National Credit Regular Consumer Credit Report, reports that as of the end of March 2011 there were 1.8 million mortgage accounts, amounting to over R770 billion and that accounts for 64% of all consumer credit.

The same report reveals that only one in every eight (12, 5%) home loan applications processed is successful, meaning the remainders of the applications do not get registered at the deeds office.

It is clear that residential mortgage credit contributes significantly to consumer credit both in value and in numbers. For many people, home is the most significant investment of their life.

Why is it that only 12.5% of mortgage loans applications are successful? Have Mortgage Financiers taken a conservative approach in their lending?

Looking back to the past 7 or so years ago or pre National Credit Act the home loan approval ratio was over 80%, and from that past experience mortgage financier have seen impairments rising as more and more clients fail to meet their mortgage repayment commitments. This has not only been restricted to mortgage loans but also to other credit products. Mortgage financers are currently sitting on billions of non-performing assets –inform of repossessed properties. And because of that experiences financers have taken a cautionary and conservative approach to their lending , attention has shifted from mass market to high value and low risk clients to safeguard their investments .They say sometimes its better to own 2% of an elephant than to own 100% of a rabbit.

Over the years mortgage financers have devised system based Risk Assessment Tools that has defined parameters on pre-assessing client applications, before they reach the credit personnel. To clients and other stakeholders, this has the effect of getting system based decisions on applications such as decline, approval and or referred for manual assessment. Much depends on what has been fed to the system.

Two key parameters of the Risk Assessment Tools are based on; (i)Affordability –Can the client afford the mortgage loan taking into account the current monthly installment repayments on existing debts and living expenses? (ii) Risk factors – Internal risk based ratings/scoring, this works well when the client has an existing relationship with the credit provider such transactional account or a credit facility and External risk based ratings taken from credit bureau scoring.

If one in every eight applications is successful how do the seven become unsuccessful? (a) Firstly some of the applications are declined upfront by the system based assessment tools – the system based tools will decline the application basing on information fed to the system, client payment behavior and affordability of the loan, however clients always have the opportunity to appeal the decision (b) some of the applications are declined by credit personnel for various reasons. (c) some of the applications are granted with conditions which clients may fail to meet and as a result the mortgage bond will never get to registration.

Conditions placed may force the client to sale existing property that the client owns and some will be unwilling to sale the property. A deposit of say 5%-50% may be required from the client and the client may not be in a position to raise such an amount and the transaction does not proceed.

If credit personnel and Risk Assessment Tools have been effective and in use why has the level of impairments been on the rise in recent years? And what can be done to mitigate credit risk?

Most of the non-payments being experienced today are as a result of mortgage loans granted in previous years and looking back at those delinquent accounts there are various reasons that can be drawn from that;

(1)Additional debt

After mortgage loan is granted, some clients have a tendency of increasing their debt without having their income proportionally increasing. Soon after a mortgage loan is granted and well before it’s even registered some clients have a tendency of going for additional debt by borrowing more e.g.(motor finance, personal loans, credit cards etc). If these debts had been incurred before the mortgage loan was granted, the application would have been declined for affordability. From experience most additional debt is on the personal loans product, in my opinion clients would borrow to finance registration costs as well as deposit. Currently banks are reluctant to grant 100% mortgage finance. Yesteryear banks used to grant up to 108% finance, such products have been discontinued/suspended because of experience and current economic conditions.

To mitigate such risks, mortgage financers can take a quick snap shot at the clients’ bureau profile before the bond is registered. Normally registration attorneys advice financers when they are about to register the bond so that the funds can be released. It is at that stage financers can quickly relook at the client bureau profile to see if the loan is still affordable to the client. If the situation has changed for the worse new and latest documentation in form of pay slips and bank statements etc can be requested by the financer to have a better picture. If the client is unable to afford the mortgage loan at that stage, the application can be terminated. Certain clauses and conditions may need to be inserted in the loan contract to accommodate any legal implications that may come out.

(2)Fraud

In a broad strokes definition, fraud is a deliberate misrepresentation which causes another person to suffer damages, usually monetary losses. Most people consider the act of lying to be fraudulent, but in a legal sense lying is only one small element of actual fraud.

Fraud has been a major problem for mortgage loan providers in the past years. In most cases mortgage transactions granted at the back of fraudulent documentation are of high value in size.

This normally occurs when a client submits fraudulent documents such as – pay slips, bank statements, identification documents etc in order to obtain a loan. Some of these clients may temper with their pay slips to reflect a higher income so that they can afford a higher valued residential property and some may not even be employed or working for themselves. Clients who these mostly it’s for speculative purposes -to resale the property at a profit within a short period of time. Should the property market remain stagnant as it is, those clients will walk away from the property as their needs can not be met. Some of the transactions will involve related members selling to each other and at the end bank is left with the asset in their books.

