The Data Analytics Blog

Our news and views relating to Data Analytics, Big Data, Machine Learning, and the world of Credit.

All Posts

A Calculated Guess: Affordability Determination In The South African Market

February 3, 2020 at 10:00 AM

With a recent judgment being upheld in favour of the National Credit Regulator (NCR) against Shoprite Investments Limited, we thought it would be a good time to re-look at the process of affordability assessment.

There’s an old saying that states “it doesn’t matter how quickly you run from the tiger so long as you run faster than the other guy!” close-up-photography-of-tiger-792381

It’s a thought that I’ve had since witnessing credit providers clamber and shape affordability policies just prior to the adoption of the National Credit Act (2005). At that stage, lenders were given instruction to adopt policies that were not reckless (things changed later with the more prescriptive National Credit Amendment Act in 2015). It was up to the lenders to decide what these were.  Being too conservative meant excluding many potentially profitable customers. Being too aggressive meant opening the lender to being deemed reckless – but perhaps being slightly less aggressive than the most aggressive lender would allow you to avoid the teeth of the tiger (The National Credit Regulator).   Despite being 15 years down the line, a few questions remain about what is/should be allowed when it comes to calculation of affordability.  From our years in the field with many lenders, we have witnessed each lender’s individual approach to affordability.  We discuss some of the nuances here.

Spousal help

In the Shoprite case, a defence on one of the matters was that it was assumed that the borrower’s spouse was able to support the borrower (a defence that was deemed too presumptuous by the court).  So how does one bring a spouse’s affordability into the fray?  For the conservative lenders, they critically ask the borrower whether they are married in community of property or not. If they are, then they will treat the application as a joint application and request affordability documentation from both parties.  The more aggressive lenders (in fact most lenders) tend to only look at the spouse if the applicant wants to use the spouse’s income in which case they will look at the spouse’s bureau commitments and expenses.  Some lenders don’t allow for joint applications at all.  

Limit versus balance

When assessing affordability, lenders extract a credit bureau record.  This gives a list of the customer’s debt.  From it, they extract the instalment commitments, and this becomes the total monthly instalment that is used in the affordability calculation.  From our dealings, most lenders calculate it this way.

Affordability modelling

More conservative lenders will instead calculate an instalment commitment from the limit and not from the balance.  In the example illustrated the instalment won’t be R120 but instead R1,200 making the “Total Instalment Commitment” R5,700 and not R4,620.  Conservative banks will also look at a customer’s overdraft (not stored on the bureau) and utilize approximately 10% of the overdraft per month.  The rationale is despite the overdraft being a facility, a bank may have to recall the overdraft and they typically give the borrower 12 months to repay what would become a loan. 

Due to these differing approaches, if a customer has revolving products with low utilization, different lenders could calculate affordability very differently from each other.  We have yet to see the NCA or courts act on this.

Personal loan top-ups

Personal loan top-ups are essentially revolving term loans.  Here a customer is normally coming to the end of a loan term, and he/she is offered an extension of the loan with an additional cash pay-out.  The new repayment amount will normally be the same or lower than the original repayment amount (the term is just extended).  At one stage, some lenders were not conducting an affordability assessment with the rationale that a customer could already successfully service a debt of e.g. R2,000 per month and therefore should continue to service the debt.

Over time we have witnessed the vast majority of lenders now conduct affordability assessments at the time of top-up.

Annual increase

For revolving products, customers can opt for an annual automatic limit increase.  This is the only scenario where credit can be extended without an affordability calculation being done. This is not universally done, but many card providers offer this to their customers, and the Act allows for it.

Subscribe to our blog

Thomas Maydon
Thomas Maydon
Thomas Maydon is the Head of Credit Solutions at Principa. With over 17 years of experience in the Southern African, West African and Middle Eastern retail credit markets, Tom has primarily been involved in consulting, analytics, credit bureau and predictive modelling services. He has experience in all aspects of the credit life cycle (in multiple industries) including intelligent prospecting, originations, strategy simulation, affordability analysis, behavioural modelling, pricing analysis, collections processes, and provisions (including Basel II) and profitability calculations.

