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Mortgage Market Trend Outlook 2011.

Contents:

1. Introduction
2. Headline findings
3. This years forecast
4. How last years forecast (for 2010) turned out.

Introduction

In short, 2011 is likely to be a washout in the Irish mortgage market, lending will be
restricted and only done at higher margins. We thought that most of the correction could
happen in 2010 but political pressure, EU/IMF and State support as well as Regulatory
intervention stopped the market from making many of the adjustments that perhaps
should have occurred.

These changes cannot be put off indefinitely and for that reason we find many of them in
our 2011 outlook.

Lending is down 87% from peak in terms of euro figures and down 85% from peak in the
number of mortgages drawn, in the meantime €70 billion euro has left our banks and there
is somewhere between 70,000 and 100,0001 mortgages of the 790,000 we have that are in
trouble in some shape or form. Unemployment is 13.5%2 and the flow of arrears is not
showing signs of ‘curing’ but rather of worsening3.

This is creating a perfect storm for Irish banks and banks operating in Ireland. The flight of
deposits is crushing funding, the reduced repayments are also hurting a key aspect of
funding (banks use repayments to create credit and fund operating costs), our banks are
not trusted and that makes raising money expensive, at the same time, our nation has been
saved by Europe and the IMF and our bond yields seem to be showing a lower range
resistance at levels in excess of 8%.

Bearing these things in mind, our report isn’t particularly downbeat, rather it is a reflection
on the circumstances we find ourselves in. It is also important to remember that Irelands
future is not contingent upon the mortgage market, this may be a barometer of many of
our national ills but recovery will come eventually as it always does, the trajectory towards
the bottom has been painful, for many people in this country the last three years will be a
time they never forget for all the wrong reasons, but it is a necessary path that we must
walk in order to move onwards and upwards once again.

Karl Deeter
Operations Manager
Irish Mortgage Brokers
January 6th 2011

1
http://www.mortgagebrokers.ie/blog/index.php/2010/11/17/what-are-the-real-arrears-figures/
2 http://www.rte.ie/news/business/economy/unemployment.html
3
http://www.independent.ie/business/irish/mortgage-crisis-gets-worse-with-36500-now-in-arrears-2321340.html
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Our forecast this year, headline findings:

• Banks will push up interest rates by another 100bps or 1% (independent of any

move by the ECB) costing the average borrower (loan of €200k over 25yrs) an
additional €1,280 p.a. Rate hikes may start as early as this month.
• Variable interest rates will generally start to rest at or north of 5% by 2012. The state
controlled banks in particular will be forced to make some painful decisions on
interest rates they charge to customers.
• Fixed rates may be temporarily removed from the market, offered on a limited basis
or priced out of the market.
• Property prices will continue to decline.
• Segmentation of the property market.
• Total credit not likely to pass €6bn in 2011, with tranche management being a key
consideration, there may be funding gaps in Irish banks during the year which cause
delays in draw-downs.
• Rental prices.
• Large increases in repossessions.
• Distressed property sales to begin
• Banks shedding staff and closing branches.
• Failure of our mortgage rescue scheme (Deferred Interest Scheme)
• Further funding issues in Irish banks
• Loan to Value trends
• Several ‘maybe’ trends that could start in 2011

Interest rates

We envisage 100 basis points (or 1%) by year end with first moves likely as early as this
month, some banks gave an undertaking to make no more hikes until the new year (2011)
so from this point on all bets are off. In general we think the moves will come in
increments with the first 50 bps raised in the first half of the year and the second half of
them brought in during H2.

Variable rates in non-government owned banks will be near or at 5% by year end. This will
leave some lenders with little to do (e.g. PTsb) and others with significant ground for
catching up (AIB/BOI – who must follow suit eventually). Foreign banks will also respond,
the likes of NIB are only a small portion of Danske but responsible for about 30% of the
group bank losses and for that reason they will not hold back as the general price level
increases. How this, along with rising commodity prices will read into our economy
experiencing inflation is yet to be determined.

You would also have to question the rational of lending to a person at 3.5% when you can
get a coupon of 9% ‘risk free’4. In 2011 we are certain that rates are going to continue their
bank lead movement upwards.

4 ‘Risk Free’ meaning a Sovereign Bond which is far from risk free but is still considered a benchmark for low risk lending.
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Fixed Rates

Last year we determined that Standard Variables may cease to exist in favour of TVR's.
This year the product change that we are contemplating is that Fixed Rates may be
effectively discontinued. By year end it is highly likely that some banks will cease to offer
fixed rates (this will be temporary as opposed to permanent), or any that are on offer will
be at maximum premiums. It could also appear as restrictions although we are not sure if
they will restrict new business or existing clients.

