22 August 2017

There’s a new sub-prime crisis, but it’s not what you think


A decade on from the financial crisis, the reports today about the sub-prime lender Provident Financial have given us a nasty case of déjà vu. Within the space of a year, its loan repayment rates have fallen from 90 per cent to 57 per cent – leading to profit warnings, the departure of its chief executive, and a collapse in its share price.

It feels like a frighteningly familiar story. Overstretched customers at the bottom of the economic food chain rack up unaffordable loans from greedy financiers. When the music stops, the credit failures cascade upwards, bringing down lender after lender until the whole financial edifice comes apart.

So are we facing a new sub-prime crisis? There are two conflicting narratives.

The first is that Provident’s problems are unique to Provident. The firm operates in what is euphemistically known as “the non-standard credit market” – ie providing loans to people who are woeful credit risks. It does this via Vanquis Bank, which sells credit cards; Provident, which sells domestic loans; Satsuma, which does short-term online loans a la Wonga; and Moneybarn, which provides car finance.

The one-line explanation for what went wrong with the business is that Provident moved from collecting what it was owed via “self-employed door-to-door agents” to full-time “customer experience managers”. In other words, rather than outsourcing the business of debt collection it would bring it in-house.

The move followed followed claims, for example by Citizens Advice (£), that the agents of some doorstep lenders were engaging in illegal cold-calling, irresponsible lending or naked intimidation – though Provident denied that its own agents engaged in such behaviour, and said they would be sacked immediately if they did so.

The problem was that, as soon as the firm told the existing collection agents that they were being fired, they walked out rather than stay through the transition. Hence the plunging rates of debt collection, which the new staff haven’t been able to get back up.

But there’s another narrative – which is that Provident’s entire business model is evidence of a serious and potentially systemic financial problem.

The alarm here is particularly focused on the sub-prime car-finance industry, in which Provident (via Moneybarn) is the biggest player. Across the sector, the credit checks are incredibly swift and (according to many reports) rather cursory. That’s led many people to worry that the market is getting out of hand – including the Financial Conduct Authority, which has launched an investigation. There’s a particular echo of the sub-prime crisis in the increasing popularity of personal contract plans (PCPs) – clever financial innovations which offer very poor people access to very nice cars, because they are effectively leasing them rather than owning them.

Moneybarn, to be fair, doesn’t focus on PCPs: it’s more about old-fashioned lending. But that lending is going to people who are often heavily indebted already. Back in July, Liberum Capital published a research note explaining why it had put a SELL rating on Provident. The most startling figure was an estimate that “a typical Moneybarn customer spends 66 per cent of after-tax income on rent, car loan and credit card payments”. These, in other words, are people who are already drowning in debt – and the slightest rise in interest rates, or economic slowdown, or spike in inflation, could see them go under completely.

In America, it was fears that another bubble was forming in sub-prime loans that prompted the big banks to pull back from the car market in particular. So are we in for a repeat of 2008?

Personally, I’m optimistic. We’re talking about fewer borrowers and lenders: Moneybarn, for example, has only 41,000 customers. Also, regulators are now hyper-aware of the dangers of excessive lending, and have taken a whole series of steps to make sure that the dominos cannot (or should not) topple into each other as they did back then.

In fact, the real message of the Provident story is very different – because it’s about the unintended consequence of those same regulations, and the people who have suffered because of them.

If you read Provident’s annual report, there is an awful lot in there about social responsibility – to the point where the opening dozen or so pages could essentially be boiled down to the phrase “We’re not Wonga!” in 144pt bold caps. But there’s not a lot of stuff in there about interest rates.

You can get an idea of just how profitable Provident is, however, by looking at its component businesses. Last year Vanquis made £204.5 million from its 1.5 million credit card customers. Provident and Satsuma, which are part of the same unit, made £115.2 million from approximately 850,000 customers. And Moneybarn made £31.1 million from those 41,000 customers.

In other words, each customer for Provident’s credit cards, and home or online loans delivered approximately £135 in profit. For Moneybarn, it was a staggering £758.

So where are these profits coming from? Not, as you might think, from those at the very bottom of society. The average customer for Vanquis is 35-45, living in rented accommodation but with a full-time job paying £20k to £35k. Because of their “thin or impaired credit history”, the maximum line of credit is no more than £4,000, with a representative APR of 39.9 per cent. The statistics for Moneybarn are similar: £20k to £30k in income, with an APR of 33 per cent.

For Provident and Satsuma, the income is lower and the interest is higher – a lot higher. These are people on £10k-£15k, paying interest rates of 535.3% for Provident and an eye-watering 991% for Satsuma, although the loans are usually smaller and shorter-term.

How, given these statistics, can I argue that the regulations are a problem? Don’t we really need more regulations to protect people from these greedy, unscrupulous loan sharks?

The problem here is actually pretty simple. Before the financial crisis, the big banks lent to all sorts of people they really shouldn’t have. In order to prevent the same thing happening again, the rules were tightened up – now you could only get a loan for a house, or a car, or pretty much anything, if you had the sort of credit rating that would make your bank manager (if they still existed) beam with approval.

Yet this process had a very important consequence: the mass withdrawal of blue-chip financial institutions from the lower end of the market. Barclays, for example, used to be well known as a place that bankrupts could go to for a second chance. Now, such customers often find themselves locked out of the credit market.

Britain, as the official Financial Inclusion Commission points out, has a pretty comprehensive banking system: only 1.5 million people are officially “unbanked” (although a great deal more are not all that happy with the service they’re getting…).

But even those with bank accounts often struggle to get access to credit. According to Provident, there are between 41 and 43 million Britons in the “standard” credit market, and between 10 and 12 million who are locked out of it – plus approximately two million who flow between the two depending on the health of their finances.

Thanks in large part to the banks’ and regulators’ flight from risk post-2008, those 10 to 12 million – and their counterparts in foreign countries – have been left to the likes of lenders like Provident. Or to those who are far less scrupulous: since the crash, payday lending has grown massively, but so has the number of illegal moneylenders and pawnbrokers.

As Provident’s profit figures suggest, this is an incredibly profitable niche. Last year, Provident’s return on equity (ROE) across the group was 45 per cent – in other words, every £1 in assets delivered a 45p return in profit.  By comparison, Metro Bank – a challenger bank serving a more conventional market – is aiming for an ROE of 18 per cent in 2020. At the height of the boom years, Barclays’s ROE only reached 20 per cent – in these staider times, it is now barely 3 per cent.

What’s happening, in other words, is that the poorest in society are paying more – much more – than they should for credit and lending, or even for access to the banking system. Syed Kamall MEP has written powerfully on CapX about the damage this causes.

Access to credit is one of the things that lets people climb the economic ladder, in the developed and the developing world. But access to too much credit – or to credit on the terms that are generally now on offer – keeps them trapped in debt.

No one wants to open the floodgates in terms of lending – lord knows we’re all indebted enough already as it is. But encouraging the banks to expand their services, or coming up with new ways to help the unbanked and deliver low-cost, low-risk credit, would directly benefit the poorest in society. Such people will never be able to borrow on the same terms as those with unblemished credit records. But the more players there are in the market, the lower the premium they will be charged.

As it is, in attempting to protect the financial system from another crash, we’ve left millions of people with no option but to turn to the likes of Provident – which may often end up being a very improvident move indeed.

Robert Colvile is Editor of CapX