The UK’s subprime lending industry has seen huge upheaval in the last 12 months, possibly more so than any other regulated industry in the UK.
FCA-imposed rules and a surge in compensation claims have seen some of the UK’s largest lenders fall into administration in the last year, including Wonga, QuickQuid and The Money Shop, and the once £2 billion a year industry fall to less than £100 million per year1. An industry already stretched is now at the forefront of the economic slowdown due to the nature of the customers they serve.
Subprime lenders will currently be faced with operational resilience challenges, cashflow and liquidity issues, increased levels of defaults and forbearance requests, as well as concerns about complying with affordability criteria and future redress claims.
The FCA’s operational resilience requirements take on a whole new relevance in a world of enforced isolation and working from home. Rather than being a regulatory issue, operational resilience is now a fundamental pillar of a business’s viability. It is essential that firms quickly develop practical solutions to issues they encounter. Getting it wrong risks the survival of a business.
One of the key tenets of operational resilience is that firms must ensure third-party providers have robust procedures in place to ensure continuity of service to a firm’s customer base. Many subprime lenders rely on outsourcing, using third-party providers to fulfil functions such as payment collections, call centres and forbearance requests.
Subprime lenders should ask themselves whether these outsourced providers are sufficiently set up for remote working. Do they have sufficient scale-up ability to deal with a huge increase in calls? Are there enough people with the appropriate training and the ability to use call recording from home to be able to handle a high level of new enquiries and forbearance requests?
The FCA's guidance on COVID-19 notes that all firms will take "reasonable steps to meet their regulatory obligations", confirming that regulated activities may take place with staff working from home as long as staff use recorded lines and that compliance support is available when needed.
Although regulators do understand the pressure firms are currently under, we expect operational monitoring and oversight procedures to remain broadly in place. As regulated firms will know, the FCA expects financial institutions to establish ‘impact tolerances’ for business services, and then test their ability to remain within those tolerances throughout disruption scenarios. In the present environment, management may well need to revisit whether their current impact tolerances are fit for purpose and what actions need to be taken in the event of a tolerance breach.
Management should stay in contact with the FCA where they risk breaching regulatory requirements. Ensuring that senior management, compliance oversight and internal reporting systems are tested and functioning as close to ‘normal’ as possible will be key to mitigating risk at this time.
Temporary payment freeze and increased levels of defaults and forbearance
On 2 April 2020, the FCA announced that consumer credit firms are expected to offer a temporary payment freeze for up to three months on loans where consumers face difficulties with their finances as a result of coronavirus. In recognition of how this will significantly affect lenders' cash flow, the FCA has already stated on 26 March that capital and liquidity buffers are there to be used in times of stress, saying that firms who have been set buffers can use them to support the continuation of the firm’s activities. Management need to forecast what will happen beyond the three-month payment freeze and ensure that they still have enough capital and liquidity to remain solvent.
Subprime lenders also need to recognise that once an enforced payment freeze has ended they will be seeing a significant increase in default rates. If a customer defaults, it is essential that a lender’s remote working practices allow for quick communication. Failure to reach out quickly risks losing that customer’s payments forever. Equally there will be an increase in people asking for forbearance on their loans. Indeed, it seems fair that a certain level of flexibility in these times would be required. But how much forbearance should be offered? Offer too much and subprime lenders will quickly face liquidity issues, putting the survival of the business at risk.
Management need to be thorough in their financial modelling and cash flow analysis to assess exactly what levels of forbearance the business can maintain in these times, and for how long.
Cash flow and liquidity challenges
No one knows exactly how long the COVID-19 situation is going to last and it is therefore very difficult to know how much liquidity a business will need to survive. Without careful liquidity management, a subprime lender could quickly find itself in financial difficulty.
Moving to a receipts and payments basis of cash flow modelling, daily forecasting and integrating short- and medium-term forecasts can increase liquidity headroom and runway time to implement other actions. Stress-testing forecasts for different scenarios will help provide better clarity on a firm’s liquidity position. Management should also check compliance with covenants under the firm’s debt facilities. By being proactive about speaking to lenders and the impact of COVID-19 on business performance, the more chance there is of getting flexibility. Management should also remember that existing lenders and shareholders will be the most likely source of new money, so good communication and relationships are paramount.
Future redress claims
The whole subprime lending industry has grappled with the level of redress claims and this has contributed to the demise of many industry players – PiggyBank, Moneybox 24/7 and WageDay Advance to name a few. For example, just under 17,000 complaints were submitted to the ombudsman between July and December 2019. Of the cases that were taken forward, 73.5% were upheld in favour of the customer, with almost all of those complains relating to affordability2.
How can subprime lenders protect themselves against future redress claims in the current environment? With many people temporarily out of work and no way to know how long this will last, how can a lender ensure that they have robust affordability criteria in place? At the same time, pressure to lend to vulnerable customers will only be increasing. Lenders should revisit their lending criteria to make sure they are rigorous and appropriate, and that all decision-making is well documented.
Subprime lenders play an important role in the community. By focusing carefully on resilience, liquidity management and ensuring robust procedures, lenders will put themselves in the best position to survive this crisis.