2Ju
l-03
Apr
-04
Jan-
05O
ct-0
5Ju
l-06
Apr
-07
Jan-
08O
ct-0
8Ju
l-09
Apr
-10
Jan-
11
Mill
ions Unemployed
& Unemployment Rate
Unemployed <6 months Unemployed >6 & <=12 monthsUnemployed >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
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
Thou
sand
s Arrears >6 months
Arrears >6 monthsMortgage ratesArrears >6 months as % of all Mortgages
The crisis has brought with it more regulation
Page 14
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
> Higher capital ratios > New liquidity buffers > New mortgage affordability rules > Increased reporting
further tightening lending…
Page 16
> Impairment indicators > Forbearance > Pre-action protocol > Increased reporting
and lengthening arrears resolution…
Page 17
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
Page 19
Pre-arrears management may help borrowers,
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
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% £1,847Mortgage 17.3% £350Council tax 6.2% £125Water rates 1.7% £35Fuel & lighting 7.1% £144Car lease 11.6% £235Motoring costs 6.6% £134Food 22.3% £450Cigarettes/drinks 7.9% £160Clothing & footwear 2.5% £50Other child expenses 2.0% £40TV/Internet 1.9% £39Other debt repayment 4.2% £85
Available income £171
Practically eliminating their ability to absorb any shock...
as is a thorough grasp of circumstances
Page 22
Current I&ERate
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 £1,902Mortgage 17.3% £350 £467 £739 £350Council tax 6.2% £125 £125 £125 £125Water rates 1.7% £35 £35 £35 £35Fuel & lighting 7.1% £144 £144 £144 £151Car lease 11.6% £235 £235 £235 £235Motoring costs 6.6% £134 £134 £134 £141Food 22.3% £450 £550 £550 £473Cigarettes/drinks 7.9% £160 £160 £160 £168Clothing & footwear 2.5% £50 £50 £50 £53Other child expenses 2.0% £40 £40 £40 £42TV/Internet 1.9% £39 £39 £39 £41Other debt repayment 4.2% £85 £85 £85 £89
Available income £171 -£46 -£318 £116
New boiler £1,200 7.02 N/A N/A 10.35ABS car brake repair £667 3.90 N/A N/A 5.75
> 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
So how does the future look?
Page 24
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-
87Ja
n-88
Jan-
89Ja
n-90
Jan-
91Ja
n-92
Jan-
93Ja
n-94
Jan-
95Ja
n-96
Jan-
97Ja
n-98
Jan-
99Ja
n-00
Jan-
01Ja
n-02
Jan-
03Ja
n-04
Jan-
05Ja
n-06
Jan-
07Ja
n-08
Jan-
09Ja
n-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
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
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
£8,3
93
CAGR: 7.69%
£46,
148
-
10
20
30
40
50
60
0
10
20
30
40
50
6019
8719
8819
8919
9019
9119
9219
9319
9419
9519
9619
9719
9819
9920
0020
0120
0220
0320
0420
0520
0620
0720
0820
0920
10
£ Th
ousa
nds
Mill
ions Mortgage Balance/Household
Households Mortgage Balance per Household
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
£ Tr
illio
ns Mortgage Lending by Payment Type
Repayment Interest onlyCombined OtherInterest only as % of Total mortgages
Source: FSA
69.2
4%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
?
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
Thou
sand
s 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
Thou
sand
s Total Arrears
Arrears >3-6 months Arrears >6 months Arrears as % of all Mortgages
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...
Thank you!
Page 31
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