Banking institutions have not been spared either. It is now quite common practice for a loan to be rolled over on maturity. Other institutions have temporarily stopped consumer lending as they are now focusing their efforts on recovering loans. It is widely believed that bad loans are prevalent within banks, although the respective institutions do not appear to be adequately providing for them.
Truly, the dollarised environment has not been too kind to most companies listed on our local bourse. Up to now, some firms are still trying to raise sufficient funds for both working capital and capital investment. Some companies were quick to borrow at high rates averaging 37%, hoping to pay off the debt once operations picked up. Unfortunately, this was not to be for most of them. Challenges in the form of tight competition from imports, inefficiencies arising from using aged machinery and high finance costs have seen the companies continually posting losses. Product demand has again slowed, largely due to the tight liquidity in the consumption sector.
Companies had resorted to offering credit to their customers as a way of boosting earnings and to protect their market share from competition. Performance of retailers, particularly those in clothing and furniture, improved significantly owing to the re-introduction of credit mid way through 2010. Full year after tax earnings for Truworths, for instance, jumped by 143% between July 2010 and July 2011 while Pelhams’ results for the six months to September 30 2011, of US$586 000, surpassed the full year earnings to 31 March 2011 of US$121 831.
TN Holdings had a profit after tax of US$5,7 million in the six months to 30 June 2011 compared to a full year loss of US$1,7 million in 2010. Banking institutions were also on an aggressive drive in their lending after realising the funding gap in the market and the prevailing lending rates which appeared lucrative in US dollar terms.
However, evidence on the ground now seems to suggest that the method of growing sales and profits through offering liberal credit might have been overdone. The strategy is now hurting companies as defaults are increasing. Both individuals and corporates are failing to service their obligations mainly because they are over-borrowed. In the six months to January 8 2012, Truworths, for instance, increased their provision for bad debts to 5,2% from 2,4% in 2011, which could be indicative of the increasing rate of defaults.
The challenge for companies, particularly those in retailing, is determining whether or not a would-be individual customer is over-borrowed or not. It is a well known fact that disposable incomes in the economy are still low. Salaries for most civil servants for instance are still below the poverty datum line. Regardless of this fact, individuals are somehow managing to finance their conspicuous consumption. What it therefore means is that these individuals must be getting bridging finance from somewhere. The most common sources are salary-based loans or credit facilities. Individuals are hopping from one shop to another, securing goods on credit by using the very same payslip.
Banks are also falling prey to these individuals as they cannot tell how many other demands the individual’s salary may already have upon it. Most banks insist that one has to be their client for at least three months before qualifying for salary-based loans. However, individuals can simply switch to another bank as soon as they access a loan from the first one.
On corporates, some bankers are to blame as they were lax in their controls, which resulted in them giving some corporates loans that they did not deserve. Market rumours indicate that nearly half of the bad loans in the market were not secured. We have seen instances whereby one company was exposed to several banking institutions. One is tempted to ask why other banks continued to lend money to a company which was already sitting on a huge debt pile!
What the economy is in need of is a centralised credit bureau system which would help lenders establish the true creditworthiness of potential borrowers. This will ensure that individuals only borrow to levels their salaries can accommodate. Again, it will remove the existing loophole, whereby a single payslip is capable of securing multiple loans. A centralised credit bureau would also single out individuals with a poor credit repayment history.
Understandably, there are instances where corporates are left with no choice but to offer credit sales, which is normal and acceptable. In developed economies for instance, people rely heavily on credit. However, in our case where we do not have a credit bureau, companies need to be prudent. There is need to put in place risk monitoring systems to ensure that credit sales are kept within manageable levels. If credit sales are overdone, the net effect is that once debtors start to default, the company is forced to finance its working capital cycle using borrowed funds.
The subprime mortgage crisis is a good example of how wrong things can go if loans are extended to people who do not deserve them. In this regard, the stance by Truworths’ management to slow down the growth of new customer accounts is prudent if it ensures that bad debts are kept in check.
Banking institutions, on the other hand, need to be more diligent in their credit assessment procedures. There seems a need to tighten internal controls a bit more to ensure that only corporates or individuals who deserve loans are able to access them. Banks need to assess whether or not an operation is really viable and whether it will be able to generate enough money to repay the loan. Furthermore, all the necessary procedures to secure the loan should be followed.
However, it should be remembered that good security does not make a bad loan good. Realising the true value of an asset is again difficult in this environment characterised by tight liquidity. Whilst there is often an opportunity to grow earnings through increasing income from loans, banks should aim to keep the rate of defaults within manageable levels.
We therefore believe that firms should strike a proper balance between profitability and credit growth.