Future Imperfect

Editor’s Note: Members of our team attended Standard Bank’s Property Breakfast hosted at Grand West Casino in Cape Town. They received a tasty meal, some sweet treats and a look behind the curtain to see what Standard Bank’s policies are, the events that influence them and the current mortgage market leader’s preparations for the future.

Why, oh why must every corporate event feature a mediocre comedian exhorting people to “wake up” and “get loose” to pop songs from 2010 before attendees are given the information they came for? If corporate event budgets continue to tighten I hope that these MCs are cut in favour of the gifts and breakfasts!

Anyway, after the jabber and Lady Gaga died down we were finally given presentations by Standard Bank Senior Credit Manager Steven Morkel and Lightstone Property’s Andrew Watt.  And man did they give us a lot to write about!

Here’s our break-down of what we feel is the most important information…

Looking back: Standard Bank in 2015

Despite volatility across the year and Nenegate in December,  headline earnings rose 27% to R22 billion. Morkel believes that 2015 was a “brilliant financial year” and along with increased revenue the company saw its “best bad debt numbers in 9 years” (meaning that defaults on home loans declined). While share prices are currently depressed this likely reflects investor fears for the future and the Rand’s weakening rather than any disappointment at the results for 2015.

Standard Bank retained its position as both Africa’s largest bank by assets and the bank with the greatest home loan market share, in both value and volume, in South Africa. This is a position it has retained since well before 2013.

Mortgage lending, it was reported, played an important role in growth of revenue at Standard Bank with “close to 50%” of its operating income coming from mortgages.

Looking back: Home loans & property sales in 2015

With Standard Bank approving a little over 50 000 mortgages in 2015 it is easy to see how the company came to rely heavily on this source of income. While the volume of mortgages it has approved has remained relatively stable across the last 4 years, the average size of the loans has continued to increase.

This has allowed revenue from mortgages to continue growing while volumes of loans have stagnated. This mortgage volume stagnation might be indicative of stagnation across the property market (this not a good sign!). Indeed, Morkel went on to say that while “mortgage lending could remain robust in the next two years…[it is] definitely heading into tough times”.

Morkel went on to explain that in 2015 some areas of the property market had already entered those ‘tough times’: retail property prices in agricultural and mining centres have been badly affected by the drought and commodity price collapse. There is evidence of a trend of demand moving away from these areas and into the urban centres of Cape Town, Johannesburg and Durban.

Andrew Watt, managing director of Lightstone Property, echoed this sentiment when he later explained that only Cape Town has experienced consistent value & volume growth increase.

Unfortunately this growth was not evenly spread across the city and the 5 top performing suburbs (in descending order: Greenpoint, Rondebosch, Sea Point, Gardens & Claremont) Accounted for 13% of the value of sales in 2015.

Standard Bank has also detected an upward trend in the average length of time each home owner spends in their property before selling (and consequently keeping the same bond) and attributes this to the growing pressure the consumer is facing from inflation and a growing lack of job security.

Looking forward: Murky waters!

Property Prices

Growing insecurity and uncertainty were the big themes of the 2nd half of 2015 in South Africa and, unfortunately, the structural and external problems that caused this trend remain firmly in place. So despite a healthy set of results Standard Bank is set to closely watch GDP growth in 2016.

As agriculture and mining centres continue to suffer, urban hubs will be the focus of property price growth acceleration as the economy slows. Property prices in these urban centres (Cape Town chief among them) will see property price inflation while other, more rural centres will likely see deflation or at best stagnation.

This will contribute to a continued slowing of average property price appreciation with projections showing a move down from the 5.5% achieved in 2015 to 3.5% in 2016.

With this in mind the Standard Bank group is taking “a long view” of the economic environment and while the feeling is that 2016/2017 is not a “looking good” the bank is cautiously optimistic that the mortgage lending situation will remain “manageable”.

Standard Bank Targets

Unfortunately being cautiously optimistic that a situation will remain “manageable” isn’t particularly happy tidings in the world of business. Morkel would later reveal, what I believe to be, two telling indications of the troubled times Standard Bank sees ahead:

  • Competition for low risk clients in low risk areas between the banks will be fierce and Standard Bank is hoping to aggressively pursue these clients.
  • Despite this strategy the group, which is the country’s largest mortgage lender, has set a target of retaining the same number of mortgages this year as last year.

