There is light at the end of the tunnel for South African consumers. All the local banks are expected to follow Standard Bank’s example shortly and start lowering their lending criteria for households, which could lighten the heavy financial burden of households considerably.
Since mid-2005 banks have raised their lending criteria. The National Credit Act introduced in July 2007 has also severely hampered the borrowing capacity of households. Over a two-year period the South African Reserve Bank also increased its repo rate to banks from 7% to 12% in 2008, resulting in the prime overdraft rate increasing from 10,5% to 15,5%.
Banks and other financial institutions previously encouraged people to use their so-called home equity to improve their lifestyle. This trend came to an end last year and in many instances it was reversed when property values started declining as a result of the downswing in the house market.
The situation has been exacerbated since September last year into the second quarter this year owing to the global financial crisis following the collapse of Lehman Bros in the US. The global liquidity crisis, or lack of liquidity, has resulted in major constraints on the balance sheets of local banks and the cost of capital has increased considerably. This has compelled the banks to raise their lending criteria.
The global liquidity situation has since returned to normal and liquidity is once again abundant. The SA Reserve Bank has followed the example of other central banks with sharp cuts in the Bank’s repo rate, resulting in the local banks’ prime overdraft rate returning to the 10,5% level that prevailed in 2006.
According to the Ernst & Young Survey for the second quarter of this year, the net percentage of local banks applying stricter lending criteria for businesses has declined from 87% in the first quarter this year to 72% in the second quarter. They expect a further decline to 61% in the third quarter. On the other hand, the net percentage of local banks applying stricter lending criteria for households has only declined from 86% in the first quarter of this year to 85% in the second quarter, and is expected to be 75% for the third quarter.
Although a lowering of lending criteria is usually fairly closely linked to the Reserve Bank’s repo rate, the sharp cuts in the bank rate has had little effect on the banks’ lending criteria until now (see accompanying graph). One can understand why Mr Tito Mboweni criticised the banks a few months ago for not passing on the benefits of lower interest rates to consumers. After all, the Reserve Bank formulates monetary policy and the banks execute it.
South African banks raised their lending criteria long before their foreign counterparts, but the opposite is now true. Most US and European banks started lowering their lending criteria in the first quarter of this year in line with the sharp interest rate cuts. Furthermore, foreign capital is more cheaply accessible to local banks and is more readily available. However, local banks will argue that their write-offs and bad debt provisions continue to increase.
The question is whether the banks are not currently overproviding and being too conservative, as the Ernst & Young Survey indicates that the net percentage of local banks experiencing higher defaults has dropped from 37% in the fourth quarter of last year to 27% in the second quarter of this year. The fact is also that defaults by borrowers decrease when interest rate fall and the benefit is passed on to them. Households are currently struggling so much they are inclined rather to incur debt.
According to the statistics recently released by the Reserve Bank, credit-card usage continues to decline and was R742 million lower in the second quarter than the previous quarter, and R917 million less than at the end of last year. Total bank overdrafts at commercial banks also declined by R1,9 billion in the second quarter compared with the previous quarter.
One bright spot in the statistics released by the Reserve Bank is that loans and advances by commercial banks increased by R195 billion, or 11,7%, in the second quarter of this year compared with the previous quarter. However, this is not the first swallow of summer, as the total loans and advances are still R31,9 billion less than the R1 895,6 billion at the end of last year.
The lowering of lending standards will undoubtedly have a positive effect on consumer sentiment. It should also confirm the bottoming of house prices. Investors in domestic economically cyclical shares should be amply rewarded over the next year in spite of the current downward correction in international stock markets and especially in China.
As cash and fixed-interest investments will in all likelihood not be the best asset class for the next few years, I believe any weakness in equity prices in the coming months should be regarded as a buying opportunity.
Source: Plexus Asset Management, September 2, 2009.
