2011 Credit: A Game of Risk- Mortgage Lending in South Africa. Consumer Credit A look into some aspects of consumer lending – Mortgage Lending in South African market. Assessment of mortgage loans and a preview of how consumers fall into arrears. B.Matanda B.Matanda 11/17/2011
Credit – A game of Risk : Mortgage Lending in SouthAfrica.National Credit Regular Consumer Credit Report, reports that as at the endof March 2011 there were 1.8 million mortgage accounts, amounting to overR770 billion and that accounts for 64% of all consumer credit.The same report reveals that only one in every eight (12, 5%) home loanapplications processed is successful, meaning the remainders of theapplications do not get registered at the deeds office.It is clear that residential mortgage credit contributes significantly toconsumer credit both in value and in numbers. For many people, home isthe most significant investment of their life.Why is it that only 12.5% of mortgage loans applications aresuccessful? Have Mortgage Financiers taken a conservative approachin their lending?Looking back to the past 7 or so years ago or pre National Credit Act thehome loan approval ratio was over 80%, and from that past experiencemortgage financier have seen impairments rising as more and more clientsfail to meet their mortgage repayment commitments. This has not only beenrestricted to mortgage loans but also to other credit products. Mortgagefinancers are currently sitting on billions of non-performing assets –inform ofrepossessed properties. And because of that experiences financers havetaken a cautionary and conservative approach to their lending , attentionhas shifted from mass market to high value and low risk clients to safeguardtheir investments .They say sometimes its better to own 2% of an elephantthan to own 100% of a rabbit.Over the years mortgage financers have devised system based RiskAssessment Tools that has defined parameters on pre-assessing clientapplications, before they reach the credit personnel. To clients and otherstakeholders, this has the effect of getting system based decisions onapplications such as decline, approval and or referred for manualassessment. Much depends on what has been fed to the system.
Two key parameters of the Risk Assessment Tools are based on;(i)Affordability –Can the client afford the mortgage loan taking intoaccount the current monthly installment repayments on existing debts andliving expenses? (ii) Risk factors – Internal risk based ratings/scoring, this works wellwhen the client has an existing relationship with the credit provider suchtransactional account or a credit facility and External risk based ratingstaken from credit bureau scoring.If one in ever eight applications is successful how do the seven becomeunsuccessful? (a) Firstly some of the applications are declined upfront bythe system based assessment tools – the system based tools will decline theapplication basing on information fed to the system, client payment behaviorand affordability of the loan, however clients always have the opportunity toappeal the decision (b) some of the applications are declined by creditpersonnel for various reasons. (c) some of the applications are granted withconditions which clients may fail to meet and as a result the mortgage bondwill never get to registration. Conditions placed may force the client to saleexisting property that the client owns and some will be unwilling to sale theproperty. A deposit of say 5%-50% may be required from the client and theclient may not be in a position to raise such an amount and the transactiondoes not proceed.If credit personnel and Risk Assessment Tools have been effectiveand in use why has the level of impairments been on the rise inrecent years? And what can be done to mitigate credit risk?Most of the non-payments being experienced today are as a result ofmortgage loans granted in previous years and looking back at thosedelinquent accounts there are various reasons that can be drawn from that;(1)Additional debtAfter mortgage loan is granted, some clients have a tendency of increasingtheir debt without having their income proportionally increasing. Soon aftera mortgage loan is granted and well before it’s even registered some clientshave a tendency of going for additional debt by borrowing more e.g.(motorfinance, personal loans, credit cards etc). If these debts had been incurredbefore the mortgage loan was granted, the application would have been
declined for affordability. From experience most additional debt is on thepersonal loans product, in my opinion clients would borrow to financeregistration costs as well as deposit. Currently banks are reluctant to grant100% mortgage finance. Yesteryear banks used to grant up to 108%finance, such products have been discontinued/suspended because ofexperience and current economic conditions.To mitigate such risks, mortgage financers can take a quick snap shot at theclients’ bureau profile before the bond is registered. Normally registrationattorneys advice financers when they are about to register the bond so thatthe funds can be released. It is at that stage financers can quickly relook atthe client bureau profile to see if the loan is still affordable to the client. Ifthe situation has changed for the worse new and latest documentation inform of pay slips and bank statements etc can be requested by the financerto have a better picture. If the client is unable to afford the mortgage loan atthat stage, the application can be terminated. Certain clauses and conditionsmay need to be inserted in the loan contract to accommodate any legalimplications that may come out.(2)FraudIn a broad strokes definition, fraud is a deliberate misrepresentation whichcauses another person to suffer damages, usually monetary losses. Mostpeople consider the act of lying to be fraudulent, but in a legal sense lying isonly one small element of actual fraud.Fraud has been a major problem for mortgage loan providers in the pastyears. In most cases mortgage transactions granted at the back offraudulent documentation are of high value in size.This normally occurs when a client submits fraudulent documents such as –pay slips, bank statements, identification documents etc in order to obtain aloan. Some of these clients may temper with their pay slips to reflect ahigher income so that they can afford a higher valued residential propertyand some may not even be employed or working for themselves. Clients whothese mostly it’s for speculative purposes -to resale the property at a profitwithin a short period of time. Should the property market remain stagnantas it is, those clients will walk away from the property as their needs can notbe met. Some of the transactions will involve related members selling toeach other and at the end bank is left with the asset in their books.
