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  • 1. A Structured Debt Finance Initiating Coverage Rand Market 16 November 2004 South African Home Loans – House in order • South African Home Loans (SAHL) has originated residential home SAHL FORECAST PRE-TAX PROFIT loans for almost six years against a rapidly changing interest rate and 600.0 property price landscape. 400.0 • The company has captured approximately 4% of SA’s residential mortgage market with its 58,000 (registered and approved home loans) 200.0 customers with a book value of R17.3bn. Rm 0.0 • In addition, SAHL lays claim to two-thirds of SA’s mortgage (200.0) securitisation market and almost a quarter of SA’s R26.8bn total (400.0) securitisation market, having issued its fourth Residential Mortgage 2005 2006 2007 2008 Backed Security (RMBS), Thekwini 4, earlier this year. Income Expenses Pre-tax profit Investor considerations Source: Standard Bank Group and SAHL • Management change: Simon Stockley, a co-founder and past Chief Executive Officer, elected to leave the group at the end of September MARKET SHARE 2004. His successor, Kevin Penwarden, was appointed Chief Operating Officer in February 2003 and subsequently became 4% Managing Director in June this year. Stockley, meanwhile, will advise 2% 4% the group for the next twelve months – and is restrained from 32% replicating SAHL for three years. The rest of the management team, 18% experienced in the mortgage industry, remains in place. • Financial: Results for the six months ended August 2004 indicate that SAHL is on track to report an operating profit in F2005 (in excess of 15% R20m) and should be cash flow positive by F2006. 25% Absa Standard Bank • Margin squeeze: Although the margin between JIBAR +2.1% (SAHL’s Nedbank Firstrand offer to borrowers) and Prime -1% (banks’ “normal offering” to middle- Investec Other banks SAHL income earners) has narrowed from 105 bps four years ago, SAHL has Source: SAHL and SARB exponentially grown its home loan book. • New products: SAHL recently launched complimentary products NATIONAL HOUSE PRICES (Caps, Quickcash and Insurance) and management anticipates that SAHL will launch a hybrid (fixed/variable) home loan product as well as 36 a credit card within the next six months. It has also entered into 24 discussions with corporates for white-labelling opportunities. • Tight risk criteria: Investors in Thekwini securitisations have no Index 12 recourse to the servicer (SAHL), but security is firmly related to home 0 loan pool performance, which is founded in SAHL-implemented rigid risk criteria. (12) (24) In this research report, we have detailed the Thekwini securitisation structure and provided an overview of SAHL – including details of the 4 9 4 5 0 7 2 -9 -9 -9 -0 -0 l-9 l-0 ov ov ar ar ar company’s loan origination, administrative and collection processes as Ju Ju M M M N N Nominal well as financial information, credit considerations and pool information. A Real (CPI deflated) broad study of the macroeconomy and the residential property market Real (Building cost deflated) concludes the review. Source: Standard Bank Group and Deeds Office Kate Rushton, Henry Flint & Elna Moolman (+27 11) 378-7278 Global Markets Research Important disclaimer – please refer to back page Important disclaimer – please refer to back page
  • 3. D Global Markets Research 1. Investor considerations 1.1 Strengths SAHL • Profitability and small balance sheet exposure: As indicated by management, SAHL should SAHL should report an operating profit in F2005 and be cash flow positive by F2006. Through securitisation, report an SAHL’s exposure is limited to its contribution to each Thekwini’s reserve fund (a total of R77m); operating profit 2005 • Brand awareness: SAHL has built on its “switch and save” brand, which is now becoming well recognised. This strong brand would be difficult (and costly) to duplicate and forms a high barrier to entry; • Operating efficiency: SAHL is smaller than a traditional bank and, through its niche offering, is able to run a tight operation. It has taken up a banking activity, which requires comparatively little infrastructure required for the delivery and distribution of product; • Product diversification: SAHL launched several new complimentary products earlier this year – (Quickcash, Caps and Insurance) and will be launching a further suite of products (hybrid fixed / floating loan, credit card and white-labelling) within the next twelve months; and • Shareholders: Standard Bank, JP Morgan and the IFC are major shareholders and are represented on the board as well as on SAHL’s audit, credit and remuneration committees. Strong performance to The Thekwini pools date on • Credit track record: Since inception, SAHL has written off bad debts of R1.4m, including a one-off Thekwini pools exceptional loan of R950,000. Excluding this one large write-off, SAHL’s bad debt write-offs total R469 000 – less than 0.003% of its current book of R13.8bn (registered). Write-offs within the Thekwinis total R6,800. In addition rehabilitation statistics indicate that SAHL is currently achieving a high success rate (95%) in its rehabilitation process. SAHL does not hold any properties in possession. • Regular audits: Standard Bank conducts monthly audits on registered loans (a random 10% is selected of which 4% is audited). Deloitte and Touche conducts due diligences on the securitisations and audits the financial statements on a bi-annual basis; • Well-seasoned and low PTI: The pool is well seasoned, due to the high proportion of loan switches (75% of loans are switches from other financial institutions) and carries a low Payment-to- Income (PTI) – the weighted average PTI ranges from 14.39% for the Thekwini 1 to 16.20% for the Thekwini 4; • Low LTVs: The weighted average Loans-to-Values (LTVs) for all the Thekwinis to date are less than 62% (based on historical values); and • Geographically diverse: The Thekwini pools are geographically diverse yet concentrated in high loan value areas such as Gauteng and the Western Cape. Noteholders • Trigger mechanisms: Several triggers have been implemented to protect noteholders. The most significant is the arrears trigger whereby, once 0.60% of the principal balance is three months or more in arrears, the trigger takes effect. i.e. cash is “trapped” in the respective Thekwini. The triggers have not been breached by any of the Thekwinis; • Ratings: Rating agencies Moody’s and Fitch rate the Thekwinis investment grade. All of the class A notes carry a rating; and Page 3
  • 4. D • No basis risk: Borrowers’ JIBAR-linked mortgages reset quarterly, on the same day as the notes, Global Markets Research thereby eliminating basis risk. 1.2 Challenges • Maintaining key staff: Succession planning led to a smooth transition between Stockley and Penwarden. However, due to SAHL being a relatively new originator and a smaller operation in A challenge to comparison to other banks, SAHL remains vulnerable to maintaining key staff. This is partially mitigated by a staff share incentive scheme, where options may be exercised only four years from maintain key the date of offer; staff • Dissipating price competitive advantage: When SAHL was launched to home owners in February 1999, the difference between JIBAR +2.1% (SAHL’s offer to borrowers) and Prime -1% (banks’ “normal offering” to middle-income earners) was 196 bps. A year later the average had fallen to 105 bps and by 2002, the figure declined to 59 bps. The differential average of this “advantage gap” moved to 83 bps in 2003 and the average for the year-to-date (end-September) is just 40 bps suggesting SAHL’s competitive price advantage over banks is narrowing. However, of SAHL’s 47,000 clients, only 451 clients (less than 1%) switched out of SAHL between July and September 2004. And, of the 451 clients, 145 switched for a better rate and 131 for a package offered by a competitor; • Operating under low risk macro considerations: SAHL has operated under a declining interest rate environment and increasing house price market. Standard Bank’s view is that activity in the residential property market is expected to remain buoyant, supported by persistent low interest rates and accelerating economic growth. Should the “property bubble” burst, SAHL could be exposed to potentially higher arrears. However, given SAHL’s tight credit criteria, its exposure is likely to be lower than banks’. • Similar company entering the market: SAHL has enjoyed “exclusivity” in the pure home loan market for some time. Another entrant into the market cannot be ruled out. Page 4
  • 5. D A SOUTH AFRICAN HOME LOANS Global Markets Research 5 2 COMPANY OVERVIEW 6 2.1 Timeline and rate changes 7 2.2 Management 8 2.3 Shareholders 9 3 STRATEGY 10 4 SERVICE AND PRICING 12 4.1 Pricing 12 4.2 Service 15 5 FINANCIAL INFORMATION 15 5.1 Historical 16 5.2 Interim results 16 5.3 Forecast 18 5.4 Income statement 20 5.5 Balance sheet 20 5.6 Cash flow 21 6 LOAN ADMINISTRATION, ADMINISTRATION AND COLLECTION 22 6.1 Origination process 25 6.2 Administration (collections) and loss control 26 Page 5
  • 6. D Global Markets Research 2. Company overview SAHL was established in July 1998 and six months later commenced originating mortgage loans. SAHL SAHL originates loans (as detailed in Section 6) for two distinct avenues – the Thekwini securitisation established in programme (approximately 70% of loans originated) and the Blue Banner programme, a Standard Bank 1998 and … funded vehicle (approximately 30% of loans originated). Under the Thekwini programme, loans are housed in a home loan warehouse, Main Street 65 (Pty) Ltd, prior to being securitised. Once the value of loans within the warehouse exceeds a set amount, the loans are transferred to Special Purpose Vehicles (SPVs) – the Thekwinis. The Blue Banner loans, meanwhile, are administered by SAHL but funded on Standard Bank’s balance sheet. SAHL registered its first floating rate loan in May 1999 and issued its first Residential Mortgage Backed Securitisation (RMBS), Thekwini 1, in November 2001. By June this year, it had successfully issued four such instruments and is investigating a fifth during the first six months of next year. (The Thekwini 4 … has captured securitisation process and related noteholder and investor considerations are detailed in Section 7). 4% of SA’s residential In almost six years, the company has captured 4% of SA’s residential mortgage market and now has approximately 58,000 customers (registered and approved) and assets under management (book) of property market R17.3bn. Figure 1 illustrates funds under management of registered loans (about 47,000 loans and a book of R13.8bn). This figure excludes loans that are in the pipeline. FIGURE 1: TOTAL ASSETS UNDER MANAGEMENT FIGURE 2: MARKET SHARE (AS AT END OCTOBER 2004) (AS AT END JULY 2004) 14,000 2% 4% 4% 11,200 32% Rand million 18% 8,400 5,600 2,800 15% 0 25% Apr-99 Aug-00 Dec-01 Apr-03 Aug-04 Absa Standard Bank Nedbank Assets under management Investec Other banks SAHL Source: SAHL Source: SAHL and SARB The initial attraction to potential borrowers, and one of SAHL’s key competitive advantages, is the offer of interest rates linked to JIBAR (2.10% over JIBAR), which equates to a lower interest rate than from traditional home loan lenders (typically Prime -1% for middle-income earners). SAHL’s high service levels have proved the differentiating factor in maintaining, and rapidly growing, its clients base during the recent squeeze between JIBAR and Prime. (Price and service are discussed in detail in Section 4). In addition, SAHL has broadened and complimented its existing offering through new products, such as Insurance, Quickcash and CAP loans. And, another suite of new products will be launched within the next twelve months (as detailed in Section 3). Page 6