With property price growth slowing there will also be a slowing in the growth of the average loan value, particularly as the banks pursue low risk lending which generally means smaller LTV (loan to value loans). Even if the same targets are achieved (nothing guarantees this) we will therefore see a decline in Standard Bank’s revenue growth (remember nearly 50% of revenue is generated from mortgages) in 2016.

But why might such a big player in the market be aiming so low? While it might seem desirable to dominate a market this is not always the case! All our top financial institutions (and our financial system is rated one of the best in the world) seek to balance their various assets to ensure that, should one asset suffer significant losses, the entire operation is not threatened.

So, given our particular economic environment (even before the various recent ‘hiccups’) no local institution would find it desirable to have a dramatically dominant share of the home loan market as this would be akin to placing all the eggs in one basket. Better to have a share that is balanced (and each bank has a different take on what it considers ‘balanced’) by other revenue streams and assets, perhaps even internationally based ones.

But there is, of course, another reason: a very real potential for a downgrade of South Africa’s investment status to ‘Junk’. This sovereign downgrade would be quickly followed by a downgrade of all companies based in South Africa as no institution can have a rating higher than that of its home country. This would be a costly turn of events and throw all projections and targets out the window.

The downgrade bogeyman is increasingly real and increasingly scary

Standard Bank’s assessment, according to Morkel, is that the odds are nearly 50/50 that ratings agencies will downgrade South Africa.

If there is a downgrade certain portfolio managers will be forced to divest (even if they don’t want to) as their mandates preclude them from holding stocks and bonds that have a junk status. This will result in a shock to the JSE, the Rand and a jump in the price of international and local credit.

Current projections without a downgrade put prime lending at 12.25% by the end of 2018. With a downgrade Standard Bank is projecting a lending rate as high as 15.25% by the end of 2018. The resultant turmoil will also see the local currency pushed out to R20 to the dollar (or beyond).

All of this will further raise the cost of living as South Africans struggle under the weight of more expensive imports (petrol and now even mealies) and more expensive credit. Millions of heavily indebted households will crumble under this one-two punch combination.

It’s hard not to be alarmist about the consequences of the downgrade.

Home loans

Morkel believes that whether or not South Africa receives a downgrade the economy is already operating in a bad space. The general feeling is that things across the next two years will get worse before they get better. The only uncertainty is the degree.

Like the JSE, which is said to have already started pricing for a downgrade, all the banks will also begin (or have already begun) to adopt strategies to insulate themselves from the risks of both a slow and a sharp decline.

One home loan policy that clearly illustrates this is the fact that it has become increasingly unlikely that a home loan applicant will receive a loan that is 100% of the value the property. The maximum that clients can expect going forward is 90%.

At an LTV below 90% banks are now paying very close attention to the risk profile of the client. Going forward there will be an increasing scrutiny of the customer and those considered to be good clients (low risk, low debt) with a sizeable deposit (10% or more) will sail through.

Additionally, banks will only be offering interest rates below prime to exceptional applicants. These applicants will need to

  • Have absolutely clean credit records
  • Have relatively low exposure to debt
  • Have a sizeable deposit
  • Be purchasing in an area that the bank believes will retain value

Mortgage lending is looking attractive when compared to the rest of the credit environment, particularly as the market is currently saturated with unsecured lending. Mortgage lending is therefore expected to continue at similar trajectory (remember their targets) but Morkel stressed that ANY ‘wobbles’ in the economy could result in a dramatic pullback.

He also stressed that the average rate will be prime plus X for the foreseeable future. With X related closely to the economic situation and the assessed risk of the applicant. BUT again there will be fierce competition for quality applicants (low risk, good areas) and these clients can still expect prime minus.

Main tips for 2016/2017:

  • Urban centres will continue to see price appreciation. Cape Town in particular will likely continue to buck slow growth trends

 

  • Not all properties and areas are created equal: if you’re looking to maximise returns pay close attention to the factors contributing to property price.

 

  • If you’re buying into a complex: Body Corporate and HOA performance will be incredibly important. If records are inaccurate, non-existent or indicate dire financial problems, lending will not occur. As a result a well-run BC or HOA will likely add value to the property.

 

  • Save for a deposit! Even if this delays your property plans the potential savings you receive from a better interest rate will be well worth the wait.

 

  • Credit History remains incredibly important. Keep credit exposure low and keep up to date with payments.
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