On 22 May 2020, the FCA published a guidance consultation on payment deferrals for mortgage borrowers (May Guidance) which supplements the original FCA March guidance (March Guidance) published on 20 March 2020.
The new May Guidance extends the period customers can request a payment deferral and also sets out detail on the FCA's expectations for firms where borrowers are coming to the end of a payment deferral.
At the same time the PRA has published a statement in relation to the application of regulatory capital and IFRS 9 requirements to loans impacted by the FCA guidance (PRA Statement).
The May Guidance provides the following clarifications:
- The period during which customers can ask for a 3 month payment deferral has been extended to 31 October 2020.
- Firms should be well advanced in their planning and approach to the end of payment deferrals. The FCA May Guidance provides more detail around the expectations of firms in relation to this.
- Where a customer is coming to the end of a payment deferral and cannot immediately resume full payments, firms should offer them either a full further 3 month payment deferral or a partial 3 month payment deferral, unless the firm can demonstrate it is not in the customer's best interests and a different option is more appropriate.
- Where a firm has dealt with a customer at the end of a payment deferral period before the May Guidance comes into force, it should review whether the outcome the customer has received is likely to be consistent with the outcome that customer would have received under the May Guidance. If the outcome is not consistent, the firm should take reasonable steps to contact such customers.
- Firms need to contact customers in good time before the end of a payment deferral period and engage with them about their options. The May Guidance sets detail on the nature, timing and content requirements for these communications.
- Given the number and volume of payment deferrals currently in place, firms should ensure that their processes and procedures are of sufficient scale to accommodate the processes required and customer queries/engagement.
- New Payment Deferrals
Can a customer who has not previously been granted a payment deferral request one?
Borrowers who have not previously received a payment deferral can request a payment deferral for up to 3 months. The criteria for the provision of a payment deferral (or indeed any of the other support measures available for borrowers) remains the same as under the March Guidance other than the fact that payment deferrals can now be requested until 31 October.
Can a customer who has not previously been granted a payment deferral, but who was in a payment shortfall prior to 20 March 2020, be granted a payment deferral?
Customers who had a payment shortfall prior to 20 March 2020 and who have not yet had a payment deferral, may request one.
- Existing Payment Deferrals - Fair Treatment Of Customers
How should firms treat customers who are approaching the end of a payment deferral period granted under the previous March Guidance?
Firms need to ensure that the manner in which they seek to recover sums and any increase in the total amount payable when the payment deferral ends is compatible with PRIN 6 and MCOB 2.5A.1R (acting in the customer's best interests).
There are different categories of customer in this context:
- Category 1 – customers who are able to resume full payments immediately;
- Category 2 – customers who are currently unable to resume full payments due to circumstances arising out of COVID-19; and
- Category 3 – customers who had a payment shortfall prior to 20 March 2020.
What do firms need to do towards the end of a payment deferral?
Firms should take reasonable steps to contact customers in good time before the end of a payment deferral in order to discuss with the customers whether they can start to resume making payments and to engage with them about their options.
This contact should:
inform the customer of what happens if they do not respond including the impact on their next monthly payment; and
- explain any default arrangements (e.g. capitalisation) or term extension.
- If the customer does not respond, firms can proceed on the basis that the customer is able to resume full payments.
In making this assessment, firms can also use other sources of information to understand the needs and circumstances of customers although there is no requirement on firms to do this. The type of information includes information already held by the firm or information provided by others (e.g. CRA or open banking sources).
How should firms treat Category 1 customers who are able to resume full payments immediately?
This category of customer should be given information about how to access different options to repay sums covered by a payment deferral in good time before they are bound by any default arrangements the firm puts in place. This can be a digital or scripted process.
The options for the customers include:
- paying a lump sum; or
- extending the term to maintain the customer's previous repayment levels where these are legally possible.
The default arrangement is then capitalisation. If the amounts are to be capitalised the firm needs to give the customer personalised information on the impact of doing so on their monthly payments and the term of the mortgage.
How should firms treat Category 2 customers who are unable to resume full payments?
Where a customer indicates that they cannot immediately resume full payments, firms should offer them a further full or partial payment deferral for 3 monthly payments based on what the customer considers they can currently afford, unless the firm can demonstrate that a deferral is obviously not in the customer's best interests and a different option is more appropriate.
In making this assessment, firms should consider both the customer's need for support and the longer term effects of a payment deferral on the customer's situation including the customer's ability to repay accrued interest once the period of the payment deferral ends.
Firms are not required to verify or investigate a customer's individual circumstances beyond identifying the customer's assessment of what they can currently afford.
This does not prevent firms from agreeing a longer term solution that enables the customer to resume payments sustainably, such as an extension of the term or alternative products, where it is in the customer's best interest.
Firms should give customers adequate information to understand the implications of any support offered, including the consequences for the total amount payable under the mortgage contract. This should include personalised information on the impact on their monthly payments or the term of the mortgage.
Firms may use a digital or scripted process to assess customer circumstances, offer payment deferral options up to 3 months and provide the customers with the information required in order to enable the customer to choose between these options.
