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OVER the past few months, much has been much written about the significant rise in household debt, especially that of an unsecured nature.
Industry experts have reserved their commentary to provide assurance that the financial system is not at risk. With unsecured debt being a small part of bank debt with no correlation to asset values, such as a house, they may be right.
The financial system is usually only at risk when significant amounts of debt show signs of non-performance, and as a consequence the market starts to notably devalue the asset funded by the debt.
The result is that the asset value drops below the debt outstanding, leaving the lender with less security than the outstanding loan.
A snowball effect then takes place, resulting in more sellers than buyers of the asset class and borrowers losing their appetite to repay a loan on an asset with negative equity, further exaggerating the problem.
However, what has not been written about is the negative effect of the increase in unsecured credit on consumers and their ability to participate in the economy.
Their purchasing power is relied upon by many industries to maintain our economy and its growth. Perhaps more important, though, is that consumers' financial state is imperative to society’s sense of empowerment and general wellbeing.
The current scorecard does not read well.
If 45% of consumers have negative monthly cash flow (based on our research), the average consumer spends 40% of their monthly income on servicing unsecured debt and arrears account obligations, and 47% of credit active consumers (9.22 million consumers out of a total 19.6 million) have impaired records (three or more missed payments) and consequently receive aggressive collection calls, experience stress to afford household needs and have little or no savings, then one cannot feel financially empowered or generally well.
The situation has steadily worsened over the past few years, really hurting the economically active consumers in our society. If we look back four years ago there were 2.5 million fewer consumers with impaired records, 40% more mortgages granted and 300% less unsecured credit sold (comparing the quarters ending June 2008 and 2012 respectively).
This is a significant portion of our economically active population, who now spend their disposable income on unsecured debt attracting high costs for consumables instead of wealth creating, lifestyle improving mortgages.
However, it is not just debt that is being oversold to our consumers. Insurance, savings and similar sales-driven products are also taking their toll.
In our sample of overindebted public servants, we found the following:
• Even though they were ove indebted (monthly cash flow could not service their debt instalments) they had an average of six insurance/savings policies deducted from the public servants' payroll and two additional policies paid via debit order.
Of these policies, 40% were savings products yielding a return at best of 10% per annum while their debts attracted yields of 60%. Of their income, 8% went towards policies.
• Most of these public servants could not give adequate details of the benefits of their policies or their beneficiaries.
• 30% had garnishee deductions where the collector was on average over deducting R1 100 per order.
Consumers in the mass affluent market (income levels between R7 000 and R40 000 per month) who need access to financial advice usually end up with a salesman selling a product from which he or she will earn their income via commission.
This presents a fundamental conflict of interest, only made worse by the low levels of financial literacy in this market segment. Perhaps access to independent and objective advice for the mass affluent consumer would limit such abuse?
Perhaps the Financial Advisory and Intermediary ServicesAct needs to be refocused to ensure that people are given honest and objective advice presented in clear and simple terms, with full disclosure of fees and costs?
There are quick and easy solutions
While the above presents a critical view of the market, we also believe there are quick and easy solutions that will arrest the current trends and in fact could improve them immediately. The solutions we suggest include:
• Allow a once-in-a-lifetime opportunity to set off savings funds (including retirement savings) against unsecured debt balances. The current unsecured loan book (excluding credit facilities) is less than 5% of total savings, therefore not significantly affecting liquidity or similar unintended consequences.
Setting this debt off against such savings means that the consumer will be saving on the yield differential. Currently consumers earn around 7% per annum (net of fees but before tax) on savings funds (Source: Alexander Forbes Global Manager Watch Best Investment View 5 year view) while they pay approximately 60% per annum on unsecured debt (this includes interest, service fees and collection fees on arrear debt).
This would mean a 53% better return on their savings funds (without taking into account their tax consequences on savings products) per annum. Extrapolate this to the term of the unsecured loan, and one can quickly realise the significant benefit for the consumer and society.
• Provide easily enforced affordability rules on reckless lending. This could take the form of limiting debt instalments to a maximum of 40% of gross pay. The consumer, employer, lender and magistrate can easily understand, recognise and enforce this rule ensuring the same voidable provisions where lenders breach this rule.
• Provide retrospective, easily enforced affordability rules on Emolument Attachment Orders. Ensure no employee has garnishee deductions totalling more than 25% of his gross salary. This would disincentivise collectors to rely on this collection mechanism that is open to so much abuse.
• Provide easily enforced affordability guidelines to insurance policies. I suggest that a broker needs to consider net salary, debt instalments, and existing policy deductions prior to offering an additional policy.
If debt instalments and existing policy deductions exceed 50% of net income, then it is not appropriate for the consumer to add another policy.
Perhaps one can build in exceptions for policies with substantially differentiated benefits or focusing on a specific risk previously not covered.
• Provide easily enforced, appropriate advice guidelines for brokers. For instance, where a consumer has unsecured debt, brokers should not sell savings policies or limit the monthly cash flow allocated to savings.
• Prevent credit life charges of more than, say, R8 per R1 000 of the loan outstanding.
In summary, most consumers are experiencing financial stress which could certainly add to the economic stresses of our society.
However, the challenges are easily corrected and small actions could result in substantially relieved consumers. Perhaps there is now opportunity for financial services providers to secure the trust and business of these very same distressed consumers by providing solutions and protecting them accordingly.
In protecting the consumer against poor financial decisions, unscrupulous lenders and collectors, excessive products and irresponsible decisions they will be maximising the consumers' cash flows they so rely on for repayment of their debts.
*Guest columnist Clark Gardner is CEO of Summit Financial Wellbeing and 6cents.co.za.
