Benefits of improved and ‘more conservative’ mortgage lending

(by John Loos)

As interest rates gradually rise, we are arguably seeing the benefit of the past seven years of improved and more conservative mortgage lending.

The onset of more conservative lending standards by banks, from around 2008 onward, was not always popular with the public or the property industry. But as interest rates have begun to gradually rise, a lack of significant increase in financial pressure-related home selling to date, despite a weak economy on top of rising interest rates, may mean that we are now reaping the benefits of those positive changes seven years ago.

Although some deterioration is ultimately expected, no rise in financial stress-related home downscaling yet arguably reflects good decisions made seven years ago.

Rising interest rates, and a resultant rise in debt-servicing costs as a percentage of disposable income (known as the debt-service ratio), normally bring about a rise in various forms of financial stress, and cause household credit health/performance to deteriorate.

Although there are no doubt households feeling additional pressure brought on by gradually rising interest rates and a deteriorating economic growth rate, the reality is that in recent times we have had the nice problem of incorrectly over-expecting when it comes to the level of bad debt and financial pressure-related home selling.

That all-important household debt-service ratio has been gradually rising for over a year-and-a-half, driven higher by a partial shift to the higher-priced non-mortgage credit forms, as well as by rising interest rates since January 2014. While the debt servicing cost rise has been gradual, we had expected that by now it would have brought about some rise in financial stress in the residential market. As yet, however, we have not seen meaningful signs of this. In the third quarter of 2015 FNB Estate Agent Survey, the percentage of home sellers selling to downscale due to financial pressure actually declined on the previous quarter’s 13 percent, to 11 percent, remaining at multi-year low levels far below the 2009 high of 34 percent

It is at this point that we are arguably beginning to see the benefits of some undoubtedly good decisions made about seven years ago with regard to banks’ credit appetite. The decisions made by the various lending institutions at the time were not always popular. But good decisions are not always popular.

The more conservative mortgage lending approach since that time led to overall residential mortgage debt levels growing at a pedestrian pace ever since. This has been key to driving down overall household sector indebtedness, which is measured by the household debt-to-disposable income ratio.

Despite significant growth in non-mortgage borrowing since the financial crisis in 2008/9, the household debt-to-disposable income ratio has declined by over 10 percentage points, from an all time high of 88.8 percent back in 2008 to 77.4 percent by the second quarter of 2015.

More conservative household sector mortgage lending has been key to this highly positive move downward, with the household sector’s mortgage debt-to-disposable income ratio declining from 49.2 percent to 35.4 percent over the same period.

While the overall level of household indebtedness remains high, the noteworthy decline has meaningfully lowered its vulnerability to interest rate hiking.

This does not mean that we won’t see any rise in bad debts or financial pressure-related home downscaling should interest rates continue to rise gradually. We probably will, ultimately, with some lag.

If one examines another residential-related indicator of financial pressure, namely the TPN percentage of tenants in good standing with their rental payments, the second quarter 84.26 percent is slightly off the 85.9 percent high late in 2014. So economic, cost of living and interest rate pressure may indeed be starting to mount.

But the fact that to date, the financial pressure-related residential market numbers remain so good, and have been undershooting our expectations, we believe is very much due to the mortgage lending/borrowing practices of the past seven years lowering the overall vulnerability of the household sector to negative economic events.

And from the point of view of the household sector’s longer term financial stability, while the SARB is under no major pressure from an inflation point of view to raise interest rates hastily, it would probably be desirable for it to continue to very gradually lift interest rates back up to more normal levels. This, we believe, would sustain slow household credit growth for longer, and cause a much needed further decline in the debt-to-disposable income ratio. Yes, looking forward, the good decisions will probably not be the popular ones.

(John Loos is a household and property sector strategist at FNB Home Loans.)

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