Rates to freefall

The turn in the interest rate cycle looks set to accelerate over the year ahead. Even our conservative Reserve Bank Governor Tito Mboweni is smiling…

Reserve Bank Governor Tito Mboweni’s comment that he wanted to cut the repo rate by 200 basis points but was restrained by his more conservative colleagues can be taken with a grain of salt, but it is a positive indicator that we can expect further interest rate cuts down the line, probably as soon as the next meeting of the Bank’s monetary policy committee (MPC) meeting in April.

The 100 points reduction, with effect from 6 February, is welcome — not just from the point of hard-pressed consumers, but as a prod to help kick-start the country’s flagging economy. Some analysts expect the prime lending rate to fall to 12 percent by June.

Better times are ahead

Apart from the direct relief these reductions afford indebted consumers — whether struggling to repay housing bonds, motor vehicle leases, bank overdrafts, credit card balances, or the new fridge — the forward scenario is one of hope. Hope that better times are ahead.

Public confidence has slid badly over the past two years and this pessimism has been exacerbated not simply by economic duress, but by political strife and uncertainty. Easier borrowing helps concentrate the mind on fundamentals.

Lower interest rates, however, do not herald a return to the glory days prior to the downward cycle which started in June 2006. Then money was freely available; financial institutions fought marketing duels to lure customers into their lending maw. Mortgage rates to 'preferred' borrowers were as low as two percent below prime, or more, and banks were offering 110 percent mortgages which covered legal and transfer costs.

That’s not going to happen now, nor in the foreseeable future. This is not simply the result of the tougher credit conditions imposed by the National Credit Act (NCA), but also because the banks currently do not have the same liquidity. As a result they are charging higher premiums, effectively increasing interest rates to most new customers, even the most creditworthy.

This could add one or two percent to borrowing rates and this should effectively put a damper on the appetite for new borrowings.

Basically this means that instead of getting a bond at a rate below prime, the borrower will probably pay 100 points or so above the prime rate. This will apply to other forms of credit, although one wonders whether the crisis-ridden motor industry will still be forced to subsidise credit facilities just to move metal.

Growth in credit to the private sector has fallen sharply

One of the major concerns of the Reserve Bank in its struggle to control inflation has been the degree of household indebtedness. Although its prime motivation in increasing interest rates was to counter growing inflation, it was also aimed at curtailing consumer borrowing and spending. This, coupled with the National Credit Act, has done the trick and growth in credit to the private sector has fallen sharply.

Unfortunately the boom in the middle 2000s was a consumer-led boom. South Africans tightened their purse-strings out of necessity and stopped buying. Thus producers slowed down production; all economic sectors suffered. The problem now is whether, faced with the worldwide slump, particularly in demand for commodities — a major export — commerce and industry can pick up again.

In hindsight, one has to wonder about the efficacy or even the necessity of the downward rate cycle. Was our household indebtedness to income ratio really so frightful? Household debt in SA in the third quarter of last year in the form of banks’ loans and advances was equivalent to 79 percent of one year’s nominal GDP. The comparative figure in the US, as it entered the meltdown of 2008, was 365 percent.

The local lending clampdown is illustrated demonstrably by the sharp downward trend in mortgage advances since the beginning of 2007. In December 2008 year-on-year growth in the value of mortgage advances (the total net outstanding balance on mortgage loans at financial institutions) slowed down to 13,2 percent from 14,9 percent in November, based on Reserve Bank data. This is quite a fall from the high of almost 31 percent y/y recorded in October 2006. Data available from Absa for new residential loans approved by banks up to the end of the third quarter of 2008 showed a fall of 30 percent on a y/y basis.

This is the accumulated result of a slower residential market, the National Credit Act and tighter credit criteria by the banks.

Residential mortgages are by far the largest mortgage category (about 78 percent of total banking sector mortgage advances).

The smaller commercial component holds up better, but new lending in the commercial mortgage market has nevertheless slowed significantly.

The decline in the household debt/service ratio, as mentioned earlier, is probably a good indicator of mortgage market credit quality and this, comments FNB property strategist John Loos, augers well for a turn for the better on residential default rates this year.

Published courtesy of Pam Golding Properties Intellectual Property Magazine.

Article by: Article By: Pam Golding Properties Intellectual Property Magazine