  • 7. D Global Markets Research 2.1 Timeline and rate changes A timeline of key events reflecting corresponding month-end prime rates and SAHL’s offer rate is detailed below. TABLE 1: SAHL TIMELINE SAHL’s rate (JIBAR + Year Month Event Prime rate 2.10%) as at month end 1998 March Concept born by founders including Simon Stockley and Dave Barber July SAHL formalised Jul 24.00% Jul 22.41% August Aug 25.50% Aug 24.68% October Oct 24.50% Oct 21.72% November Nov 23.50% Nov 20.69% December Dec 23.00% Dec 20.36% 1999 January Jan 22.00% Jan 19.16% February SAHL launched to SA home owners Feb 21.00% Feb 18.04% March Mar 20.00% Mar 16.99% April Apr 19.00% Apr 16.23% June Jun 18.00% Jun15.56% July Jul 17.50% Jul 14.19% August Aug 16.50% Aug 14.15% September Sep 15.50% Sep 13.45% 2000 R1.2bn funding from Standard Corporate Merchant bank and JP Morgan January Jan 14.50% Jan 12.25% 2001 Competitors reduce margins to defend market share June Jun 13.75% Jun 11.98% July Jul 13.00% Jul 11.75% September Sep 13.00% Sep 11.12% November Thekwini 1 launched Nov 13.00% Nov 11.26% 2002 SAHL’s rates remain lower than banks’ prime rate January Jan 14.00% Jan 12.31% March Mar 15.00% Mar 13.13% June Jun 16.00% Jun 14.12% September Sep 17.00% Sep 14.91% November Thekwini 2 launched Nov 17.00% Nov 15.58% Co-founder Dave Barber departs, Kevin February 2003 Penwarden appointed COO Feb 17.00% Feb 15.54% June Jun 15.50% Jun 13.66% August Aug 14.50% Aug 12.61% September Sep 13.50% Sep 11.28% October Thekwini 3 launched Oct 12.00% Oct 10.12% December Dec 11.50% Dec 9.83% June Thekwini 4 launched; and Jun 11.50% Jun 10.21% 2004 Kevin Penwarden appointed MD August Aug 11.00% Aug 9.50% Co-founder Simon Stockley resigns, takes Sept 11.00% Sept 9.35% September on advisory role; Kevin Penwarden takes the helm as CEO October Oct 11.00% Oct 9.50% Page 7
  • 8. D Global Markets Research 2.2 Management The departure of Chief Executive Officer Simon Stockley was planned. This is evident by the Penwarden appointment of his successor Kevin Penwarden as Chief Operating Officer in February 2003 – and as takes the helm Managing Director in June this year. Penwarden has been responsible for the day-to-day running and all operational aspects of SAHL for some time now. Business continuity has been secured through Stockley’s undertaking to take on an advisory role to the board and management over the next twelve months – and he is restrained from creating another SAHL, or similar, in the SA market for the next three years. In a letter to investors, Stockley said: “As an existing or potential investor to the current and future Thekwini issues, there should be no concerns in respect of SA Home Loans’ ability to continue servicing and originating assets in line with the eligibility criteria and transaction documents.” The board consists of five directors – one executive director and four non-executive directors. Another executive director will be appointed shortly, probably internally sourced. The board meets eight times per year and has an independent chairman, Harish Mehta. TABLE 2: BOARD STRUCTURE Executive Appointed Resigned Employer KL Penwarden 14 Feb 2003 SJ Stockley 11 Mar 1998 31 Oct 2004 Non-executive H Mehta 1 Jan 2001 Universal Web Printing Ltd SA Melnick 1 Dec 1998 31 Mar 2003 Peregrine Investments Ltd JJ Coulter 15 Nov 2000 JP Morgan Chase Bank Ltd L Rapp 26 Aug 2002 Standard Bank of SA Ltd CR Tasker 14 Feb2003 Standard Bank of SA Ltd AH Hemphill (Alternate to JJ Coulter) 1 Jan 2001 7 Oct 2003 JP Morgan Chase Bank Ltd BA Smith (Alternate to JJ Coulter) 7 Oct 2003 JP Morgan Chase Bank Ltd Source: SAHL Financial Report 2004 (Adjusted for Stockley’s departure) Harish Mehta Chairman Mehta is the Group Managing Director of Universal Web Printing. His directorship profile extends across nine different organisations including Standard Bank of Southern Africa, Fasic Investment Corporation and Kimberley Clark of SA. He was recently appointed to the board of Spar South Africa. Management is divided into four key areas. A brief curriculum vitae of the head of each area follows: Management • Financial – Crispin Harrison; divided into four • Operational – Rob Poley; key areas • Sales – Terry Rayson; and • IT Systems and Credit – Guy Saville. Kevin Penwarden: B Compt. (Hons); CA (SA) Managing Director and Chief Executive Officer Penwarden, a top-ten chartered account student in SA and ex-senior manager of several financial institutions, joined SA Home Loans in 2003 as an executive director and Chief Operating Officer. Previously, he was Managing Director and senior country officer of the Chase Flemings Southern African operations (stockbroking, asset management and merchant banking). Prior to his appointment as CEO, he was responsible for the day-to-day running and all operational aspects of SA Home Loans. Page 8
  • 9. D Crispin Harrison: B.Com, B.Compt (Hons), ACMA, CA (SA), PGDipM Global Markets Research General Manager: Finance Harrison spent two years with Natwest Markets (London) followed by two years at Credit Suisse Financial Products (London) in charge of the Equity Derivatives Risk desk. In 1995, Harrison moved to NBS Bank, Management first in the Treasury division and then as Director of the Retail division in charge of Pricing and Product team reflects Development. He is a founding member of SAHL and currently heads up the Finance, Securitisation, experience in Quickcash and the Caps departments. the mortgage Robert Poley: AIB (SA), IMM industry General Manager: Operations Poley joined SAHL as Manager of Client Retention after a 20 year career with NBS, which encompassed various positions including Business Analyst/Project Manager in the IT division and ultimately Strategic Manager responsible for all new developments. Before leaving NBS, he managed the migration of the Mortgage Loan Book to FNB and BoE Private Bank. Poley joined SAHL in August 2002 and was appointed to executive management of SAHL in April this year and currently heads up Legal, Compliance, Securities, Client Services, Customer Courtesy Centre and Loss Control. Terry Rayson: BSc (Social Science, Political Studies) National Sales Manager Rayson worked in advertising for the Daily Telegraph (United Kingdom) before moving to SA in 1974 to join IBM’s sales division. He has held directorships with national and local property companies specialising in the commercial and industrial property environments. Rayson joined SAHL in July 1999 and set up the sales infrastructure. He currently heads a sales force of over 100, comprising nine branches and a head office call centre. Guy Saville: B.Com CA (SA) General Manager: Information Technology After qualifying as a CA, Saville worked in the UK, focusing on the development and implementation of newly emerging IT disciplines and became an International Financial Controller for a worldwide group. He returned to SA and joined NBS Bank, where he became General Manager: IT; led a business re- engineering programme; and became a member of the Mortgage Loans executive team. After the BoE/Nedbank merger, he was involved in setting-up a new mortgage origination company. He joined SAHL in March 2004 and is responsible for SAHL’s IT development and technical implementation. SAHL has 2.3 Shareholders ordinary share capital of SAHL has ordinary share capital of R306m. The only major change to the shareholding structure (Figure R306m 3) since SAHL’s inception occurred in 2003 when Peregrine Holdings sold its shareholding to the International Finance Corporation (IFC). Peregrine had supplied “seed” capital for the start-up of SAHL and no longer deemed its holding as core. None of the shareholders have approached management with the intention of divesting their shareholdings. FIGURE 3: SHAREHOLDING STRUCTURE (as at February 2004) 5% Major 7% shareholders 20% 42% include Standard Bank and JP Morgan 26% Standard Bank Group JP Morgan Ventures Corporation International Finance Corporation SAHL Incentive Trust Other minorities Source: SAHL Annual Financial Statements 2004 Page 9
  • 10. D Global Markets Research 3. Strategy SAHL’s strategy, and to a certain extent its competitive advantage, lies in its unique characteristics. These include: • SAHL is not a bank; • It specialises in home loans, funded through the securitisation process; • SAHL does not need to subsidise a range of financial products and operates on a low overhead structure without an extensive branch network; • Its lending rate is based on JIBAR (fixed at JIBAR +2.1%), which has been consistently lower than Prime; and • Home-owner insurance installments are charged in advance, alleviating compound interest charges; legal fees are discounted by 50%; SAHL pays no commission to estate agents; and charges a nominal once-off bond preparation fee instead of monthly administration fees. In investigating the group’s ability to successfully compliment its previously “mono-product” offering, we examined SAHL’s three new “products” (Caps, Quickcash and Insurance) which have been introduced over the last twelve months. • Caps: Earlier this year, SAHL introduced cap loans i.e. loans carrying a fixed cap rate set at JIBAR +2.1% plus 1%, 2% or 3%. This cap applies only if interest rates exceed the selected fixed cap rate. Borrowers are offered a two-year contract – with the potential to extend following expiry – and Caps, charged a premium of between R7,000 and R23,000 per R1m depending on the cap selected. This Quickcash and amount is capitalised to the bond and there is therefore no upfront cash outlay. Insurance TABLE 3: CAP RATE SUCCESSES TO DATE compliments Value of loans portfolio Phase Date introduced Rate offered Clients secured secured (Rm) Pilot phase Jan ’04 10.9% & 11.9% 168 4.4 Phase 2 May ’04 11.1% & 12.1% 1,431 315 Phase 3 Aug ’04 11.2%, 12.2% & 13.2% 790 180 Phase 4 Nov ’04 10.5%, 11.5% & 12.5% In process In process Source: SAHL • Quickcash: Borrowers seeking to access their home loan funds prior to property registration are No bad debts able to do so via SAHL’s Quickcash facility. Borrowers are charged an administration fee plus recorded on Prime +2% for the facility. SAHL has already lent R16m to clients with the funding provided by Quickcash SAHL. The average period of the loans equates to 36 days with the longest repayment currently on loans the books at six months. No bad debts have been recorded in this area and Quickcash should add some R3m – R5m p.a. to SAHL’s bottom line by 2007. TABLE 4: QUICKCASH YEAR TO DATE R Income YTD 1,300,663 Expenses YTD 660,005 Profit YTD 640,658 Loan book - count 289 Loan book value 13,946,716 Source: SAHL • Insurance: SAHL now offers insurance to new clients. Selling bond protection to cover pre- registered clients has the twin advantage of also securing SAHL’s risk (e.g. assists in eliminating complications surrounding deceased estate properties). SAHL collects the insurance payments on the policies (underwritten by Regent Life) and passes them directly to Regent Life, who in turn returns commission earned on securing these new policies to SAHL. This insurance offering should add some R7m p.a. to SAHL’s bottom line in commissions within five years (Table 5). Page 10
  • 11. D Global Markets Research TABLE 5: INSURANCE TO DATE Process Amount Clients contacted 10,531 Policies sold 3,075 Conversion rate 29% Total sum insured R720m Total premiums R7m p.a. Source: SAHL In the next twelve months, SAHL will launch another suite of products: Hybrid loan • Hybrid home loan: SAHL is looking to launch a hybrid fixed/floating rate home loan product next year. The loan will be structured so that a portion of the borrower’s loan is fixed, with the other launching in portion JIBAR-linked. The fixed portion is set at JIBAR +2.1% plus some pre-determined rate, 2005 similar to the CAP offering. • Credit card: SAHL also intends launching a credit card. When customers sign their SAHL loan registration documents, they will receive a credit card (carrying threshold limits commensurate with SAHL’s eligibility credit criteria matrix – detailed in Section 6, Table 13). This provides SAHL with a “bounty” sign-on fee from the appointed bank. • Corporate/Trade union alliances: SAHL has the ability to tailor-make products and create additional distribution channels for its products. It has already entered into agreements with certain SAHL has corporates/trade unions in offering home loans to staff. In one instance SAHL, through negotiations ability to tailor- with the human resources representatives of a particular trade union, agreed to pay the individuals’ make products union membership fees for two years in return for encouraging employees to switch, or take out new home loans with SAHL. • White-labelling opportunity: SAHL has entered into discussions to offer its home loan product under a certain company’s label i.e. similar process to no-name branding in retailers. SAHL originates and services the book and assists in the marketing (on the said company’s stationary). Longer-term, and perhaps more risky, new products could include: • Service support: SAHL has the infrastructure to offer their back office as service support to other home lender operators; • Securitisation: SAHL is considering assisting other financial organisations in securitisation; not as arrangers, but as third party administrators and providing assistance with waterfall payments etc; and • Commercial property loans: SAHL is currently investigating the viability of securitising commercial property loans. Page 11
