In September 2018, new rules published by the Financial Conduct Authority (FCA) on persistent debt and intervention by lenders for credit card borrowers at risk of financial difficulties became effective. Under the new rules, lenders are required to prompt customers who carry credit card balances over long periods of time to change their repayment behavior. In S&P Global Ratings' view, these rules could improve the performance of receivables backing U.K. credit card asset-backed securities (ABS) primarily through an increased payment rate, although yield could moderately deteriorate. In addition, we believe that tail-risk that could arise from large shares of high balance accounts that are currently only making minimum principal repayments could be reduced if the new rules result in partial amortization of these receivables.
Frequently Asked Questions
What are the new persistent debt rules?
The new rules consider customers to be in persistent debt when the amount paid toward interest, fees, and charges over 18 months exceeds principal repayments over the same period. Under the new rules, firms offering personal credit cards are required to contact customers after they have been identified as being in persistent debt. At month 18, firms must notify borrowers about their situation. Borrowers will be informed about the benefits of increasing monthly payments, as well as potential implications if they remain in persistent debt for two consecutive 18-month periods. Borrowers will be encouraged to contact lenders to discuss their financial circumstances and a prospect of a monthly payment increase without an adverse impact on the borrowers' financial situation. In addition, borrowers will be provided with the contact details for not-for-profit debt advice bodies.
Subsequent correspondence is required at month 27, at which point the customer's situation will be reassessed. The 18-month correspondence will be repeated if the customer's repayment behavior is unchanged. If borrowers remain in persistent debt at month 36, the lenders will have to reintervene. At this point, lenders will offer borrowers alternative ways of repaying their outstanding balance quicker.
The repayment options available may include increased monthly payments on the credit card or the option to transfer the balance on the credit card to a lower interest personal loan. The aim of both options is to repay the balance over a reasonable period, typically within three to four years.
Where the repayment options are unsustainable, e.g., the borrower is unable to repay the balance in a reasonable period, the FCA requires lenders to show 'forbearance' by reducing, waiving, or canceling any interest, fees, or charges on the outstanding balance. Ultimately, borrowers could see their credit card suspended and be reported to credit reference agencies if they fail to implement remedies.
How will the new rules affect the collateral performance of U.K. credit card receivables?
In credit card ABS, any adverse movement in one of the three key performance variables (charge-off rate, monthly payment rate, and gross yield) might be offset by positive movement in the other two variables, which may help to maintain the current ratings on the notes. For example, a rise in the payment rate or a drop in the charge-off rate may mitigate a drop in yield.
Following the introduction of the new rules, we expect the payment rate (which we define as total collections received in a particular month divided by the pool balance at the beginning of the month, expressed as a percentage) to increase. This is because borrowers in persistent debt will be incentivized to either increase their monthly payments or to pay off the outstanding balance through debt consolidation. Otherwise, they might lose access to credit card financing. Some lenders might choose to increase the minimum payment due altogether to minimize the proportion of borrowers reaching the early-stage persistent debt. In our view, a high payment rate benefits a transaction as during the amortization period, the note principal is paid down more quickly, meaning noteholders are exposed to losses for a shorter period.
As for the charge-off rate (defined as losses on principal receivables divided by the pool balance at the beginning of the month, annualized and expressed as a percentage), we forecast a positive impact on outstanding collateral performance. The new rules intend to reduce borrowers' long-term debt, which in itself should reduce the likelihood of borrowers entering arrears. We also expect tail-risk could be reduced, if the new rules result in partial amortization of receivables from relatively high balance accounts that are currently only making minimum principal repayments.
Lastly, we anticipate that yield rates (the finance charge and fee income in a particular month divided by the pool balance at the beginning of the month, annualized and expressed as a percentage) could be reduced. This is because borrowers in persistent debt would now more actively target the reduction of their outstanding credit balance, which should result in lower borrowing costs. In addition, for those borrowers who remain in persistent debt at month 36, we expect forbearance offered by the lender to further reduce the yield rate.
What is the likely rating impact of the new rules on U.K. credit card ABS?
The risk appetite of each lender drives the underwriting standards, which, along with macroeconomic developments, will translate into a different exposure to borrowers that could fall into persistent debt. The impact on performance from the new rules in individual credit card programs could therefore be different.
We monitor the collateral performance of credit card programs to ensure that realized performance remains consistent within our base-case expectations. Based on the performance data received since the rules became effective in September 2018, we have not observed any material changes in receivables performance across all rated programs. This is to be expected, given the short period of time since introduction. As borrowers and lenders adjust to the new rules, all else being equal, we expect payment rates will increase, and charge-offs and yield will decline. However, we currently believe it is unlikely that this would result in changes to our base-case and stressed performance assumptions, as these are calibrated to reflect performance through an economic cycle and reflect the revolving nature of credit card portfolios. Therefore, we do not expect the new rules to have any ratings impact on outstanding U.K. credit card ABS.
Related Criteria
- Global Methodology And Assumptions For Assessing The Credit Quality Of Securitized Consumer Receivables, Oct. 9, 2014
Related Research
- U.K. Credit Card ABS Index Report Q3 2018, Nov. 19, 2018
- How We Rate And Monitor EMEA Structured Finance Transactions, March 24, 2016
This report does not constitute a rating action.
| Primary Credit Analysts: | Marta Gorska, London + 44 20 7176 2523; marta.gorska@spglobal.com |
| Feliciano P Pereira, CFA, London + 44 20 7176 7021; feliciano.pereira@spglobal.com | |
| Secondary Contact: | Matthew S Mitchell, CFA, London (44) 20-7176-8581; matthew.mitchell@spglobal.com |
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