The South African credit bureau TransUnion recently released data on the performance of various different products within the bureau in their ”Quarterly Overview of Consumer Credit Trends” for the third quarter of 2020. With the COVID-19 crisis, 2020 was characterised by a severe reduction in account originations and payment holidays in Q2 with a high increase in non-performing accounts in Q3 as payment holidays ceased and stressed consumers failed to pay their accounts.
The table below illustrates how each product showed worse performance (in terms of accounts moving to 3 months or more delinquent) year-on-year in Q3.
The table typically follows payment hierarchical patterns with credit cards performing best, but also illustrates risk-appetite for each product with clothing, microloans and retail instalments all showing the worst performance. For the retailers the closure of stores in Q2 meant fewer new good accounts were washing through, so the bad performing books in Q3 are/were accentuated.
What does stand out, however, is the performance of mortgages that suffered a 350-basis point slump year-on-year in Q3. This is off a low overall “bad rate” too.
Will the mortgage books bounce back, or will we see ourselves enter a mortgage provision spiral as we did in 2008/09?
“When the spiral begins the knock-on effects can be catastrophic with provisions taking a hard hit.”
Provisions in mortgages are unlike other product classes in consumer credit. When the spiral begins the knock-on effects can be catastrophic with provisions taking a hard hit. Banks around the world valued their books very differently post 2009 compared to pre-2008. A certain South African retail bank’s mortgage book valuation dropped by over 90% due to the knock-on effect of a mortgage provision spiral. Now the property market has been subdued for some years (compared to the bullish period leading up to 2008) so we are not expecting a mortgage crisis, but it is possible that a spiral will affect mortgages significantly as we enter a bearish market.
How does the spiral work?
- An increase in defaults loans will mean the banks will need to make a difficult choice on whether to show leniency on the defaulting customers or to take strong action with repossession being the ultimate act. An increase in defaults also typically means that the book is not aging as expected and that the Probability of Defaults (PDs) experienced are higher than expected. Increase in defaults typically leads to more repossessions.
- More repossessions will mean the bank is left with an increased amount of stock (properties) to sell.
- More stock will likely mean bigger haircuts (i.e. difference between the net selling price of the property and its value) as the market becomes a buyer’s market. More stock together with the fact that banks will tighten lending criteria, will push property prices down.
- Bigger haircuts will mean an increase in shortfalls (i.e. where the net-value received for a property is less than the outstanding balance of the mortgage).
- More shortfalls will mean fewer voluntary sales to avoid defaulting (in bullish markets, consumers in financial destress may be pushed to sell their property; they’d likely make a profit from the property thus incurring no shortfall).
- Lower house prices will also contribute to more shortfalls and this in-turn results in much higher loss-given-defaults (LGDs). Higher PDs and LGDs pushes up provisions dramatically.
- Fewer voluntary sales to avoid defaulting means more accounts will now default and the spiral continues.
The difference between a bullish and bearish market is illustrated in the image below. Whether we enter a bearish market and endure a mortgage spiral will depend on defaults increasing (generally due to the stressed South African economy) and whether banks enforce an increased number of repossessions.
Whether we enter a bearish market and endure a mortgage spiral will depend on defaults increasing (generally due to the stressed South African economy) and whether banks enforce an increased number of repossessions.
Performance bounce back for the retailers
At Principa we work closely with many retailers and we are aware that for many of them, Q3 saw accounts accelerate to a 3+ arrears state, but thereafter the book improved somewhat (i.e. those who were already stressed – accelerated to default – an inevitable ultimate state for some. On the other hand, the survivors are those resilient to the economic woes and continued to perform well; new accounts are also open). We look forward to establishing whether the same is true for mortgages when the performance figures are released for Q4.