Are the banks to blame for the property crisis?

Private Property South Africa
Ewald Kellerman

The property market has recently started to show signs of improvement. The 4th quarter FNB Property Barometer shows that the average time on the market has decreased to just over 13 weeks compared to a high of 16 weeks in the 3rd quarter of 2009. The FNB House price index hit rock-bottom at -7.4% y/y deflation in May 2009, but has since recovered to a positive growth rate to 5.8% year on year inflation by February 2010. The financial media is littered with good news of an improving property market.

However, it cannot yet be said that the property market is in great shape. It is clear that this is still predominantly a buyers market with most sellers settling for prices under the asking price, compared to a couple of year ago when it was only about half of the sellers settling for less. Average time on the market is still over three months compared to less than a month before 2007.

Consumer price inflation is currently sitting at 6.2%. If you subtract this from the house price inflation figure of 5.8% quoted in the FNB House Price Index, the real house price inflation rate is still negative year-on-year, despite the recent market improvement.

Are the banks to blame for the property crisis? Well, it is true that banks are key players in the property market, and thus do influence it to a degree. But they are not the major influence as some would believe. This honour goes to the far bigger global economy, to government with its array of economic policies, and to the Reserve Bank interest rate policy.

Stringent lending criteria by home loan banks have been a hot topic for quite some time now. At a stage of the property downturn, estate agents surveyed by FNB were quoting this as a major reason for weak activity levels in the property market. Around that time, banks had started restricting loan-to-value policies for new loans granted, implying an increased number of loans for which significant deposits were required. However, the banking sector was not driving the weakening property trend through these actions, The evidence of a deteriorating situation was there before this tightening in credit criteria. Therefore, rather than driving the cycle they were merely responding to a deteriorating economic and property trend, caused by the greatest global financial and economic crisis since the Great Depression, rising local interest rates at the time, and surging consumer price inflation eating into disposable income.

You see, South Africa is a very open economy. The value of SA’s exports is about a third of its gross domestic product. The significance of this is that we are extremely reliant on the global economy, and extremely vulnerable to global economic shocks, which can severely dampen demand for our exports and this curtail our economic growth. We are also highly exposed to global inflation shocks due to our high dependence on exports, and the inflation surge up until mid-2008 was predominantly cause by such imported inflation, and the SARB responded by raising interest rates. Therefore, what happens internationally flows almost freely into our economy, affecting our job market and thus our housing market heavily. Even though our local banks have been a great deal more responsible than some of the banks in more developed countries, we couldn’t avoid experiencing the severe effects of the global recession.

From a home loan bank’s perspective, defaults usually occur in the first year to year and a half after the commencement of the loan, i.e. the near term is the highest risk period for the loan. In these early stages, loan-to-value ratios are still very high, compared to an older loan where, normally, the value of the property has increased and a portion of the capital has been repaid. In these crucial first stages of the loan, the banks are exposed to the highest risk, and in the event of early default they experience the biggest loss.

Oversupplies in the market put pressure on the price of stock currently for sale. We have already established that most properties are being sold at a discount to their perceived price in the boom years. Therefore, banks have to be very careful with regard to the loan-to-values that are currently being granted. In the event of a default, the loan-to-value decision could have a very significant impact on the level of near term losses.

Property owners have a much longer investment time horizon when buying property. The risks highlighted for the banks are the biggest at the time when the customer is at his most vulnerable in the early stages of the loan, and for our industry the emphasis is largely on the short term. Property investors, by contrast, normally take a long term view on property, and some capital depreciation in the short term would probably concern many of them far less than it would a bank.

These differing objectives result in a situation where a customer wants to buy with a long-term view, while a bank is looking at the risks faced today, and a misunderstanding of these contrasting focuses are perhaps a reason as to why the banks get blamed for their so-called “pro-cyclical” behaviour.

Our economy and thus our property and mortgage market is highly reliant on the economic well-being of the whole world. Banks have a big responsibility towards customers to ensure that they practice prudent lending policies (both morally and legally). Due to this sector’s inability to fight against these far more powerful global forces, it means that a weak and fragile global economic situation would essentially require a far more cautious lending approach than the better times of a few years ago. This is not necessarily what banks want, but we believe it is appropriate under the circumstances.

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