Irish bank swap rates are ranging from 7% (2yr) to 11% (5yr) and at those prices offering a
fixed rate below that is nonsensical, in particular when it creates a transfer from taxpayers
to the borrower via a non commercial rate in a tax payer owned institution. This is one
driver behind the demise of fixed rates in 2011, the other is a reduction in the amounts
being kept in current accounts. As well as the fact that if you want to utilize the funds that
banks actually use for fixed rates then why not purchase a sovereign bond with it?

Property prices

Will continue a downward trajectory, however, there is a genuine issue with financing costs
which may negate any benefit to buyers who continue to hold out. This is not a call to buy
now, or ever for that matter, merely an observation about financing costs, if interest rates
go the direction we believe they will then much of the gain to the buyer will be captured.

As an example, a buyer who purchased a property for €400,000 in 2007 with an ECB+1%
tracker is paying about €1,479 per month and their mortgage balance is €370,000 and
we’ll say that they are in negative equity of €70,000. The cost of credit over the life of the
loan is going to be €132,000 and the total repaid will be €532,000.

Then you have the person who held out and bought at today’s price of €300,000 but their
rate is 4% (with no price promise), their monthly payment is €1,432 finance costs will be
€215,000 and the total repaid is €516,000 so the savings is nowhere near the perceived
difference in price. The difference in financing costs (€16,000) also needs to be offset for
the three years rent paid from 07-10 because at the back end of the loan in year 27 (for the
second person), the one who bought in 07’ is living mortgage free.

Banks are going to capture any gains in price by negating the gain from a cost perspective.
Cash buyers are probably best advised to hold out for another year and then see where the
market is at that point for now the trend is still downwards but not accelerating5.

The total number of properties for sale is slowly coming down and the oversupply of
120,0006 will take some time to work through (not confusing ‘empties’ with ‘oversupply’),
but properties are selling at the right price and that is important to remember.

Residential Property Tax is also something to remain aware of, much of this hinges upon
whoever is in power after the coming election, it may be unpopular at the polls but a
recurring property tax is likely to be introduced from 2012 with an announcement later in
the year. Site Value Tax is the fairest but implementation is difficult, however, we suspect
that the new postcodes and well run property cadastre will tie into this and both of these
are already in the making.
5 http://www.daft.ie/report/Daft-House-Price-Report-Q3-2010.pdf
6 http://www.irishtimes.com/newspaper/property/2010/1202/1224284552711.html
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Segmentation of the property market (residential)

An increased acceptance of a two tier property market (apts vs. houses) is likely to be
confirmed in 2011. From our experience buyers are just not that interested in apartments,
this will present problems for apartment sellers as the only way to attract them will be via
price drops, having said that, a 2 bed apartment for three times the average industrial wage
is a good thing, it is only bad for many of the sellers.

Getting there will take time however as so much supply is now in state hands. The market
will further segregate into cities/towns and hinterlands in each county with each further
displaying their own dynamic and market clearing prices. Our ongoing view is that the
market will be active in certain price ranges and certain neighbourhoods (up to €500k
non-apartment second hand homes in cities) with little activity elsewhere.

Total Credit

The figure of €5bn in lending for 2010 is part forecast on our part as the Irish Banking
Federation figures have not yet been released. However, we believe that an estimation of
€4.75 to €5 billion is reasonable; it is based on the quarter on quarter figures for the year
to date. In 2011 we do think that we will see a higher level of lending in the region of €5-
6bn (which we calculated by correlating our brokerage figures against the wider market
and then looking at the existing pipeline and expected drawdown’s).

This is a weak basis for a forecast call but it’s the best we have to work with at present, and
the adjustments in the property market as many people’s positions are liquidated will
likely ensure that there are good deals available and they will be bought. Lending to
households has been trending down since 2007 and has been negative since Q3 of 2009
2010 is likely to have been our low point from a mortgage credit perspective.
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Taking all of these considerations we are confident in our call of €5-6bn which means
another year in the trenches for people in the Mortgage business, but a likely upwards
turning point in 2012, the number of loans will increase (as the size of individual loans
decreases) with 30-45,000 draw downs in 2011.
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Average loan sizes are likely to decline as buyers move towards lower loans to value and
property prices drop.