  • 12. D Global Markets Research 4. Service and pricing Since the inception of the securitisation program, SAHL has operated under favourable market conditions – house prices have been rising sharply in the face of increased demand on the back of softening interest SAHL offers rate levels. This improves consumers’ debt positions. But what if competition intensifies, or banks enter a borrowers price war? What impact will this have on SAHL’s competitiveness and service offering? JIBAR+2.10% SAHL management believes it offers both a price and service proposition to survive under such market conditions. We discuss both in detail. 4.1 Pricing SAHL’s competitive price advantage lies in its ability to offer middle-income earners competitive mortgage rates at JIBAR +2.10%. These earners are often able to secure bank loans at Prime -1% (Figure 4). We refer to the difference between the two as SAHL’s advantage gap. FIGURE 4: JIBAR AND PRIME 26.0 22.0 18.0 % 14.0 10.0 6.0 Jul-98 Oct-99 Jan-01 Apr-02 Jul-03 Sep-04 Difference JIBAR JIBAR+2.1 Prime - month end between Prime -1% and JIBAR Source: Bloomberg +2.1% has When SAHL was launched to SA homeowners in February 1999, the difference between JIBAR +2.1% narrowed and Prime -1% (the advantage gap) was 196 bps. A year later the average had fallen to 105 bps and by 2002, the figure declined to 59 bps. Though the differential average moved to 83 bps in 2003, the average for the year-to-date (end-September) is just 40 bps. (Figure 5) FIGURE 5: JIBAR +2.10% less PRIME -1% - THE ADVANTAGE GAP 2.8 2.1 1.4 % 0.7 0.0 (0.7) Jul-98 Oct-99 Jan-01 Apr-02 Jul-03 Sep-04 Difference between Prime -1 and JIBAR + 2.1% Source: Bloomberg Page 12
  • 13. D There was an extended narrowing gap between JIBAR (the rate that banks pay for funding) and Prime Global Markets Research (the rate that banks charge borrowers) from approximately August 2003 to June 2004. (Figure 6.) This narrowing is concerning as this has been one of the key selling points to borrowers. Management contends that banks can’t “break” their lending links from Prime rates and therefore they may have to Unlike SAHL, reduce their average level of discounting to Prime. i.e. by offering new loans closer to Prime rather than banks are Prime -1% or Prime -2%. “unable” to re- FIGURE 6: PRIME less JIBAR price 6.0 5.0 % 4.0 3.0 2.0 Jul-98 Oct-99 Jan-01 Apr-02 Jul-03 Sep-04 Prime - JIBAR Source: Bloomberg We have examined these arguments – that of a deviating JIBAR trend, and banks inability to re-price. Details of clients who have switched from SAHL to other banks in the last three months were also studied. These arguments and mitigations are listed below. JIBAR has deviated from 4.1.1 Mitigation 1 – Trend analysis its long-term SAHL management contends that: “It is unlikely that JIBAR's 20-year trend has fundamentally changed. trend Perhaps there is a little more uncertainty surrounding rates, which is translating into JIBAR deviating briefly from its long-term trend.” We calculated JIBAR’s long-term trend (plotted in red in Figure 7), and established that JIBAR has indeed deviated from its long-term trend from approximately August 2003 to June 2004. Since then, it has moved closer to its trendline, which corresponds to the recent widening between Prime and JIBAR (Figure 6). It also supports the trending in the advantage gap back to 70 bps. FIGURE 7: JIBAR TREND LINE ANALYSIS 16 14 12 % 10 8 6 Jan-99 Feb-00 Mar-01 May-02 Jun-03 Aug-04 Jibar Jibar trend Source: Bloomberg and Standard Bank Group Page 13
  • 14. D 4.1.2 Mitigation 2 – Ability to re-price Global Markets Research Even if the compression between Prime and JIBAR, as described above, had continued, we believe that SAHL has the SAHL has the ability to successfully re-price its offering to borrowers. When SAHL’s business began, the ability to reprice cost to business equated to 85 – 90 bps and servicing the book, an additional 40 bps. Both of these costs reduced once SAHL reached critical mass earlier this year (the point at which SAHL would be profitable should it cease to originate loans – and hence cease funding originating costs). In addition, SAHL has small, yet growing, income from new products in the form of: • Quickcash (refer to Section 3 - Strategy); • Caps (refer to Section 3 - Strategy); and • Commission on insurance (refer to Section 3 - Strategy) SAHL does not really need to use this ability to re-price right now. A study of new business secured during this “narrowing advantage gap” period shows that SAHL is writing new business (in value terms) some 115% ahead of the same period last year. And, hence, SAHL business proposition includes more than just price, i.e. service. (Section 4.2) 451 clients have 4.1.3 Mitigation 3 – Switch analysis switched out of We acknowledge that SAHL’s competitive price advantage was temporarily squeezed for a while, and the SAHL between company did not elect to re-price. We have, therefore, examined how many clients have switched OUT of July and SAHL into another institution given the narrowing gap between JIBAR +2.10% and Prime -1%. Of SAHL’s September 2004 47,000 clients, only 451 clients (less than 1%) switched between July and September 2004. (Figure 8.) Of the 451 clients, 145 switched for a better rate and 131 for a package offered by a competitor (Figure 9). These figures are still rather small in percentages terms when considering SAHL’s total loan pool. We believe that banks could probably pro-actively target clients they believe could be lost to SAHL (i.e. undertake a mini-price war) for a while, and SAHL could shave some bps off its offering, but the benefit would only (temporarily) lie with the borrower. FIGURE 8: BANKS SWITCHED TO (July to September) FIGURE 9: REASONS FOR SWITCH 19 451 58 155 45 42 1 43 28 14 145 1 89 89 131 1 18 8 3 Building loan (SAHL Unable to accommodate) 2 100% Bond (SAHL unable to accommodate) Absa Nedbank SA Bond Restructions on self-employed Sanlam FNB Investec Unhappy with service RMB OMB Standard Bank Further advance declines Package offered by competitor Perm Trans Randbond Better rate offered Unknown Other Unable to trace Source: SAHL Source: SAHL Page 14
  • 15. D Global Markets Research 4.2 Service SAHL “prides itself on offering its clients a superior service level and believes that exceptional service is “Superior certainly a differentiating factor that encourages new clients to switch, resulting in SAHL being able to services” retain its clients.” assists in retaining clients To ensure SAHL maintains its high level of service, it undertakes the following: • Character profiling for new staff to ensure they meet strict criteria; • Ongoing in-house training; • Continuous reinforcement of client-centric attitudes; • Promote professional, yet individual communication with clients; • Recognise and incentivise the client services team to ensure a pleasant and fun working environment; • Unique IT system that reinforces first call resolution and call ownership; and • IT systems that record a client’s query history, allowing any agent to resolve further queries. By following its motto of “ecstatic client services”, SAHL maintains that by “nurturing its staff” and recognising that they are highly valued assets to their organisation, it ensures that they “thoroughly enjoy their job”, and “portray this passion” across to its client base. SAHL won the SAHL operates a customer courtesy centre, whose function includes confirming details of loans with 2004 Daily News clients after the granting stage. This assists in: Readers’ choice award for the • Identifying errors/concerns early in the process; best mortgage • Improves the quality of attorney instructions; and lender • Reduces non-take up (NTU) levels. SAHL won the 2004 Daily News Readers’ Choice award for the best mortgage lender. The Reader’s Choice is an annual competition where consumers vote for the business they perceive to be best in their field. The competition was divided into four categories with various sub-divisions. SAHL claimed first prize in its class. Page 15
  • 16. D Global Markets Research 5. Financial information We have split the financial analysis into three sections, historic, interim results to end August 2004, and forecasts. Detailed financial statements appear at the end of this section. Since inception, 5.1 Historical SAHL recorded SAHL has reported operating losses on its income statement since inception. This reflects the nature, and losses rapid growth, of the business – SAHL pays for origination costs up front and receives annuity income over the life of the loan. A snapshot of historic income to expenses highlights this phenomenon. To obtain a fairer reflection of income versus expenses, we have not included interest received or interest paid in Figure 10. We have also stripped out profit on sale of fixed assets, impairment costs and gains on the revaluation of financial assets. Against this background, the expenses to income ratio has improved from 4.6 times in F2003 to 1.3 times in F2004. We have also plotted the number of loans registered. This gives an indication of the expense-led nature of the business. FIGURE 10: INCOME VS EXPENSES 160 20,000 Loans registered p.a. '000 120 16,000 Rand million 80 12,000 40 8,000 0 4,000 (40) 0 2002 2003 2004 Expenses Income Number of loans registered Pre-tax loss Source: SAHL Financial Statements 2003, 2004; Standard Bank Group Income exceeds 5.2 Latest interims expenses at Latest interim results for the six months end-August 2004 indicate that SAHL is indeed on track to break August interims even in F2005. A condensed interim income statement reveals that, for the first time, income exceeds expenses. (Table 6) TABLE 6: INCOME STATEMENT FOR THE SIX MONTHS ENDED 31 AUGUST 2004 Six months end 31 August 2004 R’000 Income 78,338 Expenses 69,137 Origination 45,996 Support services 6,306 Servicing 6,476 Administration and fixed costs 5,641 Securitisation costs 4,718 Net Interest received 1,428 Net profit before provisions 10,629 Source: SAHL Page 16
  • 17. D Two further areas within the income statement warrant comment: origination costs and securitisation Global Markets Research Origination and costs. It is these two items that relate to “new growth” costs, and to a certain degree determine capital requirements. securitisation represent new In the six months to August 2004, SAHL approved R6bn worth of loans at a cost of R46m. A brief study of growth costs the origination cost per loan in prior years is detailed in Figure 11. FIGURE 11: ORIGINATION COST TO LOAN INDEX 120.0 Index March 2001 = 100 100.0 80.0 60.0 40.0 20.0 Mar-01 Nov-01 Jul-02 Mar-03 Nov-03 Jul-04 Origination costs to loan index Source: SAHL In contrast, overall securitisation costs as a percentage of expenses is marginally increasing. In 2004, this ratio dipped because of a disproportionate rise in group expenses versus securitisation expenses. This Securitisation was largely due to a sharp increase in loans approved during the year – without a proportionate rise in costs as a securitisation expenses. Management has indicated that the percentage should plateau at 5% – 6% from percentage of 2006 onwards. total expenses to average We have also touched on the main items in a condensed balance sheet (Table 7) and discussed its constituents. 5% –6% TABLE 7: BALANCE SHEET FOR THE SIX MONTHS ENDED 31 AUGUST 2004 Six months end 31 August R’000 Capital Employed 168,741 Total share capital 137,460 Long-term liabilities 31,281 Employment of capital 168,741 Fixed assets 3,598 Investments and loans 104,424 Deferred tax 38,480 Current assets 87,617 Current liabilities (65,379) Source: SAHL Page 17
  • 18. D Global Markets Research 5.2.1 Notes to the balance sheet • Long-term liabilities − About R17m relates to the loan facility as described under interest expenses below; and − The remainder relates to Quickcash funding. • Investments and loans − Almost R77m relates to start-up loans – loans made to the Thekwinis as subordinated debt; and SAHL amortizes − Loans to the share incentive trust of R27m. the securitisation • Current assets: costs over the − Deposits of approximately R20m; life of the − Deferred securitisation costs of R26m (SAHL amortizes the securitisation costs over the life Thekwini of each transaction); − Quickcash short-term loans of R14m; and − The remainder (R28m) relates to fees due from the SPVs. • Current liabilities: − A bad debt provision of R10m; − A creditors balance of R28m of which R13.4m relates to securitisation fees and costs; and − Shareholder funding of R28m. 5.3 Forecast In the historic and interim results sections, we detailed a broad outline of typical income and expenses SAHL will and the sources of funding thereof. Against this background, we have calculated (through discussions with report operating management) that SAHL will turn profitable in F2005 (probably to the order of R20m) and the company profit in F2005 should become cash flow positive a year later. We have plotted forecast pre-tax profit, expenses and income for 2005, 2006 and 2007 in Figure 12. (SAHL will probably begin paying tax in 2006; however, we have elected to focus purely on the pre-tax line.) Where income is typically sourced from: • The Thekwini securitisations – a servicing fee (1.3%); • Blue Banner – an origination fee (1.2%) and a management fee (0.26%); • Main Street 65 – a management fee (1.2%); • Quickcash – interest from Quickcash product (R1,000 plus Prime +2%); • The Cap product; and • Insurance commission. While expenses include: • Origination costs; • Servicing costs; • Securitisation costs; and • Head office costs, other provisions and sundry costs. And interest (which is included in pre-tax profit) takes two forms: • Interest income − Interest on cash on hand; − Interest on Main Street 65. Collateral of 1% of every loan within Main Street is deposited into a bank account. SAHL earns interest on this amount; and Page 18
