Subprime Mortgage Financial Crisis causing Havoc in US unlikely to affect SA Property

With the subprime mortgage financial crisis causing havoc in the property market in the US, many South African homeowners are asking whether a similar situation could arise locally. The answer, says Patrick OShea, CEO of Engel & Vlkers, South Africa and the O'Shea Group, is that it is very unlikely, given the structural differences between the US and South African mortgage systems. 
 
What is subprime lending and how did the subprime mortgage financial crisis occur in the US?
 
Subprime lending is a general term that refers to the practice of making loans to borrowers who do not qualify for mortgage bonds with accredited institutions, either because of problems relating to their credit history or with their inability to prove that they have enough income to support the monthly repayments on the loan for which they are applying.
 
The subprime mortgage financial crisis was essentially a sharp rise in foreclosures in the subprime mortgage market which originally started in the United States in 2006 and evolved into a global financial crisis during July 2007. Several interest rate hikes increased the monthly repayments by borrowers and property values declined causing the US housing bubble to burst. This left home owners unable to meet financial commitments and lenders without a means to recoup their losses.
 
Is this likely to happen in South Africa?
 
O'Shea says the key difference between the US and South African mortgage markets is the proliferation of collaterised debt obligations (CDO's) in the US, which makes up a significant proportion of overall home loans in that country.
 
While CDO's vary in structure and underlying collateral, the basic principle is the same. First, a CDO entity acquires its inventory, such as a mortgage book, made up of a number of individual home loans. Thereafter, the CDO entity sells this "packaged debt" to investors, usually financial institutions. This means that the entity that owns the debt is not the same entity that did the risk assessment of the individual home loans. This situation resulted in many CDO entities being far too lenient in their risk assessment practices, while some were actively encouraging fraudulent income inflation on loan applications.
 
There were implications for borrowers too. Traditionally, when payments on a mortgage were late, the personal relationship between debtor and creditor allowed some leeway when paying off a mortgage. But when subprime mortgage-backed securities were collateralized, the traditional links between lenders and their creditors were severed. This created a vicious circle when subprime loan payers defaulted on their obligations, leaving foreclosure of their mortgages as the only perceived recourse for investors in the loan.
 
O'Shea says, "Unlike in the US, there is a far closer relationship between debtor and creditor in South Africa, leading to better lending practices. With local banks keeping home loan risk on their own balance sheets, their risk assessment of individual loans is far stricter. This has translated into less reckless lending. In the US, loans were being made to individuals with total monthly repayments as high as 60-70% of joint income. In South Africa, this figure is closer to 30%."   
 
He says the introduction locally of the National Credit Act (NCA) this year has further bolstered prudent risk assessment and curbed certain reckless lending practices that may have existed. 
 
O'Shea says while current legislation in South Africa lends itself to sound lending practices, it also makes it more difficult for many South Africans to gain access to credit. "There is pressure on government to address the housing shortage at the low end of the market. While it may be tempting for government to legislate reduced home loan rates to low income borrowers, this could lead to a credit crunch further down the road."
 
He says that rather than encourage riskier lending practices, it would be far more beneficial to reduce the transfer costs on property or allow tax deductions on mortgage repayments for low-income earners.
 
O'Shea concedes however that the recent interest rises are putting pressure on home owners in the market place, particularly those in the buy-to-let and second home market.
 
He says that this, coupled with the reduced access to credit as a result of the NCA and inflation from food prices and fuel, has added further pressure to lenders and property owners. "With yet another possible rise forecast as a result of the recently released inflation figures, this could put further pressure on the market, making it a good time for astute buyers to enter the market at more realistic prices than have been offered in recent months."