Comment – By economist John Loos (Final Part of Three)

News > news - 18 Jan 2008
If one were to emphasise the household debt-to-disposable income ratio as the key predictor of a looming credit crunch, one may be tempted to raise the alarm bells as this ratio heads towards 80%, now by far the highest ever.

But more important is the debt-service ratio, i.e. the debt servicing cost of the total household sector debt burden (interest + capital)/household disposable income. This ratio had risen to 10.4% by Q3 2007. The rise signifies greater stress for the household sector mounting, but by historic cyclical increases it would not appear out of kilter. The previous 3 big cyclical peaks saw debt service ratios of around 12% (ignoring the 14% blip in 1998 and the small rise in the abnormally good 2002 cycle).

So deterioration yes, but crisis no…..based of course upon our moderate macroeconomic assumptions.

What then do the bad debt figures for banks show to date?

Once again, a fairly moderate situation. DI500s unfortunately only go back as far as 2001. Special mention mortgage loan accounts (accounts 1-2 months in arrears) rose through 2006/07 to near 3% of the total mortgage book for SA’s banks, similar levels to the peak of the 2002/03 cyclical deterioration (the abnormally good cycle). Sub-standard loans (in arrears by 3-5 months) have risen to 1.5% of the total book, doubtful loans (in arrears by 6-12 months) sit at 0.6%, and losses (more than 12 months in arrears) measured 0.9% of the total book as at
November 2007.

Some alarmists may want to emphasise that losses have risen by over 60% since end-2006, and this is true. But off a low base that growth figure is largely insignificant, and of course the total book has grown by near 30%, too, since then.

Therefore, while deteriorating, and I expect further deterioration in credit quality during the first half of 2008, these ratios would hardly point to a crisis situation in which a major portion of households would be having houses repossessed.

Therefore, at current interest rate and economic growth levels, the key ratios suggest that SA’s residential property market is in far better shape than was the case in the mid-1980s. There are no guarantees that things can’t still go pear-shaped, should the interest rate and economic growth environment turn dramatically for the worse, and the risks are always there. But based on our forecasts of a mild growth slowdown to 4% in 2008, and interest rates going into a sideways trend very soon, disaster should be avoided.


Outlook

This doesn’t mean the end of the road for market weakening just yet. I believe we should prepare ourselves for a dip into singledigit year-on-year house price inflation within the next few months, and it is conceivable that house price inflation could dip below a resurgent CPI inflation rate briefly in the near future, indicating some real house price decline.

But later in 2008, I remain of the view that we will see the turning point in the market, and a resumption of real house price inflation to even higher levels. As soon as interest rates level
out, we can expect to see some recovery in growth in new mortgage loans granted (which showed negative growth in the third quarter of 2007), a good indicator of residential demand.

This is anticipated during the second quarter. This event normally coincides with an upturn in month-on-month house price inflation, and with a considerable lag a turn in year-on-year house price inflation.

This time around (compared to the 1980s), I expect the economy to hold up far better in the long term, thus providing little chance for a slide in the affordability ratios al la mid-1980s.

Rather, the affordability issue will continue to be addressed by a move towards smaller units on smaller stands and, unfortunately, the end of the spacious lifestyle that many middle class South Africans have come to accept as the norm.
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