  • 19. D − Interest on SPV reserve funds to SAHL. SAHL funds the reserve funds within each Global Markets Research Thekwini. Each Thekwini, in turn, pays SAHL interest for this funding loan. • Interest expenses − Interest on cash overdraft; − Interest on long-term loan. SAHL received funding from Peregrine. When Peregrine divested, SAHL expunged its loan to Peregrine. SAHL raised “replacement” finance. The amount equates to about R17m and is used as working capital; and − Interest on Quickcash loan facility. FIGURE 12: FORECAST PRE-TAX PROFIT, INCOME AND EXPENSES 600.0 400.0 200.0 Rm 0.0 (200.0) (400.0) 2005 2006 2007 2008 Origination costs Securitisation costs Servicing costs Other costs Thekw ini securitisations Blue Banner Main Street Quickcash Insurance Other income Pre-tax profit Source: SAHL The largest increase in pre-tax profit should be recorded in F2006 – a leap from about R20m to R105m. The bulk of this sharp increase flows from an almost doubling of SPV fees, as annuity fees from all the Thekwinis filter through for a full financial year. Management fee contributions from Blue Banner and Main Street should increase in line with volume growth. Value of These forecasts are based on the following assumptions: approved home loans slowing • Value of approved home loans slowing: TABLE 8: HOME LOAN APPROVAL FORECASTS 2005 2006 2007 2008 Approvals (Rbn) 10.8 12.9 14.8 16.8 % change +19.4 +14.7 +13.5 Budgeting for at Source: SAHL least another Approximately 70% of the book is securitised and the remaining percent recorded under Blue Thekwini issue Banner. i.e. SAHL earns a 1.3% servicing fee on the securitised book and a 1.2% origination fee in 2005 plus 0.26% management fee on the Blue Banner loans. Blue Banner loans are administered by SAHL but funded on Standard Bank’s balance sheet; • Amortizing securitisations over the life of the existing Thekwini; Budgeting for at least one new Thekwini issue per year; • Securitisation costs average 7.5% of total costs (Figure 12); and • Other costs and income receipts rise in proportion to the home loan approvals. Page 19
  • 20. D Global Markets Research 5.4 Income statement TABLE 9: INCOME STATEMENT YEAR TO FEBRUARY R 2004 2003 2002 Interest income 10,532,895 7,636,802 3,066,846 Interest expense 3,722,121 2,805,192 3,192,140 Net interest income 6,810,774 4,831,610 (125,294) Other income 88,986,167 25,381,122 11,669,087 Fees received 82,539,255 22,025,455 10,438,453 Commission income 6,444,717 3,355,667 1,202,430 Profit on sale of fixed assets 2,195 0 23,787 Dividend income 0 0 4,417 Income from operations 95,796,941 30,212,732 11,543,793 Expenses 123,809,196 64,380,172 55,427,475 Impairment of financial assets 6,175,317 1,758,719 2,069,821 Operating expenses 117,633,879 62,621,453 53,357,654 Net profit/(loss) before taxation (28,012,255) (34,167,440) (43,883,682) Taxation 38,480,235 0 0 Net profit/(loss) after taxation 10,467,980 (34,167,440) (43,883,682) Attributable income 10,467,980 (34,167,440) (43,883,682) Source: SAHL Annual Financial Statements * Includes gain/loss on revaluation of financial assets 5.5 Balance sheet TABLE 10: BALANCE SHEET YEAR TO FEBRUARY R 2004 2003 2002 Current assets 70,659,601 23,756,939 18,816,275 Cash & near cash 21,340,957 13,951,741 11,643,803 Accounts receivables 45,170,312 9,805,198 7,172,472 Loans to customers 4,148,332 0 0 Non-current assets 109,692,057 43,850,921 31,600,455 Deferred taxation 38,480,235 0 0 Financial asset 540,427 0 0 Investments 56,212,486 34,971,611 25,610,920 Deferred expenses 12,132,519 7,484,829 4,897,778 Property, plant and equipment 2,326,390 1,394,481 1,091,757 TOTAL ASSETS 180,351,658 67,607,860 50,416,730 Current liabilities 32,038,899 22,697,529 4,337,585 Financial Liability 5,638,432 0 0 Bank overdraft 0 0 0 Accounts payables 22,296,923 22,697,529 4,337,585 Quick cash funding 4,103,544 0 0 Long-term liabilities 17,865,052 0 18,505,606 Long-term borrowing 17,324,625 0 18,505,606 Derivative financial liability 540,427 0 0 TOTAL LIABILITIES 49,903,951 22,697,529 22,843,191 Shareholders' equity 130,447,707 44,910,331 27,573,539 Share capital 305,556 233,896 169,516 Share premium 235,127,243 161,170,369 109,730,517 Accumulated deficit (104,985,092) (116,493,934) (82,326,494) TOTAL LIAB. & SHAREHOLDERS' EQ. 180,351,658 67,607,860 50,416,730 Source: SAHL Annual Financial Statements Page 20
  • 21. D Global Markets Research 5.6 Cash flow TABLE 11: CASH FLOW STATEMENT YEAR TO FEBRUARY R 2004 2003 2002 OPERATING PERSPECTIVE Net cash utilised by operating activities (17,898,964) (33,799,368) (36,244,520) Includes: Net loss before tax (28,012,255) (34,167,440) (43,883,682) Interest received (10,532,895) (7,636,802) (3,066,846) Interest paid 3,722,121 2,805,192 3,192,140 Depreciation 985,873 682,198 632,404 Impairment provision 2,898,613 1,758,719 2,069,821 Amortization of deferred expenses 4,948,002 2,971,018 814,279 Payment of deferred expenses (11,000,000) (7,128,517) 0 Bad debts 3,244 0 0 Difference in accrued interest 134 (66,129) 0 Fair value adjustment of financial liability 3,290,759 0 0 Impairment of loans to customers 41,566 0 0 (Profit)/loss on disposal 2,195 0 (23,787) Write-off of start-up loan 1,318,165 0 0 Markdown of Peregrine Investment (14,055) 13,802 0 Operating cash flow before working capital change (25,537,759) (35,936,349) (40,390,965) Working capital change 7,643,185 2,136,981 4,146,445 Increase in debtors (7,116,894) (1,062,278) 2,788,804 Increase in creditors 14,760,079 3,199,259 1,357,641 INVESTMENT PERSPECTIVE Cash flow from investing activities (55,007,838) (12,052,005) (791,510) Includes: Investment in start-up loan (22,058,441) (11,067,083) 0 Increase in loan to incentive trust (26,843,912) 0 0 Increase in loan to customers (4,189,898) 0 0 Purchase of fixed assets (1,924,358) (984,922) (843,355) Proceeds on disposal of fixed assets 8,771 0 51,845 FINANCE PERSPECTIVE Cash flow from financing activities 80,296,018 48,159,311 59,233,249 Includes: Issue of share capital 71,660 64,380 92,781 Quick cash funding 4,103,544 0 0 Increase in share premium 73,956,874 51,439,852 67,322,365 Long-term liability raised/(settled) 17,324,625 (18,505,606) (8,181,897) Short-term loans (settled) raised (15,160,685) 15,160,685 0 INCREASE IN CASH 7,389,216 2,307,938 22,197,219 Cash at beginning of year 13,951,741 11,643,803 (10,553,416) CASH AT YEAR END 21,340,957 13,951,741 11,643,803 Source: SAHL Annual Financial Statements Page 21
  • 22. D Global Markets Research 6. Loan origination, administration and collection Although investors in SAHL’s securitisations have no recourse to the company, note performance is firmly related to home loan pool performance, in particular loan origination, administration and recovery processes. SAHL has originated more than 22,000 loans this year. (Table 12.) TABLE 12: HISTORY OF MORTGAGE ORIGINATION As at year-end Feb Number of loans Amount Mortgage portfolio 1999 First loan registered in May 1999 2000 1,327 R305,886,021 R295,345,393 2001 2,069 R435,929,027 R663,926,809 2002 4,881 R1,063,879,735 R1,579,925,754 2003 8,769 R2,105,858,903 R3,392,004,600 2004 18,248 R4,793,480,706 R7,629,704,730 2005* 22,850 R8,167,978,819 R13,935,332,163 * Year-to-date (As at October 2004) This business flow stems from three main sources: • National sales centres (Branch silos): (originates 74% of loans) Given the marked increase in Sales team of volumes, the sales force (Figure 13) has expanded ten-fold from nine individuals in 1999 to 90 this 90 people year. During 2004, structural changes within the sales force were implemented, including incorporating a level of branch managers between the national sales manager and each region. The sales team has also been trained – and incentivised – on SAHL’s new product offering. Each consultant has their own target with incentives loaded at the top-end of the targets. Approximately 70% of the national sales centres’ sales originate from switching. i.e. clients switching from other financial institutions to SAHL. FIGURE 13: SAHL’S SALES ORGANOGRAM 18 consultants National Sales Manager man the call centre Telecentre Gauteng Western Cape KZN Port Elizabeth East London Bloemfontein 18 consultants 19 Consultants 16 Consultants 6 Consultants 3 Consultants 4 Consultants Johannesburg Southern Cape Pietermaritzburg 21 Consultants 2 Consultants 1 Consultant Pretoria South Coast 20 Consultants 2 Consultants Source: SAHL • Call centre (telecentre): (originates 25% of loans) Eighteen consultants man the Durban-based telecentre and sales originate largely from in-bound advertising. i.e. clients would be responding to print, radio, and more recently, television advertising. SAHL has recently shifted its advertising spend to television and other high-cost to lead media. Page 22
  • 23. D • Internet: (originates 1% of loans) Internet applications represent only a small portion of loan Global Markets Research applications. The contribution to sales volumes by region almost mirrors the dispersal of sales individuals (Figure 14). Contribution to sales mirrors FIGURE 14: 2004 CONTRIBUTION TO SALES VOLUMES BY REGION (%) sales team locations 20% 26% 3% 16% 4% 15% 16% Johannesburg Pretoria Cape Tow n Durban Port Elizabeth East London/Bloem Telecentre Strict eligibility criteria Source: SAHL Each loan is required to meet SAHL’s eligibility criteria before entering the loan origination process as set out in Table 13. This process is undertaken by the credit department. TABLE 13: SAHL’S LOAN ELIGIBILITY CRITERIA Criteria Margin-related Loan to Value (LTV) On LTV <80% 2.10% above JIBAR (where JIBAR is converted to a monthly rate and rounded up to the nearest 0.1%) On LTV 80% - 90% 2.75% above JIBAR (currently housed in Blue Banner) On LTV 90% - 95% 3.10% above JIBAR (currently housed in Blue Banner) On LTV 95% - 100% 3.75% above JIBAR (housed in Blue Banner) Applicant Age 21 years to 65 years Type Individual, company, close corporation or trust Payment-to-Income (PTI) Less than 30% Loan Maximum amount R2,500,000 Minimum amount R100,000 (R75,000 if granted in terms of approved employee benefit scheme) Maximum term 20 years Additional feature No prepayment or redraw penalties Additional feature Ability to redraw prepaid capital Property Location South African home and mostly owner-occupied Homeowners’ insurance Homeowners insurance required to be taken out and maintained Security Guarantee, indemnity and indemnity bond Source: SAHL Page 23
  • 24. D The credit function at SAHL extends to independent audits in a number of areas: Global Markets Research • Standard Bank undertakes monthly independent sample audits – detailed checks on underwriting and security documentation; • Deloitte and Touche conducts an external audit on SAHL’s financial results as well as a due diligence process on the securitisation transactions ensuring that with a 99% confidence level errors are not greater than 3%; and • Each securitisation is assigned an independent rating by Moody’s and Fitch. Fitch and Moody’s subsequently provide quarterly performance reviews. Page 24
