The Financial Conduct Authority (FCA) payment freeze is bringing challenges for lenders. Chris Laverty explains what you can do to protect your business.
In April, the FCA payment freeze was introduced to provide support for consumer credit customers, including a three-month freeze for motor finance, buy-now pay-later, rent-to-own and pawnbroking agreements. For high-cost, short-term credit (HCST), payments will be frozen for one month with no additional interest to be charged. While this will give some much-needed breathing space to customers, what will be the impact on consumer credit firms that are obliged to implement these measures?
While the FCA payment freeze is welcome, many people’s circumstances are unlikely to have changed materially by the end of this three-month period. There will be a continuing need for forbearance from lenders and, therefore, there will be continuing costs. It is these longer-term issues that are more significant.
Wider for bearance
Firms need to consider what their long-term forbearance strategy looks like. The FCA payment freeze is not intended to replace a firm’s usual forbearance strategies and this is the minimum expectation of a firm by the regulator. There is nothing to stop a firm going further in its assistance to customers.
In my experience working with consumer credit firms, there are considerable differences between how firms approach forbearance. While some are willing to implement flexible payment plans, others will put a customer in default if arrears are not cleared, terminating the loan agreement.
If managers offer too much forbearance, a firm risks its own viability; offer too little and there may be a risk of retrospective supervision by the FCA. Other questions remain. The FCA has stated that where customers do not require full forbearance, apart from HCST, firms can still charge reasonable interest during the payment freeze. But what is ‘reasonable’ and how should firms distinguish between COVID-19-related forbearance or not?
There is also the issue of customer engagement to consider. There will be customers who cease to make payments and fail to contact their lender. It is important that firms actively take steps to identify and engage with these customers, to understand their issues.
Affordability and risk of redress claims
Lenders need to protect themselves against future redress claims relating to affordability. The consumer credit industry has grappled with this issue, which has contributed to the demise of many industry players, and the FCA payment freeze raises many related issues.
Typically, affordability assessment criteria rely on a customers’ financial history over the past 30 to 90 days, but that data is no longer reliable as an indicator of whether people will be able to pay their debts going forward. Some consumer credit firms, such as Amigo and Morses Club, have suspended new lending, with many more tightening lending rules due to fears that low-income borrowers will not be able to afford repayments. Is COVID-19 now a vulnerability trigger that now needs to be considered when assessing affordability complaints? Firms need to be extremely diligent and transparent in their affordability assessments to avoid any risk of damaging redress claims once the current situation has passed.
Liquidity and capital issues
With both collections and new lending falling, the current crisis is bringing immediate liquidity and capital adequacy challenges for consumer credit firms, and management need to review their capital and liquidity strategies accordingly. The FCA has already stated 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 FCA payment freeze and ensure that they still have enough capital and liquidity to remain solvent. Careful liquidity management is essential and daily cashflow modelling can often increase liquidity headroom, while stress-testing forecasts for different scenarios can provide clarity.
Management should also check compliance with covenants under the firm’s debt facilities. Transparent communication with the firm’s own lenders is essential, not only to get flexibility, but existing lenders are also one of the most likely sources of financing at this time. However, the Coronavirus Business Interruption Loan Scheme is open to independent and non-bank lenders so this could be given careful consideration.
Motor finance – huge pressure on lenders
A closer look at motor finance - the second largest consumer credit market in the UK – illustrates the wider issues that consumer credit firms will be facing. Approximately 80% of car purchases are financed by personal contract purchases (PCPs), according to the Finance and Leasing Association (FLA). Consumers can either pay and own the car at the end of the agreement, or hand the car back to the lenders who sell the car on the second-hand market to release the residual value.
The FCA has said that firms should not use any temporary depreciation of car prices caused by coronavirus volatility to recalculate PCP balloon payments at the end of the term of their finance agreement, or must act fairly if doing so. The second-hand car market, which would be used to realise value for the lenders balance sheets, is extremely subdued owing to the pandemic, which will lead to big write-downs for lenders. Motor finance lenders already facing a drop of income due to the payment freeze could face huge additional losses, risking their financial viability.
What can you do to protect yourself during the FCA payment freeze
By conducting detailed scenario analysis, with cash flow and liquidity modelling, management will be better placed to know what the business can withstand when assessing these questions, both financially and operationally, and how their wider forbearance strategy interacts with customer engagement and collection going forwards.