Industry experts have reserved their commentary to provide assurance that the financial system is not at risk. With unsecured debt being a small part of bank debt with no correlation to asset values, such as a house, they may be right.
The financial system is usually only at risk when significant amounts of debt show signs of non-performance, and as a consequence the market starts to notably devalue the asset funded by the debt.
The result is that the asset value drops below the debt outstanding, leaving the lender with less security than the outstanding loan.
A snowball effect then takes place, resulting in more sellers than buyers of the asset class and borrowers losing their appetite to repay a loan on an asset with negative equity, further exaggerating the problem.
However, what has not been written about is the negative effect of the increase in unsecured credit on consumers and their ability to participate in the economy.
Their purchasing power is relied upon by many industries to maintain our economy and its growth. Perhaps more important, though, is that consumers' financial state is imperative to society’s sense of empowerment and general wellbeing.
The current scorecard does not read well.
If 45% of consumers have negative monthly cash flow (based on our research), the average consumer spends 40% of their monthly income on servicing unsecured debt and arrears account obligations, and 47% of credit active consumers (9.22 million consumers out of a total 19.6 million) have impaired records (three or more missed payments) and consequently receive aggressive collection calls, experience stress to afford household needs and have little or no savings, then one cannot feel financially empowered or generally well.
The situation has steadily worsened over the past few years, really hurting the economically active consumers in our society. If we look back four years ago there were 2.5 million fewer consumers with impaired records, 40% more mortgages granted and 300% less unsecured credit sold (comparing the quarters ending June 2008 and 2012 respectively).
This is a significant portion of our economically active population, who now spend their disposable income on unsecured debt attracting high costs for consumables instead of wealth creating, lifestyle improving mortgages.
However, it is not just debt that is being oversold to our consumers. Insurance, savings and similar sales-driven products are also taking their toll.
In our sample of overindebted public servants, we found the following:
• Even though they were ove indebted (monthly cash flow could not service their debt instalments) they had an average of six insurance/savings policies deducted from the public servants' payroll and two additional policies paid via debit order.
Of these policies, 40% were savings products yielding a return at best of 10% per annum while their debts attracted yields of 60%. Of their income, 8% went towards policies.
• Most of these public servants could not give adequate details of the benefits of their policies or their beneficiaries.
• 30% had garnishee deductions where the collector was on average over deducting R1 100 per order.
Consumers in the mass affluent market (income levels between R7 000 and R40 000 per month) who need access to financial advice usually end up with a salesman selling a product from which he or she will earn their income via commission.
This presents a fundamental conflict of interest, only made worse by the low levels of financial literacy in this market segment. Perhaps access to independent and objective advice for the mass affluent consumer would limit such abuse?
Perhaps the Financial Advisory and Intermediary ServicesAct needs to be refocused to ensure that people are given honest and objective advice presented in clear and simple terms, with full disclosure of fees and costs?
There are quick and easy solutions
While the above presents a critical view of the market, we also believe there are quick and easy solutions that will arrest the current trends and in fact could improve them immediately. The solutions we suggest include:
• Allow a once-in-a-lifetime opportunity to set off savings funds (including retirement savings) against unsecured debt balances. The current unsecured loan book (excluding credit facilities) is less than 5% of total savings, therefore not significantly affecting liquidity or similar unintended consequences.
Setting this debt off against such savings means that the consumer will be saving on the yield differential. Currently consumers earn around 7% per annum (net of fees but before tax) on savings funds (Source: Alexander Forbes Global Manager Watch Best Investment View 5 year view) while they pay approximately 60% per annum on unsecured debt (this includes interest, service fees and collection fees on arrear debt).
This would mean a 53% better return on their savings funds (without taking into account their tax consequences on savings products) per annum. Extrapolate this to the term of the unsecured loan, and one can quickly realise the significant benefit for the consumer and society.
• Provide easily enforced affordability rules on reckless lending. This could take the form of limiting debt instalments to a maximum of 40% of gross pay. The consumer, employer, lender and magistrate can easily understand, recognise and enforce this rule ensuring the same voidable provisions where lenders breach this rule.
• Provide retrospective, easily enforced affordability rules on Emolument Attachment Orders. Ensure no employee has garnishee deductions totalling more than 25% of his gross salary. This would disincentivise collectors to rely on this collection mechanism that is open to so much abuse.
• Provide easily enforced affordability guidelines to insurance policies. I suggest that a broker needs to consider net salary, debt instalments, and existing policy deductions prior to offering an additional policy.
If debt instalments and existing policy deductions exceed 50% of net income, then it is not appropriate for the consumer to add another policy.
Perhaps one can build in exceptions for policies with substantially differentiated benefits or focusing on a specific risk previously not covered.
• Provide easily enforced, appropriate advice guidelines for brokers. For instance, where a consumer has unsecured debt, brokers should not sell savings policies or limit the monthly cash flow allocated to savings.
• Prevent credit life charges of more than, say, R8 per R1 000 of the loan outstanding.
In summary, most consumers are experiencing financial stress which could certainly add to the economic stresses of our society.
However, the challenges are easily corrected and small actions could result in substantially relieved consumers. Perhaps there is now opportunity for financial services providers to secure the trust and business of these very same distressed consumers by providing solutions and protecting them accordingly.
In protecting the consumer against poor financial decisions, unscrupulous lenders and collectors, excessive products and irresponsible decisions they will be maximising the consumers' cash flows they so rely on for repayment of their debts.
*Guest columnist Clark Gardner is CEO of Summit Financial Wellbeing and 6cents.co.za.