Rental prices

There is strong evidence that rental prices may be levelling off or even bottoming out7, in
Dublin the supply of rental property has dropped from c. 8,500 in mid 2009 to around
3,5008 presently (using daft figures via DaftWatch). This doesn’t consider the huge supply
being held back by the National Asset Management Agency (NAMA), and to add to this we
don’t know the natural vacancy rate although some headway has been made on
determining that on the commercial property front9. A vacancy rate of about 5-6% would
be normal in many countries and that would equate to about 120,000 natural vacancies in
the Irish market – which is where we make the distinction between oversupply and
empties, ‘empties’ are in the region of 300,000 units.

Higher interest rates, the NPPR tax (and other taxes likely to be brought in) along with
ongoing maintenance costs and an absence of expected capital appreciation will all put
upward pressure on rents, the unknown factor is how this will play out with NAMA in the
mix.

7 Daft Rental Report http://www.daft.ie/news/2010/daft-rental-report-q3-2010.daft

8 Graph (and a ‘thank you’ too) - DaftWatch.Com
9 John McCartney CSO ‘Predicting turning points in the rent cycle’ (SSISI presentation) http://www.ssisi.ie/McCartney_SSISI_2-11-

10.pdf
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Repossessions

They will be far higher this year than in 2010, at least a 300% or more increase –
proceedings may take the bulk of cases through to 2012 because there is a lengthy process
and our judiciary are pro-borrower, but now that there is a text book definition of
‘unsustainable mortgage10’, the banks at least have grounds to present their case, the
ongoing forced forbearance will also start to run out for many households.

10
http://www.merrionstreet.ie/wp-content/uploads/2010/11/Mortgage-Arrears-and-Personal-Debt-Group-Report-17th-November-
2010.pdf
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Currently there are 12,000 households who have paid nothing in over a year11, to now they
have been afforded protection from the Regulator via moratoria on repossessions and pro-
borrower legislation in the annually updated Codes of Conduct for Mortgage Arrears12, but
many can expect to start receiving civil bills in 2011. The trend in arrears is going one way
only13 and the subdued level of repossessions (a mere 311 in 2010)14 in light of this is
unlikely to last.

Unemployment is expected to remain high for some time, that will also be an issue that
plays into arrears and ultimately repossessions for some time, people don’t pay their
mortgage with macro economic announcements of growth, they pay with their pay check
and as long as this figure remains high so too will the levels of arrears, that doesn’t factor
in the rate hikes we spoke of earlier, reduced take home pay due to changes in taxation and
any further wage cuts that people may experience15.

Distressed property sales

This will start in 2011 but it will be residential investors who are first in line for losing the
homes they bought. Several things will hit them at once

1. Lenders are demanding repayment mortgages and not offering ongoing interest
only facilities, or in some cases they will do so but take back the current rate (e.g.
tracker mortgages on investment properties).
2. Tax treatment of mortgage interest changed, now only 75% of the cost can be offset
against the income.
3. S23 Changes16 in the 2011 Budget (if brought in) will literally break thousands of
households or cause landlords on the edge to go right over it.

Banks will increasingly rely upon a ‘receiver of rent’ clause being enforced, so that they can
obtain rights to receive any rent that is being paid, in 2011 banks will have to get heavy
handed with residential investment property owners who are in arrears, ‘pay or possess’
will become the order of the day. Of the €334bn in private sector credit €143bn of that is
mortgages17, and about €30bn is non-principle private residence.

When you consider the drop in rent prices, along with the rise in unemployment and
increased rates and removal of interest only facilities it makes sense that we’ll see
liquidations.

Bank Branch Closures

Many banks have stated that they are closing branches already (but these are primarily
satellite branches), Ireland is already over banked, and it doesn’t make any sense for
several state owned banks to compete against each other in regional towns.
In effect we have had a ‘bonus bonanza’ in Irish banks whereby thousands of people have
jobs that shouldn’t even exist any more, it makes the AIB bonus scandal look like peanuts
in comparison.

11 http://www.independent.ie/business/irish/12000-mortgages-unpaid-for-year-or-more-2471633.html
12 http://www.financialregulator.ie/press-area/press-releases/Pages/NewMeasurestoProtectMortgageHoldersFacingArrears.aspx
13 http://www.mortgagebrokers.ie/blog/index.php/2010/09/02/mortgage-arrears-for-the-first-half-of-2010/
14 http://www.irishtimes.com/newspaper/ireland/2011/0104/1224286702036.html
15 http://www.independent.ie/national-news/grim-choices-are-being-made-as-households-struggle-to-survive-2437256.html
16 Section B7 http://www.budget.gov.ie/budgets/2011/Documents/Summary%20of%20Measures%20Combined.pdf
17
http://www.centralbank.ie/data/site/cmbs/Developments%20in%20PSC%20by%20Economic%20Sector%20Q32010.pdf
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This will need to end and 2011 is likely to be the year when it does, you have to get
operational efficiency and loss making branches are abundant in Ireland, the taxpayer
owns about half of them now and the only fair thing to do is shut down 20-25% of AIB
branches, BoI and EBS will likely need to reduce numbers by about 10-15%.

