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Sub-prime lending and debt rehabilitation. Breaking out of the loop.

Mike O’Connor, chief executive of StepChange Debt Charity, spoke at the Council of Mortgage Lenders' annual conference in London on 10 November 2015. This is a transcription of his speech.

"It’s a pleasure to be talking at the Council of Mortgage Lenders’ annual conference today. The CML has always been a thoughtful, engaging and considered trade body.

In fact we generally find the mortgage industry to have a good appreciation of the bigger picture on debt issues – the broad interplay of macro and household risks, public policy and private practice, that condition the size and nature of the personal debt problems we see at StepChange Debt Charity.

Of course there are issues that concern us as debt advisors, and public policy advocates for people experiencing debt problems now, and those vulnerable to problems in the future.

They are central to the issues I’ve been asked to talk about today… Sub-prime lending, debt and ‘rehabilitation’. And central to our understanding of what we have been seeing over the last 10 years or so. And what we might see over the next five.

About StepChange

"But first I should say a bit about what we do at StepChange Debt Charity. We’ve been going for over 20 years now and we are the largest debt advice charity in the UK.

Last year nearly 600,000 people contacted our free telephone helpline and online Debt Remedy tool for advice and support with problem debt.

We work across Great Britain and Northern Ireland and next Monday we start providing a service to help people in the Republic of Ireland, where as you know mortgages are a bigger share of problem debt than here in the UK.

We offer a full range of debt solutions and aim to get people to the debt solution that is right for them as quickly as possible. We will help people to repay their debts where they can. But we also help people with insolvency options like bankruptcy, DROs and IVAs where they need debt relief and a fresh start.

We work with around 900 partner organisations. Many of these are lenders – both secured and unsecured - and around half of our clients are referred by lenders – some in this room today. But we also work with a wide variety of charities, welfare organisations, local government and so on.

We invest heavily in these partnerships - a close working relationship and a well thought through customer journey means that people are more likely to get the help they need at the right time.

We are always happy to show people how we work. So if any of you would like to visit our main centre in Leeds, you would be most welcome.

StepChange policy advocacy

"As well as helping people directly through advice and individual debt solutions we are increasingly focusing on the need for policy change. Achieving our vision of a society free from problem debt will not be achieved one person at a time. 

We have been patching people up for 20 years. But there is a constant stream of new people struggling with problem debt.

So we need society as a whole to come up with some better solutions. Better solutions to prevent people falling into financial difficulties in the first place. And better ways of helping people to cope with financial difficulties without falling into unmanageable debt.

As a starting point we are getting more vocal at calling out problems when we see them. Last week the Financial Conduct Authority credit card review reminded us all of some of the long standing issues from before the financial crisis that are still with us. I thought the FCA focussed too much on competition as a way to avoid detriment rather than regulation of the supply side.

And the stream of recent payday lender consumer redress stories reminds us of the consumer problems that have developed since the crash but took too long to deal with.

For us, the common theme is a link between conduct issues and debt. Product features that don’t understand consumer vulnerabilities or, worse still, exploit them. Lending practices that build unaffordable debts. Collection practices that drive people in financial difficulties to decisions that make their situation worse.

Sadly these are not just old battles, but things we continue to see across the broad credit market that contribute to the problems our clients face. Happily, as a society, and as and industry, we are making progress.

A clear lesson from and legacy of the crisis is the need for effective, pro-active and when necessary robust regulation of credit markets.

But as 2007 becomes a distant failing memory, and a new credit cycle begins, policy makers may become too relaxed. There will be a tendency to forget the mistakes of the past, and as a result repeat them. A point that the mortgage market review made clearly.

Only two weeks ago we were asked about the re-emergence of a sub-prime mortgage market in the UK. Were we worried? We said we thought it should be different this time. Lenders should remember past mistakes, because the regulator should be constantly reminding them. But us debt advisors and consumer advocates we will need to keep our eyes peeled and our elbows sharp.

The lesson we learned from the crisis and all that has followed is not to assume that things will sort themselves out, or that policy makers will keep their eyes on the ball.

What we are seeing on debt right now

"So we are trying to look deeper into our clients’ experience. Trying to better understand why that stream of people needing our help keeps on coming. And trying to understand the nature of the debt problems we are seeing now so that policy makers might head off more problems in the future.

We all know that in some respects things are starting to get better for some people. Headline employment numbers have been strong and many households have had real income growth for the first time in a long time. The average unsecured debt of StepChange clients is still large at £14,000 but considerably lower than it was in 2008, making recovery look more likely for some households. And we’re told, the number of unsecured debts coming into collections is the lowest for a while.

The number of our clients who are homeowners, with or without a mortgage is down to around a quarter. Just after the recession nearly half our clients were homeowners.

Alas this warm glow of optimism is not yet strong enough to mask the existing risks that remain. And we see new risks on the horizon that could take us to some very difficult places.

Debt vulnerabilities old and new

"The pool of people on the edge of serious financial difficulty has shrunk over the last two years. But not by as much as employment figures suggest.

There are around 20 million people struggling to keep up with bills and 18 million worried about making their income last till payday. A large increase in the proportion of people coming to us with council tax, fuel and rent arrears has been a key feature of the debt story over the last two or three years. 

Household financial resilience remains low. Some 13 million people do not have the savings to keep up with essential bills for a month if their income dropped by a quarter. Almost two thirds of the workforce worry about how they would cope if they experienced an income shock.