To combat this financers need a collaborated approach and effort in some areas of common interest such as share information particularly to their clients’ banking information. Banks should be able to freely exchange clients banking information and to authenticate clients’ transactions were necessary unlike in previous years. Banking staff should continuously be diligent and look-out for such suspicious transactions and confirm employment and banking transactions with respective employers and banking institution as per current status.

Culprits should be listed on common data base for the benefit of other users. With time and improvements in systems mortgage financers should come up with a central banking data base where bank personnel and other authorized users can access clients banking transactions therefore eliminating the need for client supplying physical bank statements. Although this might be a costly project in the long term it may help to mitigate the credit and operational risk aspect. Consensus is also required between players in the banking industry as they all provide different credit products.

(3)Unforeseen circumstances

These are losses accumulated as a result of death, retrenchments, loss of jobs, transfers amongst others.

Clients should be encouraged and in some cases forced where possible to take respective insurance covers to guard against this.

(4)Unreasonable living expenses declared.

As per National Credit Act, the applicant should fill in the application form and should do that to the best of his knowledge and in honest. When carrying out assessments financial services providers use the information declared by the applicant before making a decision to grant or decline the application. If information provided is found out to be untrue, legally it becomes the clients’ fault. In some instances a client can declare unreasonable living expenses such as R200 monthly food.

The question is should financers take this amount as true and correct and carry on with the assessment or should they add on reasonable figures such as say R1000? Again the question is where is the R1000 being derived from? Or should there be a rule of thump to say if unreasonable living expenses are declared then a certain number or percentage is applied depending on salary, age etc This remains a debatable issue by I guess credit providers have some ways of going around that issue.

(5)Rise in Interest Rates

The prime rate is currently 9% per annum a level last seen in May 1974. In August 1998 it was 25.5%. This implies that a new mortgage bond of say R1 million at current prime (9%) requires a monthly repayments of R8,998 whereas in August1998 it would have been R21,387. The effects of rising interest rates have a negative effect on the repayment ability of clients as was seen around 2008/9 when interest rates were on the rise.

Residential mortgage providers are faced with a difficult task of predicting the future, where will the interest rate will be in the next 5, 10 years to come? Currently economists predict that in the few years to come interest rates will be on the rise because of mounting economic pressures on the global market. When assessing loan applications mortgage providers can stress test their clients and see if they will still be able to afford the mortgage repayments today if interest rates are to go up by say 1%, 3%, 5% and so on. For example if client is priced at 9% then the finance provider can stress test the client and see if he/she will still be able to afford mortgage repayments if interest rate is to rise to 10% ,12% ,15% etc.

The question that arises is, should the client fail to afford the bond after a stress test of say 3%, should the financial institution decline the bond now? In my opinion this need a holistic approach by looking at how much is the shortfall on the income, targeted time frame (2% interest rise over what period) and to consider approximate salary increments in the same period before a credit decision is reached.

(6)Loss of property value

Currently residential property market remains a suppressed market, it’s a buyers market and mortgage financers’ are taking a conservative approach. With current property and market forces, property values continue to be subdued. Over the past years property value has fallen faster than the outstanding mortgage loan. In some instances clients are currently sitting on higher mortgage debt than the current market value of the property.

For newer residential mortgage loans of 5 or so years old, some clients may find it difficult to dispose their properties and recover equivalent or more than their mortgage outstanding balance because of depressed property market values. If the client is desperate to sale at depressed prices, the client is still left with a balance to repay to the mortgage financiers. This scenario tempt client to “dump’’ the property back to the bank especially those who may have more than one property (mostly for speculative) or looking for quick sales.

Mortgage Financiers can ask clients to contribute towards their investments by requesting deposits of say 5% - 50% to cushion themselves and guard against loss of property value and also to make clients more committed to their long term investments.

(7)Internal Assessment Tool

In earlier years there used to be weaknesses in internal risk assessment tools. The focus of financiers was driven by volumes and market share instead of quality, quality lending is now the focus of mortgage financiers. The chase for market share might have overshadowed the need for strong assessment tools and current delinquent accounts are a result of yesteryear poor assessment tools. However, the focus has changed from quantity to quality.

As internal risk assessment tools are the first line of defense there has been a great change and improvement on that aspect in an effort to make correct, logical and consistent decisions. The introduction of the National Credit Act has also helped that cause.

Looking forward, mortgage providers especially the debt collection departments should breathe a new life as the emphasis is on making the correct decisions. For time to come the market will remain slowly picking up although the majority of clients may find it difficult to successfully acquire mortgage loans unless they adopt a saving habit (for deposits required), reduce credit appetite, improve on current debt repayments (NCR reports indicate that currently more than 56% of people who are in debt they have at least 1 account in arrears), and an improvement on conducting bank transactional and credit products.

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