In Finland during their crisis of the 90’s one third of bank staff were let go18, unfortunately
we must replicate this (although we have been avoiding doing so for some time), those
losing jobs will also be the least culpable for the crisis and in that respect it will be quite
unfair but it won’t stop the job losses from coming (eventually).

A bank workers strike or serious curtailment of services could come about during this
process; we had several of them in the past 1967, 1970, 1976 and 1992. The lagging
correlation of these strikes with recessions may yet come to fruition.

EBS is 50/50 to PTsb or Cardiff/Ross, but there will be an extension on the new final bid
date (which was already extended to c.14th Jan 2011). EBS will either have new owners or
get brought into an existing bank in 2011 and in that transition jobs will go.

Anglo/Nationwide deposit books will be auctioned; this may seem like an attractive option
for the desperately deposit hungry Irish banks but TUPE19 (Transfer of Undertakings and
Protection of Employment) will likely apply meaning the buyer will have a large headache
on their hands of having to employ all of the origination staff with the service. The only
way to fix that problem is for the banks to rapidly shed staff but they have been unwilling
to do this in large numbers to date.

Banks are going to push clients toward automated transactions (online/phone/atm based)
and use charges to punish branch users as a means to funnel more people away from the
branches in conjunction with the closures.

Failure of the mortgage scheme.

As surely as it has been announced we believe it is likely to fail20. This is assuming that
Irish policy makers do not somehow outsmart policy makers in the UK and the USA who
have tried similar schemes (the UK one actually being superior to our own as an offering).
Of the 70-100,000 borrowers in trouble we doubt that even 5% of them will get into the
scheme and those that do may likely continue to default anyway. The UK scheme which
was originally designed to help 42,000 borrowers21 had, more than a year after its
inception, helped a paltry 34 borrowers22, not even 1/1000th of the intended result.

Further funding issues in Irish Banks

The original PCAR (Prudential Capital Assessment Review) which was seen as a success
has been recalled and new targets set which mean banks must be able to take losses on
their loan books of 12%. This will leave a funding gap for many banks; the only way to fill

18
Jaakko Kiander (Labour Institute for Economic Research) THE GREAT DEPRESSIO OF FI LA D 1990-1993: causes and consequences
http://www.esri.ie/news_events/latest_press_releases/esri_policy_conference_th/index.xml
19
http://www.irishstatutebook.ie/2003/en/si/0131.html and also 1981/2006 legislation. As well as Acquired Rights Directives (77/187/EC),
(98/50/EC), Acquired Rights Amendment Directive (2001/23/EC)
20
Charlie Weston (Independent) http://www.independent.ie/national-news/deferredinterest-plan-for-homeloans-is-doomed-to-fail-2441119.html
21
BSA ‘Understanding Mortgage Arrears’ pg 25 of report http://www.bsa.org.uk/docs/publications/understanding_mortgage_arrears.pdf
22 BBC http://www.bbc.co.uk/news/business-10686369
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this at present is via the state, but that won’t stop shocks from occurring, we may see
several serious credit events before 2011 is out.

In 2010 €70 billion in deposits left our banks23, foreign deposit takers are reporting
massive increases in business, NationwideUK (Ireland) have seen their daily business go
from about 30 accounts and just under €1m a day in new business to over 160 accounts
and €10m per day in new business, this is indicative of the deposit flight showing up in
retail deposits – to now it has primarily been in corporate and institutional deposits. A full
banking or lending freeze in Q2 is a genuine risk.

Loan to Value trends

LTV’s may start to come back down. Last year we believed that more stringent
underwriting and lower LTV’s would be a hallmark of the year, and for much of it that was
the case, however the percentage a bank was willing to lend on a property did creep back
up with several lenders, this may reverse in 2011 and return to a point where bigger
deposits are required. It would also not be surprising to see the return of MIG’s (Mortgage
Indemnity Guarantees) with the bill being footed by the borrower [average cost is just over
€1,000]. Already several borrowers are only willing to go beyond 80% with a MIG.

