Mortgage Market Trend Outlook 2012 By Irish Mortgage Brokers, 33 Pearse Street, Dublin 2 www.mortgagebrokers.ie 01 679 0990

Contents: 1. Introduction 2. Headline findings 3. This years forecast 4. How last years forecast (for 2011) worked out.

Introduction We started last years report by stating that 2011 was going to be a washout, on that basis it lived up to expectations and beyond. Irish banking is still a mess, we have 14% unemployment, our budgets don't balance (most recently to the tune of minus €24.9bn) and in mortgages specifically lending is down 95% from peak, these are all very negative indicators. The last time the mortgage market looked this bad was in 1971, which was hot on the heels of the longest and most devastating bank strike in Irish history from May to November of 1970. That we can return to these lows is a sign of the destruction we are witnessing in the property market, but it is also the road to recovery, there was and still is a lot of dead wood to clear out and this is all part of that painful process where every decrease is a closer step to the bottom. Having said that, we do believe that the credit nadir (in residential mortgages) is now past, and that in the future people will look back and be of the belief that 2012 was a good year to buy, for the first time in half a decade we are no longer as strongly bearish as in the year previous. It is often true that when the last optimist gives up the market turns, and this market may well stay in the doldrums or irrational far longer than expected, but we do not believe the island of Ireland will share an identical property market future as the island of Japan has had, the caveat being that we are not talking about 'property general' but rather nonapartment houses in cities. There is no denying that it is tough out there, every quarter for almost three years has seen about a 10% increase in the number of arrears cases – 2012 will see that situation worsen, with total current live figures likely in excess of 110,000 mortgages either in arrears or restructured in order to avoid going into arrears. Deleveraging will likely outpace new credit again this year, but 2011 was probably the low point, already Bank of Ireland have pledged €1.5bn in mortgage lending for 2012 which is close to two thirds of lending that occurred in 2011 - this from a single institution. AIB have ramped up their credit teams for both new lending and problem mortgages, on a company level we are also seeing a slight increase in the number of approvals, the question is perhaps more importantly, will people take up these offers or sit on them? With property prices down last year (depending on who's figures you take) between 13% and 18% it won't instill confidence in first time buyers or people moving to purchase who are now represent 78.7% of the market. Price drops are in the region of 46% to 59.8% nationally would in our opinion mean that most of the heavy lifting has been done, but again, does that instil confidence or scare people away who want to avoid the 'final lap' in the downfall? Our crystal ball has never been harder to read, some of the outlook are contingent upon other parts, some are contradictory, but in the opinion of this firm the corner is slowly being turned and in a few short years we'll be back on the path of another boom to bust cycle having learned nothing in the process. Karl Deeter Operations Manager Irish Mortgage Brokers

Headline findings 1. We think it is likely that there will be the start of a transfer of tracker portfolios from operational state owned banks to the IBRC. 2. Rates for new business will start falling (rates for 'back book' will have a different fate) & there will be a greater divergence in risk pricing – a move which is away from incremental Tiered Variable Rates. 3. In 2012 we should find out how many mortgages are 'unsustainable'. We estimate that the final figure will be in the region of 20-25,000 mortgages. How these are dealt with is a key consideration. 4. Banks will see a strong acceleration in provision usage against debts as opposed to provision creation. 5. There will be a hunt for the 'won't pay' or 'strategic defaulter' (not the 'can't pay') who may be a much bigger cohort than expected (along with what is described as the 'lazy defaulter'), it may be as high as one in five arrears cases. 6. ECB rates, the consensus is that they will drop to a base of 0.75%, with the US and UK below that it can't be ruled out that this is a base limit. 7. Repayment/prepayment to outpace new credit creation. 8. Deposit rates will start to fall from Q1. 9. Property prices will continue on a downward trajectory. 10. Total lending in 2012 to be greater than 2011, we estimate €2.5bn to €3bn in new lending. 11. Repossessions will be higher in 2012 in particular 'voluntary possessions' will increase. 12. Fire sales are more likely than asset management. 13. 'Maybe trends'