The impact of an interest rate rise, when it comes, sits near the front our minds. We estimate that a 1% rate rise could push around a third of our clients with mortgages from a surplus to a deficit budget. They would not have enough money to pay their debts or their essential expenditure. Their prognosis for recovery gets bleaker.

This also reminds us that the ‘debt overhang’ described by the Resolution Foundation and others is still with us. The average unsecured debts of our clients with a mortgage are still at around £20,000. And around one in seven of these has a mortgage or secured loan with a sub-prime lender.

Income shocks

"So we cannot expect macro-economic improvement to eliminate household vulnerability by itself.

Recent research from the Bank of England finds weak wage growth over the last few years, below trend for the level of employment in the economy. This research also highlights how job destruction remains fairly constant over the economic cycle – averaging at around 15% of the stock over the last 10 years.

Income shocks remain a key cause of financial difficulties. Around two thirds of StepChange clients cite an income shock or significant change in circumstances as the main trigger for their debt problems.

More generally our research shows that 28% of all adults in Britain, around 14 million people, faced at least one income shock or significant change in circumstances in the previous 12 months. Those that did so are more than four times as likely to be in severe financial difficulty in the next twelve months as those that don’t.

Vulnerability to income shocks tends to be concentrated among insecure jobs. People who worked zero hour contracts, fixed term contracts or were self-employed were twice as likely to experience an income shock. These are the sort of job types that have grown strongly in the recovery so far.

The credit safety net and sub-prime lending

"So how do households with low resilience cope with these shocks? Often by using credit to get by.

Around 6.5 million people used credit as a way of coping with an income shock or change in circumstances. Using credit to meet essential costs can be a rational and appealing strategy, in the short term. Particularly for those of us, like our clients, who have a tendency to self-reliance.

But as the short term stretches out, debts mount and more credit is needed to be pay off last month’s obligations. People using credit in this way, as a safety net, are more than twenty times as likely to fall into severe problem debt as those that did not use credit.

Using credit as a remedy for financial distress is something we saw with sub-prime mortgage lending before the crash. We are still seeing it with unsecured credit now.

As debt advisors it is something that concerns us greatly. This particular use of credit does not rehabilitate people in financial difficulty. It makes their problems worse. The “safety net” becomes a snare.

Better safety nets of all sorts

"Instead we argue that people facing financial difficulty need real safety nets.

Econometric analysis of the Wealth and Asset Survey commissioned by StepChange found that 500,000 households could have avoided falling into problem debt if they had £1,000 of rainy day savings to draw on. Yet savings policy is not focused on incentivising the lower and middle income households most vulnerable to debt.

Our research has shown how the vicious cycle of debt dependency can be driven by poor forbearance practice. Six in ten of those not shown forbearance by lenders tried to cope by taking out more credit. Three in ten pay that creditor by falling behind on another bill.

We have seen some excellent progress in forbearance over the past decade and mortgage lenders have been out in front – and we always applaud good practice. We think that good practice should now by supported with statutory protection, so no creditor can gain by defecting or undermine the good practice of others.

Benefit cuts

"So safety nets are not just about welfare benefits and tax credits. But these are important.

60% of StepChange client households have someone in work. But 45% of these working households receive some benefits or tax credits – Child Tax Credit is particularly common.

But as you will know, tax credits and the Support for Mortgage Interest safety net face some significant cuts. Our initial analysis suggests the impact on our clients could be severe. Rather more so than a small increase in interest rates for instance.

Tax credits provide a safety net for about one in four StepChange clients. We estimate that our clients who will be affected by the proposed changes to the threshold and taper rate would lose £130 per month on average. 78% of these would be left with deficit budgets – up from 20% without the changes. Putting the SMI waiting limit back up to 39 weeks could reduce support for our clients affected by around £1,600 on average.

Much of the work debt advisors do is about helping people adapt financially to changing circumstances. So cuts to welfare support could significantly redraw the debt landscape.

Responsible lending going forward

"So what does this mean for responsible lending going forward?

At the margin, there will always be a tension between consumers’ vulnerability to debt and their needs and wants for credit that regulatory standards may struggle to resolve.

As risk appetites recover, these margins will no doubt be stretched. But there are clear boundaries that responsible lenders should not cross.

Lending should not put people under financial stress and should not make financial difficulties worse. Lenders must anticipate the problems consumers can face and try to manage out detriment and mange in support when things go wrong.

But lenders and debt advisors do not work in a vacuum. Responsible lending is both the object and result of broader public policy. This is perhaps most true for mortgage lending, given successive Government’s keenness to encourage more people into home ownership.

In the not so recent past, a heady mix of risk appetites and public policy produced cases of sub-prime right to buy mortgage being sold to social tenants who could never keep up with the payments. No sane society should have allowed this to happen.

This is not to say that more debt vulnerable households should not be allowed access to either credit or home ownership. But access without sustainability brings consumers harm, not joy.

If we want to reduce the stream of people falling into severe problem debt, we will need effective and well thought through safety nets designed for different needs, incomes and circumstances.

From this perspective the future is uncertain. And we may be going backwards."

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Foundation for Credit Counselling Wade House, Merrion Centre, Leeds, LS2 8NG trading as StepChange Debt Charity and StepChange Debt Charity Scotland. A registered charity no.1016630 and SC046263. It is a limited company registered in England and Wales (company no:2757055). Authorised and regulated by the Financial Conduct Authority.

*This is the average rating of our service on Feefo by DMP and DRO clients three months into their solution.

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