On that note, it is worth mentioning that many banks are likely to move to a position
whereby a solicitor can no longer work for two parties at once (dual undertaking for the
borrower and bank) and this will embed a cost into property transactions for all buyers and
sellers, equally, stamp duty may help ‘start the market’ but it will not be kick starting
anything for first time buyers who are currently the majority in the market at 38%. In fact,
the only group likely to really benefit are commercial buyers (which may help NAMA do
their job) and to a lesser extent second home/mover-purchasers because almost every
other group is either already exempt from stamp duty (remortgage, top up mortgage) or
they pay it anyway (investors).

The ‘Maybe’ trends of 2011:

Mortgage strike

This may come about due to rate hikes or by owners of investment property who simply
give up. It would be no surprise to see a mobilization of the indebted into a more singular
voice there are already groups speaking of doing this (or representing those in
difficulties24); to date they have not gained traction; that could always change.

New Lender

With rates going north of 5% a well capitalized bank with strict underwriting may see an
opportunity to enter the Irish market with a new offering on a limited basis. Anything on
this front in 2011 is perhaps likely an announcement of entry to the market in 2012. This
may not be via a new entrant (as BOSI entered in the past) but via a buyout of a state
owned institution by a bank with money to lend.

23 Irish Independent http://www.independent.ie/business/irish/over-euro70bn-in-deposits-fled-irish-banks-in-2010-2482304.html

24
www.newbeginning.ie
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Last years forecast and how it stacks up to what actually happened.

Now we can take a look at what we expected in 2010, below are the predictions we made
for the Irish market.

1. An increase of 100bps or 1% in variable rate mortgages with rate increases

as early as March on existing loans and new business

This was entirely accurate; the idea that it would start in Q1 was largely discounted but
proved accurate with AIB making their move in late March followed closely by BOI and
EBS on the same day. The pattern has tended to be that banks are making the move within
days of each other.

2. Banks seeking lower LTV's with more stringent underwriting

Entirely accurate, banks in general held lower LTV's for most of 2010 while they may have
been ‘open to business’ at 90%+ it was nigh impossible to place deals and some reports
were suggesting that 80% of applications were being turned away25.

3. A virtual end to Standard Variable rates and a move towards Tiered

Variables

Entirely accurate, variable rates are almost universally contingent upon LTV heading into
2011; TVR's have effectively taken over.

4. ECB rate changes that would be lip service

From last years report ‘We believe that one surprise in 2010 may be that the ECB does
nothing other than talk up their devotion to controlling any potential inflation’ accurate,
they did talk up the fact that rates can't stay low forever and the minor move never came.

5. Specific as opposed to widespread recovery in certain neighbourhoods at

certain price levels.

Mildly accurate, yields at some price levels (sub €200k) in certain neighbourhoods (cities)
are pointing towards there being sensible, where yields make sense from an investment
perspective and also where massive price drops are no longer happening.

6. Lending not to pass €15bn with overall credit being stagnant or negative

On the lending call this was entirely inaccurate and our worst call in a long time, on
mortgage credit being stagnant or negative we were on the ball, 2010 was a year where
repayment and prepayment outstripped lending, central bank figures showing that mass
deleveraging to the tune of €7 billion occurred.

25
http://www.irishtimes.com/newspaper/breaking/2010/1109/breaking44.html
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How did we get the first part so wrong? We though that low base rates and cash injections
to banks along with falling prices would encourage buyer activity that missed the fact that
the nation went over a cliff edge and Regulation /political will stopped the market from
adjusting more rapidly due to extended forbearance which means that about 35,000
properties that should be for sale at a discount are not on the market.

7. Fixed rates of early 2010 to represent historic lows

This has held true, fixed rates are not likely to hit the prices seen in late 09' early 2010 for a
long time, anybody who locked in during Q1 of 2010 made a very good choice.

8. A mortgage rescue scheme to be announced in H1 of 2010 as pressure

mounts

This call was made before the Green Party Minister Eamon Ryan called for a Mortgage
Expert Group. The call was only partially accurate, there was a scheme announced but it
was in H2. The expert group that was set up to consider this were only formed in the
middle of H1, so it was a decent call but we got the timing wrong.

In short, our forecasts for developments in 2010 were broadly accurate with the exception
of the credit figures which we are still beating ourselves up over having gotten them
embarrassingly wrong. That's the danger of forecasts. It is important to remember that at
the time these forecasts were made most of them were considered equally unlikely and
much of what we spoke about was not in the public domain to any meaningful degree.
The same can be said of this years forecast, like all forecasts read this with a healthy pinch
of salt.