In the wake of African Bank’s collapse, the focus should shift to the size of unsecured loan books as a percentage of total loans at all banks.
That’s the view of Farzana Bayat, Senior Portfolio Manager at Prescient Investment Management, the quantitative fund manager in the Prescient Group, who noted that unsecured loans – South Africa’s own version of sub-prime loans – have grown from R41bn in 2007 when the National Credit Act was signed into law, to R172bn in March 2014, a 26% annual compounded rate.
Unsecured loans are consumer and small business loans that are not backed by assets. They are the fastest growing segment of South Africa’s credit market, having become popular with banks and other providers because they are able to charge high interest rates, making these riskier loans far more profitable than mortgage and car loans in the low interest rate environment of the past half-decade.
“With consumers under pressure and the profitability of managing an unsecured book under pressure, the key question is which banks have made large enough provisions to cover any fall out.
“It would appear that certainly in respect of the traditional big four banks that unsecured lending is a small part of their books and provisions against bad debts would appear to be reasonable. However, the focus should be on the size of unsecured books as a percentage of total lending right now amongst all banks,” said Ms Bayat.
She added that as far as other micro-lenders and unsecured lenders are concerned, it would seem that what differentiates African Bank is their reliance on wholesale finance to fund their lending book, whereas the bigger banks and Capitec rely to a large extent on retail deposits.
“Retail money is cheaper and in times of market dislocation, banks that rely on wholesale funding are likely to be punished more by the market. The squeeze on margins is larger and quicker and the greater the mismatch between assets and liabilities, the greater the impact on profitability.”
Ms Bayat explained that with unsecured lending there’s no underlying asset as security for loans.
“When there is no security, there is a higher potential loss for the lender, so the interest rates on unsecured loans are significantly higher than secured loans. While banks are the biggest providers of credit in the market, unsecured lending is not limited to banks, and includes retailers’ lending books and store card balances, amongst others.”
She added that the big four banks look well capitalised, with capital levels higher than the minimum requirements of the South African Reserve Bank (SARB) and Basel 3, the global regulatory standard on bank capital adequacy and market liquidity risk.
Due to the nature of the risk of their book, microlenders tend to hold higher levels of capital. Historically, both African Bank and Capitec have held Tier 1 capital in the region of 30-35%, which Capitec had maintained to date. African Bank’s tier one capital ratio dropped sharply from 35% to 20% in 2008, which should have been a warning sign to debt investors.
In debt markets, a firm is at the verge of default when the market value of its liabilities matches the market value of its assets – that is, when the distance-to-default is zero.
“Abil’s creditworthiness as measured by distance-to-default has historically been lower than the major banks. Since 2012, Abil’s credit worthiness started to decline and continued to deteriorate dramatically in 2013 to 2014.
“In terms of price, our view was that ABL paper never traded at sufficiently high enough spreads to the big four banks to justify inclusion in any of our portfolios of fixed income assets, i.e. the compensation in yield for the credit risk embedded in the bonds was insufficient relative to the risk.”