by Mark Barnes, 14 July 2014, 05:22
IN TRUTH, I’m a little surprised how long it has taken for the "irrational exuberance", typical of such a supply-demand mismatch industry, to cause some spillage in the unsecured lending market in South Africa.
Is it over for unsecured lending? Hell no! It has just begun. In fact, as Winston Churchill famously said in 1942, of the battle of El Alamein: "Now is not the end, it is not even the beginning of the end. But it is, perhaps, the end of the beginning."
Unsecured lending is thriving, and will continue to do so, because there is a widespread and growing need, and because banks either don’t or can’t do it, in the main. It is hard enough for the average person in the street to get a secured loan from a high street bank. Who can offer three times asset cover in this or maintain a debt covenant of that?
Is it just so, that the banks, as they are currently constituted, need to operate in a relatively structured and secure environment — in order to attract, at such low rates, the deposits of the general public? Simplistically, a bank works like this — for every R10 of shareholders’ equity a bank can raise R90 of deposits – that kind of financial leverage would never be acceptable in, say, a manufacturing company, no matter how dominant or successful. If the bank then lends out the full R100 at a 2% margin it will make a 20% return on its R10 equity, because it is 10 times geared — simple stuff, and there’s plenty of 2% and more margin business out there, secured.
The pool of experienced credit skills in South Africa washes about in the banking system, from one employer to another (where else would they go?) resulting in consensus views and inflexible rules. In turn, that leaves little latitude for differential pricing on even vastly different credit risk. There is not enough incentive to move up the risk curve. Hey, its banking.
And so it was, way back in 1992, that the banks argued for a relaxation of the interest rate caps (imposed by the Usury Act, to guard against exploitative lending) in order for them to properly price small loans to the "informal" sector.
The feast began. Regardless of risk, actually, all small loans were raised in price. The previously unbanked couldn’t get enough of it. The lenders felt safe in the knowledge that the PERSAL system would give them first bite at their repayments, before their vast number of public service clients got near their pay packets. Let’s face it — this wasn’t a fair game.
We’ve all forgotten about it, but back in 1998, when so-called unsecured lending was booming, the prime overdraft spiked to 25.5% — tough luck if you had just taken out your first real loan at an interest rate of prime plus 5%.
A crisis had to come. They dealt with that first crisis by taking away the keys to the clients’ money — no more payroll deductions. I won’t remind you of the details, but remember Unifer, remember Saambou? We remember the corporate casualties, not the masses that fell before them.
In the corporate world, one player’s catastrophe can be another survivor’s learning curve, and so it was that African Bank learned and Capitec came into existence. The main-street banks, not to be left out, grabbed their share of the juicy looking margins — party time!
The National Credit Act helped a bit, but it was a compliance rather than an economic test — for the most part regarded as a necessary nuisance. An argument can be made that introducing such binary tests actually takes away the discerning credit scrutiny that is necessary to price this risk proper.
It wasn’t just changes in rules or rates that was required, it was a change in mind-set. The mainstream banks were not, and still are not, able to make the change from relationship and balance sheet lending to the deeply specific, personal (human and systems) interaction necessary to run a risky personal loan book — they’re better at lending money out than getting it back.
If you breach your overdraft limit, regardless of whether it’s intentional or malicious, you will not fill up with petrol, okay? If you’ve broken a covenant or you’ve missed three instalments then the lawyer’s letter comes — and they’re not kidding, and they’re not cross or anything, it’s just the rules — you’re in default and we want our money back. We’ve provided for the loss already so this is an upside only race for us now and we’re the hounds, you’re the hare. Please don’t take it personally, it isn’t. Exactly.
It is personal, and that’s where the successful unsecured players have stepped in and taken "know your client" to a whole new level. They don’t just know your cellphone number, they know where you live and what you’re up to. Why? Because they’ve been to your house before, that’s why. They also know that you’ve just had to pay for a funeral, and that if you’re given two more months and the loan is extended by six, then you’ll pull through. Your brother did last time. Your family is a good risk.
The systems and empirical decision models of the high-risk lender are of necessity better fine-tuned and closer to the client than those of their secured lender cousins — a bit like the safety systems in faster cars; you can’t drive fast unless you know you can either stop or survive the crash.
And so we find our first major business case for seasoned unsecured lenders into the future– buying up the mispriced, badly managed, rigid rules debtor’s books from their less experienced competitors. The economics is compelling — if, and only if, you price it right and manage it closely. Go buy yourself a book at 15% of face value and just collect R18 of the R100 still owed — you’ve got yourself a 20% return already, usually well within a year. After that, all the money you collect is for mahala and, what’s more, you’ve got yourself a loyal client that you helped through a crisis and kept off the bad debt listings.
There will be a life, a very profitable life, in the acquired debt market. There has always been money in garbage, but it is not for sissies.
But it is not just the lenders that have learned. All of us have experienced how the pleasure of the purchase fades long before the pain of the payments end. Worse still, if you didn’t actually buy something, you ate it. Or worse, you bought something you really, really, really didn’t need — like those fake Prada sunglasses (just saying).
So, the acceptable reasons for indebtedness have also evolved, among us. Only two streams survive, really. Something that stays and adds to your life, like that extra bathroom or paved driveway — borrowing for a purpose. Or, better still, something that improves your life and creates earnings capacity, like the cost of books for that distance learning course. So often a pricing arbitrage exists in that the implied interest rate of the terms of the supplier are higher than the interest on the debt you can borrow to pay for the goods or services up front. You’d be surprised how much more people who can’t pay up front end up paying over time, per unit of consumption.
The life cycle of the legacy micro-lending loan books in various stages of decay litter the landscape of indebted South Africa — struggling as much with this transformation as it does with many others. The half-life of a loan in default is measured in weeks or months and, sure enough, the old mess that was once opportunistic microloans will be cleared away.
Those who survived and learned through the first, both the lenders and the lent-to, have emerged a little wiser. Some will graduate into the formal sector but informal, unsecured loans are here to stay.
As the formal banks are currently structured and staffed, they are not going to solve this now. But that’s where the solution must finally come from — one banking system, capable of funding its diverse peoples. The detours must be temporary, the road must be built.
Poor people’s deposits are not being rechannelled into funding the poor. The funding flow is from the poorest people upwards, from the unbankable to the bankable — absurd when you think of it.
South Africa needs a bottom-up, enabling funding solution, if we’re ever to grow beyond social grants from above. If we are to have half a chance at being sustainable, then a solution has to be found within the "formal" oversight and guidance of our leaders and the Reserve Bank.
We’ll get there. Right now, it’s the clever money, quite a bit from yield-seeking offshore funds, that is funding the informal sector, often under the guise of helping us. They aren’t — they’re pushing the price up and they’re not here to stay. They are not us. They have put options and escape clauses and return flight tickets.
There will be a lot of money to be made in this, the aftermath of recklessness, the dawn of the more secure unsecured lending. A number of players will not only survive, but will do well, and they’ll raise the capital — where else can you find such an already-lessons-learned yield?
There will be few — maybe fewer than five players that rule the space. They won’t be all things to all people. They’ll have very, very specific experience, strong relationships and an intimate understanding of the journey that money takes into the informed lenders, from them to the people, and back again — through the many filters that make it work. They will define where the risk-return equation balances.
We’d better. Poor people need access to reasonable funding — this is not an optional extra.