While stock markets are still reeling from the bad news surrounding subprime lending in the United States, a similar meltdown is unlikely in South Africa, according to Jack Trevena, MD of bond originator BondExcel and ex-CEO of Nedbank home loans.
Trevena explains that the US home-loan market is completely different to the South African home-loan market. “For the players in the South African property market to differentiate between anecdotal bad news and the current reality, it is important to understand that it is not the traditional US home-loan market which is in crisis, but rather the sector of that market that engages in inappropriate lending to subprime borrowers,” he says.
“Subprime lending is an unusual and rather unsuitable term for home loans granted to individuals who, under any normal credit policy, would never obtain a loan,” explains Trevena. “The term ‘subprime’ refers to a rate much higher than prime. These books of debt are then backed into financial instruments such as hedge funds and sold to other investors.”
In the US and some European countries, subprime lending has become a multibillion-dollar industry that is spinning out of control.
“Obviously, normal declines in rates would cause a normal housing boom, as evidenced in the housing frenzy which was brought about quite naturally by the drop in the US repo rate to 1%. But in these countries, money is advanced to people who cannot afford a home loan under normal circumstances, causing prices to heat up even more.”
Unfortunately the US repo rate subsequently rose to about 6%. “Just doing the calculation at a bank-rate level, never mind prime, which is usually 2% to 3% above the bank rate, will show that the ARM [Adjustable Rate Mortgages] has risen by about 600%,” Trevena explains.
“This means that Americans who bought a house, say, four years ago, are now paying 600% more in interest on a home loan. Fortunately, at the time the repo rate stood at 1%, borrowers could opt for a fixed rate of 2,99% over 30 years. Those who did so are less affected by the massive increase in the interest rate.
“However, a substantial number of subprime borrowers have begun to default on their repayments, in some instances without even a single repayment being made, causing a massive crisis. This means that the books of debt and the financial instruments used to back it up, are almost worthless.”
In South Africa, the picture is very different. “Our major banks have not entertained subprime lending, as tempting as the returns may be. Each of the South African banks has resisted this high rate, high margin alternative to traditional home-loan lending. Consequently there is no major product exposure to this market,” explains Trevena.
“Where higher rate lending may have occurred in the lower segment of the market, these books of debtors are very small in the scheme of things. The current national home-loan book is in excess of R740-billion.
In addition, none of the major institutions provide facilities such as deferred repayment, which allows borrowers to start off with small repayments which increase over, say, five years to larger than normal repayments. This option is aimed at improving early cash flow.
The South African market also does not offer bullet home loans, in which only a portion of the capital is serviced over the loan period and the balance becomes due at the end of the loan term, similar to residual values in vehicle finance.
Only one financial institution in South Africa offers an interest-only loan, which implies that the full capital remains outstanding over the term of the loan and becomes due in full at the end of the loan term, at which point it may be restructured.
Trevena says that the absolute “junk bonds” of high-risk home loans are the so-called ninja (no income, no job or assets) loans, in which up to 120% of the value of the property is borrowed. “Products like this one are simply ridiculous,” he says.
“It is therefore clear that South African financial institutions have been conservative and responsible in their thinking and lending, and have, as a result, avoided the trap of improving margins using ‘exotic’, meaning ‘extremely high risk’ products,” says Trevena.
“The reality is that the South African home-loan market is now faced with a cocktail of bad news. The US home-loan saga as described above, the recently implemented National Credit Act [NCA], rising interest rates, the deeds office strike and the winter seasonality, have all combined to cause a slowdown in the property market. Just an interest rate rise or the winter season in isolation could have resulted in lower property sales and therefore reduced home-loan lending.
“However, the type of reckless lending practised in the US, which has in any case been prohibited by the NCA since 1 June 2007, does not take place in South Africa and therefore it is incredulous to expect that the South African property market will experience a similar ‘meltdown’ as experienced in the US.
“The players in the South African property market can’t allow themselves to be unduly influenced by this cocktail of bad news. Property remains at double-digit price growth year-on-year and year-to-date and the recent interest rate increases have amounted to only a 24% rise in interest cost, nowhere near the 600% experienced in the US.
“Property remains a good investment, particularly as rental rates increase and property sales continue to perform well in South Africa,” concludes Trevena. — I-Net Bridge