Solid mortgage debt repayment performance has much to do with a major lowering of overall household indebtedness since 2008, along with the SARB’s more moderate approach to interest rate hiking these days. A hypothetical model simulation of a 2008-style economic shock, in 2017 yields far better results in terms of bad debt levels this time around, were such a shock to take place.

KEY POINTS

 Most of the recent indications have been that the Residential Mortgage Market has been slowing down in terms of volume and value of new lending, with little or no real growth to speak of.

 Looking forward, we are not projecting any major change to this situation. The FNB forecast is for slightly improved economic growth in 2017 of 1%, from an expected 0.2% rate for the entire 2016, and for interest rates to remain at current levels through 2017/18

 Average House Price growth is forecast at 3% for 2017, after an expected 5.1% average for 2016.

 In terms of mortgage market transaction volumes, after a forecast 6.3% decline in the volume of bonded property transactions by individuals (Natural Persons) for 2016 as a whole, a further -2% decline is projected in 2017.

 Using NCR (National Credit Regulator) data for mortgages in arrears for longer than 3 months, which we classify as “non-performing loans”, under the FNB economic and interest rate forecasts the projection is for the value of such non-performing loans as a percentage of total loans to resume a gradual declining trend in the near term, averaging .3.2% of total loans outstanding in 2017 after a forecast 3.3% for 2016 as a whole.

 Residential Mortgage Sector vulnerability to economic and interest rate shocks has been greatly reduced through a significant reduction in the level of Household Sector indebtedness since 2008.

We conduct a hypothetical model simulation where we re-create a 2008-style economic shock in 2017. The result is a significantly smaller deterioration (rise) in industry-wide non-performing loans to 5.7% of the value of total loans in 2018, compared to a more severe 9.2% peak in 2010 just after the financial crisis. 

Most of the recent indications have been that the Residential Mortgage Market has been slowing down in terms of volume and value of new lending, with little or no real growth to speak of. That should not be too surprising, given that interest rates have risen mildly in recent years, and the country’s economic growth rate hovers not far from zero, constraining employment and income growth for households.  

Looking forward, we are not projecting any major change to this situation. The FNB forecast is for slightly improved economic growth in 2017 of 1%, from an expected 0.2% rate for the entire 2016. That mildly improved expectation is on the back of the belief that the SARB (SA Reserve Bank) is done with interest rate hiking for the time being, and will keep interest rates at current levels, where Prime Rate is 10.5%, through 2017 and 2018. In addition, we assume some normalization of Agriculture GDP (Gross Domestic Product) in 2017 as the drought conditions ease, and signs of some mild global economic turnaround could also be mildly more supportive of our domestic economy next year.

However, a 1% economic growth forecast remains a weak one, and that would not be expected to lead to any major mortgage market strengthening just yet. Average House Price growth is forecast at 3% for 2017, after an expected 5.1% average for 2016. Only in 2018 do we project a slight strengthening in the annual average price growth rate to 4.7%, should mildly improved economic forecasts hold. But in both 2017 and 2018, such average house price forecasts would translate into house price decline in real terms, i.e. when one adjusts house price inflation for general Consumer Price Index (CPI) inflation.

In terms of mortgage market transaction volumes, after a forecast -6.3% decline in the volume of bonded property transactions by individuals (Natural Persons) for 2016 as a whole, a further -2% decline is projected in 2017, with positive growth in the bonded component of property transactions only returning to positive growth in 2018. Growth in the average value per bonded property transaction by individuals is forecast to slow to as low as 1% for 2017, contained by a financially constrained Household Sector.

However, while the Residential Mortgage Market is indeed slow, we have not seen a major deterioration in financial stress levels in the market to date. Viewing NCR (National Credit Regulator) data, we did admittedly see mortgages in arrears for longer than 3 months, which we classify as “non-performing loans”, rise to 3.4% of the value of total Household Sector mortgage loans outstanding by the 2nd quarter of 2016, from a lowly 3.1% at the end of 2015. But this is not a severe rise, and the percentage remains very low compared to a painful high of 9.4% reached in the 1st half of 2010, following the 2008/9 recession and 2008 Prime Rate interest rate peak of 15.5%. And Should the FNB economic and interest rate forecasts indeed play out in the next few years, the projection is for this non-performing loan percentage to resume a gradual declining trend in the near term, averaging .3.2% of total loans outstanding in 2017 after a forecast 3.3% for 2016 as a whole.

So, while there is a distinct lack of growth in the Residential Mortgage Market, which appears set to continue, the market continues to perform well, under the poor economic circumstances, in terms of the level of mortgage debt repayment performance.

 Solid mortgage debt repayment performance has much to do with a major lowering of overall household indebtedness since 2008, along with the SARB’s more moderate approach to rate hiking these days This solid performance has much to do with the major changes in the stringency of mortgage lending subsequent to the financial “crisis” of 2008/9, and is perhaps also due to a more cautious Household Sector in recent years.

