In the initial stages of 2017, the Residential Mortgage Market has remained one of very low growth. However, while this can be ascribed to recessionary economic conditions and low levels of consumer confidence, the levels of financial stress in the market remain moderate, and it is conceivable that mortgage arrears levels could even decline in the near term should interest rates continue to move sideways.
With the Rand holding, South Africa could still be on track for some improvement in mortgage arrears
The most relevant indicators point to the level of Household Sector Mortgage Arrears likely being on track for further near term decline (improvement). Total Arrears, according to NCR (National Credit Regulator) data, had risen mildly early in 2016, from a low of 8.2% of the value of total mortgage loans outstanding in the final quarter of 2015, to 9.4% in the 2nd quarter of 2016. However, following a SARB (South Africa Reserve Bank) stalling of interest rate hiking after March 2016, this percentage receded once more to 8.8% of total mortgage loans by the final quarter of last year.
The quick recovery (return to decline) in Household Sector Mortgage Arrears levels, in these times of weak economic growth, may come as a surprise to many, but it shouldn’t. It is arguably explained by ongoing slow (and good quality) new mortgage lending growth, which translates into steady decline in the Mortgage Debt-to-Disposable Income Ratio, which in turn contributes to the declining trend in the Household Sector Debt-to-Disposable Income Ratio.
From a high of 49.2% as at the first quarter of 2008, the Household Sector Mortgage Debt-to-Disposable Income Ratio has declined all the way to 33.9% by the final quarter of 2016.
This massive improvement has been key in driving the Overall Household Sector Debt-to-Disposable Income Ratio down from an all-time high of 87.8% in the 1st quarter of 2008 to 73.4% by the end of 2016.
This has greatly reduced the vulnerability of the Household Sector to events such as recessions interest rate hikes since 2008.
Looking at the most recent Deeds data extracts for bonded property transactions by individuals (“Natural Persons), FNB saw a continuation of year-on-year decline in the 1st 3 months of 2017 to the tune of -4.5% in terms of volume of such transactions, and a lesser decline of -0.6% in terms of the value of such transactions.
With that weak estimate of this proxy for new residential mortgage lending growth early in 2017, the value of Mortgage Advances growth ticking along slowly to the tune of only 3% year-on-year as at April 2017, and Nominal Disposable Income growth expected to be in a significantly higher 6-7% range, it is highly likely that the declining trend in the Mortgage Debt-to-Disposable Income Ratio continued into the early stages of 2017. The same is likely for the overall Household Sector Debt-to-Disposable Income Ratio, with overall Household Sector Credit growth measuring a lowly year-on-year rate of 2.9% as at April 2017.
A declining Household Sector Debt-to-Disposable Income Ratio has meant that, as soon as interest rates stopped rising after March 2016, the all-important Household Sector Debt-Service Ratio (The interest cost on Household Debt expressed as a ratio of Disposable Income) began to decline mildly once more. This ratio is arguably the best predictor of the direction of mortgage arrears. FNB believes that its return to a state of decline, implying declining interest costs as a percentage of Household Sector Disposable Income in the 2nd half of 2016, was key in reversing the short-lived increased in mortgage arrears early last year.
For the Debt-Service Ratio to remain in a state of decline through 2017 and beyond depends on Household Sector Credit growth under-performing Household Disposable Income growth, and for interest rates to remain moving sideways
Given the very weak state of consumer Confidence, as reflected in the negative readings of the FNB-BER Consumer Confidence Index, FNB expecst a relatively cautious consumer in 2017 and even the few years beyond, lifting their savings rate mildly and going slowly on borrowing growth in a weak economic and employment environment.
But can interest rates play ball? Yes, but much depends on the Rand’s behaviour
A key question is whether interest rates will be able to remain moving sideways, or will further increases be required. Key to rates continuing to move sideways will be a relatively well-behaved Rand. Any policy announcement of political event that dents investor sentiment severely and knocks the Rand sharply weaker can lead to renewed interest rate hiking. That will remain a key risk to mortgage debt repayment performance through the next few years of likely political and policy uncertainty.
The Firstrand Base Case, however, is for the SARB to maintain interest rates at current levels where Prime Rate is 10.5% through to 2019.
Right now, there is even speculation of a rate reduction in some circles, with the Rand reasonably stable and food price inflation coming off strongly as drought conditions are alleviated in many parts of the country.
The Producer Price Inflation Rate for Agriculture reflects the drought alleviation, having slowed from 20.7% as at June 2016 all the way to -4.4% year-on-year deflation as at April 2017.
This is normally a lead indicator for the direction of the Consumer Price Index (CPI) for food, whose inflation rate has also declined from a high of 11.4% as at December 2016 to 6.75% in April 2017.
This is a material drop in what is one of the major sub-indices within the overall CPI
With Food a key influence, the Overall CPI inflation rate itself has slowed from 6.7% year-on-year in December 2016 to 5.3% by April 2017.
This brings the inflation rate back within the SARB’s 3-6% target range, which bodes well for stable interest rates in 2017 (Rand permitting)
Under these benign inflation and interest rate circumstances, it is conceivable that the Household Debt-Service Ratio could decline further, as could Household Sector Mortgage Arrears and Non-Performing Loans (Mortgage Loans 90 days and more in arrears).
Can mortgage lending sector competition levels heat up?
A 2nd risk to any Mortgage Sector forecast has to do with possible changes in competition levels within the Mortgage Lending Sector, which may or may not lead to changes to lenders’ risk “appetites” and pricing of home loans.
At present there is not much more than a vague hint of change in this regard, coming in the form of slight increases in the Effective Home Loan Approval Rate according to Ooba data, and a slight reduction in the average differential above Prime Rate on home loans in recent months. In addition, FNB have estimated some slight increase in the Average Loan-to-Purchase Price (LTP) Ratio for the industry, using Deeds Data.
But for the time being these changes are too little and too soon to draw conclusions regarding any major move in industry-wide competition levels.
Mortgage Lending Sector competition level changes, and the Rand and its potential impact on interest rates, remain key risks to mortgage credit repayment performance in the next few years.
However, based on the FNB base case forecast, where CPI inflation remains within the target range, interest rates remain at current levels through the forecast period to 2019, and economic growth shows slow but positive annual averages (the recent 2-quarter recession being short in duration), FNB’s projection is for anaemic Mortgage and overall Household Credit growth to sustain the decline in the Household Debt-to-Disposable Income Ratio, and thus the Debt-Service Ratio. This would cause the value of Non-Performing Household Sector Mortgage Loans (Loans 90 days and more in arrears) to decline as a percentage of the value of Total Mortgage Loans outstanding in 2017 from 3.3% of the value of total mortgage loans outstanding in 2016 to 3.1% for 2017.
Perhaps ironically, tough economic times and resultant weak consumer confidence levels can do a lot of good in terms of promoting more cautious financial behavior and a decline in indebtedness relative to disposable income. This reduces vulnerability of households to interest rate hikes.
Read more here: FNB Mortgage Barometer – 8th of June 2017