Debt and Risk (The Bugle)

I recently saw a graph that alarmed me. No doubt, economists and our country’s economic policy makers have seen the same graph. They would be concerned and would be asking some probing questions. The graph was entitled “Household Sector Credit Growth” and indicated the South African year-on-year % change of residential mortgage loans by banks, the year-on-year % change of non-mortgage household sector credit growth (lent by Banks) and the year-on-year percentage change in total household sector credit. As at November 2012 mortgage loan growth was bumping along the bottom at 1.13%. The alarming aspect was the exponential growth since early 2010 in non-mortgage credit, which had reached 25% by November 2012. This growth has drawn up the total household credit growth to 10.37%. Whereas previously both mortgage and non-mortgage debt had grown in tandem, the past two years have seen non-mortgage credit shoot off in its own (upward) direction. 

South African banks have been busy – just not on lending money for mortgage bonds. Non-mortgage credit extension represents unsecured lending by banks on typically short term goods that depreciate over time (such as TV’s, fridges, cars). This represents consumption expenditure and contrasts with mortgage credit extension, which is secured long-term lending representing investment expenditure. For any individual to consider taking on debt they need to ask themselves if what they are buying is comfortably affordable and what the risk is (i.e. their vulnerability) if circumstances were to change – such as the cost of finance increasing or their disposable income used to service the debt drying up. 

Economists have asked the same questions for a group of households. FNB’s latest report on household sector financial vulnerability asks these questions. A measure of affordability is the debt-to-disposable income ratio. Currently still very high at 76%, even though it is down from its 2008 peak of 82.7%, the steady increase in non-mortgage credit growth and the stagnation of disposable income growth leads them to believe that this measure may be back on the increase. Slower economic growth, which we have witnessed in the second half of 2012, affects disposable income growth negatively. An excellent measure of risk has been developed by FNB called the Household Sector Debt Service Risk index. On a scale of 1 to 10 this index has been climbing for the past 5 consecutive quarters to a current level of 6.68 and remains well above the long-term (32 year) average of 5.3. This risk index takes into account three main areas of risk: Overall Indebtedness risk, the Indebtedness growth risk and the Interest rate risk. We have enjoyed relatively low interest rates for a sustained period of time with our prime rate at 8.5% and structural consumer price inflation at around 6%. When interest rates are at their low point in their cycle the most likely movement is upwards and the risk then is how such an upward movement will impact on vulnerable households. 

The warning and advise to households is to limit debt to assets that appreciate over time and to ensure your risk is limited in the event of a higher cost of money or lower disposable income.

(Author: Andreas Wassenaar, published in The Bugle, 23rd January 2013)