To combat this financers need a collaborated approach and effort in someareas of common interest such as share information particularly to theirclients’ banking information. Banks should be able to freely exchange clientsbanking information and to authenticate clients’ transactions were necessaryunlike in previous years.Banking staff should continuously be diligent and look-out for suchsuspicious transactions and confirm employment and banking transactionswith respective employers and banking institution as per current status.Culprits should be listed on common data base for the benefit of other users.With time and improvements in systems mortgage financers should come upwith a central banking data base where bank personnel and other authorizedusers can access clients banking transactions therefore eliminating the needfor client supplying physical bank statements. Although this might be acostly project in the long term it may help to mitigate the credit andoperational risk aspect. Consensus is also required between players in thebanking industry as they all provide different credit products.(3)Unforeseen circumstancesThese are losses accumulated as a result of death, retrenchments, loss ofjobs, transfers amongst others.Clients should be encouraged and in some cases forced where possible totake respective insurance covers to guard against this.(4)Unreasonable living expenses declared. As per National Credit Act, the applicant should fill in the application formand should do that to the best of his knowledge and in honest. Whencarrying out assessments financial services providers use the informationdeclared by the applicant before making a decision to grant or decline theapplication. If information provided is found out to be untrue, legally itbecomes the clients’ fault. In some instances a client can declareunreasonable living expenses such as R200 monthly food. The question isshould financers take this amount as true and correct and carry on with the
assessment or should they add on reasonable figures such as say R1000?Again the question is where is the R1000 being derived from? Or shouldthere be a rule of thump to say if unreasonable living expenses are declaredthen a certain number or percentage is applied depending on salary, age etcThis remains a debatable issue by I guess credit providers have some waysof going around that issue.(5)Rise in Interest RatesThe prime rate is currently 9% per annum a level last seen in May 1974. InAugust 1998 it was 25.5%. This implies that a new mortgage bond of sayR1 million at current prime (9%) requires a monthly repayments of R8,998whereas in August1998 it would have been R21,387. The effects of risinginterest rates have a negative effect on the repayment ability of clients aswas seen around 2008/9 when interest rates were on the rise.Residential mortgage providers are faced with a difficult task of predictingthe future, where will the interest rate will be in the next 5, 10 years tocome? Currently economists predict that in the few years to come interestrates will be on the rise because of mounting economic pressures on theglobal market.When assessing loan applications mortgage providers can stress test theirclients and see if they will still be able to afford the mortgage repaymentstoday if interest rates are to go up by say 1%, 3%, 5% and so on. Forexample if client is priced at 9% then the finance provider can stress test theclient and see if he/she will still be able to afford mortgage repayments ifinterest rate is to rise to 10% ,12% ,15% etc.The question that arises is, should the client fail to afford the bond after astress test of say 3%, should the financial institution decline the bond now?In my opinion this need a holistic approach by looking at how much is theshortfall on the income, targeted time frame (2% interest rise over whatperiod) and to consider approximate salary increments in the same periodbefore a credit decision is reached.
(6)Loss of property valueCurrently residential property market remains a suppressed market, it’s abuyers market and mortgage financers’ are taking a conservative approach.With current property and market forces, property values continue to besubdued.Over the past years property value has fallen faster than the outstandingmortgage loan. In some instances clients are currently sitting on highermortgage debt than the current market value of the property.For newer residential mortgage loans of 5 or so years old, some clients mayfind it difficult to dispose their properties and recover equivalent or morethan their mortgage outstanding balance because of depressed propertymarket values. If the client is desperate to sale at depressed prices, theclient is still left with a balance to repay to the mortgage financiers. Thisscenario tempt client to “dump’’ the property back to the bank especiallythose who may have more than one property (mostly for speculative) orlooking for quick sales.Mortgage Financiers can ask clients to contribute towards their investmentsby requesting deposits of say 5% - 50% to cushion themselves and guardagainst loss of property value and also to make clients more committed totheir long term investments.(7)Internal Assessment ToolIn earlier years there used to be weaknesses in internal risk assessmenttools. The focus of financiers was driven by volumes and market shareinstead of quality, quality lending is now the focus of mortgage financiers.The chase for market share might have overshadowed the need for strongassessment tools and current delinquent accounts are a result of yesteryearpoor assessment tools. However, the focus has changed from quantity toquality.As internal risk assessment tools are the first line of defense there has beena great change and improvement on that aspect in an effort to make correct,logical and consistent decisions. The introduction of the National Credit Acthas also helped that cause.
ConclusionLooking forward, mortgage providers especially the debt collectiondepartments should breathe a new life as the emphasis is on making thecorrect decisions.For time to come the market will remain slowly picking up although themajority of clients may find it difficult to successfully acquire mortgage loansunless they adopt a saving habit (for deposits required), reduce creditappetite, improve on current debt repayments (NCR reports indicate thatcurrently more than 56% of people who are in debt they have at least 1account in arrears), and an improvement on conducting bank transactionaland credit products.