How should firms react to the increasing numbers of customers who wish to temporarily suspend their monthly loan and credit card payments, whilst remaining confident that they are still meeting their legal and regulatory requirements? In this Insight we set out what firms need to do and highlight some pitfalls to steer clear of.
What does the FCA's guidance cover?
The FCA has already published guidance for mortgages, and has this week published proposed guidance applicable to firms offering personal loans, overdrafts, credit cards, store cards and catalogue credit.
The guidance is intended to ensure that consumers who, until now, have been financially stable, can access a minimum level of financial support.
Where a customer is "already experiencing or expects to experience" temporary payment or financial difficulties as a result of the coronavirus pandemic, and wants a payment holiday, the guidance is that firms should allow this for up to three months, without the customer incurring any charges and without the customer having their credit rating affected. Firms are 'not prevented' from continuing to charge interest during the payment holiday.
The guidance emphasises that it is important for firms to give customers adequate information to understand the implications of the payment holiday, including the accrual of interest and how this will impact the total balance, term and/or subsequent repayments.
In the context of credit cards, a payment holiday would technically breach FCA rules (CONC 6.7.5R) which require a minimum payment each month that is sufficient to prevent negative amortisation. The FCA has relaxed this rule so that it does not apply where the relief is being offered as a result of the COVID-19 guidance. Firms can require a token payment of up to £1 where their systems do not allow for nil payments to be made.
A lack of clarity
This guidance has been pulled together quickly and in an environment where it is difficult to know where we'll be three months from now, so it is perhaps not surprising that it is not entirely clear. On the one hand, there is a clear requirement that if a borrower tells a lender that they are facing temporary payment difficulty, the firm should grant a three month payment holiday without any real individual assessment or investigation. On the other hand, the FCA reiterates that its existing forbearance rules and guidance will continue to apply.
The FCA is in danger of making an over-simplistic assumption that all customers seeking payment holidays are facing temporary payment difficulties. It appears in places to neatly divide borrowers into two camps – those who are up to date and who, after a payment holiday, are expected to go back to being up to date, and those who are already in financial difficulty. In fact, there is a good chance that many of these currently up to date customers' immediate and short-term payment difficulties will turn into longer term financial difficulties going forwards, and this creates complexity for firms. For example, when exactly does a customer go from having 'temporary' payment difficulties to longer term financial difficulties such that their credit rating should start to be affected?
The FCA makes it clear that firms are still expected to apply forbearance over and above this minimum level where consumers are in serious and immediate financial difficulty, so, for example it tells credit card issuers to 'consider safeguards' to help borrowers at the end of the payment holiday period in the event of a sudden increase in their payments. However the FCA gives no practical guidance as to what those safeguards might be.
Firms should consider this complexity now, and avoid following the FCA's simplistic approach, as it may result in complaints and 'benefit of hindsight' scrutiny in the future. Issues to think about include how to identify and treat 'vulnerable' customers and whether/how to further assist borrowers who are already being treated with forbearance. The FCA is clear that in the event that a customer is someone who, under normal FCA rules, is eligible to be treated with forbearance, interest that might otherwise accrue during the payment holiday should be waived. Interest waivers are not usually given to borrowers under fixed sum loan agreements, even as a forbearance measure. Repayment plans and short settlements are more usual. This is because interest has been pre-computed and added to the loan at the outset, so the systems just aren't set up to apply mid-term interest waivers. If this requirement applies to fixed sum loans with pre-computed interest, this will be a real headache for lenders.
Credit card interest rates
The FCA's guidance also sets expectations in relation to the prices firms set for credit cards. The FCA makes the observation that where credit cards are usually marketed or offered to low income customers or those with poor credit ratings, interest rates can be high; and it says that firms must 'review their prices to consider whether they are consistent with the obligation to treat customers fairly in the light of the exceptional circumstances arising out of Covid-19'.
A lack of clarity
Despite the observation about high rate cards, it would appear that this requirement applies to all issuers irrespective of whether their book of customers is prime or sub-prime, and irrespective of customers' individual circumstances. There is also no guidance on whether credit card accounts should be frozen in conjunction with any rate adjustment. This is important - there is a risk that if a customer's rate is reduced without any associated freeze on the account, the customer may be tempted to increase usage of the card, which may not be in their best interest longer term.
Again, similar questions arise in relation to credit card rates as for payment holidays. Credit cards derive a huge proportion of their income from their net interest margin; and rates are set in the context of a variety of complex factors including risk of default, competition, and availability of promotional rates. Suggesting that rates should be reduced as an isolated solution, rather than as one of a number of options and tools available to lenders to assist customers in temporary or longer term financial difficulty is over-simplistic and could create issues in the future, the most obvious one being finding the answer to the question of when it is 'fair' to increase rates again; and of course, how firms mitigate the impact of this on their own financial situation, any breaches of co-brand agreements and potentially even investor covenants.
