Covid-19: new FCA guidance on consumer credit and the implications for ABS and specialty finance

The Financial Conduct Authority (the FCA) has published the following guidance on how certain regulated firms should respond to customers experiencing or reasonably expected to experience payment difficulties as a result of circumstances relating to the Covid-19 outbreak:

• 20 March 2020 (as updated on 25 March 2020), the FCA provided guidance to mortgage lenders, mortgage administrators, home purchase providers and home purchase administrators (the Mortgage Guidance); and
• 9 April 2020, the FCA published temporary guidance for regulated firms that issue:
  • personal loans (which means a regulated credit agreement, secured (other than on land) or unsecured, including a guarantor loan, a logbook loan (secured by a bill of sale), home collected credit or a loan issued by a Community Development Financial Institution), and applies to credit union loans where they are regulated credit agreements and generally for firms that have acquired such loans¹ (the Personal Loan Guidance); and
  • credit cards (including retail revolving credit), and applies to firms that have acquired credit cards and retail revolving credit debts (the Credit Card Guidance, and together with the Personal Loan Guidance, the "Personal Finance Guidance"),

(together, the Mortgage Guidance and the Personal Finance Guidance, the "FCA Guidance").²

The FCA Guidance comes into full force from 14 April 2020 and will have implications both for regulated firms and for finance providers (Specialty Lenders) to those regulated firms and investors (ABS Investors) in structures holding consumer loans and mortgages, including specialty finance lending and warehouse facility lending for asset backed financings (e.g. RMBS and consumer finance ABS). These Lenders will also be considering the contents of Sam Woods’ (CEO of the Prudential Regulation Authority (the PRA)) “Covid-19: IFRS 9, capital requirements and loan covenants” letter to CEOs dated 26 March 2020 (the PRA Letter), which is discussed further below.

FCA Guidance

Mortgage Guidance

The Mortgage Guidance covers two key areas: “payment holidays” (being an arrangement under which a firm permits the customer to make no payments under a relevant contract for a specified period without being in payment shortfall) and repossessions.

• Payment Holidays: If a customer is experiencing or reasonably expects to experience payment difficulties as a result of circumstances relating to Covid-19, and wishes to receive a “payment holiday”, a relevant firm (as listed in the paragraph above) should grant a customer a payment holiday for three³ monthly payments, unless it can demonstrate it is reasonable and in the customer’s best interest to do otherwise. This guidance applies in respect of a customer regardless of whether they are in a payment shortfall at the time of the Covid-19 outbreak.
• Repossessions: Firms should not commence or continue repossession proceedings against customers at this time, given the unprecedented uncertainty and upheaval they face, and government advice on social distancing and self-isolation. This applies irrespective of the stage that repossession proceedings have reached and to any step taken in pursuit of repossession. Where a possession order has already been obtained, firms should refrain from enforcing it.

It should also be noted that the Mortgage Guidance acknowledges that lenders and administrators of unregulated products are subject to the requirements of the Consumer Protection from Unfair Trading Regulations 2008, as part of which lenders are required to ensure that they adhere to the overarching standard of “professional diligence”. The FCA acknowledges that a breach of the Mortgage Guidance may tend to establish a breach of this professional diligence standard even where the lender is not regulated under the Financial Services and Markets Act 2000.

The FCA will review the Mortgage Guidance in the next three months and will extend the period of the payment holidays if appropriate.

Personal Finance Guidance

The Personal Finance Guidance sets out the FCA’s expectation that if a customer is already experiencing or reasonably expects to experience temporary payment difficulties as a result of circumstances relating to Covid-19, and wishes to receive a “payment deferral” (being an arrangement under which a firm permits the customer to make no payments under their regulated credit agreement for a specified period without being considered to be in arrears), a firm should grant the customer a payment deferral for three⁴ months⁵.

Firms are not prevented from continuing to charge interest during the payment deferral period. If the consumer is unable to resume payments at the end of this period because of payment difficulties at that time, the firm should work with the customer to resolve these difficulties in advance of payments being missed. If a customer who received a payment deferral as a result of circumstances relating to Covid-19 is entitled to forbearance under the FCA’s existing rules then, as part of this, the FCA expect any interest accrued during the payment deferral period to be waived.

The FCA will review the Personal Finance Guidance in the next three months and may revise it if appropriate.

PRA Letter

The PRA Letter sets out the PRA’s guidance to regulated firms relating to Covid-19 in certain key areas, notably the treatment of borrowers who breach covenants due to Covid-19. The PRA Letter states that, while loan covenants are significant in lenders’ credit risk management, it is important that such risk management takes into account fully the differences between “normal” covenant breaches and some of the breaches that might occur because of Covid-19. For example, where a covenant breach has a direct link to Covid-19 and is of a general nature or is firm-specific but unrelated to the solvency or liquidity of the borrower, the PRA would expect lenders to consider waiving the resultant covenant breach (as compared to covenant breaches that arise because of borrower specific issues unrelated to Covid-19).

Firms would be expected to waive such breaches in good faith and not to impose new charges or restrictions on customers following a covenant breach that is unrelated to the facts and circumstances that led to that breach.

The PRA reassures regulated firms that such covenant breaches or waivers should not automatically (other things being equal) trigger a default under the EU Capital Requirements Regulation or result in a move of the loans up the scale for calculating forward-looking expected credit loss.