Tracker loans being removed from Bank balance sheets If the state owns two banks outright they can move a loan book from one to another at their own discretion as the loans are already entirely state owned. In the case of Irish banks this may occur between the likes of Ptsb or AIB (but perhaps not EBS) to IBRC. Doing this with a tranche of trackers could be a tactical move by the state to make those banks more marketable to a buyer (with 2014 being a target year to make a sale). If IBRC took on bad tracker loans at a set discount – utilizing loan provisions already set aside but not yet used - it would mean we have banks that appear to have a strong capital base with reduced asset quality doubts. Trackers are all nearly all loss makers at present, if it were not for the recent ECB 3 year issue of Long Term Refinancing Operations and Emergency Liquidity Assistance this situation would have already stopped banks from functioning. Central banks are the only thing holding the Irish financial system together at present. If non-performing trackers were removed along with a sizeable chunk of performing trackers it would take banks out of the 'death by a thousand cuts' spiral they are in. This approach is along the lines of how the UK dealt with Northern Rock, creating a good & bad bank – which did create a loss for British tax payers but at the same time it allowed a faster sale. In our case we already own the 'bad loans' so putting them all in one place may be the sensible thing to do and have IBRC act as one giant collections agency (as Certus presently do for Bank of Scotland loans). Some of our state owned banks have c. 55% of their loan books on tracker, this alone will stifle their ability to lend and reduces operational cash flow. Something needs to give, and in this case we believe it is most likely to be that banks somehow manage to get these loans off their balance sheet. Changes to rates for New Business and the 'back book'. While we have said for two years that existing loan standard variables would rise as would new loan rates we are taking a different approach this year. We now think that existing loans may well see prices rise, in particular in the case of AIB who's existing variable rates are even better than trackers (they don't go up with ECB rate increases but they do come down with ECB rate drops!). Funding costs are too far out of line with existing lending prices, resolving this is likely to result in a political storm. Thankfully the Financial Regulator has indicated that their office will not be used as a strong-arm in this battle. On the other hand new business rates may start to drop below the existing loan standard variable rate. The difference now will be that risk pricing will no longer be about an arbitrary tiering along several LTV bands, rather it there will be a price region below 80% LTV and one above that, with the difference widening to 75-100bps rather than the current 20-30bps. The disparity in rates at present will end, at the lowest end you have AIB at the highest you have Ptsb, both will see significant pricing change this year, the former up the latter down. The quality of applicant who can afford to purchase property at this point is very high, they represent an opportunity to banks who lend prudently at good margins if cheap central bank liquidity is available. Fixed rates will remain a problem, typically they are created via an interest rate swap

(banks with large numbers of current accounts are different) where a fixed loan is turned into a variable rate income for the bank. Currently Irish banks are persona non-grate in the swaps markets and in many cases additional collateral must be pledged meaning you have fewer assets to gain liquidity with; thus we can expect fixed rates to remain expensive or not readily available in 2012. One upside is that in general terms we think that variable mortgage rates will start to universally settle in the region of 3-4% over ECB (while not tracking specifically) by 2014. At the moment the marginal cost of funding in banks is (in general) in the region of 3% and higher (in some cases over 4%), this is contradictory to seeing rates come down for new business, but if the first point occurs then banks will not be in a situation where they are seeking SVR margin to substitute tracker losses, effectively, if our first prediction is wrong then much of the rest of them will be too. Unsustainable mortgages The banks have a large book of unsustainable mortgages (from the bank perspective) – namely tracker loans – this feeds in with our first point about the possibility of getting rid of them. Borrowers also hold a huge number of unsustainable mortgages. We think that at least 50% of the loans greater than 180 days in arrears (most recent figures are 46,371) will be deigned as 'unsustainable'. The IMF estimate that 40% of the 'greater than 180 days' in arrears cases are now above 365 days in arrears (25,188 mortgages). Taking these figures along with a consensus estimate from different banks on their own loan books gave us a read of something in the region of 20,000 to 25,000 mortgages that will result in a 'non-standard forbearance' outcome – which may be 'mortgage to rent', 'split loan' or one of the other Keane Report solutions (including repossession). Far from being a negative thing, dealing with these problem loans will give closure to borrowers and banks alike, a key consideration in this is about who will win the Department of Justice versus Department of Finance bout. One wants mortgage debt included in new debt legislation the other doesn't, that legislation could be a big game changer. Banks will heavily utilize provisions against bad debts As the number of 'unsustainable mortgages' is determined there will be an onus upon banks to start using up the provided for but as yet unused funds set aside to deal with this. The general view that banks have been using up this money does not hold, one bank has thus far used only 1% of the provisions set aside to date. In the pre-Christmas mortgage arrears submissions made by every bank (likely to result in Central Bank publication c. March 31st) determining an estimate on this number was a requirement and once known the banks will start to work through these loans, using provisions set aside for that purpose in the course of that path. Hunting down the 'won't pay' group. This is an extremely sensitive topic as the natural inclination is to empathize with the genuine (and far greater) cohort who couldn't pay if they wanted to due to personal circumstance.