How should firms treat Category 3 customers who had a payment shortfall prior to 20 March 2020
The provisions on treatment of borrowers at the end of a payment deferral do not apply to customers who had a payment shortfall prior to 20 March 2020 however, firms may consider agreeing a further payment deferral if this would be appropriate under MCOB 13.
Note that MCOB 13 contains specific provisions about the capitalisation of payment shortfalls, including that a firm must not automatically capitalise a payment shortfall where the impact would be material.
Given the unprecedented uncertainty and upheaval caused by COVID-19 and the practical limitations imposed as a result of the Government's social distancing and self-isolation measures, the FCA has also confirmed that firms should not commence or continue any repossession proceedings against customers at this time. As a result there will be a moratorium on repossessions of any residential and buy-to-let properties for a period now running up to 31 October 2020. Crucially, this applies irrespective of the stage that repossession proceedings have reached and applies to any step already taken in pursuit of repossession. In the event that a possession order has already been obtained, the FCA's clear guidance is that firms should refrain from enforcing it.
The PRA has now published further draft guidance which is supplementary to the joint statement published by the PRA and the Bank of England on 20 March 2020 and the PRA's Dear CEO letter on 26 March. The statement addresses the accounting and regulatory treatment of lending products impacted by the FCA's March Guidance and May Guidance.
The statement sets out the PRA's view on the correct accounting treatment of lending products impacted by measures taken to support borrowers during COVID-19. This includes the PRA's view on the correct application of the International Financial Reporting Standards 9 (IFRS 9) expected credit loss accounting (ECL) and the regulatory definition of default under the Capital Requirements Regulation (CRR), in the context of firms' assessment of the accounting and capital treatment for exit from, or extension of, COVID-19 related payment deferrals.
The PRA has confirmed its view that the grant of payment deferrals in accordance with the FCA guidance set out above should not automatically result in:
- the loan being regarded as having suffered a significant increase in credit risk (‘SICR’);
- the loan being automatically regarded as being credit-impaired; or
- the triggering of a default under the CRR.
This means that, for first time payment deferrals, the PRA considers that firms are not required to make any immediate changes to their accounting or regulatory treatment of the loans for CRR purposes.
However, In the case of borrowers approaching the end of a payment deferral, firms should distinguish between Category 1 customers and Category 2 customers in line with the FCA's May Guidance.
- Category 1 Customers
The guidance confirms that for Category 1 customers, who are able to resume full payments immediately, the PRA would not expect firms to treat such loans as being in default for CRR purposes provided payments are made under an agreed revised schedule.
- Category 2 Customers
In the case of Category 2 customers, who either cannot resume full payments immediately or who are only able to resume payments at a reduced level, firms' assessments for regulatory capital and accounting purposes need to establish whether these borrowers should be treated as being in default (for CRR) or as having suffered a significant increase in credit risk or credit impairment (for IFRS 9).
For borrowers unable to resume payments, the PRA does not consider the grant of a payment deferral under FCA guidance as triggering the counting of days past due, as generating arrears or as resulting automatically in the borrower being considered unlikely to pay under CRR. Firms should look to the agreed revised schedule of payments when making the assessment of whether the borrower is past due on any material credit obligation owed to the institution or has any indicators of unlikeliness to pay.
Category 2 customers may be unable to resume full payments temporarily due to short term liquidity challenges (for example, because they are on furlough and suffering a temporary drop in income), or due to financial difficulty that is more likely to be longer term (for example, due to redundancy). In assessing unlikeliness to pay, firms should obtain information from the borrower and should place significant weight on information that indicates the underlying reason for the inability to make payments. Where a borrower's financial difficulty is more likely to be longer term, then, given that concessions for such a borrower is likely to classify as forbearance for CRR purposes, the firm will need to assess whether this results in the loan becoming a distressed restructuring that is likely to result in a diminished financial obligation and therefore the loan being in default under the CRR.
In the context of ECL accounting treatment the PRA reminds firms of three basic principles it outlined in its Dear CEO letter of 26 March, which are critical of firms' implementation of the IFRS 9 ECL requirements:
- ECL should be implemented well and on the basis of the most robust, reasonable and supportable assumptions in the current environment in order to enhance consistency and reduce the risk of firms recognising inappropriate levels of ECL, whether they be under-statements or over-statements;
- Forward-looking assessments need to take a balanced view of both the potential impact of the virus and the unprecedented level of support provided by governments and central banks domestically and internationally to protect the economy; and
- The assumptions that have been used in implementing ECL prior to COVID-19 and related actions should not be applied mechanically to the current circumstances, because those assumptions may no longer hold in the context of the current unprecedented situation.
The PRA considers that, where a borrower is granted a further full or partial payment deferral, this does not automatically result in a SICR or credit impairment for ECL purposes, given that further payment deferrals can be used for short term liquidity difficulties. Firms should refer to the agreed schedule of payments as the trigger for counting days past due (30 days for determining that a loan has suffered a SICR and should move to stage 2; 90 days for determining that a loan is credit impaired and should move to stage 3). In cases where a loan suffers a SICR or credit impairment but is not past due, the PRA advises firms to exercise careful judgement as firms may not have collected detailed information to enable them to consider other SICR and credit impairment indicators beyond whether the borrower is past due. For further detail please contact a member of our team.
If you would like to know more or would like to discuss anything further, please get in contact.