Coronavirus driving motor finance customers to the brink? New guidance from the FCA

In light of the difficulties many borrowers are facing making payments due to COVID-19, the FCA has updated its temporary guidance on the following products:

1. Motor finance (including hire purchase, conditional sale and personal contract hire agreements)
2. Buy-now-pay-later (BNPL), rent-to-own (RTO) and pawnbroking; and
3. High-cost-short-term credit (HCSTC)

The guidance is effective from 17 July 2020 and is intended to run until 31 October 2020 unless otherwise renewed or updated.

Firms are expected to (temporarily) offer exceptional and immediate support in exceptional circumstances arising out of the coronavirus pandemic – such as a loss of, or reduction in, income. The guidance does not apply to longer-term payment difficulties.

We focus on the motor finance sector in this piece.

Motor Finance

• Customers who have not yet received a payment deferral, who are experiencing or reasonably expect to experience temporary payment difficulties as a result of coronavirus and who wish to receive a payment deferral, should be offered one for 3 months’ worth of payments.
• The customer’s best interests should be considered when deciding whether to offer a payment deferral – to include a consideration of their ability to repay any accrued interest within a reasonable time period.
• Where a 3 month full payment deferral is not considered appropriate, firms should offer other temporary relief, such as a partial, or shorter period of, payment deferral.
• Firms remain able to offer more generous forms of support such as waiving interest.
• Firms are expected to keep clients aware of the availability of payment deferrals and give them appropriate information to understand the implications.
• Customers coming to the end of a payment deferral period should be distinguished between those who can resume full payments immediately and those who are unable to do so as a result of coronavirus. Customers should be contacted before the end of a payment deferral period to discuss their options.
• Where customers can resume full repayments, the deferred amounts must be payable over the remaining term of the agreement - or a longer period if this is in the customer’s best interests.
• Where customers cannot resume their full repayments, a full or partial payment deferral should be offered to reduce payments to an affordable level, for a period of 3 months.
• Where a customer has received a payment deferral and interest accrues which would not have accrued without that deferral, the FCA will expect interest to be waived. This is so that customers are not in a worse position regarding interest than they would have been if they had made their full repayments.
• There are specific aspects of the guidance for PCP customers, which focus on the need to work with the customer where they cannot meet the balloon payment and especially where there may be a disparity between the amount of the balloon payment and the vehicle’s value.

Impact on motor finance firms’ funding arrangements

• Many motor finance firms fund their business by financing their receivables (i.e. the payments that they receive from their customers under motor finance contracts) with third party banks and other specialist funders.
• These financing transactions are mostly structured as invoicing discounting facilities (where the funder purchases the receivables from the motor finance firm outright) or borrowing base facilities (where the motor finance firm retains ownership of the financed receivables). In both cases, the funder provides a discounted advance raised against or referable to a pre-agreed value of receivables that satisfy specific characteristics (so called “eligible receivables”). The discounted advances are then repaid over a period similar to the underlying motor finance contract.
• “Eligible receivables” criteria almost always include a criterion that the customer is no more than an agreed number payments in arrears. Or, put another way, receivables that exceed the agreed number of payments in arrears fall out of the borrowing base or otherwise cease to be eligible. This is because the deterioration of the credit quality of the customer reduces the overall value of the asset pool and the amount of credit that funders are prepared to lend against it. This may trigger an immediate repayment obligation for the motor finance firm borrower if the amount of the loans it has borrowed exceeds the then borrowing base.
• The coronavirus pandemic and related FCA guidance about payment deferrals and other customer forbearance measures will no doubt have brought the arrears-based criterion and its impact on vehicle finance facilities into sharp focus. We expect that many motor finance borrowers and their lenders will be examining their facility agreements to ascertain when a receivable is in arrears under those agreements and how compliance with the FCA guidance might affect this determination and any related repayment triggers.
• Relatedly, funders often include restrictions on the ability of their motor finance borrowers to amend their credit and collection policies because certain types of amendments (e.g. extending collection periods, payment deferrals, waivers and/or write-offs) could adversely affect recoveries from the underlying financed receivables. That said, there are often carve-outs allowing amendments that need to be made to comply with applicable law or regulation (and which complement the “compliance with laws” undertaking that is given by borrowers on almost every financing transaction). This type of provision may come under increased scrutiny as a result of the pandemic, with funders and borrowers asking themselves (and maybe each other) whether or not FCA guidance constitutes “regulation” under financing arrangements.

Andrew Dodds, Partner in the banking and finance practice at Stevens & Bolton LLP, comments:

"The revised guidance offers a roadmap (pun intended!) for firms offering motor finance credit. The contents are not surprising, but will no doubt add pressure and complexity to the decision-making process that providers of credit already have to undertake. It also remains to be seen how much any temporary payment deferrals or interest waivers may affect the profitability of such firms as the pandemic continues and their ability to comply with their own financing arrangements. However, the guidance will be a welcome comfort to customers suffering temporary financial difficulties or job losses due to coronavirus. As always, the key message is for both the motor finance lender and its customer to engage with one another early in the hope of the best possible outcome in difficult circumstances. That same message applies to the motor finance firm borrowers and their lenders in relation to the knock-on effect that the FCA guidance may have on, for example, the eligibility of receivables for funding and the borrowing base in a given suite of finance documents."