There are broadly two types of 'won't pay' borrowers, the first is the 'strategic defaulter' who makes a conscious decision to favour their own balance sheet versus that of the banks. The second is better described as a 'lazy defaulter' who is far less mercenary but still chooses personal use of the funds over servicing debt, they may cancel their direct debit and then under-pay, or obtain preferable terms when they should perhaps not be given. In our research we heard estimates ranging from 10% to as high as 20% being that group which is believed to be in arrears or a restructured loan by choice. This is far in excess of what we thought was possible. However, if as the IMF believe, 20% of the 770,000 loans are in some form of trouble (c. 150,000 mortgages (this takes in the < 90 days cases too, hence it is larger than our previous quote of 110,000) and 20-25,000 that are unsustainable you are left with about 125,000 mortgages of which 15-30,000 of them (10-20% of cases in the category) are behind or on restructured terms by choice. If the 10-20% was only on 90 days plus arrears that is still 6,200 – 12,400 mortgage accounts. This need not be specifically nefarious in every example, because an investor with a primary home and three other properties may have gotten another year of interest only when they were meant to be on capital and interest and it only came about by using hard tactics with the lender. However, embedded in there somewhere are also people who have simply decided they will not pay irrespective of circumstance, in the coming year banks will take particular interest in those borrowers and they may well become pariah given that we nationally have such strong support for those in trouble outside of their own control. ECB Rates We think that the base rate will go to 0.75% this year, two other possibilities are that it will merely sit at 1% or that it will go below 0.75% which is more in line with the USA, UK and Japan. A zero interest rate policy is not likely, nor are rate hikes beyond 0.25% from the 0.75% point. With the Federal Reserve ready to offer rate trajectory opinion, we may well see the ECB start to loosely follow suit as it would give markets better interpretation of future expectation and that could be one facet to solving the European crisis. Repayment/Prepayment to outpace new credit The coming year is likely to see a contraction of credit as the power of deleveraging wins out against leveraging. This is not a new trend but it is one that we believe is set to continue until at least 2014. Our estimates on credit creation in mortgages (covered later) versus the current speed of repayment which is in the region of €5bn per year means that

new mortgage lending will rise in 2012 but the total value of loans will drop. Deposit rates will start to fall in Q1-Q2 This seems contradictory given the problems banks are having on the funding side, but if you can't get margin on your assets then you equally cannot pay more for liabilities (deposits). Banks will need to test the stickiness of deposits (in state assisted banks), up to now attrition has been low on domestic retail deposits (down c. 9% last year) compared to the flight in corporate deposits, while those moving to foreign banks are not doing so on the basis of price. Some banks are paying more for deposits than they are charging on existing loans, if banks can't get their prices up then the natural inclination is for deposit prices to come down, for that reason opting for 1yr fixed accounts in the region of 4% immediately will likely prove to be a good choice. There are only three tools in a bankers box for making money (in retail lending), increase prices, lower deposit rates and gain operational efficiency (lay off staff), every one of these will be implemented to some degree in 2012. Property prices will continue to drop The trajectory is not changing, but we think that cities will come out first, and housing stock in particular (as opposed to . MyHome.ie said that Q4 saw the slowest drop in prices since 09' while Daft.ie said that the same period saw the fastest drops so far. Due to the make up of their datasets it may be a case that cities are already slowing down when it comes to price drops while the non-Dublin market plays catch up, it's too early to tell. The residential market is still dominated by owner occupiers who place a premium on the standard value of a property, for that reason it would be no surprise if we saw city houses stay in the single digits in terms of price drops in 2012. This may be the year that certain neighbourhood’s bottom out, as property is not a homogeneous stock it is fair to assume that this will be pockmarked in desirable locations and at certain price levels. We have passed through the bottom of mortgage lending A call like this may go terribly wrong, but our estimates are that the bottom has now passed in mortgage credit and that it occurred in 2011. Bank of Ireland have pledged €1.5bn in lending in 2012 (how much actually occurs is another thing), AIB plan to sanction in the region of €1bn in loans and their sanction conversion is currently between 80 and 90%. Ptsb are hoping to double last years lending and in adding in other banks plans we are confident that lending will be higher in 2012 (not by much), in the region of €2.4- €3bn. The continuation of TRS in 2012 should give some confidence to buyers as it insulates against price drops from a cost perspective, if banks can get an injection of life (via asset removal), if they reduce rates as mentioned previously and the ECB goes to a historical low then the market is set for an increase, the power of confidence may cause this forecast to falter, but we have seen clients of our firm sit on sanctions for many months and of late a larger number are calling in to have valuations instructed (so that they can use the approval to buy). Credit advancement will see a recovery prior to general property prices, with that in mind this is perhaps a prerequisite to a functioning market, and it must by nature come first.

