An interest rate shock could unseat the consumer credit recovery

Gareth Stokes, FAnews Online Editor

There are many factors that contribute to the profitability of financial services providers. Fund and asset managers, medical schemes administrators, life companies, short-term insurers and financial advisory practices tend to make more money when the eco

One option is to consider the recently launched Momentum/UNISA Household Financial Wellness index, which identifies four categories of financial wellness. At its launch in April 2012 the index found that 48.5% of households fell in the Drifting Unwell category, with a further 30.5% in the Drifting Well category. Economists note that adverse economic events – such as another round of recession – could do untold damage to the household financial wellness profile observed here. But there are other ways to test the “temperature” of local consumer finances...

Line up for your credit check...

Financial advisors understand better than most the importance of a comprehensive “consumer financial health” check. Among their first advice tasks is to conduct a financial needs analysis with their new clients, including an assessment of income, expenditure, assets and liabilities. A quick and easy test of a potential client’s financial wellbeing – not often considered by advisors – is the ITC or credit report. “A person’s credit report is one of the most important tools consumers can use to maintain their financial security and credit rating,” notes US politician, Ruben Hinojosa. “Many do not know how to obtain one, or what to do with the information it provides.”

Local consumers can approach credit bureaus such as TransUnion (http://www.transunion.co.za/) or Experian (http://www.experian.co.za/) for a copy of their credit reports, for a small fee. The former company notes: “Your credit report contains information that has been gathered by the bureaus on an ongoing basis from many sources that you have applied to for credit or services.” In a nutshell – this report reflects your financial reputation – and is used by lenders to determine whether you are a good credit risk or not. The trick is to combine the thousands of individual health checks to obtain a better understanding of the country’s credit position

South Africa’s credit health check

The TransUnion SA Consumer Credit Index (CCI) does just that, by considering Credit Bureau data of consumer credit card utilisation and the number of consumer credit accounts in arrears along with economic statistics (prime interest rates and household debt to disposable income from the SA Reserve Bank) and other proprietary analytics such as non-discretionary CPI and True Money Supply. “TransUnion’s indicator combines actual consumer borrowing and repayment behaviour obtained from the extensive TransUnion credit database, with key, publicly available macroeconomic variables impacting household finances,” explained Geoff Miller, CEO TransUnion Credit Bureau.

Credit health refers to the ability of consumers to service existing credit obligations within the constraints of their monthly household budgets. Where does South Africa stand? The Q2 2012 CCI number, released on 29 May, declined from 54.4 points in Q1 to just 50.7 points. (A score of 50 points or more reflects moderate improvements in consumer credit health.) “It is a more cautious picture than we saw in Q1, but after strong improvements to credit health in 2010 and 2011, it would be a mistake to interpret the Q2 results too negatively, as one quarter does not make a trend,” said Miller. “It does, nonetheless, suggest that lenders may need to re-assess their risk appetite for new loans and adapt accordingly.”

Underlying the latest index decline is an increase in the number of consumer loan impairments (consumer accounts that are more than 90 days in arrears of their required payments). The number of impaired accounts has risen almost  9% since mid-2011, comprising 1.8% of total accounts. This is bad news given the National Credit Regulator’s Consumer Credit Market Report for December 2010 to December 2011 which reveals R107.6 billion in new credit granted and 9.72 million new credit applications across the industry in the final quarter of 2011. By 31 December last year the country’s consumer credit balances stood at R250 billion in mortgages, R141.26 billion in credit facilities, R112.99 billion in unsecured credit and R927.37 million in short-term credit!

The interest rate bomb is ticking

Any decline in consumer credit health is of major concern, particularly given the surge in unsecured lending! “The rise in the number of impaired accounts at a time when interest rates are at multi-decade lows and when, on the whole, household income growth appears to be matching the rate of new household borrowing, suggests that impairments may be concentrated in isolated markets – and the unsecured loan market stands out as a potential source of the bulk of these impairments,” concludes Miller.

Consumers are the backbone of the domestic economy. The apparent dependence on unsecured credit products to “get by” could have significant consequences if interest rates resume an upward trend through 2013. Financial advisors will have to pay close attention to their client’s credit reports when structuring optimal long-term savings plans. Remember, your client’s ability to service debt – both secured and unsecured – impacts on the affordability of the risk and savings products you recommend.

Editor’s thoughts: While researching today’s article we stumbled upon a great quote by Charles Dickens: “Credit is a system whereby a person who can not pay gets another person who can not pay to guarantee that he can pay.” His comment has more clout today, in the wake of the global credit crisis, than when it was first issued. Are you concerned about the impact of pending interest rate hikes on your client’s monthly cash flows? Please add your comment below, or send it to gareth@fanews.co.za