National Credit Act prohibits type of lending that led to the huge meltdown in US loans markets

Isaac Moledi

Isaac Moledi

Stock markets are once again reeling from the bad news surrounding sub-prime lending in the US.

This is the second time in less than a year when US markets have brought turmoil in emerging markets as a result of sub-prime lending.

Sub-prime mortgages, according to Absa group senior economist Jacques du Toit, are non-prime mortgage loans, or mortgages of a low quality and a high risk compared with the rest of the mortgage market.

These housing loans are made by lenders to individuals with poor credit records.

A mortgage expert explains why a similar meltdown is unlikely in South Africa.

Jack Trevena, managing director of bond originator Bond Excel, says the US home loan market is completely different from the South African one.

In the US and some European countries, Trevena says, subprime lending has become a multibillion-dollar industry that is spinning out of control.

"Obviously, normal declines in rates would cause a normal housing boom, as evidenced in the housing frenzy that was brought about quite naturally by the drop in the US repo rate to one percent.

"But in these countries, money is advanced to people who cannot afford a home loan under normal circumstances, causing prices to heat up even more," Trevena says.

Unfortunately, the US repo rate subsequently rose to about six percent.

"Just doing the calculation at a bank rate level, never mind prime, which is usually two to three percent above the bank rate, will show that the adjustable rate mortgage has risen by about 600percent," Trevena explains.

This means that Americans who bought a house, say, four years ago, are now paying 600 percent more in interest.

"Fortunately, at the time the repo rate stood at one percent, and borrowers could opt for a fixed rate of 2,99 percent over 30 years.

"Those who did so are less affected by the massive increase in the interest rate," he says.

But Trevena says a substantial number of sub-prime borrowers have begun to default on their repayments, in some instances without even a single repayment being made, causing a massive crisis.

This means that the books of debt, and the financial instruments used to back it up, are almost worthless.

In South Africa, the picture is very different, says Trevena.

"Our major banks have not entertained sub-prime lending, tempting as the returns may be," he says.

He says each of our banks has resisted this high rate, high margin alternative to traditional home loan lending. That is why there is no major product exposure to this market.

"Where higher rate lending may have occurred in the lower segment of the market, these books of debtors are very small. The current national home loan book is in excess of R740 billion," Trevena says.

In addition, none of the major institutions provide facilities such as deferred repayment, which allows borrowers to start off with small repayments which increase over, say, five years, to larger than normal repayments.

The South African market also does not offer bullet home loans, in which only a portion of the capital is serviced over the loan period and the balance becomes due at the end of the loan term, similar to residual values in vehicle finance, he says.

"Our financial institutions have been conservative and responsible in their thinking and lending, and have, as a result, avoided the trap of improving margins using 'exotic', meaning 'extremely high risk' products," says Trevena.

In addition, Trevena says, the type of reckless lending practised in the US is being prohibited by the National Credit Act, to ensure that a similar meltdown does not take place in South Africa.