Repossessions to increase, in particular 'voluntary possession' and 'assisted sales'. 2011 actually saw a reduction in the number of possession orders (246) for the first time since 09' and down from the 327 granted last year. This delay in dealing with problem loans is primarily regulatory, (although some say the Dunne ruling during the summer is the cause) via the mortgage arrears resolution process and the various codes of conduct on mortgage arrears. However, as this is the year that banks must define 'unsustainable' and start to deal with them, and that Standard Financial Statements only became required from mid 10' it means that lenders should now have a good idea of which loans will work out and which ones won't, that will lead to a sharp increase in banks taking back properties, there will also be last years uncompleted pipeline to consider. Given that 33% of repossessions last year were to a single sub prime lender, followed closely by another sub primer at 10% it is reasonable to expect that with the prime-banking (if there is such a thing) loan book due to come on stream these numbers will jump. Voluntary possession and assisted sales will probably be the main growth area. Fire sales more likely than asset management. It wouldn't be a surprise to see a bank give out a number of approvals to potential buyers and then hold an auction, effectively they are just re-issuing the property they own and it is now secured by the future cash flows of a different buyer. Banks are also not effective property managers, if you can imagine what owning lots of property would do to a bank from an operational perspective it is not far off how they were damaged by credit pricing and financing costs from a banking perspective. This is the reason that fire sales will still be a strong feature in 2012 with more estate agents entering that particular market. The 'maybes' These are a few wildcard things that could occur 1. A 'mortgage strike' starts after debt laws and bank resolutions for debtors are viewed as being 'too little too late' 2. A tax strike begins as another year of austerity kicks in, this will be a chain reaction from the likes of the campaign against the household charge. 3. An Irish bank is sold when at present there are no bidders or active interests. 4. A foreign bank exits the market and has Certus undertake their historical loan book.

How our 2011 forecast worked out... The forecasts we made for 2011 are below 1.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. Bank margins did indeed go up independent of the ECB rate hikes did start in early Q1. We also mentioned that AIB and BOI would come under pressure to raise prices, that did occur – more so in BOI who are not Government owned, AIB caved to political pressure. Margin increases fell shy of 1% on average but all said this was a good call. We also mentioned increased mortgage costs and commodity prices feeding into inflation – as it turned out much of Irelands 2.9% inflation rate in 2011 was specifically in these areas. 2. 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.. Variable rates in many cases are at or north of 5% (or not far off it) as predicted, the cases where this has not occurred are mainly due to political pressure in some of the covered institutions, the most notable being AIB who recently were pushed into giving a rate cut when they didn't pass on rate rises (which is a pure margin undercut). This also counts as a good call in our opinion. 3. Fixed rates may be temporarily removed from the market, offered on a limited basis or priced out of the market. Sometimes we get it really wrong (the confession is coming soon), and sometimes we are right on the money. Irish Mortgage Brokers were first past the post on this one, we figured that with funding issues and the state of the swap market that fixed rates would be removed or priced out in many institutions and that is exactly what happened almost across the board. This call was our 'call of the year'. 4. Property prices will continue to decline. The obvious is obvious, no awards for something a gibbon would have gotten right. We didn't figure upon a percentage as any index factors in far more than we can get our collective heads around, instead we make due with general trajectory. We also figured that cash buyers should stay out of the market for another year- on that basis and our ongoing opinion on the market that was a good call, and 2012 is going to be a good year for buying in cash as many prices are below fundamental cost using rental yields as a gauge. We also reckoned on a property tax starting in 2012, this was not unique to our firm, but it was not a political certainty either. 5. Segmentation of the property market. (Residential) This was the belief that there would be a two tier market, one for apartments the other for houses. And a further segregation into cities vs. hinterlands, and that activity would be in non-apartment second hand homes in cities sub €500k. This was a good call, but it was

