Balancing the unsecured: Indebtedness rises alongside overall wealth

Just as a middle class has emerged in South Africa over the past decade, consumer debt has become a central feature of the retail banking market. While household wealth has risen significantly since 1994, reaching R3.5trn ($426.65bn) by 2012, indebtedness has accelerated too. By November 2012 the system counted some 19.6m active individual borrowers, up 4.5% (some 890,000) on the previous year, according to investment bank Investec. “It has been retail banking rather than more exotic products that have driven our banks’ performance,” Gill Marcus, governor of the South African Reserve Bank (SARB), told OBG. Alongside the big four banks – Standard, FirstRand, Absa and Nedbank – a segment of specialist banks has transformed a stagnant microfinance industry into a class of eager lenders to low- and mid-income earners. A market of roughly 9.5m formal-sector employees – out of a total labour force of nearly 18m – has proven one of the most attractive segments for unsecured lenders.

Rise Of The Specialists

While credit to the private sector expanded 9.6% in the year to November 2012, the fastest pace since February 2009, the key driver of growth has been unsecured lending. Whereas lending backed by collateral is dominated by mortgages and vehicle loans, unsecured credit (loans not backed by collateral, typically on the basis of advances on salaries at significantly higher interest than prime lending rates) have emerged as a key instrument to extend funding for lower- and middle-income earners.

Credit card debt rose 31.9%, from R62bn, ($7.56bn) to R81bn ($9.9bn), in the year to November 2012, while term loans grew 33.6% by value, from R427bn ($52.05bn) to R570bn ($69.5bn), in the same period, according to SARB data. Yet the single fastest-growing segment in consumer lending was unsecured, rising on average 25% a year since 2005 – but with growth accelerating significantly to 47.7% year-on-year (y-o-y) in 2011 and 49.3% y-o-y by the second quarter of 2012, to R43.3bn ($5.3bn). While still accounting for less than 10% of the total consumer loan book, such growth has far out-paced that in mortgages, which increased at a rate of 5.3% in the year to the second quarter of 2012, to a total of R140bn ($17.07bn), according to the National Credit Regulator (NCR). “Unsecured lending has grown rapidly in the last year, but from a low base,”

Cas Coovadia, managing director of the Banking Association of South Africa, told OBG.

New Lenders

A lack of social cohesion has served to constrain typical microfinance activity, wherein timely loan repayments are usually ensured by an individual’s sense of responsibility to his community. In the midst of a small banking crisis at the start of the millennium, new lenders specialising in unsecured lending emerged from the acquisition of struggling microfinance banks.

The two largest unsecured lenders in order of size, African Bank Investments Limited (ABIL) and Capitec, emerged in 1999 and 2002, respectively, following the decline of several other microfinance lenders. Acquiring the personal loan books of several struggling banks, the two grew at exponential rates.

ABIL led the pack with an unsecured loan book of R53bn ($6.46bn) by September 2012, recording 33% growth over the previous year, while Capitec achieved compound annual growth of 74% in its loan book from 2003 to 2012, reaching R18.8bn ($2.3bn). Smaller specialist lenders like Bayport, a subsidiary of Transaction Capital with a R4bn ($487.6m) loan book, have also entered the segment, although six major lenders – the big four commercial banks and two leading specialist lenders – accounted for 88% of the R140bn ($17.07bn) unsecured lending segment. By March 2012 the two specialists led the market in unsecured loans, with ABIL holding 31% of the market, followed by Capitec and Nedbank at 14% each, Absa and FirstRand at 13% and Standard Bank at 12%, according to NCR figures.

Driving Growth

A variety of factors supported this rapid expansion in unsecured credit. Efforts to extend the credit market to a growing number of low-and mid-income earners, who typically do not own sufficient collateral to borrow, supported the aggressive expansion of specialist lenders. While unsecured loans were marketed to low-income earners exclusively at the start of the millennium, lenders have increasingly expanded up the income ladder in recent years. Indeed, by the third quarter of 2012, four-fifths of all unsecured loans were extended to mid-income customers in the Living Standard Measure 4 to 7 bracket. According to Investec, some 62% of unsecured credit recipients earned less than R10,000 ($1219) a month, with a further 22% earning up to R15,000 ($1828) a month.

New Rules

The relative retrenchment of the big four commercial banks from the mortgage segment also played a role in encouraging a shift toward borrowing in the unsecured space. Larger banks scaled down new lending for home purchases in anticipation of higher capital charges for mortgage books under the Basel III rules enforced beginning in January 2013.

The majority of unsecured loans were of smaller values, with 66.3% of these loans standing at less than R45,000 ($5485) and 14.9% between R60,000 ($7314) and R100,000 ($12,190). Interest rates on unsecured loans from specialists averaged 31% in the third quarter of 2012, compared to 19% for mortgages, 22% for secured loans and 23% on unsecured loans from commercial banks, according to NCR data. A significant part of such loans is used for home improvements, with 23% of unsecured loans in the third quarter of 2012 taken for building and renovation. “We see around 30% of such loans going towards immoveable home improvements, so it makes sense for banks, which account for over 80% of such loans, to move into unsecured mortgages,” Coovadia told OBG. By late 2012 specialists like ABIL announced the launch of dedicated unsecured mortgages to circumvent the challenges of accessing property deeds in townships and rural areas.

