arrears: what next?

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Arrears: What next? November 2011 Page 1

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

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Page 1: Arrears: what next?

Arrears: What next?

November 2011

Page 1

Page 2: Arrears: what next?

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?

Page 3: Arrears: what next?

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

Page 4: Arrears: what next?

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

Page 5: Arrears: what next?

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

Page 5

Page 6: Arrears: what next?

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

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1991

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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%

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50%

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100%

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£ Tr

illio

ns Gross & Net debt

Net debt Gross debt Net debt/GDP Gross debt/GDPSources: ONS, HM Treasury, Office for Budget Responsibility

Page 7: Arrears: what next?

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%

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1-10

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11

GBP

Bill

ions Mortgage Lending

Gross Advances - LTVs -Rates

Gross mortgage advances Mortgages with LTV <=75%

Page 8: Arrears: what next?

...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

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1993

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1995

Jan-

1997

Jan-

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Jan-

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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

Page 9: Arrears: what next?

Average house prices have held up...

Page 9

165

107

0

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250

Jan-

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Jan-

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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

Page 10: Arrears: what next?

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

Page 11: Arrears: what next?

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

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0020

0120

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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

Page 12: Arrears: what next?

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

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1.0

1.2

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Apr

-92

Jan-

93O

ct-9

3Ju

l-94

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-95

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ct-9

6Ju

l-97

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-98

Jan-

99O

ct-9

9Ju

l-00

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-01

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02O

ct-0

2Ju

l-03

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-04

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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-

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ct-9

9Ju

l-00

Apr

-01

Jan -

02O

ct-0

2Ju

l-03

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-04

Jan-

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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

Page 13: Arrears: what next?

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

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1987

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Thou

sand

s Arrears >6 months

Arrears >6 monthsMortgage ratesArrears >6 months as % of all Mortgages

Page 14: Arrears: what next?

The crisis has brought with it more regulation

Page 14

Page 15: Arrears: what next?

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

Page 16: Arrears: what next?

> Higher capital ratios > New liquidity buffers > New mortgage affordability rules > Increased reporting

further tightening lending…

Page 16

Page 17: Arrears: what next?

> Impairment indicators > Forbearance > Pre-action protocol > Increased reporting

and lengthening arrears resolution…

Page 17

Page 18: Arrears: what next?

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: Arrears: what next?

Page 19

Pre-arrears management may help borrowers,

Page 20: Arrears: what next?

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

Page 21: Arrears: what next?

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

Page 22: Arrears: what next?

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

Page 23: Arrears: what next?

> 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

Page 24: Arrears: what next?

So how does the future look?

Page 24

Page 25: Arrears: what next?

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%

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12%

Jan-

87Ja

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RPI vs. Total pay growth

Gas bills +22.3% y-o-y

Electricity +12.9% y-o-y

Food +6.5% y-o-y

Page 26: Arrears: what next?

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%

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UK USA Germany

Page 27: Arrears: what next?

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

-

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£ Th

ousa

nds

Mill

ions Mortgage Balance/Household

Households Mortgage Balance per Household

Page 28: Arrears: what next?

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

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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%

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Q1-

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08

Q1-

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Q1-

10

Q2-

10

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10

Q4-

10

Q1-

11

Q2-

11

Variable rate mortgages

as% of Total mortgages Weighted average variable rate

Page 29: Arrears: what next?

?

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

0

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1996

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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%

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0

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Thou

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s Total Arrears

Arrears >3-6 months Arrears >6 months Arrears as % of all Mortgages

Page 30: Arrears: what next?

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...

Page 31: Arrears: what next?

Thank you!

Page 31