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Property Talk

Property Talk

Author: Andreas Wassenaar
Date: 2014-10-03
It is all about managing risk. As a purchaser of a home and applicant to a financial institution for mortgage finance, the bank's attitude to you is a function of your ability to service the level of debt you are exposed to, or not. You therefore become a simple risk assessment exercise and your eventual score on the criteria used to evaluate your risk profile determines whether your application will be successful or not. 

A statistically beautiful way of measuring overall household sector debt-service risk has been developed by FNB in what they call the Household Debt-Service Risk index. An index is typically a summary of several underlying data time series and acts as a simple measure represented by a single figure. As the underlying components change the index changes and the overall trend of the index is therefore a great indication of what can be expected in the future.

As measured by the FNB Debt-Service Risk index, the overall profile of South African households improved in the second quarter of 2014 to 5.33 (on a scale of 1-10) and although still marginally above its 33 year average level of 5.21 is significantly down from the 6.56 high recorded in the 3rd quarter of 2012 and well-below the 7.19 peak reached in the 1st quarter of 2006. On the flip side the risk is still far above the low reached in 1998 at 2.62.

This risk index is compiled using 3 main variables, the debt-to-disposable income ratio of households (my favourite one to watch), the trend in this debt-to-disposable income ratio (i.e. is it growing or declining?) and the level of interest rates relative to the long-term average consumer price inflation (i.e. 5 year average). Simply understood, when households are highly indebted their risk of default is high, when the growth rate of debt to disposable income is high (even if their overall debt is still low) their risk of default is high, and when interest rates are close to the long term structural inflation rate the risk of an increase is higher (i.e. the only reasonable direction move is up, such as what we currently have).

If you have been following the spectacular collapse of African Bank, the (prior) leader in unsecured lending in South Africa, you would have some insight into the dramatic decline in unsecured lending and with the pedestrian growth of secured mortgage lending, we see that overall household credit growth was recorded at 4,71% in the second quarter. At the same time nominal household disposable income has grown at 7.84%.

 As long as this figure grows at a higher rate than overall debt we are happy and our risk profile as a group is improving. If you are in a retail business that relies heavily on consumer credit (e.g. vehicle sales) then slow growth in household credit is not great for business in the short term. The consolation however is a financially better off consumer base in the medium term. The result of slower overall credit growth has meant that our debt-to-disposable income ratio has declined (improved) to 73.5% as at the 2nd quarter of 2014 - down by almost 10 percentage points from 83% recorded in early 2009. 

This is good as it means that households in general are better off to weather an interest rate "storm" now than in 2009. Two of our risk variables - overall indebtedness and the growth of debt to disposable income, have improved. FNB's third measure of risk - the interest rate risk index, remains high as the current prime rate at 9,25% remains moderately close to our long-term average inflation rate (currently close to 6%). The risk here is therefore for an upward movement in interest rates. However, the overall picture of risk is positive and improving.

For further information and an interactive analysis of this article follow my blog: andreaswassenaar.blogspot.com.