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An unsecured lending bubble looms

23 March 2012 Gareth Stokes
Gareth Stokes, FAnews Online Editor

Gareth Stokes, FAnews Online Editor

The trouble with market bubbles is they inflate in plain view. We watch as they expand and even comment on how wonderful the growth in the underlying asset class is. In the United States, for example, house price growth was virtually exponential through t

South Africa’s latest private sector credit extension numbers suggest that we have learnt little from the US sub-prime debacle. Why do I say this? To answer this question we need to consider what went wrong in the US. The root cause of the housing market bubble was poor lending practices. The asset (a house in this case) matched neither the liability (size of the mortgage loan) nor the risk associated with the transaction. US banks made multiple errors, extending loans to individuals who had no hope of repaying them and offering 100% mortgages on hopelessly overvalued properties! The subsequent incorrect rating and on-selling of sub-prime mortgages ripped the global financial system asunder... Turning the spotlight on South Africa we find a different type of credit monster.

The unsecured lending monster bares its teeth

Unlike the US, where high-risk mortgages were underpinned by hopelessly overvalued assets, local lenders are offering loans without any security at all. We call this section of the market “unsecured lending” – or credit issued without collateral. Banks extend these small and risky loans to employed individuals because they earn “fatter” margins. The risk is that when a client defaults on such a loan, the bank has no recourse except perhaps to blacklist the client. How serious is the situation?

A graph of private sector credit extension shows a huge disconnect between the growth rates of “good” credit – mortgages and vehicle finance underpinned by assets – and “bad” or unsecured credit. At 31 December 2011 the year-on-year growth of the latter category is a staggering 32%, versus mortgage growth of only 2%. Of even more concern is that unsecured lending amounted to 46% of new consumer borrowing last year. The National Credit Regulator reports that unsecured credit balances have grown from R7.971 billion in 2008 to R21.213 billion last year.

Analysts are divided over whether the latest numbers point to a bubble. One camp reckons the banks – led by the likes of Capitec Limited and African Bank – are merely playing catch-up with our developed world peers. They say that the balance of unsecured to secured lending is quite acceptable, and that unsecured lending can grow at the current rate for many more years without imploding. Those in the other camp warn that unsecured lending is a temporary solution to long-term consumer problems. Consumers are using expensive and inflexible facilities to fund small purchases such as computers, home improvements, vacations and unexpected expenses – creating a situation that can only end in tears!

Ignoring the warning signs

Why is unsecured lending taking off? Some speculate the growth in this credit class is among the unintended consequences of the recently implemented National Credit Act. Banks are simply shifting their lending activities to the most profitable section of the credit market – micro-loans. But it seems banks have forgotten the “school fees” they so recently offered up. In the first instance unsecured lending (in the form of sub-prime loans) almost brought down the global economy… In the second, local banks are only now recovering from massive recession-linked bad debt write offs. Why, we wonder, extend unsecured credit to shell-shocked consumers. They will take the lifeline – but they may not be able to pay the money back.

The banks’ marketing agents are having a field day. A week or two back we stumbled upon an advertisement from Capitec, which urged: Don’t make use of costly vehicle finance – rather get up to R150 000 from us and buy the vehicle cash (or words to similar effect). What? I guess Capitec is lucky that comparative advertising is banned – because a comparison on the costs (interest and other) incurred in an unsecured personal loan versus a vehicle-backed hire purchase deal could be telling! The bank should probably be reprimanded for confusing the personal loan and cash purchase issue too...

Is the current surge in unsecured credit cause for concern? The answer, for many reasons, is yes. This form of lending is clearly a move by banks to generate larger incomes from their lending activities – often at the expense of low and mid-income families. It is also a ticking time bomb for the financial services industry. Loan defaults will become a problem if South Africa continues on its current “slow growth” path without addressing the massive unemployment overhang.

Editor’s thoughts: Banks are supposed to make money by offsetting interest on deposit taking and lending activities. With the prime lending rate fixed at 9% the revenue generated by mortgage loans and other asset-backed products is dwindling… The move to unsecured lending products, where banks can charge rates as high as 32%, is therefore not surprising. Do you think the shift to unsecured lending (especially micro-loans) is due to regulatory changes introduced in the National Credit Act? Add your comment below, or send it to gareth@fanews.co.za

Comments

Added by Bidnis Man, 30 Mar 2012
For once you are wrong. Microloans have very short repayment terms. If you have a book of this business and defaults start to rise you can increase your requirements for new loans quickly enough. There would have to be a massive spike in unemployment for something to happen here. If that happens the mortgage backed lending will be in even worse shape. I am still sceptical of the property market. It would appear to me that residential properties have a n amount still to deflate.
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Added by Irene, 28 Mar 2012
All we can hope for is that the Registrar and Reserve Bank act more prudently than their overseas counterparts and remain strict in their oversight and regulatory functions to ensure SA banks consistently maintain the correct levels of reserves and adequately provide for bad debts and non-performing loans. The SA taxpayer cannot afford the bail out even one of our 4 or 5 "too big to fail" banks!
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