Retail banking: Rand heightens unsecured risks
African Bank seeks rights issue; Impairments at record high
South Africa’s largest unsecured lender, African Bank, is asking investors for more capital this autumn, as the country’s previously thriving consumer finance sector faces greater challenges. Added to the effects of a wave of trade union strikes, the rand was among the currencies worst hit by increased outflows from global emerging markets over the summer. Unsecured retail lending is the area of South Africa’s financial sector most at risk.
“My concern is that impairments [in unsecured lending] are picking up in a still benign environment,” says Johann Scholtz, head of research at Afrifocus Securities in Cape Town.
Scholtz wonders how much more impairments will rise if the economy “turns south” – something he strongly expects, given the falling rand and a current account deficit suffering from geopolitical effects on the oil price.
Scholtz’s worries are especially relevant to African Bank. The lender specializes in consumer finance and relies on wholesale funding, which has become more expensive on the international market because of expectations of US rate rises.
In the sector as a whole, although unsecured loans account for only about 10% of loans, according to Scholtz, the contribution to profits is more like 25% because of high yields, so problems in unsecured lending mean a glum outlook for sector profitability.
By the end of August, African Bank’s share price had fallen more than 40% since a May 3 profit warning. The price of shares in the second-largest retail specialist, Capitec, also fell, by 16%, although this bank has more ability to fall back on transactional banking revenues.
African Bank’s loan-loss ratio rose to a record 14.9% at the end of March, from 12.4% a year earlier. Marcus Borner, the bank’s executive for balance sheet management, says credit losses will stay “at or above” this level for the next six to 12 months.
Sector-wide, slowing credit growth and the seasoning of loans extended two to three years ago are among the reasons impairments have risen over the past year, despite the macro-economy (as Scholtz points out) being fairly stable.
But the rand’s depreciation and events in the Middle East mean there is more pressure on consumer wallets via imported inflation. Lower-income borrowers – those unable to take out mortgages – will be particularly affected.
“As our customers tend to spend more of their income on transport, the impact of [higher] petrol prices will have a disproportionate impact on our customer market,” says Borner.
Meanwhile, an increase in strike activity at the end of August (particularly in the mining and construction sector) is adding to macroeconomic woes and unsecured clients’ ability to repay loans while they are on strike.
If strikes are successful, there might be an increase in wage levels. Previous wage increases have, in part, enabled the retail lending sector to grow. Still, strikes in August and September last year added to African Bank’s impairment charges, says Borner.
As mortgage lending is less relevant to those on lower incomes, unsecured lenders such as African Bank, according to Borner, have a higher proportion of clients liable to go on strike compared with the big-four banks.
In early August, African Bank announced that in light of the “challenging market backdrop” it intended to raise R4 billion ($392.2 million) in new equity before the end of the year, in a rights issue underwritten by Goldman Sachs. That might pacify investors.
But the National Credit Regulator (NCR) is also due to come up with proposals on the South African equivalent of payment protection insurance by the end of the year, perhaps bringing more bad news for unsecured lenders.
The NCR laid the way for the unsecured boom in 2007 by removing a size limit on loans on which banks could charge the maximum permitted rate, as banks could then extend unsecured credit where before they might have granted mortgages.
Perhaps, via new rules on credit insurance, the NCR might end the boom too. Scholtz points to Nedbank, where he says credit insurance keeps the unsecured book profitable, despite bad debt at 13%.
“The economics of personal loans wouldn’t make sense if you excluded credit life insurance,” he says.