The Credit Crunch-The View from the Sharp End

Alan Gilmour

Marketing Director

Landsbanki I Heritable Bank

November 2007

2

A Health Warning

• I am a marketer

• Am not saying I have all the answers!

• Am not claiming special authority or expertise in this subject

BUT

• Hopefully you will find something useful or helpful in what I am about to say

3

Tonight’s Roadmap

• Who is Heritable Bank

• What is the credit crunch

• Why did it happen

• What does it mean for the UK and for the UK economy

• What are the lasting implications for the global economy

4

Landsbanki I Heritable Bank

Established 1877 in Glasgow

London based since 1950s

Acquired by Landsbanki in 2000

£1.1billion in loan assets

Funded by Deposits

Specialist Niche Lending

Creative lending solutions

5

StructuredPropertyFinance

Pre-PlanningResidential Dev.Commercial Pre-

let

Residential Mortgages

Broker-basedSpecialist

Owner OccupiedBuy to let

Finance For ProfessionalsWorking capital

financeLegal / other professions

Asset Finance

Broker-based SME’s

Leasing and HP

Deposit Taking

Retail SavingsWholesale Deposits

Equity Participations

Geared investment

Specialist lending businesses fully financed by deposits

Our Business Lines

6

Bluffers Guide to the Credit Crunch

• NINJA lending in the US

• Growth in borrowing short and lending long

• Securitisation of lending and development of Collaterised Debt Obligations– Credit risk and ownership detached

– Pricing not reflecting the real risk

• New debt instruments approved and graded by rating agencies

• BNP Paribas suspends three investment funds with exposure to US sub-prime market

• Inter-bank lending fear and concerns led to sudden stop on inter-bank lending

• Run on Northern Rock

• Confidence in financial system nose dives and lines of credit dry up

• Boom time for savers, not a good time for non balance sheet lenders

7

Storm clouds have gathered

• Global Crisis – Affecting UK– Sub Prime Mortgage collapse in US– US Mortgage bank failures– Banks Collapse in Germany– Resignations of Chuck Prince and Stan O’Neil– Banks squeezed on short term liquidity– Toxic Debt/Derivatives – Unquantifiable losses– Run on Northern Rock in UK – Redundancies in financial services– Loss of confidence in Banks, Rating Agencies and regulation– Securitisation and debt markets closed– Liquidity scarce in all markets– Deposit funded lenders – Open for business

• UK Banking suffered more damage in 7 weeks than in 200 years

• Mortgage finance bonanza is over

…..and won’t blow over soon

9

Known Losses So Far…….Just in October

• Citigroup $11bn• Merrill $8bn• Morgan Stanley $3.7bn• HSBC $3.4bn• Bear Sterns $3.2bn• UBS $3.4bn• Deutsche Bank $3.4bn• Bank of America $3bn• Barclays Bank $2.6bn• BNP Paribas $2.1bn• Credit Suisse $1bn• Wachovia $1.1bn• IKB $1bn

……. And on and on and on……..

=$46.9 bn

10

What’s the Damage?

• $700 bn of sub prime asset backed securities now in circulation

• $600 bn of bonds backed by slightly higher credit quality

• $390 bn of mortgage debt backed CDOs issued in 2006

• Goldman Sachs estimate ‘credit losses may reach $400 bn’

The Correct Answer……. No One Really Knows!!!!!!!

11

Northern Rock-A Political Mess, A Flawed Business, A Personal Tragedy

• The Flawed Business– Aggressive and ambitious growth strategy pursued on back of securitised lending– Total lack of liquidity in business model-successful for as long as banks prepared to lend

• The Political Mess– £24bn state lending……and counting– No clear exit strategy to protect the taxpayer– Unlevel competitive playing field

• Level of deposit guarantee• Lending funded by guarantee

– Protect the taxpayer and the depositor NOT the shareholder

• The Personal Tragedy– 5000 jobs in branches and call centres at risk– High level of shareholding among staff– Impact on jobs across the FS sector

12

Where were the regulators?

• The Treasury

• The Bank of England

• The Financial Services Authority

Were they

a) Asleep?

b) Looking in the wrong place?

c) Confused on roles and accountabilities

13

Forget politics – What about the real world?

• Economy still growing but at lower rates than recent years

– Further interest rate rises unlikely – two year SWAP rates falling

– Unemployment at historic low and outlook is reasonable

• US problems – not our problems– Over-supplied market– Sharp interest rate rises after decades of

low rates– Evidence of poor selling practices

2 year semi-annual offered swap rates 2007

4.80

5.00

5.20

5.40

5.60

5.80

6.00

6.20

6.40

Dec-06

Jan-

07

Feb-0

7

Mar

-07

Apr-0

7

May

-07

Jun-

07

Jul-0

7

Aug-0

7

Sep-0

7

Oct-07

Nov-07

%

14

Does this spell disaster for property?

