Debt Relief: Implications for Sovereign Credit Ratings and the Credit Market

Government policy is a major component of sovereign credit worthiness 
As fixed income managers, we have been extremely focussed on the credit rating agencies and their assessment of South Africa of late. The recent credit rating downgrades have been because of the erosion of South Africa’s economic, fiscal and institutional strength. This has all been centred around an extremely uncertain policy environment. Policy change has largely been focused on actively trying to address South Africa’s extreme income inequality, which is considered dangerous and one of the highest in the world. However, these types of policy changes do not come without their risks in creating further unwanted imbalances that may be detrimental from a ratings perspective, and even lead to a consumer that is worse off down the line.

One such example of this policy change is the recent proposal from the Department of Trade and Industry (DTI) on the amendment to the National Credit Act (NCA) to allow for Debt Relief. Consumers are finding it difficult to repay loans as slow economic growth, retrenchments and rising unemployment has diminished household income. Efforts to introduce amendments to the NCA to provide for Debt Relief and forgiveness is an urgent item on Parliament’s agenda as debt continues to cripple many South Africans. The National Credit

Regulator (NCR) is also in favour of some form of Debt Relief. We believe that a proposal to relieve consumers of their debt is flawed and if implemented, is another example of a potential further erosion of financial stability in South Africa. This will most certainly lead to a deterioration in the integrity of the robust and well capitalised financial sector which the rating agencies have highlighted as one of the few credit strengths in their recent assessments of SA.

Regulation needs time to take effect 
There have been many regulatory measures that have been introduced by the DTI in attempt to control and reduce household over indebtedness, and to hold credit providers to account for reckless lending. Figure 1 shows the high levels of consumer indebtedness compared to the average over time. Although still high, the overall levels of indebtedness have started to decline. The affordability Assessment Regulations outline the affordability criteria that credit providers must adhere to and came in effect on 14 September 2015. On the 6th May 2016, limitations on fees and Interest Rate Caps came into effect, and finally regulations around credit life were issued on the 9th February 2017 and have recently become effective.

There is also provision in the NCA for consumers to use Debt Review as a relief measure. This is provided to consumers mainly through restructuring of loans to reduce instalments, reducing interest rates to predetermined levels and waiving of fees by credit providers.  

Debt Relief, however goes one step further and allows certain consumers that qualify, complete relief of their debt burden. Some parliamentary officials have urged that those who qualify should extend to retrenched workers, social grants recipients, the poor, the highly indebted working class and middle class students with student loans. The Banking Association has explained that this regulation would create uncertainty and slow down the banks’ own initiatives. Each consumer has entirely different circumstances. A ‘one size fits all’ strategy would not work and banks need the flexibility to deal with consumers on a case by case basis. Some of these solutions include: short term payment moratoria, debt restructurings and debt consolidation. A prescriptive law or regulation would remove this ability for the banks to tailor solutions for customers according to their individual needs and circumstances. We argue that regulation recently introduced by the DTI should be monitored to determine its effects, before enacting a drastic measure such as Debt Relief.

Unintended Consequences 
As investors in the debt capital markets, we finance the banks, microfinance companies and other credit providers in the retail sectors such as Edcon and RCS. We acknowledge there are credit providers that have acted recklessly in the past and some are still acting recklessly. A key component in our assessment of credit worthiness of these entities is asset quality: more specifically, how conservative their provisioning policies of their lending books are, their collection of bad debt procedures and debt write-off periods. Debt Relief would completely undermine the integrity of these policies and would make it extremely difficult to assess these entities and their credit quality. The reluctance from investors such as ourselves to lend to these entities in the financial sector would only lead to lending rates (yields) going up, specifically bank funding spreads, which would have drastic consequences for the credit market. The rising cost of credit in the financial and banking sector would have major knock-on effects for Corporate and Retail South Africa and the cost at which they can do business.

Besides the consequences for the sovereign credit ratings, the financial sector and us as investors, there will be unfortunately unintended consequences for consumers themselves, the very group that the NCR is trying to protect. Access to credit and cost of credit will be much tighter. Lenders will immediately be more reluctant to lend to those consumers that may qualify for Debt Relief. Whilst we acknowledge that some of these consumers cannot afford their debt burden, unsecured lending has afforded the previously unbanked sector of the population access to credit which has improved their quality of living. This could drive consumers to the unregulated market as loan sharks would almost certainly emerge to prey on those consumers that cannot access credit through the regulated channels. Debt Relief could also encourage further irresponsible borrowing and could encourage consumers to take on more debt that they knowingly cannot afford.

Along with some of the other policies that are being explored in Parliament currently, this is another example of government trying to address diminishing household income and inequality through measures that may have drastic consequences for the economy. The credit rating agencies are almost certain to see this as a further deterioration in the institutional strength and integrity of our financial sector. An erosion of our financial strength such as Debt Relief, may initially provide a boost to suffering low income households, but will ultimately be the cause of further consequences such as the rising cost of credit and ultimately, inflation and unemployment.

August 24 2017 By Bronwyn Blood, Granate Asset Management (RMI) Investing & Markets, Politics