Consequences

The FCA Guidance will have a material impact on the consumer loan and mortgage markets, and inevitable knock-on consequences for Specialty Lenders in relation to their loans to such consumer credit providers and ABS Investors in relation to structures backed by consumer loans, credit cards and mortgages. In this context, Specialty Lenders are keen to appear supportive of the principles of the PRA Letter, in both the regulated and unregulated (e.g. bridging loans and unregulated buy-to-let loans) consumer credit market even where the FCA Guidance does not directly cover the credit they provide. In addition, non-bank lenders to SMEs (and Specialty Lenders lending to them) have also been concerned to follow the spirit of the FCA Guidance and PRA Letter in light of Principle 6 (treating customers fairly) applying more broadly than solely consumer credit. 

Notwithstanding the PRA Letter, Specialty Lenders will need to give thought to whether any support they provide to consumer credit providers and for structures backed by consumer loans and mortgages should be conditional. For example, careful consideration will need to be given to: (a) whether the originator or sponsor of a transaction should be prohibited from taking excess spread out of the deal (if they would otherwise be allowed to); (b) potential repricing of economics (including reductions in servicing fees); and/or (c) short/long term adjustments to the covenants, events of default, eligibility criteria and/or substitution mechanics. Amendments to eligibility criteria should be carefully considered, given the spirit of the PRA Letter would appear to preclude amendments that bluntly strip out Covid-19 impacted receivables, if that change would create an automatic or inevitable default by the borrower/issuer in the structure. Instead, specialty lenders would more clearly adhere to the principles of the PRA Letter by simply precluding the future addition of assets directly impacted by Covid-19 to the relevant pool of receivables or borrowing base. 

It should also be noted that many Specialty Lenders waiving defaults so far in the pandemic have been willing to do so in return for the delivery of significantly increased information in relation to the relevant consumer finance providers’ underlying businesses, lending structures and portfolios. It will be interesting to see how this additional information is applied by Specialty Lenders as part of the inevitable restructuring of certain businesses and transactions in and following the pandemic. In particular, it is important to note that consumer finance providers are not required to provide payment holidays or payment deferrals or forbear on repossessions, if an underlying borrower falls into arrears/defaults for reasons unrelated to Covid-19. However, differentiating between borrowers unaffected by Covid-19 and those which are, is likely to prove difficult in practice. The approach taken by Specialty Lenders to such borrowers will develop in the coming months as this additional information (amongst other factors) advances Specialty Lender thinking on each transaction.

Indeed, it remains to be seen how the FCA Guidance and other policy measures of the regulators will develop when the Covid-19 issues dissipate. There is likely to be a lag (potentially significant) between the reduction in social distancing measures and the return to financial health of businesses and consumers or, failing that, insolvencies and personal bankruptcies. The regulators will continue to support their principles of good regulation (notably “treating customers fairly”), but, as the situation improves, the impact of Covid-19 on a particular underlying borrower will become more indirect and tangential, at which stage greater consumer lender discretion is likely to apply to any extension of a payment holiday, payment deferral or deferral of a repossession. Thus, the development of regulatory guidance (or lack thereof) (in conjunction with the enhanced information received by Specialty Lenders) will contribute to the approach taken by Specialty Lenders and ABS Investors in reacting to defaults in the asset pools backing their transactions and the potential restructuring that those transactions might require as a result.

It should be noted that the FCA Guidance and the PRA Letter do not preclude rating agency downgrades of borrowers and debt instruments, which are already taking place. Certain regulatory forbearance in this regard is detailed in the PRA Letter for regulatory capital calculations on defaulted assets, but it is unclear how long such forbearance will remain in place, whether it will be expanded to cover non-defaulted but nonetheless weaker credit of borrowers and debt instruments, and what the implications will be for specific credit rating triggers in debt documents. These rating related issues will also likely delay the execution of new transactions. 

Finally, certain other jurisdictions have imposed similar regulatory guidance and policy to the UK, but the approach taken by a Specialty Lender or an ABS Investor that is incorporated abroad and/or not subject to PRA supervision may be materially different to a PRA regulated Specialty Lender or ABS Investor that wants to adhere to the spirit of the PRA Letter. This will require a collaborative approach taken by such ABS Investors and syndicate Specialty Lenders in addressing Covid-19 related issues.

In this context, we are looking at the implications that Covid-19 is having for our clients (notably Specialty Lenders) as they navigate these unprecedented circumstances. The specific implications for each financial product remains under constant review.

For further reading, please see our other Covid-19 publications.

¹The Personal Loan Guidance does not apply to business loans, high-cost short-term credit agreements, buy now pay later agreements, hire purchase agreements (including motor finance), peer to peer agreements, pawnbroking agreements, premium finance, credit card and other retail revolving credit agreements or overdrafts.

²It should be noted that the FCA’s approach to overdrafts is covered in separate guidance that is not directly relevant to mainstream Specialty Lenders and ABS Investors, so is not referenced in this note.

³A firm may also decide to put in place a payment holiday or payment deferral for a longer or shorter period than three months, if it is appropriate to do so in the individual circumstances of the case and the firm reasonably considers it as being in the best interests of the customer. For example, if the loss of income as a result of Covid-19 is temporary, than a payment holiday or payment deferral of less than three months may be reasonable.

⁴Please see footnote 3 above.

⁵Where a customer is in pre-existing financial difficulty, the FCA’s existing forbearance rules and guidance in CONC would continue to apply. These would include for example the firm considering suspending, reducing, waiving or cancelling any further interest or charges, deferring payment of arrears or accepting token payments for a reasonable period of time.