Reaching The Limits

Despite the retrenchment by commercial banks, total household debt has continued to grow on the back of unsecured lending, with debt to household disposable income rising from 75.6% in the first quarter of 2012 to 76.3% in the second quarter of that year. Although the cost of servicing debt has fallen along with interest rates, household indebtedness has increased – an apparent contradiction the SARB attributes to the rise of unregulated lending. As borrowers have faced growing challenges in repaying debt and have been frozen out of new lending from conventional banks, they have increased their total exposure through credit cards, store cards and informal lenders. As household indebtedness grew in 2012, specialist lenders gradually extended larger loans with longer tenors, with about 69.8% of unsecured loans extended over 30 months or more by the third quarter of 2012, according to the NCR. “Some credit providers offer longer terms and larger loans than in the past, with perks like six-month grace periods after first instalments – all of these are signs that the system is frothy,” Mike Brown, CEO of Nedbank, told OBG.

As borrowers delayed repayment of unsecured loans, the number of accounts reported as current dropped in line with growing debt levels, reaching 70.6% of all accounts by mid-2012, down from 73.9% in December 2011, according to Investec. By the third quarter of 2012, the number of retail borrowers with impaired credit records – those with three or more payments in arrears – exceeded peak levels recorded in 2010 when impairments reached a high following the 2009 slowdown. The NCR found in that the third quarter of 2012 some 9.1m of the total 19.5m active credit customers were impaired, with as many as 3.6m in deep credit impairment. Unsecured lenders typically seek garnishee orders from the courts following loan impairments, allowing them to impose compulsory debt repayment taken from a borrower’s salary before he or she is paid. The debate on unsecured lending reached a crescendo following the events in Marikana where 36 people died following strikes at the Lonmin mine. Studies by the NCR following the riots found that over 15 micro-lenders had been charging excessive interest rates, above the 31% NCR-imposed cap, and had used garnishee orders without proper legal backing. While the media debate tended to include all types of unsecured credit in their reports, including that provided by illegal lenders, registered banks argued that the excesses were caused Credit standing of consumers, 2009-12 by informal lenders, which account for some R12bn ($1.46bn) in credit, according to the NCR.

Curbing Exuberance

While still accounting for only 9% of total lending, the growth in unsecured loans prompted the authorities to take action. In November 2012 the Treasury and the SARB signed an agreement to promote responsible lending and prevent the snowballing of household debt. The NCR, established in 2007 with the passage of the National Credit Act, is meant to protect borrowers and promote responsible lending. “With a R1.2trn ($146.3bn) credit industry, our role is both in enforcement as well as in educating the consumers about their rights, which we do in conjunction with the Financial Services Board and the Consumer Affairs Office,” Nomsa Motshegara, CEO of the NCR, told OBG. With a remit covering all lenders with loan books exceeding R500,000 ($61,000), credit bureaux and debt counsellors, the regulator imposed caps on lending rates and loan terms, while embarking on a consumer education campaign to improve awareness of borrowers’ rights. The regulator surprised many in February 2013 when it called for a R300m ($36.57m) fine on African Bank for reckless lending practices, sending a signal to lenders on excessive lending.

Limits

While it claims to have returned some R43m ($5.24m) in funds to wronged consumers since inception, the limits to the NCR’s protection became evident as it raised alarm bells around unsecured lending in late 2012. Although the regulator began drafting revisions to the act in late 2012 to close loopholes exploited by more aggressive lenders, the recent agreement between the central bank and Treasury is expected to curb the excesses of unsecured lending by reviewing the terms of assessment of loan affordability, granting relief measures for borrowers in arrears, and reviewing the use of court debt orders and garnishee orders. The Banking Association has committed since November 2012 to avoid using garnishee orders against borrowers in default. Growth has slowed the excesses of early 2012, with y-o-y growth in unsecured loans dropping from 49% y-o-y in July to 39% in September and 22% in November according to the NCR, and the SARB reporting falls in month-on-month lending growth. While the announcement of new rules covering the terms of such loans have played a role, specialist lenders have slowed credit expansion in the latter part of 2012.

Risk Provisioning

Both ABIL and Capitec tightened new loan criteria while increasing their provisioning for non-performing loans. By November 2012, both lenders reported that a third of clients applying for new loans were over-extended, making them ineligible for new unsecured debt. “Eighteen months ago we’d approve 80 out of 100 loans. In 2012 it was 77 out of 100, and by the end of 2012 it was 68 out of 100,” Leon Kirkinis, CEO of ABIL, told Bloomberg in January 2013. While the average provisions for bad debt stood at 60-70% of unsecured loans in 2012, both raised the level of capital held against bad debt substantially later in the year. Capitec announced in August 2012 that it had raised its arrears coverage ratio to 174% in anticipation of a rise in defaults.

“Defaults on unsecured loans could rise in 2013, but specialist banks that are more exposed in this segment hold significantly more capital for such loans than the larger banks that are less exposed, and the higher interest on such loans should cover any such rise,” René van Wyk, registrar of banks and head of the bank supervision department at the SARB, told OBG.

While the market for unsecured loans remains frothy and faces a likely rise in defaults in 2013, cooler heads among specialist lenders and stricter regulatory oversight of market conduct from the SARB, the Treasury and the NCR have started to curb the excesses of 2012. Lenders expect growth in unsecured lending to drop by around half to 15% in 2013, which could affect consumption by low- and mid-income earners. While the driver of profitability in retail banking is likely to shift towards the wealth side, unsecured lending will continue to play a key role in financing both consumption and home improvements in the future.

The challenge for both regulators and market participants will be to strike a balance between access to debt and the preservation of financial stability. Preference for counter-cyclical actions by the regulator and conservative provisioning by lenders should insulate the banking sector from the excesses of consumer debt witnessed in more advanced economies like the US.

Unsecured loans market, March 2012