also one that was slowly revealing itself anyway. 6. 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. We totally sucked on this one, and to boot, total credit remains the one thing we have gotten consistently wrong every year, being in each case too optimistic about the level of credit contraction. We didn't even get to 50% of the lower bound we thought would occur (€5bn). That the levels of lending would drop by over 95% to numbers not seen in 40 years was beyond what we thought was likely. It just goes to show that what you think versus what you get are two different things! We look forward to apologizing on this front again in 2013. 7. Rental prices to stabilize. This was not a bad call, but it is also too early to say with any certainty that it is fully correct. Some research has suggested this is happening but we don't have enough to determine that it is correct or only 'kind of correct', mediocre call at best. 8. Large increases in repossessions. The build up has been coming for some time and it has not been worked through, which is why 2012 will be a much bigger year on this front, in particular as new legislation comes into play for dealing with personal debt. However, we did think that there would be a strong increase in repossessions and that is not how it played out, in 2010 there were 311 and in 2011 it dropped to c250. We had actually figured upon a 300% increase, talk about a terrible call. However, changes in the regulatory regime and to a lesser extent a ruling by Elizabeth Dunne in the summer caused many cases to cease progressing. That will not be the case this year. 9. Distressed property sales to begin Allsops & Space had the first auction in April 2011, they were acting in the first instance exclusively for one lender, and this is in line with what we thought – that residential property investors would be some of the first casualties as all of the protections for distressed mortgages were towards home buyers rather than investors (which we are inclined to agree with). The main belief was that we would see liquidations, and they came in spades in 2011. Estate agents are also now regularly dealing with 'bank owned' property, which means there are many 'distressed' sales on the market that don't make it into the auction rooms. This was a good call. 10. Banks shedding staff and closing branches. This was not as active a prediction as we thought. There were bank branches closed as IBRC (The bank formerly known as Anglo) took over Irish Nationwide, but in general terms banks are not closing unprofitable branches, whether this is part of some negotiation that is not within the public domain or if it is by general design we don't know. What we do know is that it is a waste of money in cases where taxes are supporting any institution with unprofitable branches, but beyond that there isn't much more to say, this was a mediocre call because it is happening but not at the rate we expected. 11. Failure of our mortgage rescue scheme (Deferred Interest Scheme)

That several banks didn't choose to operate this scheme and that any reports to date suggest that the take up has been minimal is evidence that this scheme is a failure. If it wasn't we wouldn't have needed the Keane report, this was a good call. 12. Further funding issues in Irish banks We felt that with increased levels in PCAR that the state would be further called upon, and that we could have credit events in the banks. The first part was correct, the second would have been except that we were not given permission to burn bond holders. 13. Loan to Value trends A move towards lower LTV's was the prediction, it was a good call. BOI have come down to a maximum of 90% (from 92%), KBC are down to 80% and many others did the same. All said, banks are seeking a bigger 'buffer' of equity with the people they take risks on. The 'maybe trends'.... We also had a few 'maybe' trends, things that 'could' occur but that are based upon gut feeling rather than any ongoing analysis of the market, they were: Mortgage Strike: This is something that we felt has been gaining legs for quite some time. It first popped up on the radar in early 09' and again in mid 09' when Ptsb first raised their rates. If 100,000 borrowers genuinely went on strike in a concerted manner it would create a massive paradigm shift in banks and force solutions far faster, but thus far people do not seem to want that collective approach (even though it would work – proving that 'the masses are asses'). The most significant call for it was via the borrower representation group 'New Beginning' in November but it hasn't happened yet, and therefore it was ultimately a bad call. We kept this in again but this time we think the kick-start won't be banks raising rates, rather it will be as a result of something else like debt legislation or taxes. New Lender: The call was that a state owned institution would be bought by a bank with money to lend. The BOI purchase does tick this box to a degree, but it didn't significantly change the face of the market, so this was a mediocre call at best. We look forward to seeing how wrong we were in 2013. Sincerely, Karl Deeter Operations Manager Irish Mortgage Brokers 01 679 0990