Housing Outlook – A mixed picture

• Capital Economics - 3% (2008 and 2009)

• CML +1% (2008)

• Knight Frank +3% (2008)

• King Sturge +7% (2008)

• Bovis - new build prices -3% (2008)

• Evidence of sharp regional variations

……flat market but not a crash

15

What the Press think

• ‘Two years of downturn predicted for housing’ Times 08/11/07

• ‘Commercial property gloom spreads’ Financial Times 04/11/07

• ‘Property fears as bonuses squeezed’ Financial Times 03/11/07

• ‘Outlook uncertain for house prices’ Financial Times 31/8/07

• ‘House prices drop for second month running’ Times 08/11/07

• ‘Quietening down on the building sites’ Times 08/11/07

• ‘Housing Boom to fizzle out’ Daily Telegraph 08/11/07

……can be self fulfilling

16

17

British Love Affair with Property

• 14.6m owner-occupied dwellings in England

• 8.2m households with mortgages

• Media frenzy– 21 property programmes on terrestrial TV pw– Weekly property supplements in press

• 36% of UK wealth is tied up in property

• 71% of UK property is owner-occupied, v 63% average across the EU

• 185,000 holiday or second homes exist in the Uk.

• UK home ownership– 1953 32%– 1961 43%– 1971 51%– 2006 70%

…an Englishman’s home is his castle

18

Housing is Political Dynamite

• Queens Speech– 3 million new homes by 2020

– Increased social and affordable housing

– Simplification of planning

• July 2006: Gordon Brown signalled housing a priority

– National Housebuilding target to 240,000 from 220,000

– Housing Minister in Cabinet

– Promotion of long term fixed rate mortgages to ease affordability

– Return to Council House Building? Or Private sector?

• HIPs – easier property purchase

• Yvette Cooper – Housing Green Paper – increased role of private sector

• Kate Barker 2005 Housing Review and 2007 Planning White Paper – to make it easier to build

• Review of Green Belt around fast growing cities (eg Cambridge)

• Miles report – long term mortgages

…..Positive for the housing market

19

Housing remains in crisis

• Annual New Build is below required level– 185,000 (Est. NHBC)

• Household formation at 230,000 per annum and rising

– Fewer occupants per dwelling– Rising population - Immigration– Increased longevity– Second home ownership rising

• Estimated housing shortage between 2-3 million homes and rising at between 50k-100k per year

…..demand outstrips supply…and someone has to build 3m homes!

Housing Trends

-50,000

100,000150,000200,000250,000300,000

Year

Housing starts

Housing target

revised

20

Reasons to be cheerful?

• Forecasts remain reasonably optimistic

• Political agenda is strongly supportive – Housing = Votes

• Credit crunch has not impacted the real economy (yet)

• Supply/demand imbalance – Houses must be built

……and yet

21

What about the fundamentals?

• Some worrying trends

– 50% rise in mortgage arrears in 2008

– Closure of sub prime market

– Immediate possession orders highest level since 1990 crash (Capital Economics)

– London and South East boosted by City Bonuses – outlook?

• Increase in individual insolvencies

• Consumer debt at very high levels

• Market boosted by mortgage equity withdrawal – likely to unwind

DTI

BoE

22

What about the fundamentals?

• Some worrying trends– 50% rise in mortgage arrears in 2008

– Closure of sub prime market

– Immediate possession orders highest level since 1990 crash (Capital Economics)

– London and South East boosted by City Bonuses – outlook?

• Increase in individual insolvencies

• Consumer debt at very high levels

• Market boosted by mortgage equity withdrawal – likely to unwind

• House price:earnings ratio is at a historic high

23

Reasons to be cheerful?

• Short term challenges

– Market and global

– Financial tightening – risk/reward

– Opportunities for shrewd investors

• Medium/Long term – Back to trend

– Supply and demand imbalances

– Political imperative

– British love of property

UK House Prices from 1966

0

100,000

200,000

300,000

Year

Valu

e

Source:

DCLG

24

The Doomsday Scenario

• When banks lose money they get cautious and scale back lending

• This cuts liquidity in the economy

• Laws of supply and demand mean borrowing costs increase

• House prices fall

• Consumer spending funded by cheap credit falls

• Companies costs increase

• Less money to fund expansion

• Government receipts fall

• Public spending cuts

• Tax rises

• Growing unemployment

………………..So keep your fingers crossed and make a wish that it will be alright on the night

25

Impact on Landsbanki I Heritable Bank

• Highly liquid and well capitalised at outset– Bank and Group

• Strong balance sheet lender

• Ferocious competition for deposits– Savers never had it so good!

• Savers continuing to save but spreading the risk– No evidence of flight to High St

• Lending growth remains strong but early signs of slowdown in customer confidence and slowdown in housing price growth

• Margins under pressure from high LIBOR rates but neutralised but slowdown in competitive pressures from securitised lenders

………CAUTIOUS OPTIMISM

26

Will the world be stronger after the fire?

• An opportunity to re-balance the economy which has become overly dependent on cheap credit financed consumer spending

• Increase in household savings encouraged by higher interest rates for savers

• More long term investment

• Improved public knowledge about personal finance

• More sustainable pricing

• Better risk assessment processes

• Changes to way capital market works

• Renewed focus on liquidity by the authorities

………..Yes! Yes! Yes!