The result has been a healthy decline in the value of Household Sector Mortgage Loans as a percentage of Household Sector Disposable Income, from a 49.2% all-time high early in 2008 to 34.7% by the 2nd quarter of 2016. Everything hangs together, so important for the mortgage market is that total household indebtedness also be brought to lower and more manageable levels. Indeed, the Household Sector debt-to-Disposable Income ratio has also declined substantially, from an 87.8% high in early-2008 to 75.1% in the 2nd quarter of 2016.

This improvement in the level of household indebtedness, greatly lowering household sector vulnerability, has been the key factor helping mortgage debt repayment performance to remain at relatively low levels, to date, through the most recent period of economic weakness and interest rate hiking. In addition, the magnitude of interest rate hiking has not yet been extreme, and interest rates remain relatively low even despite the hikes to date. So households have not been severely tested yet. But perhaps a 3rd important contributor has been the SARB’s very slow pace of rate hiking, which has sent out the signals to borrowers and lenders to “keep it tidy”, but at the same time has given them ample time to prepare themselves in various ways for further rate hikes.  

 A hypothetical model simulation of a 2008-style economic shock, in 2017, yields far better results in terms of bad debt levels this time around We then used our FNB Home Loans Econometric Model to attempt to test how the level of Household Sector vulnerability has changed since 2008 due to this improvement in the level of indebtedness. We did this by attempting to re-create an inflation and economic shock similar to that of 2008.  

It must be stated that this “shock” scenario is not what we expect to happen, but merely for the purpose of testing Household Sector vulnerability. In this Shock Model Scenario, we took oil prices back up to a brief high of $150/barrel late in 2017 (a far less likely event these days compared to 2008), assumed a major global food price inflation shock similar to that of 2008, and a Rand depreciation significantly more severe than in our actual FNB forecast.

We also assume a significant global economic recession. In this hypothetical Shock Scenario, the modeled outcome is a GDP contraction of -2.1% in 2017, and a CPI inflation high of 10.5% in 2018, with Prime Interest Rate assumed to peak at 15.5% (same as in 2008) early in 2018 as a result. This hypothetical scenario is all very similar to that of 2008/9. It produces a sharp -36.9% decline in the volume of bonded transactions by individuals (Natural Persons), and a -2.1% average house price deflation rate in 2018.

It also, as should be expected, leads to a significant rise in the value of mortgages in arrears for longer than 3 months to 5.7% of the value of total loans outstanding in 2018. However, should this hypothetical modeled event occur, this would represent a vastly better situation than that following the 2008/9 recession, where this nonperforming loans percentage for the mortgage industry peaked a higher 9.2% in 2010, according to NCR data.  

The modeled 2008-style shock situation thus points to the substantial lowering of household indebtedness relative to income levels as a key contributor to the stability in the Residential Mortgage Sector in recently tougher economic times. While a 2008-style oil-driven inflation and economic shock is not expected, the current economic environment remains weak, and if anything our FNB growth forecast risks do lie to “the downside”.

Therefore, while the vulnerability of the Household and Residential Mortgage Sector to economic shocks has been greatly reduced since 2008, we believe that more is needed. And indeed, further healthy decline in the Debt-to-Disposable Income Ratio is forecast in the next few years, as credit growth looks set to remain “pedestrian”. 

HOW VULNERABLE IS THE RESIDENTIAL MORTGAGE MARKET TO ECONOMIC SHOCKS THESE DAYS?

A key question often asked is how vulnerable is South Africa’s Housing Market, and thus its Residential Mortgage Market, to potential economic shocks, which could take place in various forms, including negative economic growth and employment shocks or rising inflation and interest rate shocks?  To attempt to answer this question, we make use of the FNB Home Loans Econometric Model, a “top down” econometric model in which we can view how macroeconomic forecast simulations could impact on the Household Sector, and then on the Property and Mortgage Market.  

For this exercise, we firstly “super-impose” FNB’s “Core View”, or in other words the bank’s main macroeconomic forecast on the model.

THE FNB MACRO FORECAST OVERVIEW

The FNB Macroeconomic Forecast is one of “muted economic recovery” in 2017 and 2018. The view is that the global economy has shown some indications of mild turnaround, and that this means that the worst part of the global commodity price slump could be behind us.  

Indeed, we have seen some key Leading Business Cycle Indicators turning gradually for the “better”, with the Composite OECD + 6 Major Economies’ Leading Business Cycle Indicator’s year-on-year growth turning slightly positive in August, after almost 2 years of year-on-year decline. The IMF Metals Commodity Price Index, too, has seen some mild increase through much of 2016, after a massive broad decline all the way from 2011.