What restructuring professionals need to know about consumer lending companies as regulators issue viability warnings

Out-Law Analysis | 14 Aug 2017 | 1:06 pm | 5 min. read

ANALYSIS: Financial regulators have warned that the UK is experiencing a consumer credit boom and that the current level of lending could lead to widespread defaulting on loans. This could create problems for consumer finance companies who, regulators say, have not been pricing risk properly.

The alarming growth in the consumer lending sector is not supported by wider economic conditions and there are already signs of sector activity in the restructuring market. This will only increase in the current economic climate and once regulators apply pressure on firms that can't demonstrate they are dealing with the problems regulators have identified.

There is no special insolvency regime for consumer finance companies so normal insolvency procedures and rules will apply.

Regulators are worried about the credit boom, and about lenders' ability to survive as economic conditions worsen.

The Bank of England said in a recent Financial Stability Report that consumer credit is growing at four times the rate of household incomes and in the context of a low wage, low interest rate economy, with a freeze on public sector pay increases and a fall in real wages since the onset of the financial crisis.

There are estimated to be in excess of 50,000 consumer finance businesses in the UK with a total lending stock of £198 billion, 34% of it relating to credit cards, 30% to dealership car finance and the remainder relating to personal loans, store credit and other lending. Nearly 90% of new cars are sold using some form of finance. Given the involvement of individual consumers, the sector is highly regulated.

The Financial Stability Report said that although loss rates remain low this is partly as a result of banks’ net margins on new lending falling and major lenders using lower risk weights to calculate the capital they need to hold. The increase, the report explains, is partly a matter of a cultural shift towards use of dealership finance and technological changes leading to an increase in on-line shopping, contactless payments and use of credit cards. Over the past 10 years, UK banks’ total write-offs on UK consumer credit lending have been 10 times higher than on mortgages.

The Prudential Regulation Authority (PRA) recently expressed concern about the reducing resilience of consumer credit portfolios (421KB / 6-page PDF) because of “the combination of continued growth, lower pricing, falling average risk-weights and some increased lending into higher risk segments”.

In particular, the PRA is concerned that firms’ pricing of risk is overly influenced by the current benign macro-economic environment, that rising consumer indebtedness has not been fully considered in firms’ assessment of risk and the specific reliance on 0% credit card offers. Motor finance is seen as a particular risk given it is the fastest expansion amongst consumer credit products under PCP (personal contract purchase) deals, which are heavily dependent on the residual value of the vehicle being able to cover the outstanding balance of the debt. The PRA is also concerned about the adequacy of management information and delayed recognition of credit losses. As a result, the PRA is requiring firms to provide evidence as to how they are addressing these concerns, specifically on credit scoring, stress-testing and prior consideration of a borrower’s total debt.

Against this backdrop it is not surprising that firms such as Moneybarn and Provident Financial Group have issued profit warnings and that the regulators are beginning to show their concern.

Regulation is affecting profitability

In 2014 regulation of consumer credit moved from the Office of Fair Trading (OFT) to the FCA and from that point consumer credit firms have been subject to a more complex set of rules and principle based regulation than before under The Financial Services and Markets Act 2000 (FSMA), the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 and the FCA Handbook.

In addition the FCA has taken specific action in sectors where it considers that customers, and in particular vulnerable customers, have not been adequately protected. Many of these changes, such as the introduction of an interest cap on providers of high cost short term credit, have had a direct effect on the profitability and viability of consumer finance firms. The FCA has also ordered some lenders to pay millions of pounds in redress to customers for a variety of failings including inadequate affordability assessments and unfair or misleading collections practices.

Regulation and restructuring

Although consumer lending is a regulated activity, consumer finance businesses do not have their own tailored insolvency regime or insolvency process such as the special administration procedures brought in after the financial crisis for other investment banks and other financial services companies. Therefore the standard insolvency regime and insolvency processes under the Insolvency Act 1986 are applicable, though subject to specific powers of the FCA and additional duties on officeholders.

The FCA as the regulator for consumer finance firms has been granted limited powers in relation to insolvency processes of authorised firms, or non-authorised firms performing regulated activities without authorisation, under Part XXIV of the FSMA.

These powers include allowing the FCA to:

  • apply for an administration order or present a winding-up petition in relation to an authorised person, who is an appointed representative or is carrying on a regulated activity in contravention of the general prohibition;
  • apply for an order under section 423 of the Insolvency Act 1986 dealing with transactions defrauding creditors;
  • participate in insolvency proceedings, attend creditor meetings and receive creditor reports of an authorised person;
  • receive reports from officeholders if they think a regulated activity is being carried on in contravention of the prohibition; and
  • provide consent before directors can file a notice of intention to appoint administrators or apply for an administration order.

The FCA may challenge in court any decision or implementation in relation to a company voluntary arrangement. The FCA may also apply to appoint administrators or to wind-up the relevant company on the basis it is unable to pay its debts or otherwise on a just and equitable basis. The FCA has a right to receive all notices to creditors and to attend and participate in meetings in relation to an insolvency process.

Insolvency practitioners

Officeholders have additional duties and risks to consider in relation to an appointment over a regulated consumer finance business.

Whether appointed as a liquidator, administrator, receiver or trustee in bankruptcy, an IP has a duty to report to the FCA if the relevant person acted in a way that breaches the general prohibition or carries out a credit-related regulated activity without the necessary permission, as covered by sections 19 and 20 of the FSMA.

Many of the regulated activities in relation to consumer finance are carried on by IPs before or after their appointment as administrators, liquidators or nominees, such as the administration and collection of debts.

Prior to the regime change in April 2014, IPs could operate in reliance on group consumer credit licensing operated by their insolvency regulators or occasionally with direct licenses obtained from the OFT. Since 1 April 2014, unless they have obtained full FCA authorisation, IPs have had to rely on a limited statutory exclusion. This provides that officeholders acting during a formal appointment under the Insolvency Act 1986 or any pre-appointment obligations carried out in ‘reasonable contemplation’ of acting in a formal capacity may provide, and their firms may also provide, debt counselling, debt adjusting and credits information outside of the FCA regime. This is outlined in paragraph 52 of the Schedule to Financial Services and Markets Act 2000 (Exemption) Order 2001 as amended by The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No.2) Order 2013.

On appointment IPs may also engage in administration and collection of debts within the exemption. However, there is still a risk if the relevant underlying consumer credit agreement was entered into without authorisation or the IP seeks to enforce a claim. An IP on appointment does not have authorisation to enter into or exercise a lender’s rights and duties under a regulated credit agreement. An IP must also comply with the various notices that are required before demand can be made under a regulated credit agreement.