  • 25. D Global Markets Research 6.1 Origination processes Once a loan has been originated through the sales process, it enters an origination process. This origination process is best explained through a flow diagram. FIGURE 15: BRANCH SILO LOAN ORIGINATION Lighthouse 4 Valuation 1 Branch 2 WinDeeds 3 ITC Request Credit Deeds check Loan and New application enquiry client details Val details details SPV Deeds details search Require 1 Receipt of 2 Process credit credit 3 Capture 4 Pre-credit/check capture/ loan application check and deeds check correct client confirm income and request from branch search If clear and loan details valuation Branch silo Branch silo Branch silo Branch silo If not clear 5 Receipt of valuation, package 6 Fwd to credit loan for credit ensure loan in Offer dept for credit terms of credit criteria with 7 Return to decision Approved required conditions originating Credit dept Notify channel Branch silo Declined Branch silo 8 Change to 5 Branch original loan consultant details Branch silo 9 Letter of acceptance 10 Take on (LOA) obtained Credit dept from client Branch silo Source: SAHL 1. The branch silo receives a fully completed bond application for processing. ITC credit 2. Credit checks and deed searches are performed if information received is negative (i.e. judgements, insolvency etc, which falls outside the credit policy). The information is forwarded to the branch and checks the application is placed on hold until the matter is resolved. If the matter is not cleared, the undertaken application is withdrawn by the branch. 3. If credit checks and deed searches are clear, then all client and loan information/details are captured on Lighthouse (SAHL’s home loan IT system). A prospect number is subsequently generated. 4. All information captured is checked for correctness and income is confirmed telephonically. A valuation is now requested via Lighthouse. A schedule is forwarded by email three times daily to valuers on SAHL’s panel instructing them to perform a physical property valuation. Lighthouse monitors the valuer daily. 5. On receipt of the valuation from the valuer, the system is updated and packaged for the credit department ensuring that the loan falls within the eligibility criteria (as detailed in Table 13) and has met all the required conditions. 6. Once all the criteria have been met, the prospect is forwarded to the credit department for a decision. If a change to the original application (Stage 8) takes place (due to a valuation not being met or an Strict eligibility incorrect salary), the branch will be advised, which in turn will advise the client and confirm client criteria approval. 7. The credit department receives the prospect and performs the necessary checks. Once a decision has been taken (approved, declined, offer) the prospect is returned to the originating channel/silo, which in turn advises the branch/consultant of the outcome, who in turn will notify the client. 9. Upon acknowledgement by the branch of approvals and offers, the system generates a Letter of Acceptance (LOA) at the branches. The consultant obtains the clients signature on the LOA. 10. The silo forwards the file, together with the signed LOA to the credit department for take-on and the system forwards the prospect to the legal queue for onward transmission to attorneys. Page 25
  • 26. D The telesales and internet origination flow diagrams differs in one main area – the client and loan details Global Markets Research are captured correctly immediately and a prospect number is immediately generated by the system. Origination serves a further important role: that of valuations. Valuers are all independent of SAHL and are required to • Be members of the South African Institute of Valuers; • Hold R5m in indemnity insurance; and Valuers are all • Have their performance checked by audit processes. independent of SAHL 6.2 Administration (collections) and loss control The collection process, as detailed in Figure 16, is equally important to the origination process. Of the 288 cases where legal proceedings commenced, it reached sales in execution on 50 properties and has made eight losses totalling R1.4m since inception. FIGURE 16: COLLECTIONS PROCESS 1. Client Services 2. Collections 3. Arrears 4. Legal 5. PIPs/ process returned <1 and 1 month > 1 month to foreclosure to Insolvency and debit orders cases foreclosure sale deceased estates Source: SAHL 6.2.1 Description of process 1. 10 day grace period before arrears case. 2. Courtesy calls – confirm contact details and forward first notice. Arrears reports in order of highest to lowest potential loss. Escalate clients who wish to enter into an arrangement. Establish reason for non payment. Try and identify borrowers who can afford payment/borrowers who cannot afford. Escalate to arrears department for foreclosure. 3. Client contact firm. Arrears reports in order of highest to lowest potential loss. Arrangement considered where client has sufficient equity in property. Consent to judgement a condition to arrangement. Arrangements/foreclosure approved with mandates. Foreclosure – high court. Eviction order and attachment of movables simultaneously. Foreclosure against surety. 4. Minimum bids approved in terms of mandate. 5. Loss write-offs approved in terms of mandate. Responsible for marketing and selling properties. SAHL management attributes a rehabilitation percentage according to each of the aforementioned five stages in its collection process: • 1 month in arrears – better than 80% chance of rehabilitation; Rehabilitation is • 2 months in arrears – better than 55% chance of rehabilitation; offered to • 3 months in arrears – better than 35% chance of rehabilitation; and defaulters • >3 months in arrears – better than 20% chance of rehabilitation. Page 26
  • 27. D Once a client is in arrears with payment, SAHL offers various arrears arrangement options to those Global Markets Research prepared to reach an agreement – or be “rehabilitated”. These include: • Reschedule arrears over the remaining term; • Waive arrears and pay a reduced instalment (maximum six months); • Waive arrears and pay a higher instalment ; • Waive arrears and pay no instalment (maximum six months); • Pay instalment for agreed period and waive on completion; and • Waive instalments for an agreed period. The customer’s overall payment profile is re-examined to establish their monthly home installment affordability. An ITC check would reveal the level of debt elsewhere (credit cards and store cards) and SAHL’s PTI of 30% may no longer apply – against this background, a PTI of 25% may not even be acceptable. A snapshot of rehabilitations over a six-month period ending September 2004 presents a fair reflection of typical rehabilitation statistics according to management. These rehabilitation statistics therefore indicate that SAHL is currently achieving a high success rate (95%) in its rehabilitation process. TABLE 14: REHABILITATION STATISTICS APRIL 2004 – SEPTEMBER 2004 Apr May Jun Jul Aug Sep Total Blue Banner 9 9 4 9 20 32 83 Main Street 65 4 1 1 3 5 14 28 Thekwini 1 2 2 0 2 10 4 20 Thekwini 2 12 12 6 8 8 4 50 Thekwini 3 2 8 3 4 2 11 30 Thekwini 4 3 4 18 9 5 0 39 TOTAL 32 36 32 35 50 65 250 Source: SAHL Rehabilitations are increasing in line with the growing book. An additional 20 loans were “rehabilitated” during this six month period, but have since not fulfilled their SAHL has no agreements. These loans will now move to the legal/foreclosure stage. properties in In the year to date, SAHL has experienced 40 sales in execution, 30 of which “stayed” as the client made possession payments, three third-party sales proceeded, six sales proceeded and SAHL obtained in excess of reserve. SAHL currently has no properties in possession (PIP). TABLE 15: BAD DEBT WRITE-OFFS Instrument Amount (Rands) Thekwini 1 4,079 Thekwini 2 2,800 Thekwini 3 0 Thekwini 4 0 Main Street 65 1,213,647 Blue Banner 270,615 TOTAL 1,419,142 Source: SAHL Since inception, SAHL has recorded R1.4m of bad-debt written off. The largest amount is found in Main Street 65 where a loan of approximately R950,000 was written-off on a single property. Excluding this one Bad debts large write-off, SAHL’s bad debt write-offs total R469,000 – less than 0.003% of its current book of written off about R17.3bn (approved and registered). R1.4m Page 27
  • 29. D Global Markets Research 7. The securitisation process SAHL was established in July 1998 and six months later commenced originating mortgage loans with the explicit intention of using securitisation as a method of funding the loans. This approach allows institutional investors and fund managers to purchase the rights to the income streams from a pool of underlying mortgages. SAHL has issued four Residential Mortgage Backed Security (RMBS) structures (Thekwini 1 to 4) over the last three years, with a collective volume of R6.8bn. The creditworthiness of each RMBS is fully evaluated by rating agencies and, therefore, for the purposes of this report, we have limited the discussion on the securitisation process. SAHL originates loans and SAHL originates loans (as detailed in Section 6) and houses them in a home loan warehouse, Main Street houses them in 65 (Pty) Ltd, which is funded through a warehousing short-term loan. Once the value of loans within the warehouse exceeds a set amount, the loans are transferred to a Special Purpose Vehicle (SPV), a home loan Thekwini. The Thekwini SPV then issues senior and junior notes to investors. warehouse The funds received by the Thekwini SPV are subsequently used to repay the warehousing short-term loan. Noteholders receive a quarterly coupon and distribution of principal. Borrowers’ JIBAR-linked mortgages are reset quarterly, on the same day as the notes, thereby eliminating basis risk. All four current Thekwini SPVs offer a step up and call feature. This gives the Thekwini SPV the right to call the RMBS at a certain point in time. In the case of all the Thekwinis, the RMBS is callable after five years. (The Thekwini 1’s callable date is November 2005). The RMBS are structured to give the SPV an incentive to call the securities by stepping up the coupon on the RMBS at the same time. Given the call structure, investors view the Thekwini securities as having an effective maturity of five years. In addition, Thekwini 2 has a two-year substitution period, while Thekwini 3 and Thekwini 4 have implemented two-and-a-half year substitution periods. In other words, they may add new loans to their pools or substitute existing ones during that time. This helps reduce the average cost of funding and the bonds are more investor-friendly. The “bullet payment” alleviates prepayment issues and allows for better predictability of cash flows for fund managers. We have detailed the process for Thekwini 4, SAHL’s most recent securitisation in Figure 17 and the SAHL funds a priority of payments waterfall in Table 16, but limit our discussion to three areas of interest – the reserve account guarantee trust, reserve fund and hedge provider: • Reserve fund: Upon issuance of the notes (issue date) SAHL funds a reserve account equating to a pre-determined percentage (0.6% for Thekwini 4) of the initial notes outstanding. This percentage is subsequently increased, through excess spread, to a higher set percentage (1.1% in the case of Thekwini 4) of the initial notes outstanding. In the event of a shortfall in available funds to meet senior expenses, amounts in the reserve fund are utilised. (After three years, the reserve fund may be reduced to 0.6%.) SAHL injected R26.25m into Thekwini 1, R16.23m into Thekwini 2, R22.00m in Thekwini 3 and R15.00m into Thekwini 4. The reserve fund is utilised for possible future losses (i.e. for liquidity purposes) as long as there are notes outstanding. • Guarantee trust: The guarantee trust, which initially guarantees the performance of the home loans to Main Street 65, is granted an indemnity and mortgage by the (home loan) borrower. i.e. the mortgage rights do not lie with Thekwini 4, but with the guarantee trust. All security, however, is ceded to the Security SPV which has been incorporated for the sole purpose of holding and realising security for the benefit of the noteholders. Page 29
