• The past 2 and a half years of interest rate hiking have been mild, with only 2 percentage points’ worth of rate hiking by the SARB (Reserve Bank) in total. However, under the FNB “Base Case” economic forecast, some mild increase in Household Sector Mortgage Non-Performing Loans through the 2016-2018 forecast period is still expected to come.
• Various indicators in the Home Owner market have for a while pointed to mounting financial constraints or in some cases, more recently, a small rise in financial stress. But no indicators yet point to “severe” financial stress”. The softening indicators include a decline in estimated percentage of sellers upgrading, slower levels of home maintenance and upgrades, and a slight lift in the percentage of sellers selling in order to downgrade due to financial pressure.
• In the Housing Rental Market, a noticeable signal of some build in financial pressure was also seen in 1st Quarter 2016 TPN stats. From a high of 86% of total tenants back at a stage of 2014, the percentage of tenants in good standing has declined to 82.2% by the 1st quarter of 2016, the 1st quarter’s quarter-on-quarter decline being the most noticeable in this current cycle to date.
MORTGAGE CREDIT HEALTH OUTLOOK – BEWARE OF LAGS. STILL SOME IMPACT FROM PAST INTEREST RATE HIKES TO COME
The past 2 and a half years of interest rate hiking have been mild, with only 2 percentage points’ worth of rate hiking by the SARB (Reserve Bank) in total. However, under the FNB “Base Case” economic forecast, some mild increase in Household Sector Mortgage Non-Performing Loans through the 2016-2018 forecast period is still expected to come.
Long before banks begin to see the impact of a weakening economy or rising interest rates in their arrears and non-performing loan levels, there are quite a number of leading indicators in the Household Sector, as well as in Residential Market data, of building financial constraints that can provide “early warnings”
The best single “macro-predictor” of Residential Mortgage Arrears levels/trends is the Household Sector Debt-Service Ratio. The Debt-Service Ratio indicates the Total Interest Paid on all outstanding Household Sector Debt per quarter, expressed as a ratio of Household Disposable Income per Quarter.
The level of this ratio is thus determined by the level of Household Disposable Income, the amount of outstanding Household Debt, and the average borrowing rate on that debt.
The Debt-Service Ratio began to rise noticeably from early-2014, as a result of the start of SARB interest rate hiking. From 8.5 late in 2013, the ratio has risen to 9.7 by the 1st quarter of 2016. The magnitude of the rise has been limited by further decline in the Household Sector’s Debt-to-Disposable Income Ratio. So, whereas the average quarterly Prime Rate had risen by almost 2 percentage points from the 1st quarter of 2014 to the 1st quarter of 2016, the Debt-Service Ratio had risen by a lesser 1.2 percentage points.
Nevertheless, with a traditional lag which could typically last up to around 2 years, consumer credit health should ultimately deteriorate somewhat, and mortgage arrears would ultimately increase as a percentage of volume or value of total accounts open. This typical lag drives our current forecast of a mild increase in “Non-Performing” Mortgage Loans in the near term.
In FNB’s forecasting, they define “non-performing” loans as those in arrears for longer than 90 days, using NCR data. From what FNB believes to have been the low point in 2015, 2 years after the Debt-Service Ratio bottomed in 2013, FNB projects the value of non-performing mortgage loans to rise moderately through our forecast period from 2016 to 2018, from 3.4% of the value of total mortgage loans in 2015 to 4.7% by 2018.
This projection is based on a forecast of mild further interest rate hiking, to where Prime Rate peaks at 10.75% later this year, taking the Debt-Service Ratio to just above 10%.
Through the outer forecast years of 2017 and 2018, the Debt-Service Ratio is projected to move sideways next year and then to decline very slightly, the decline being due to further slight decline in the level of Household Debt relative to Disposable Income (“Debt-to-Disposable Income Ratio), while interest rates are forecast to move sideways through both years.
However, the considerable lag time from when the Debt-Service Ratio begins to decline until when the Non-Performing Loan percentage begins to decline implies that we don’t yet see the start of a decline in this percentage during the forecast period to 2018, but one would assume that such a decline could begin to take place by 2019.
A 4.7% high in the Non-Performing Loans percentage, however, would reflect a modest outcome in a weak economic environment with a rising interest rate cycle. In 2010, 2 years after the 2008 interest rate and Debt-Service Ratio peak, the Value of Non-Performing Loans as a Percentage of Total Mortgage Loans Outstanding peaked at a very high 9.2%.
This time around, the ratio is contained by significantly less interest rate hiking, along with a lower level of household indebtedness compared with 2008.
The Household Sector Income, Debt and Mortgage Arrears model projections rest on “benign” FNB Macro-Economic forecasts which include weak albeit slightly improving economic growth in 2017 and 2018, Prime Rate peaking at 10.75% late in 2016 and moving sideways through 2017, and Consumer Price inflation averaging 6.6% in 2016 before slowing back into the 3-6% target range in 2017 and 2018.