How to manage legacy loan book risk

Chris Laverty Chris Laverty

Companies in the consumer credit space are facing regulatory and operational challenges that represent a threat to their ongoing financial viability.

One of the key drivers of this is the well-publicised increase in historical redress claims from claims management companies (CMCs), which continues to affect the level of risk attached to legacy/historic loan books.

Although CMCs have been under Financial Conduct Authority (FCA) regulation since April 2019, it is unlikely that this will significantly reduce the number of claims in the near future.

This raises fundamental challenges for existing management teams as to how this risk can be quantified and managed. These challenges are also relevant to lenders and investors into consumer credit firms, as their secondary exposure to firms’ activities could present a risk to return.

As administrators of Wonga, and advisor to other companies within this subsector, we have valuable insight and experience of the issues facing these firms and the resulting financial pressures.

Options a company might consider to manage inherent risk in their legacy loan books include:

Companies Act proceedings – scheme of arrangement

A scheme of arrangement (SoA) seeks to provide a positive solution for both redress creditors and a company by reaching a compromise arrangement. It is particularly relevant where the threat of historic redress claims could hamper future growth or turn the firm unviable.

A level of compensation is put aside for the specific creditor category, where the validity and value of any claim is agreed within a certain time period. This puts some time frames and parameters around the process that would otherwise not exist.

An SoA requires a voting threshold of 75% to be met by the class of creditors – if the threshold is met, it will bind 100% of the impacted creditors.

In August 2019, Instant Cash Loans (ICL), which owns The Money Shop, Payday Express and Payday UK, contacted almost two million customers to seek their support for an SoA. The court has sanctioned this approach and the creditors’ meeting is awaiting.

Insolvency Act proceedings - company voluntary arrangement

A company voluntary arrangement (CVA) is similar to an SoA in that it allows a company to reach a compromise with its creditors in order to make a distribution over a pre-agreed period. There are different voting thresholds in a CVA and while an SoA is proposed under the Companies Act 1985, a CVA is technically an insolvency procedure and therefore requires an insolvency practitioner to act as a nominee and supervisor of the company’s CVA proposal.

A CVA is generally deemed to be an easier and cheaper process than an SoA. However, a CVA is an insolvency process and, if not successfully voted for by the compromised creditors, can result in the actual insolvency of the company.

Sale of book

This could be specific portfolios or a company’s whole loan book. There are issues to consider though, as the uncertain nature of historic liabilities could lead to a challenging sales process and might not create shareholder value.

With the Financial Ombudsman Service (FOS) allowing claims outside the six-year statute of limitations, liabilities might not be attached to active lending, putting off any potential purchasers.

It is possible to benefit from a sale without historic liabilities in a structured approach, but the potential for set off and the challenging structure of diligence could still put off purchasers.

Wind down operations/run off

Companies may decide to wind down operations or gradually run off the business. This route allows other costs to be crystallised, for example redundancy costs and contract terminations, and it can sometimes be the best way to realise value in the firm and prevent equity erosion.

Approved persons should consider the risk of historic redress claims in running off a lending book. Unless there is an insolvency process to deal with such claims, this will bring the scrutiny of the regulator.

A firm must remain solvent during a wind down or run off process and the viability of this can be hard to judge with continuing redress claims. Curo Transatlantic (which owned payday lenders Wage Day Advance and went into administration in February 2019) tried to wind down its business, but the sheer volume of claims meant that the financial and operational burden of resolving them became unsustainable.

Planning ahead

We firmly believe that proactive acknowledgement of status and assessment of future options will reap rewards and remove significant uncertainty and risk for management and stakeholders. By taking control and thinking strategically now about available options, it is possible to crystallise risk, preserve equity value and prevent business erosion going forward.

Our financial services restructuring team can advise firms and their lenders on proactive steps that can be taken to increase operational resilience and to address risks in the legacy book.

For more information and advice, contact Chris Laverty.

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