  • 30. D • Hedge provider: The fixed swap provider hedges the interest rate risk that may occur if the issuer Global Markets Research (SAHL) receives a floating rate of interest under the home loans but is obliged to pay a fixed rate of interest on the class A3 notes up until the coupon-step date. (This applies only to Thekwini 3 and Thekwini 4 where the class A3 notes carry fixed rates prior to the step-up period.) FIGURE 17: THEKWINI 4 SECURITISATION STRUCTURE Indemnity and first Mortgage over the Home Loan borrowers’ property Guarantee Security Trust Security Cession SPV Servicing Excess Spread Guarantee SA Home Loans Loans Reserve origination Servicing Fund Monthly payment Notes Issue The Thekwini Fund 4 Home Loan Borrower Investors (Proprietary) Limited Loans Quarterly obligations Committed Loan Interest Rate Facility Hedging Redraw facility Hedge provider Source: Thekwini 4 offering circular (structure similar to Thekwini 3 and Thekwini 2) TABLE 16: SIMPLIFIED PRIORITY OF PAYMENTS FOR THEKWINI 4 Order Payment 1. Certain costs and expenses (including taxes, director fees and SPV expenses) 2. Interest on the class A notes 3. Interest on the class B notes 4. Interest on the class C notes 5. Arrears reserves A, B, and C replenished 6. Top-up reserve fund to pre-determined amount 7. Fund redraws and repay principal under the redraw facility 8. Purchase of further advances up to the step-up date 9. Purchase of further loans and substitute loans during substitution period 10. Principal redemption (a bullet type payment – a capital repayment) 11. Hedge termination payments Source: Standard Bank Group, Thekwini 4 offering circular and Moody’s Institutional investors and fund managers purchasing the rights to the income streams from a pool of underlying mortgages are protected by credit enhancement features (triggers) provided by the originator and servicer, SAHL. • Arrears trigger: Once 0.60% of the principal balance is three months or more in arrears (five months or more in the case of subsidy accounts), an arrears trigger takes effect. i.e. cash is “trapped” in the respective Thekwini in terms of the priority of payments (Table 16 reflects waterfall payments). This trigger reverses once the percentage drops below 0.5%. Figure 18 indicates the arrears for all the Thekwinis is well within the arrears trigger of 0.6%. (Arrears rehabilitation process details are contained in Section 6.2.) Page 30
  • 31. D FIGURE 18: ARREARS TRIGGER VS ARREARS FOR ALL THEKWINIS Global Markets Research 0.75 0.60 0.45 % 0.30 0.15 0.00 Feb-02 Aug-02 Jan-03 Aug-03 Jan-04 Aug-04 Trigger Thekwini 1 Thekwini 2 Thekwini 3 Thekwini 4 Source: SAHL • Redraw facility: Borrowers may request to: − Redraw any principal repaid; − Take a further advance (up to a maximum of the bond amount); or − Take a further loan (an advance over and above the initial bond amount, thus requiring a second bond to be registered). Such requests within the Thekwinis are initially funded from principal prepayments, but a redraw facility (funded by Standard Bank) is available should there be insufficient liquidity within the redraw fund. Redraw facility However, should arrears (greater than three months – and five months in the case of subsidy loans) within available the Thekwini exceed 1.2% of the outstanding loan balance, such redraw requests under the facility cease. This can only be reversed once arrears fall below 0.9%. To date, principal prepayments have covered all redraw, advance and further loan requests. Borrowers do not pay a penalty for prepayment. • Substitution triggers: A static pool carries a lower risk than a pool with substitution. Therefore, for Substitution Thekwini 2, Thekwini 3 and Thekwini 4, which carry substitution periods, a number of triggers have been implemented, including: triggers exist − New loans may not be of a different (lower) quality than the initial pool; − Weighted average LTV of the pool of home loans does not exceed the initial loan pool by one percentage point; − Weighted average PTI of the pool of home loans does not exceed the initial loan pool by one percentage point; and − The aforementioned arrears trigger is effective. Page 31
  • 32. D Global Markets Research 8. Pool information In the case of an RMBS, investors rely on the rating assigned to the RMBS by a rating agency in order to Rating agencies assess the credit quality of the investment (ratings are discussed in Section 10) as well as mortgage pool assess the information (Table 17). This section covers the pool information and identifies some key differences between the Thekwinis. credit quality of the investment 8.1 The pool TABLE 17: POOL DATA (As at September 2004) T1 T2 T3 T4 Current At issue** Current At issue Current At issue At issue As at Sept 2004 Nov 2001 Sept 2004 Nov 2002 Sept 2004 Oct 2003 Jun 2004 Number of loans 3,684 5,854 4,872 4,563 8,373 6,261 9,350 Bad-debts R4,000 - R2,800 - R0 - R0 written off All Arrears * 14.05% - 16.57% - 14.77% - 5.97% Arrears > 60 < 1.03% - 1.00% - 0.71% - 0.21% 90 Days * Arrears > 90 0.91% - 0.86% - 0.78% - 0.02% days * Margin over 2.10% 2.10% 2.10% 2.10% 2.10% 2.10% 2.10% JIBAR Aggregate R675,827,387 R1,098,751,783 R1,076,829,164 R976,308,317 R1,994,209,010 R1,427,759,510 R2,488,902,921 current balance Average current R183,449 R201,568 R221,024 R213,961 R238,171 R228,040 R266,192 balance Largest current R1,620,052 R1,774,673 R1,255,460 R1,482,034 R1,941,449.27 R1,965,697 R2,011,536 balance Shortest 0.0 years 1.8 years 2.1 years 2.7 years 2.1 years 4.0 years 3.5 years maturity Longest maturity 17.3 years 20.0 years 19.8 years 20.0 years 19.8 years 20.0 years 19.8 years Weighted 15.6 years 18.5 years 17.1 years 18.8 years 18.1 years 18.9 years 18.8 years average maturity Weighted 14.39% 16.05% 14.80% 18.44% 14.41% 15.76% 16.20% average PTI Highest PTI 29.96% 29.90% 30.85% 29.92% 30.40% 29.07% 30.87% Weighted 55.04% 59.78% 61.05% 63.54% 61.71% 63.12% 62.91% average LTV Highest LTV 91.18% 79.98% 142.62% 79.98% 94.22% 79.98% 99.87% Aggregate R210,910,347 R147,063,849 R127,411,778 R53,375,790 R155,406,864 R50,254,455 R116,520,692 potential redraw Largest potential R1,534,000 R996,757 R748,541.79 R1,309,804 R1,797,675.27 R591,557 R915,022.51 redraw Oldest loan 66 months 30 months 62 months 39 months 60 months 48 months 65 months Youngest loan 32 months 0 months 2 months 0 months 2 months 0 months 2 months Weighted average 46 months 10 months 26 months 5 months 15 months 5 months 7 months seasoning * As % of each respective current Thekwini book. Loan classified in arrears once 10-day delay in payment. Figure also includes “Technical arrears” – those arrears that are usually less than 15 days resulting from a technicality and are typically less than R500. ** Initial home loans Source: SAHL 8.2 Pool data analysis 8.2.1 House prices Rising house One area where the landscape has been changing is house prices. (A full discussion of the residential property market is contained in Section 12). prices Increases in mean house prices, as registered by the deeds office in key cities, are reflected in Figure 19. The bulk of the growth has taken place over the last three years (Table 18). Page 32
  • 33. D TABLE 18: MEAN HOUSE PRICES JANUARY 2001 – JANUARY 2004 BY KEY CITIES (R’000) Global Markets Research City January 2001 January 2004 % change Cape Town 225.0 405.0 +80% Durban 180.0 310.0 +72% East Rand 170.0 300.0 +76% Johannesburg 230.0 360.0 +57% Pretoria 210.0 336.5 +60% Source: Deeds Office FIGURE 19: MEAN HOUSE PRICES AS REGISTERED BY THE DEEDS OFFICE Bulk of growth Mean house prices as registered by the 420,000.0 over the last three years 356,000.0 deeds office (R'000) 292,000.0 228,000.0 164,000.0 100,000.0 Mar-93 May-95 Jul-97 Sep-99 Nov-01 Jan-04 Shift towards higher value Cape Town Durban East Rand loans Johannesburg Pretoria Source: Deeds Office This trend is clearly evident when studying the value of homes within the various Thekwinis. The average current balance in Thekwini 1 is R183,449 while Thekwini 4’s is R266,192 — an increase of almost 45% over a two-and-a-half year period between the two issues. Graphically, it is clear that the percentage of home loan balances has shifted in favour of those in the region of R200,000 – R300,000 and R300,000 – R400,000 (Figure 20). FIGURE 20: THEKWINI HOME LOANS 35.0 28.0 21.0 % 14.0 7.0 0.0 Thekwini 1 Thekwini 2 Thekwini 3 Thekwini 4 Home loan 100,000 -150,000 Home loan 150,000 - 200,000 Home loan 200,000 - 300,000 Home loan 300,000 - 400,000 Source: SAHL Page 33
  • 34. D 8.2.2 Redraws Global Markets Research Borrowers may request to redraw any principal repaid, take a further advance or a further loan. As Potential redraw expected, more principal has been repaid in the “older” Thekwini 1 than in “newer” Thekwini 4 and in Thekwini 1 therefore the potential redraw in Thekwini 1 (R210,910,347) is higher than that of Thekwini 4 higher than (R116,520,62). However, Thekwini 3’s potential redraw is higher than Thekwini 2 due to size – the Thekwini 2 is a R1bn securitisation structure vs Thekwini 3’s R2bn, i.e. double the size and hence Thekwini 4 weighted redraws are likely to be larger. 8.2.3 Payment-to-income Although weighted average Payment-to-Incomes (PTIs) across all the Thekwini’s are well below SAHL’s 30% threshold, there are marked differences between the Thekwini 3 and Thekwini 4 PTIs. This is due to the timing of the origination of the loans. Some loans were originated at high interest rates, installments PTIs dependent are now much lower under a lower interest rate environment and hence the PTIs are much reduced. This on timing of is clearly the case for Thekwini 2, which issued notes during an interest rate environment of Prime at origination of 17.00% and PTIs averaged 18.44%. These PTIs are now at 14.08%. loans 8.2.4 Prepayment Prepayments (Figure 21) have only breached the 5% level on two occasions, in May 2002 - August 2002, and in May 2004 - August 2004. There does not appear to be any seasonality attached to pre-payments. FIGURE 21: THEKWINI PREPAYMENTS 6.0 4.8 3.6 % 2.4 1.2 0.0 Nov 01 - Feb 02 - May 02 - Aug 02 - Nov 02 - Feb 03 - May 03 - Aug 03 - Nov 03 - Feb 04 - May 04 - Feb 02 May 02 Aug 02 Nov 02 Feb 03 May 03 Aug 03 Nov 03 Feb 04 May 04 Aug 04 TK1 TK2 TK3 TK4 Source: SAHL Page 34
  • 35. D Global Markets Research 9. Brief issue pricing and spread analysis There have been 26 AAA Mortgage Backed or Asset Backed securitisations since SAHL commenced its Spreads have Thekwini 1 programme in November 2001; 11 of which are expected to mature within four to five years halved … from date of issue. Figure 22 and Table 19 illustrate the narrowing – in fact, almost halving – of spreads over that time. i.e Thekwini 1’s spread at time of issue was 70 bps, and the Prime Realty Obligors Packaged Securities issued earlier this month, secured a spread of just 38 bps on its A1 Notes and 40 bps on its A2 notes. Figure 22 suggests this trend is bottoming out and should plateau for a while. FIGURE 22: SPREADS OF NEW AAA ISSUES (as at date of issue) 95.0 80.0 THE1A THE2A Basis points 65.0 50.0 THE3A1 THE3A2 THE4A1 THE4A2 35.0 … but have plateaued 20.0 19-Apr-01 05-Nov-01 24-May-02 10-Dec-02 28-Jun-03 14-Jan-04 01-Aug-04 17-Feb-05 THE1A CARD1 FIN1A THE2A1 THE3A1 THE3A2 ERS1A THE4A1 THE4A2 CARDA2 PRP1A1 PRP1A2 Source: BESA statistics TABLE 19: SPREAD STATISTICS – AAA, 4/5 years maturity only 2001 2002 2003 2004 Number of AAA issues 1 3 3 5 Average spread 70.00 76.67 48.67 39.20 40 (CARDA2, Highest spread 70 (THE1) 90 (CARD1) 52 (ERS1A) PRP1A2) Lowest spread 70 (THE1) 65 (THE2A1) 45 (THE3A1) 38 (PRP1A1) Average size of securitisation (Rm) 1,150 1,215 761 719 Largest size (Rm) 1,150 (THE1) 1,730 (CARD1) 1,366 (THE3A1) 1,585 (THE4A1) Smallest size 1,150 (THE1) 916 (FIN1A) 305 (THE3A2) 234 (PRP1A1) Source: BESA statistics Page 35
  • 36. D Global Markets Research 10. Ratings and rating agency comments Rating agencies Moody’s and Fitch have assigned ratings to the Thekwinis. We have summarised the key opinions of these agencies below. Full credit agency quarterly reports are available on SAHL’s website. 10.1 Moody’s Strengths of the transaction • Good quality borrowers, mainly switching from other home loan providers to SAHL; Moody’s cites a • Relatively conservative loan-to-value lending policy; strength as • A tight excess spread capture trigger provisioning against arrears and resulting, if breached, in an good quality increased reserve fund; borrowers • No basis risk as the mortgage loans and the notes are based on 3-months JIBAR and are resetting and … at the same time; • Creditworthy back-up servicer in Standard Bank of South Africa (Baa2/Prime-2/C+); and • The previous outstanding Thekwini transactions also rated by Moody’s are currently performing in line with expectations. Weaknesses and mitigants • Relatively young originator but experienced management and strong shareholder structure; … a weakness • A two-and-a-half year substitution period, which is mitigated by tight early amortization triggers as (SAHL) being including, inter alia, an arrears trigger and additional credit enhancement; a relatively • Increased risk due to pro rata amortization of the notes, which again is mitigated by tight young performance-related triggers; and originator • The interest rate risk arising from the issuance of a fixed rate note (class A3 notes fixed rate to step-up date) is mitigated through an interest rate swap with Standard Bank. Source: Moody’s TABLE 20: MOODY’S RATINGS Securitisation Moody’s Thekwini 1 Class A Notes Class B Notes (Upgraded from in May 2004) Thekwini 2 Class A1 Notes Class A2 Notes - Class B Notes Class C Notes Thekwini 3 Class A1 Notes Class A2 Notes Class A3 Notes Class B Notes Class C Notes Thekwini 4 Class A1 Notes Class A2 Notes Class A3 Notes Class B Notes Class C Notes Source: Moody’s Page 36
