Does anyone remember SAAMBOU Bank?

Most investors are familiar with the phrase "as safe as houses." The suggestion is that a brick-and-mortar investment in a home is one of the safest long-term investments one can make. We like to believe that depositing money at a bank is a similarly 'safe' investment. But this belief does not always hold true.

Banks, like any other form of business, can run into financial difficulty. And while there are additional safety nets in place in the form of industry regulators and the central bank, there is no guarantee that nothing will go wrong.
 
We only have to cast our eyes back five years to recall the most recent banking failure in South Africa. At the time, Saambou bank was riding the crest of the wave as a well-established and well-run banking operation. But behind the public facade things were certainly not going to plan.

Banks are not impenetrable fortresses

Early in September 2002, the Registrar of Banks placed the management responsibilities of this once proud bank in the hands of a curator. "Recent events pertaining to Saambou Bank Limited (SAAMBOU) have led to a situation where SAAMBOU will evidently be unable to repay deposits made with it or will probably be unable to meet all of its obligations when legally obliged to do so," read the matter-of-fact official announcement.

Authorities were forced to take action because the bank was experiencing increasing liquidity problems and it was not certain the institution would be able to repay deposits and meet other legal obligations as required. Drastic measures were implemented to prevent a run on the bank. This included closing branches across the country to deny panicked investors access to their deposits and the implementation of a staged withdrawal plan.

Fortunately for Saambou depositors, FirstRand's First National Bank came to the rescue. The bank bought out Saambous operations and also acquired Saambou's traditional housing book, comprising 60, 000 accounts and valued at R8 billion. The bank also took over approximately half of Saambou's low-cost housing book, which comprised a total of about 20, 000 accounts worth about R1 billion.

Sub-prime crisis is not going away

We've reminded readers about the Saambou Bank failure because of recent rumblings from the United States and other Western powers over the so-called sub-prime contagion. For those of you who are not familiar with the term, sub-prime refers to the bank practice of extending mortgages to people with less than acceptable credit records. The practice caused few concerns while low interest rates prevailed in the US. But after a series of interest rate hikes lasting some two years, the sub-prime market ran into the brick wall of affordability.

Local stock market analysts want us to believe that the sub-prime crunch in the United States is a blip on the investment horizon which will bypass South Africa. What they forget is that exposure to questionable lending practices is not limited to banks in the US. Banks in Europe also have significant exposure to the sub-prime mortgage market.

These analysts also forget that global equity markets are about more than banks only. What about the possible knock-on effect of even a single bank running into financial trouble? Although South Africa has not got any direct exposure to the sub-prime mortgage market it is unlikely we will emerge unscathed if the problem leads to a huge implosion in the US or Europe.

Some tremors already felt at Northern Rock

Any doubts as to the severity of the situation were dispelled with Friday's chilling news from the UK. It emerges that the Bank of England (England's central bank) had to hand a lifeline to Northern Rock, the country's fourth largest mortgage lender. It should be noted that the bank remains solvent, and that the central bank bail-out was to help with liquidity concerns which resulted from the sub-prime crisis.

Northern Rock depositors took a less calm stance. Just as South African investors did when Saambou looked shaky; they queued for hours to withdraw deposited funds. Investors were equally harsh, dumping Northern Rock shares and knocking USD 1.7 billion from the bank's market capital. Shares fell to a seven year low of GBP 4.33 per share.

The message is clear. A bank does not have to be directly exposed to the sub-prime lending market to be at risk of operational difficulties. The knock-on effect of the sub-prime lending debacle will be increasingly felt as credit extension and lending policies are tightened to deal with the existing problem. And if a couple of banks in the UK are taking strain, you can be sure that other US and UK based operations are facing similar troubles. Should any of these institutions topple, South Africa will be unable to escape some of the fallout.

Editor's thoughts:
The local investment market is not short of financial scandals. Examples include MasterBond, LeaderGuard and more recently Fidentia. The difference between these cases and the sub-prime lending crisis is that the sub-prime lending crisis is the result of poor business decisions rather than mismanagement, misrepresentation or fraud. World stock markets crashed when the extent of the problem first became apparent and South African markets fell in sympathy. However, since then, our markets have powered ahead in the belief that we are immune from this problem. Do you think we've heard the last of the sub-prime problem? Send your comments to gareth@fanews.co.za