Mortgage Barometer – Residential Mortgage Market Stress

If interest rates don’t rise further in 2017, it is conceivable that South Africa could have a year of improving (declining) Residential Mortgage Market “Stress”, and some mild decline in mortgage arrears levels. This is due to the likelihood that Household Sector Credit will continue to grow noticeably slower than Nominal Disposable Income growth, thereby further lowering the all-important Household Debt-to-Disposable Income Ratio, which in turn lowers the vulnerability of households to interest rate hikes. But it’s the forecasting of interest rates that always remains the “hazardous business”.

Examining recently released 3rd Quarter 2016 NCR (National Credit Regulator) data, FNB saw a mild decline (improvement) in both the volume and value of Household Sector mortgage arrears as a percentage of total mortgage advances.

From 9.4% of the value of total Household Mortgage Advances in the 2nd quarter of last year, the value of Household Mortgage Arrears declined to 9.1% in the 3rd quarter.

This “turnaround” came after 2 prior quarters of increase in the percentage, and keeps the total arrears percentage at relatively modest levels compared to the 16% historic high reached back in the 1st quarter of 2009 around the time of the last recession.

FNB regards “non-performing loans” only as those loans in arrears for 90 days of longer. This category’s percentage was 3.33% of total mortgage loan value, which had also declined from the prior quarter’s 3.37%, and is also sharply lower these days than a 9.4% high of early-2010.

In another measure of financial stress in the residential market, FNB uses their FNB Estate Agent Survey estimate of the percentage of total home sellers believed to be “selling in order to downscale due to financial pressure”. This estimated percentage, too, has “leveled out” after a brief increase from a multi-year low of 11% in the 3rd quarter of 2015 to 14% around mid-2016, to record 13% in the final quarter of 2016.

This 13% estimate remains a relatively low level, too, when comparing it with the 34% peak reached in the 2nd quarter of 2009.

So, after some signs of deterioration late in 2015 and early-2016, the rise in residential mortgage market stress seemed to quickly fade, and remains modest compared to previously recorded highs.

Why has Mortgage Market Stress been so Moderate this Time Around to Date?

In tough economic times, this perhaps begs the question as to why the Residential Mortgage Sector has, to date, managed to come off relatively unscathed? The answer has much to do with the overall pace of lending to households, both within the Household Mortgage Sector as well to the overall Household Sector. The moderate pace of Household Credit growth has underperformed Household Disposable Income growth for much of the time since early-2008, causing a significant lowering in the Household Debt-to-Disposable Income Ratio from an 87.8% all-time high in the 1st quarter of 2008 to 74% by the 3rd quarter of 2016.

This has contained the Debt-Service Ratio’s (The total interest on household debt expressed as a percentage of Household Sector Disposable Income) levels in recent years in the face of gradual interest rate hiking.

This Debt-Service Ratio is arguably the best single “macro-predictor” of the level of Household Sector Mortgage Arrears, and is influenced by the level of Household Debt relative to Disposable Income as well as by interest rate levels.

Interest rate hiking from early-2014 to early-2016 lifted the Debt-Service Ratio mildly, from a multi-year low of 8.6% at the end of 2013 to 9.7% by the 1st quarter of 2016. With something of a delay, this caused a mild increase in the Household Sector Mortgage Arrears percentage from late in 2015 to early-2016.

However, stable interest rates since March 2016, coupled with further decline in the Debt-to-Disposable Income Ratio in the 2nd and 3rd quarters of last year, started to once more lower the Debt-Service Ratio mildly to 9.6% by the 3rd quarter of last year. This ratio, too, remains low compared to the 13.9% peak reached in the 3rd quarter of 2008, at the peak of the previous interest rate hiking cycle (where Prime Rate peaked at 15.5%)

When the Debt-Service Ratio peaks and begins to decline, the reaction in terms of a decline in mortgage arrears is usually quite quick, and so it comes as little surprise that the mortgage arrears percentage has once again begun to decline by the 3rd quarter of 2016.

Outlook – Decline in Mortgage Market Stress in 2017??? Interest Rates and Economy must ‘Play Ball’

So, given the ongoing declining trend in the Household Debt-to-Disposable Income Ratio, a period of sideways movement in interest rates has a similar impact on mortgage arrears to a mild interest rate cutting cycle, because that declining Debt-to-Disposable Income Ratio lowers the Debt-Service Ratio.

Looking forward, FNB forecasts “more of the same”, i.e. a long sideways movement in interest rates at current levels, along with further decline in the Household Debt-to-Disposable Income Ratio, and thus further decline in the Debt-Service Ratio.

From an expected average of 74.16% for 2016 as a whole (4th quarter 2016 data not yet available), the forecast is for a further multi-year decline in the Household Sector Debt-to-Disposable Income Ratio to 72.8% for 2017 and on to 67.8% by 2019.

This projection of further decline in the Debt-to-Disposable Income Ratio is based on the expectation of a weak economic growth recovery at best, with consumer confidence remaining subdued, thereby still constraining household borrowing growth.

This in turn, along with the FNB projection of a multi-year sideways movement in interest rates at current levels, leads to a forecast of decline in the Debt-Service Ratio from an estimated average of 9.6% for 2016 to 9.4% in 2017 and further down to 8.8% by 2019.

Based on FNB’s macro projections, it is plausible that non-performing mortgage loans, expressed as a percentage of total mortgage advances for households, decline through the 2017 to 2019 forecast period. As previously mentioned, FNB classifies “non-performing” mortgage loans as those loans in arrears for 90 days and longer (thus excluding 0 to 3 month arrears from this calculation). As at the 3rd quarter of 2016, the value of such loans was 3.33% of the value of total mortgage advances. After averaging a projected 3.26% for 2016, the forecast is for a decline to 3.04% in 2017, and further lower to 2.28% in 2019.

Key to such forecasts is an economy that continues to grow “moderately positively”, and no further interest rate hiking during the 3 year forecast period.

Such forecasts don’t come without risks, especially in the current uncertain times of possible ratings downgrades and resultant dips in investor confidence. Should such dips play out, causing sharp Rand weakening, there is no guarantee that further interest rate hiking can’t take place.

The important point, however, is that should interest rates not rise further, likely ongoing decline in the Household Debt-to-Disposable Income Ratio, resulting in decline in the Debt-Service Ratio, could conceivably see to it that mortgage market stress is lowered in 2017 and beyond.

Read more here: Mortgage Barometer – Mortgage Market Stress – January 2017