  • 37. D Global Markets Research 10.2 Fitch Fitch has rated three of the Thekwinis. Comments relating to Thekwini 4 (the latest securitisation) include: Fitch has Credit committee highlights rated three of the • The portfolio of loans has a low weighted average original loan-to-value ratio of 64.16% and a low Thekwinis weighted average debt-to-income ratio of 16.34%; • The portfolio is geographically concentrated in a manner consistent with the South African market. Concentrations are Gauteng at 45.49%, the Western Cape at 23.31% and Kwa-Zulu Natal at 17.96%; • Sound originator underwriting and servicing procedures; • To compensate for any liquidity shortfall that may arise from funding redraws, further advances and further loans, a redraw facility will be available to the issuer at 3.5% of the initial note balance. Source: Fitch Thekwini 4 Presale report TABLE 21: FITCH RATINGS Securitisation Fitch Thekwini 1 Class A Notes AAA(zaf) Class B Notes * A- (zaf) Thekwini 3 Class A1 Notes AAA(zaf) Class A2 Notes AAA(zaf) Class A3 Notes AAA(zaf) Class B Notes A(zaf) Class C Notes BBB(zaf) Thekwini 4 Class A1 Notes AAA(zaf) Class A2 Notes AAA(zaf) Class A3 Notes AAA(zaf) Class B Notes A(zaf) Class C Notes BBB(zaf) Source: Fitch Thekwini 4 Presale report. * Upgraded from BBB (zaf) Page 37
  • 38. D Global Markets Research Overview 1 – Thekwini 1 TABLE 22: THEKWINI 1 ABRIDGED INFORMATION Loan information Current Original Number of loans 3,684 5,854 Balance R676 m R1,099 m Reserve Fund 2.1% of the initial amount outstanding of the notes (funded by subordinate loan) Redraw facility 3.5% of the original balance of the home loans Note information Class A Class B Rating: Moody’s (Upgraded from Fitch AAA(zaf) A- (zaf) (Upgraded from BBB (zaf)) Amount (Rm) 1,150 100 Margin over 3-month JIBAR 0.70% 2.30% Step-up margin following coupon step-up date 0.98% 2.875% st Interest payment dates Quarterly on the 21 day of February, May, August and November Coupon step-up date 21 November 2005 FIGURE 23: TK1 DISTRIBUTION BY LTV (In %)* FIGURE 24: TK1 GEOGRAPHIC DISTRIBUTION* 6% 0% 5% 1% 8% 31% 38% 30% 25% 12% 18% 26% Up to 40 41-50 51-60 61-70 Eastern Cape Free State Gauteng 71-75 76-80 85 + Kw aZulu Natal Western Cape Source: SAHL Source: SAHL • Highest LTV 91.18%, lowest LTV (25.96%); and • Gauteng-based loans 30%; and • Average LTV 55.04% • Western Cape-based loans 38% FIGURE 25: TK1 HOME LOAN SIZE* FIGURE 26: TK1 ARREARS PERFORMANCE* 3% 3% 9% 1% 1% 20.0 7% 3% 9% 16.0 21% 12.0 % 8.0 23% 20% 4.0 R0 - R30,000 R30,001 - R40,000 R40,001 - R50,000 R50,000 - R75,000 0.0 R75,001 - R100,000 R100,001 - R150,000 Nov-01 May-02 Dec-02 Jul-03 Feb-04 Sep-04 R150,001 - R200,000 R200,001 - R300,000 R300,001 - R400,000 R400,001 - R500,000 R500,001 + All Arrears % Arrears % >60 <90 days Arrears % >90 d Source: SAHL Source: SAHL • Highest current balance R1.6m; and • Arrears (>90 days) currently at 0.91% of the current book; • Average current balance R183,449 and * All based on current pool • Bad debts written off in TK1 total R4,000 Page 38
  • 39. D Global Markets Research Overview 2 – Thekwini 2 TABLE 23: THEKWINI 2 ABRIDGED INFORMATION Loan information Current Original Number of loans 4 872 4 563 Balance R1.08bn R0.97bn Reserve Fund 1.0% of the initial amount outstanding of the notes (funded by subordinate loan), growing to 1.5% Redraw facility 3.0% of the original balance of the home loans Note information Class A1 Class B Class C Rating: Moody’s Amount (Rm) 1,000 55.2 27.1 Margin over 3-month JIBAR 0.65% 1.20% 2.15% Step-up margin following coupon step-up date 1.05% 1.50% 2.70% Interest payment dates Quarterly on the 21st day of February, May, August and November Coupon step-up date 21 November 2007 FIGURE 27: TK2 DISTRIBUTION BY LTV (In %)* FIGURE 28: TK2 GEOGRAPHIC DISTRIBUTION* 1% 0% 5% 1% 14% 17% 29% 14% 12% 1% 0% 42% 1% 16% 3% 26% 18% Up to 40 41-50 51-60 61-70 Eastern Cape Free State Gauteng 71-75 76-80 81-85 85 + Kw aZulu Natal Mpumalanga North West Northern Cape Northern Province Western Cape Source: SAHL Source: SAHL • Highest LTV 142.62%, lowest LTV (1.75%); and • Gauteng-based loans 42%; and • Average LTV 61.05% • Western Cape-based loans 29% FIGURE 29: TK2 HOME LOAN SIZE* FIGURE 30: TK2 ARREARS PERFORMANCE* 20.0 5% 3% 4%0%0% 1% 6% 11% 16.0 20% 12.0 % 8.0 28% 4.0 22% R0 - R30,000 R30,001 - R40,000 0.0 R40,001 - R50,000 R50,000 - R75,000 Nov-02 Mar-03 Jul-03 Dec-03 Apr-04 Sep-04 R75,001 - R100,000 R100,001 - R150,000 R150,001 - R200,000 R200,001 - R300,000 All Arrears % Arrears % >60 <90 days R300,001 - R400,000 R400,001 - R500,000 Arrears % >90 days R500,001 + Source: SAHL Source: SAHL • Highest current balance R1.3m; and • Arrears (>90 days) at 0.86% of the current book; and • Average current balance R221,024 • Bad debts written off in TK2 total R2,800 * All based on current pool Page 39
  • 40. D Global Markets Research Overview 3 – Thekwini 3 TABLE 24: THEKWINI 3 ABRIDGED INFORMATION Loan information Current Original Number of loans 8 373 6 261* Balance R1.99bn R1.43bn* Reserve Fund 0.8% of the initial amount outstanding of the notes (funded by subordinate loan), growing to 1.2% Redraw facility 3.5% of the original balance of the home loans Note information Class A1 Class A2 Class A3 Class B Class C Rating: Moody’s Fitch AAA(zaf) AAA(zaf) AAA(zaf) A(zaf) BBB(zaf) Amount (Rm) 1,366 305 195 105 29 Margin over 3-month JIBAR 0.45% 0.49% 9.58%** 1.15% 2.10% Step-up margin following coupon step-up date 1.20% 1.25% 1.25% 1.70% 2.80% Interest payment dates Quarterly on the 21st day of February, May, August and November Coupon step-up date 21 November 2008 ** Fixed rate note. * R0.6 bn worth of loans were pre-funded FIGURE 31: TK3 DISTRIBUTION BY LTV (in %)* FIGURE 32: TK3 GEOGRAPHIC DISTRIBUTION* 5% 2% 16% 1% 0% 16% 25% 11% 14% 1% 0% 44% 2% 17% 18% 25% 3% Up to 40 41-50 51-60 61-70 Eastern Cape Free State Gauteng 71-75 76-80 81-85 86+ Kw aZulu Natal Mpumalanga North West Northern Cape Northern Province Western Cape Source: SAHL Source: SAHL • Highest LTV 94.22%, lowest LTV (1.26%); and • Gauteng-based loans 44%; and • Average LTV 61.71% • Western Cape-based loans 25% FIGURE 33: TK3 HOME LOAN SIZE* FIGURE 34: TK3 ARREARS PERFORMANCE* 1% 20.0 5% 4% 2% 0% 5% 0% 12% 16.0 20% % 12.0 8.0 4.0 29% 22% 0.0 R0 - R30,000 R30,001 - R40,000 Oct-03 Dec-03 Feb-04 Apr-04 Jun-04 Sep-04 R40,001 - R50,000 R50,000 - R75,000 All Arrears % Arrears % >60 <90 days R75,001 - R100,000 R100,001 - R150,000 Arrears % >90 days R150,001 - R200,000 R200,001 - R300,000 R300,001 - R400,000 R400,001 - R500,000 R500,001 + Source: SAHL Source: SAHL • Highest current balance R1.9m; and • Arrears (>90 days) at 0.78% of the current book; and • Average current balance R238,171 • Zero bad debts written off in TK3 * All based on current pool Page 40
  • 41. D Global Markets Research Overview 4 – Thekwini 4 TABLE 25: THEKWINI 4 ABRIDGED INFORMATION Loan information Current Original Number of loans 9,350 5,291 Balance R2.5bn R1.37bn* Reserve Fund 0.6% of the initial amount outstanding of the notes (funded by subordinate loan), growing to 1.1% Redraw facility 3.5% of the original balance of the home loans Note information Class A1 Class A2 Class A3 Class B Class C Rating: Moody’s Fitch AAA(zaf) AAA(zaf) AAA(zaf) A(zaf) BBB(zaf) Amount (Rm) 1,585 643 107 115 50 Margin over 3-month JIBAR 0.39% 0.39% 10.34%** 1.00% 2.10% Step-up margin following coupon step-up date 1.15% 1.15% 1.15% 1.75% 2.80% Interest payment dates Quarterly on the 21st day of February, May, August and November Coupon step-up date 21 August 2009 ** Fixed rate note * R1.13 bn worth of loans were pre-funded FIGURE 35: TK4 DISTRIBUTION BY LTV RATIO* FIGURE 36: TK4 GEOGRAPHICAL DISTRIBUTION* 1% 0% 16% 7% 2% 16% 24% 11% 14% 1% 0% 42% 2% 17% 18% 25% 4% Eastern Cape Free State Gauteng Up to 40 41-50 51-60 61-70 Kw aZulu Natal Mpumalanga North West 71-75 76-80 81-85 86+ Northern Cape Northern Province Western Cape Source: SAHL Source: SAHL • Highest LTV 99.87%, lowest LTV (1.24%); and • Gauteng-based loans 42%; and • Average LTV 62.91% • Western Cape-based loans 24% FIGURE 37: TK4 HOME LOAN SIZE* FIGURE 38: ARREARS PERFORMANCE* 15% 10.0 1% 3% 6% 6% 8.0 15% 6.0 % 4.0 2.0 33% 0.0 21% 01-Jun-04 01-Jul-04 01-Aug-04 31-Aug-04 R50,000 - R75,000 R75,001 - R100,000 All Arrears % Arrears % >60 <90 days R100,001 - R150,000 R150,001 - R200,000 Arrears % >90 days R200,001 - R300,000 R300,001 - R400,000 R400,001 - R500,000 R500,001 + Source: SAHL Source: SAHL • Highest current balance R2.0m; and • Arrears (>90 days) at 0.02% of the current book; and • Average current balance R266,193 • Zero bad debts written off in TK4 * All based on current pool Page 41
  • 42. D Global Markets Research C THE INDUSTRY AND ECONOMY 42 11 ECONOMIC ENVIRONMENT 43 11.1 Economic growth 43 11.2 Inflation and inflation rates 44 11.3 Exchange rate 44 12 RESIDENTIAL PROPERTY MARKET 46 D CONTACTS AND DISCLAIMER 49 Page 42
  • 43. Global Markets Research D 11. Economic environment Activity in the residential property market is expected to remain buoyant, supported by persistent low interest rates and accelerating economic growth. Inflationary pressures should remain relatively benign and interest rates are therefore not likely to rise substantially once the upward cycle commences (not expected until 2006). While Inflation rising inflation is forecast to rise in the next 12 to 18 months, it will most probably remain within the SARB’s 3% to 6% towards year-end target band. but target not threatened The most significant threat to inflation remains high and volatile international oil prices, although the relatively strong rand continues to mitigate the impact on domestic fuel prices and hence, inflation. However, should the rand falter while oil prices are at high levels the impact on inflation will be more severe. 11.1 Economic growth The economic growth trajectory of South Africa has improved significantly since the first democratic elections were held in 1994. The country’s re-admittance to the global economic sphere after years of isolation has opened up opportunities in international trade and capital markets. Investor perceptions towards the country have changed to such an extent that financial inflows (largely absent under the previous dispensation) have grown strongly. Though flows are mainly portfolio-related, direct investment inflows have also been strong. South Africa’s new global standing definitely has its benefits but it also exposes the country to external shocks. Various international crises and developments have impacted on South Africa’s economic growth in the last decade. The most important of these are the 1997 – 1998 Asian crisis and the global slowdown that was compounded by the 2001 terrorist attacks on the US. Subsequent retaliation has prolonged the negative impact despite a solid global recovery since 2002. FIGURE 39: SOUTH AFRICA’S REAL GDP GROWTH IN GLOBAL CONTEXT 6 4 Real GDP % y/y 2 Economic 0 growth to remain (2) buoyant (4) 1990 1993 1996 1999 2002 2005 South Africa World Source: SARB & IMF A democratic South Africa also brought with it improved economic and fiscal management. Through sound (but rather restrictive) monetary policies, inflation has declined to historically low levels. Government finances were transformed from a “debt trap” situation in the early 1990’s to one where the budget deficit in relation to GDP has declined to lower levels than in most countries. During this process, the government was also able to provide significant income tax relief to all taxpayers (although lower income groups have benefited more). Improved economic fundamentals have laid the foundation for sustainable economic growth at higher levels (growth still falls short of the levels required to create jobs and eradicate poverty). Higher growth rates have been supported by the bounce back in the global economy since 2002 together with positive domestic factors Page 43