If requested, firms must allow the use of up to £500 of an arranged overdraft interest free for up to three months. This protection is to be provided just as firms are implementing the FCA's previously announced new rules on overdrafts which come into force on 6 April 2020. These rules ban fixed fees for borrowing through overdrafts. As a result of firms no longer being able to charge daily or monthly fees, most, if not all, of them have already notified customers that interest rates on overdrafts will increase.
As for credit cards, firms are being told to 'review their prices to ensure they are consistent with the obligation to treat customers fairly' and, in particular, the FCA is clear that until July, firms are expected to ensure that customers are no worse off under the new pricing model than they were under the old. This is an extremely challenging requirement. The FCA appears to realise this, suggesting that firms take the step of simply not increasing their interest rates as notified or by making manual adjustments, which raises the question of whether COVID-19 is going to hasten the end of free-if-in-credit banking.
The overdraft guidance indicates that, at the end of the three-month period, firms should make individual assessments of whether customers who have had the 0% overdrafts are in financial difficulty. If they are, then the firm should provide forbearance under normal policies and processes. This is also likely to be a sizeable task given that volumes of customers taking up this opportunity is expected to be large.
FCA initiatives to reduce consumer debt
Over the last year, credit card issuers and banks have been grappling with rules designed to reduce credit card and overdraft debt. Firms have been told to contact customers in persistent credit card debt and customers who repeatedly use their overdrafts and encourage them to reduce their balances. This inevitably necessitates consumers being encouraged to pay more, which is, of course, inconsistent with the FCA's response to COVID-19. Unsurprisingly, therefore, the FCA's guidance is allowing firms to delay the implementation of these strategies as appropriate.
Consumer Credit Act 1974 (CCA) considerations
Some CCA-regulated agreements, such as credit cards and overdrafts, will be variable while many others, such as fixed sum loans, will not. Furthermore, some agreements will have pre-computed interest applied at the outset, whilst others will have interest applied daily or monthly in arrears.
It is important to remember that under section 82(2) CCA, where an agreement varies or supplements an earlier agreement, the modifying agreement is to be treated as revoking the earlier agreement and containing provisions reproducing the combined effects of the two agreements. A new regulated modifying agreement must be signed by the customer, pre-contractual information must be provided and form and content requirements must be complied with. In the best of times, this is inconsistent with commercial norms and an increasingly digital society, but in the current circumstances, it is completely unrealistic.
In order to avoid creating a modifying agreement under section 82(2) CCA, forbearance by way of concessionary waiver is the usual route, but this is open to challenge if the concessionary letter is poorly drafted (for example, if it indicates that there has been a bilateral agreement between lender and borrower); or if the lender adds interest accrued during the payment holiday: this could be construed not as a waiver of the lender's rights, but the creation of new ones.
In the event of enforcement, a borrower might argue that an unenforceable modifying agreement was created, and that a court should not grant an enforcement order because the customer was prejudiced by the breach in that he/she incurred extra interest. Further down the line, complainants may seek to exploit deficiencies in the approach taken.
What steps should firms take to mitigate their risk?
- Check the regulated agreement – is it variable and what are the scenarios in which there is a right to vary? For example, many variable agreements will give lenders the right to vary where it is the right thing to do as responsible lenders.
- If it is possible to vary the agreement unilaterally under a variation clause, document internally the basis upon which this is being done and also the basis upon which the decision has been made to make the change immediately rather than giving prior notice.
- If it is necessary to offer forbearance by way of concessionary waiver, confirm this in a customer communication and make it clear that the agreement is not being varied and that this is a concession only.
- Discuss with the business now the need to start thinking about what steps can be taken to keep customers' creditworthiness/ affordability/ and vulnerability under review.
- If a customer appears to be vulnerable now, or in three months' time, then consider whether interest that will accrue and/or has accrued during the payment holiday should be waived.
- Provide information across all communication channels that enables customers to understand the implications of their payment holiday, including the accrual of interest and how this will impact the total balance, term and/or subsequent repayments.
- Consider follow-up communications, ensuring customers are provided with the option to end a payment holiday early if it is no longer required or to make reduced payments during this period instead.
The proposed guidance is open for consultation until 9:00am on 6 April 2020. If confirmed, the measures would start to come into force by Thursday 9 April 2020. Draft motor finance-specific guidance is expected to be published shortly.
The FCA has stated that it will review the guidance in the next three months in the light of developments regarding coronavirus and may revise the guidance if appropriate.