Latest Posts

The 7 types of credit risk in SME lending

  It is common knowledge in the industry that the credit risk assessment of a consumer applying for credit is far less complex than that of a business that is applying for credit. Why is this the case? Simply put, consumers are usually very similar in their requirements and risks (homogenous) whilst businesses have far more varying risk elements (heterogenous). In this blog we will look at all the different risk elements within a business (here SME) credit application. These are: Risk of proprietors Risk of business Reason for loan Financial ratios Size of loan Risk industry Risk of region Before we delve into this list, it is worth noting that all of these factors need to be deployable as assessment tools within your originations system so it is key that you ensure your system can manage them. If you are on the look out for a loans origination system, then look no further than Principa’s AppSmart. If you are looking for a decision engine to manage your scorecards, policy rules and terms of business then take a look at our DecisionSmart business rules engine. AppSmart and DecisionSmart are part of Principa’s FinSmart Universe allowing for effective credit management across the customer life-cycle.  The different risk elements within a business credit application 1) Risk of proprietors For smaller organisations the risk of the business is inextricably linked to the financial well-being of the proprietors. How small is small? The rule of thumb is companies with up to two to three proprietors should have their proprietors assessed for risk too. This fits in with the SME segment. What data should be looked at? Generally in countries with mature credit bureaux, credit data is looked at including the score (there is normally a score cut-off) and then negative information such as the existence of judgements or defaults; these are typically used within policy rules. Those businesses with proprietors with excessive numbers of “negatives” may be disqualified from the loan application. Some credit bureaux offer a score of an individual based on the performance of all the businesses with which they are associated. This can also be useful in the credit risk assessment process. Another innovation being adopted internationally is the use of psychometrics in credit evaluation of the proprietors. To find out more about adopting credit scoring, read our blog on how to adopt credit scoring.   2) Risk of business The risk of the business should be managed through both scores and policy rules. Lenders will look at information such as the age of company, the experience of directors and the size of company etc. within a score. Alternatively, many lenders utilise the business score offered by credit bureaux. These scores are typically not as strong as consumer scores as the underlying data is limited and sometimes problematic. For example, large successful organisations may have judgements registered against their name which, unlike for consumers, is not necessarily a direct indication of the inability to service debt.   3) Reason for loan The reason for a loan is used more widely in business lending as opposed to unsecured consumer lending. Venture capital, working capital, invoice discounting and bridging finance are just some of many types of loan/facilities available and lenders need to equip themselves with the ability to manage each of these customer types whether it is within originations or collections. Prudent lenders venturing into the SME space for the first time often focus on one or two of these loan types and then expand later – as the operational implication for each type of loan is complex. 4) Financial ratios Financial ratios are core to commercial credit risk assessment. The main challenge here is to ensure that reliable financials are available from the customer. Small businesses may not be audited and thus the financials may be less trustworthy.   Financial ratios can be divided into four categories: Profitability Leverage Coverage Liquidity Profitability can be further divided into margin ratios and return ratios. Lenders are frequently interested in gross profit margins; this is normally explicit on the income statement. The EBIDTA margin and operating profit margins are also used as well as return ratios such as return on assets, return on equity and risk-adjusted-returns. Leverage ratios are useful to lenders as they reflect the portion of the business that is financed by debt. Lower leverage ratios indicate stability. Leverage ratios assessed often incorporate debt-to-asset, debt-to-equity and asset-to-equity. Coverage ratios indicate the coverage that income or assets provide for the servicing of debt or interest expenses. The higher the coverage ratio the better it is for the lender. Coverage ratios are worked out considering the loan/facility that is being applied for. Finally, liquidity ratios indicate the ability for a company to convert its assets into cash. There are a variety of ratios used here. The current ratio is simply the ratio of assets to liabilities. The quick ratio is the ability for the business to pay its current debts off with readily available assets. The higher the liquidity ratios the better. Ratios are used both within credit scorecards as well as within policy rules. You can read more about these ratios here. 5) Size of loan When assessing credit risk for a consumer, the risk of the consumer does not normally change with the change of loan amount or facility (subject to the consumer passing affordability criteria). With business loans, loan amounts can range quite dramatically, and the risk of the applicant is normally tied to the loan amount requested. The loan/facility amount will of course change the ratios (mentioned in the last section) which could affect a positive/negative outcome. The outcome of the loan application is usually directly linked to a loan amount and any marked change to this loan amount would change the risk profile of the application.   6) Risk of industry The risk of an industry in which the SME operates can have a strong deterministic relationship with the entity being able to service the debt. Some lenders use this and those who do not normally identify this as a missing element in their risk assessment process. The identification of industry is always important. If you are in manufacturing, but your clients are the mines, then you are perhaps better identified as operating in mining as opposed to manufacturing. Most lenders who assess industry, will periodically rule out certain industries and perhaps also incorporate industry within their scorecard. Others take a more scientific approach. In the graph below the performance of an industry is tracked for two years and then projected over the next 6 months; this is then compared to the country’s GDP. As the industry appears to track above the projected GDP, a positive outlook is given to this applicant and this may affect them favourably in the credit application.                   7) Risk of Region   The last area of assessment is risk of region. Of the seven, this one is used the least. Here businesses,  either on book or on the bureau, are assessed against their geo-code. Each geo-code is clustered, and the projected outlook is given as positive, static or negative. As with industry this can be used within the assessment process as a policy rule or within a scorecard.   Bringing the seven risk categories together in a risk assessment These seven risk assessment categories are all important in the risk assessment process. How you bring it all together is critical. If you would like to discuss your SME evaluation challenges or find out more about what we offer in credit management software (like AppSmart and DecisionSmart), get in touch with us here.

Collections Resilience post COVID-19 - part 2

Principa Decisions (Pty) L

Collections Resilience post COVID-19

Principa Decisions (Pty) L