  • 44. D (including low inflation and interest rates). The outlook for the economy in 2005 is positive with growth Global Markets Research expected to outperform 2004 levels. 11.2 Inflation and interest rates Inflation has fallen sharply since the beginning of the 1990s supported by the global deflationary environment, restrictive domestic monetary policy and an improvement in labour productivity. Inflation fell to historic lows at the end of 2003 on account of a strengthening in the rand exchange rate after a sharp depreciation occurred in 2001 and 2002. After generally exceeding the SARB’s inflation target since its inception, the monetary policy measure of inflation CPIX (which excludes the effect of changes in mortgage lending rates) finally moved below the 3% to 6% target range in late 2003 and has remained there. Inflation has been rising marginally since the beginning of 2004 mainly on the back of rising fuel prices. Excluding fuel prices, inflation would have steadily declined to significantly lower levels. FIGURE 40: BENIGN INFLATION ENVIRONMENT SUPPORTS HISTORICALLY LOW INTEREST RATES 30 24 18 % y/y 12 6 Benign inflation environment 0 resulted in Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 historically low Headline consumer inflation CPIX Inflation target range Prime lending rate interest rates Source: SARB The positive inflation performance has resulted in interest rates declining sharply in recent years. While inflation is expected to rise in the next 12 to 18 months, it should remain under control. CPIX is not expected to breach the 6% upper limit of the inflation target range during this period (despite current high oil prices), which means that upward pressure on interest rates is unlikely before 2006. 11.3 Exchange rate A significant appreciation in the rand since late 2002 after its fallout in 2001 has contributed to falling Strong interest rates supported by the benign inflation environment. A turnaround in the rand (sharp depreciation) comeback in poses a significant risk to inflation, interest rates and disposable incomes of households. The outlook for rand supports the rand depends on various factors, the most important of which are domestic interest rate levels in low inflation and relation to other economies, the widening current account of the balance of payments, domestic economic fundamentals and growth, perceptions towards South Africa as an investment destination and the interest rates performance of the US$ on international currency markets. Page 44
  • 45. Global Markets Research FIGURE 41: RAND COMEBACK AND RESILIENCE FAVOURS LOW INFLATION AND INTEREST RATES D 120 16 96 13 Index 1995=100 72 10 R/US$ 48 6 24 3 0 0 Jan-97 Jan-99 Jan-01 Jan-03 Real effective exchange rate of the rand index R/US$ Source: SARB Based on current information, we expect the rand to remain relatively strong, although with a weakening bias in the medium term. This forecast takes account of expected inflation, interest and growth rate differentials between Rand is expected South Africa and its major trading partner economies. Also the US$, which has been weak on international to remain currency markets, is not poised for recovery anytime soon. Barring any unforeseen shocks, the performance of relatively strong the rand should not highjack the positive outlook for inflation and interest rates. Page 45
  • 46. D Global Markets Research 12. Residential property market Improved The residential property market continues to be buoyant, supported by healthy consumer fundamentals household and relatively low interest rates. Data collected from the Deeds Office indicates that house prices are levelling off, but this data is often revised substantially and therefore the slowdown needs to be confirmed spending power in subsequent reports. and low interest rates caused a FIGURE 42: NATIONAL HOUSE PRICES RISE TO NEW HIGHS housing boom but … 36 24 Index 2000 = 100 12 0 (12) (24) Mar-94 Nov-95 Jul-97 Mar-99 Nov-00 Jul-02 Mar-04 House prices may be leveling Nominal Real (CPI deflated) Real (Building cost deflated) off Sources: Standard Bank Group, Deeds Office Figure 43 compares the prices of new and existing houses. The data is indexed in such a way that both indices are 100 in January 2000, which means that they cannot be used to compare the actual prices of new and existing houses but only their growth rates. Clearly, the prices of existing houses have increased much faster since last year than the prices of new houses. However, this does not necessarily imply that an existing house is more expensive than a new house. FIGURE 43: EXISTING HOUSE PRICES GROW FASTER THAN NEW HOUSE PRICES 200 160 Index Jan 2000 = 100 120 80 40 0 Mar-93 Nov-94 Jul-96 Mar-98 Nov-99 Jul-01 Mar-03 Existing houses New houses Sources: Standard Bank Group, Deeds Office Page 46
  • 47. Global Markets Research House prices of mortgages financed by Standard Bank1 seem to follow the same trend as national houses D (Figure 44) and are also reflecting a slowdown in both nominal and real terms in recent months. The year-on- Standard Bank year growth in nominal house prices continues to fluctuate around record high levels, while the recent rise in data confirms inflation means that real growth has subsided somewhat in recent months. trend FIGURE 44: STANDARD BANK HOUSE PRICES DISPLAY A SIMILAR TREND 500,000 430,000 Index 2000 = 100 360,000 290,000 220,000 150,000 Mar-95 Nov-96 Jul-98 Mar-00 Nov-01 Jul-03 Nominal Real (CPI deflated) Real (Building cost deflated) Source: Standard Bank Group Nominal house There seems to be a divergence in different house price indices (Figure 45) prices declined . According to data from the Deeds Office, nominal house prices have declined in April (the latest month in April recorded), while Standard Bank and Absa’s indices indicate continued growth in house prices. The divergence can at least partly be explained by methodological differences in the indices. The Deeds Office’s data covers all the houses registered in a particular period, while each bank’s index only includes mortgages financed by the particular bank. Further, Absa’s house price index includes only houses in the 80m2 – 400m2 size category valued at R1.6m or less, while Standard Bank’s index includes all houses valued R1m or less, irrespective of its size. FIGURE 45: NOMINAL HOUSE PRICES COMPARED 220 192 Index 2000 = 100 164 136 108 80 Jan-99 Apr-00 Jul-01 Oct-02 Jan-04 Standard Bank Absa Deeds Office Source: Standard Bank Group 1 Only mortgages with assessment values up to R1 million are included in the analysis. Similar to the national house prices above, the three-month moving average of the assessment values is used. Page 47
  • 48. D House prices continue to be supported by healthy consumer fundamentals and housing affordability. Global Markets Research Despite a rise since the end of 2002, South Africa’s household debt to income ratio is still relatively low, which means that households still have scope to increase their debt and hence finance and afford more expensive houses. This is echoed by indices of housing affordability, which is still low relative to historical values. The national affordability index (Figure 46), which is calculated as the instalment to income ratio, Housing combines the impact of income, interest rates and house prices, and should therefore give a good indication of the affordability of residential property. The instalments are calculated based on the median affordability national house price and the Prime rate, while disposable income per capita is used to measure income. echoes An increase (decrease) in the affordability index signals that the instalment to income ratio is rising consumer (declining) and hence that people spend a larger (smaller) proportion of their income on their property so fundamentals’ that the affordability of houses is seen to be deteriorating (improving). positive outlook for house prices FIGURE 46: NATIONAL AFFORDABILITY INDEX AND INTEREST RATES 170 30 152 24 Index 2000 = 100 Index 2000 = 100 134 18 116 12 98 6 80 0 Mar-93 Mar-95 Mar-97 Mar-99 Mar-01 Mar-03 Affordability index Prime (Right axis) Source: Standard Bank Group Despite the slight deterioration since late last year, the national affordability index is still relatively low Positive interest compared with most of the 1990s. The deterioration since late 2003 can mainly be ascribed to soaring rate outlook house prices. However, the interest rate cuts since mid-2003 have clearly mitigated the impact of rising house prices on affordability, which explains the improvement in affordability since early 2004. The should support relationship between the affordability of houses and interest rates is illustrated in Figure 46. A rise in prolonged interest rates impact negatively on affordability by increasing the monthly instalments. However, affordability eventually a rise in interest rates also negatively affects house prices, which in turn improves affordability. Page 48
  • 49. Global Markets Research D D. Contacts and disclaimer Robert J Van Eyden – (Director – Corporate and Investment Banking) (+27-11-378-7242) Henry Flint – (Deputy Head Global Markets Research: Rand) (+27-11-378-7202) Fixed Income Technical Leigh Cosser Theunis De Wet Nicolette Roussos Darran Grabham +27-11-378-7239 +27-11-378-7223 +27-11-378-7217 +27-11-378-8313 Forex Corporate and Credit Ryan Smith Seamus Vasey Jason Costa Kate Rushton +27-11-378-7234 +27-11-378-7201 +27-11-378-7220 +27-11-378-7278 Sales – South Africa Giles Heeger – Head Market Sales and Structuring (+27-11-378-7216) Johannesburg Lance Basserabie Peter Bybee Lee-Anne Walker Ryno Deysel +27-11-378-7208 +27-11-378-7212 +27-11-378-7204 +27-11-378-7203 Freda Hamersma Chantal Flynn Sybil Kekana Zaid Moola +27-11-378-7207 +27-11-378-7214 +27-11-378-7206 +27-11-378-7240 David Rajak Steve Barnes Tracy Spence Yvonne Maitin +27-11-378-7241 +27-11-378-7219 +27-11-278-7221 +27-11-378-7225 Kindly email should you wish to be included on our research distribution list. Do visit our web site to view our most recent research or to access our archives. Analyst certification The authors certify that: 1) all recommendations and views detailed in this document reflect his/her personal opinion of the financial instrument or market class discussed; and 2) no part of his/her compensation was, is, nor will be, directly (nor indirectly) related to opinion(s) or recommendation(s) expressed in this document. Disclaimer This document does not constitute an offer, or the solicitation of an offer for the sale or purchase of any investment or security. This is a commercial communication. If you are in any doubt about the contents of this document or the investment to which this document relates you should consult a person who specialises in advising on the acquisition of such securities. Whilst every care has been taken in preparing this document, no representation, warranty or undertaking (express or implied) is given and no responsibility or liability is accepted by the Standard Bank Group Limited, its subsidiaries, holding companies or affiliates as to the accuracy or completeness of the information contained herein. All opinions and estimates contained in this report may be changed after publication at any time without notice. Members of the Standard Bank Group Limited, their directors, officers and employees may have a long or short position in currencies or securities mentioned in this report or related investments, and may add to, dispose of or effect transactions in such currencies, securities or investments for their own account and may perform or seek to perform advisory or banking services in relation thereto. No liability is accepted whatsoever for any direct or consequential loss arising from the use of this document. This document is not intended for the use of private customers. This document must not be acted on or relied on by persons who are private customers. Any investment or investment activity to which this document relates is only available to persons other than private customers and will be engaged in only with such persons. In European Union countries this document has been issued to persons who are investment professionals (or equivalent) in their home jurisdictions. Neither this document nor any copy of it nor any statement herein may be taken or transmitted into the United States or distributed, directly or indirectly, in the United States or to any U.S. person except where those U.S. persons are, or are believed to be, qualified institutions acting in their capacity as holders of fiduciary accounts for the benefit or account of non U.S. persons; The distribution of this document and the offering, sale and delivery of securities in certain jurisdictions may be restricted by law. Persons into whose possession this document comes are required by the Standard Bank Group Limited to inform themselves about and to observe any such restrictions. You are to rely on your own independent appraisal of and investigations into (a) the condition, creditworthiness, affairs, status and nature of any issuer or obligor referred to and (b) all other matters and things contemplated by this document. This document has been sent to you for your information and may not be reproduced or redistributed to any other person. By accepting this document, you agree to be bound by the foregoing limitations. Unauthorised use or disclosure of this document is strictly prohibited. Copyright 2004 Standard Bank Group. All rights reserved. Page 49