UK High-Cost Short-Term Credit Market Insight Report 2018
What does this report contain?
This report is focused on the High-Cost Short-Term Credit (HCSTC) market, including payday loans, in the UK. It also includes an overview of other similar high cost general loan products.
The Financial Conduct Authority (FCA) Handbook definition of the High-Cost Short-Term Credit market includes unsecured consumer loans with Annual Percentage Rates (APR) of 100% or more where the credit is due to repaid or substantially repaid within 12 months.
– The FCA definition excludes certain loans such as those secured by a mortgage, home credit agreements (where the lender calls at the consumer’s home to provide the loan and collect payments, otherwise known as ‘doorstep loans’), and bank current account overdrafts.
For our analysis of the HCSTC market, we follow the FCA Handbook definition with the exception that we have widened the definition to include loans with APRs over 95%.
– Some market participants are offering loans with APRs of (for example) 99.9% possibly to ensure the loans are outside the boundary of the specific regulation of HCTSC.
– We consider that these loans are likely to be economically similar to loans with APRs of 100%.
We quantify the market size, historical growth rates, segmentation patterns and levels of industry profitability while reviewing key factors behind these figures.
We also carry out an in-depth analysis of the relevant drivers of industry growth – in particular the macroeconomic environment and regulatory framework – setting out historical trends and available forecasts.
Our forecast for industry growth is based on this analysis of historical trends and growth drivers, with a focus on the effects of regulation on the profitability of HCTSC providers.
What are the objectives of this report?
Over the last decade HCSTC lending has emerged and grown into a major industry with customers measured in millions.
– The HCTSC industry, previously characterised as the ‘payday lending industry’, is frequently in the news.
– Particularly prior to the FCA’s price control regulation, lenders were often criticised for charging excessive rates of interest and fees which allegedly exploit low-income consumers. However, many lenders inspired high levels of customer loyalty and enjoyed satisfaction rates that would be the envy of the mainstream banks.
– The FCA has imposed stringent regulations on the market including – highly unusually – a price control mechanism. When it introduced the new regulations it forecast that only four or five of around 400 payday loan providers would remain in the market. Although many firms have withdrawn there are still at least 30 active High-Cost Short-Term Credit market participants and even some new entrants.
This report aims to explore the industry behind these apparent contradictions, probe the factors which have driven its historical growth and recent decrease in size and provide a view on how the market is likely to perform in the future, setting out the reasons why we believe this is a probable outcome.
Other questions the report considers include:
– Why did the High-Cost Short-Term Credit market grow so rapidly in the UK and what factors have made it develop more rapidly here than elsewhere?
– Who are the main companies in the market, who owns them and how have they performed?
– What impact has the FCA’s price cap had on the market?
– How have lenders adjusted their business models in response to it?
– What further impact might regulation have on both the HCSTC and other HCC lending markets in the future?
The report is intended for:
– Operators of payday lending and other HCSTC businesses themselves
– Investors in these businesses
– Potential new entrants to the market
– Market regulators and policymakers
– Banks, analysts, consultants and other parties with interests in the sector
What are the sources and methodology?
This report is based on:
– Interviews with senior-level contacts in the consumer credit industry
– Extensive research into published industry sources
– In-depth analysis of the macroeconomic environment and relevant market drivers
– Financial analysis of the accounts of companies in the industry
Information from these sources has been synthesised and presented clearly and concisely with extensive use of charts, tables and insightful quotes from interviews to illuminate points and support conclusions. Market forecasts have been constructed using simple assumptions which are clearly stated. Supporting evidence is provided for our assumptions but readers can easily flex them to model alternative scenarios.
HCSTC Market Summary
HCSTC Market Definition
The High-Cost Credit market includes unsecured consumer loans with Annual Percentage Rates (APR) of 95% or more where the credit is due to repaid or substantially repaid within 12 months.
– The FCA defines High Cost Short-Term Credit (HCSTC) to include loans with APRs over 100%. We have widened this to include loans that we consider are economically similar with interest rates between 95% and 100%.
– Relevant loans include payday loans (in general up to 1 month in duration), short-term instalment loans (up to 6 months) and high-interest personal loans (over 6 months).
The market excludes loans such as those secured by a mortgage, home credit agreements (where the lender calls at the consumer’s home to provide the loan and collect payments, otherwise known as ‘doorstep loans’), and bank current account overdrafts. It also excludes credit cards.
HCSTC comprises just 0.1% of the total UK unsecured consumer credit lending market measured by value of loans outstanding.
Being designed for short lending periods, HCSTC loans have historically had interest rates which were often well above 300%.
– Quoted Annualised Percentage Rates (APRs) have extended higher than 4000%, although lenders point out this measure may be of limited relevance for short-term loans.
– Interest rates are now capped at 0.8% per day (292% per year) under one part of an FCA price control.
The products are aimed primarily at sub-prime or near-prime customers.
Service levels are generally high with well-designed websites, quick and simple application processes followed by an instant decision and transfer of funds shortly afterwards.
High-Cost Credit Market Growth and Drivers
The market grew rapidly to reach over £1 billion of revenue at its peak in 2013. This growth resulted from the convergence of three key drivers:
– A significant increase in the number of customers in the sub-prime segments as a result of the economic downturn
– Significant reduction in the appetite of the mainstream banks for serving such customers
– The ‘light touch’ regulatory environment in the UK which created an environment more favourable to high-cost credit providers than elsewhere in Europe and North America
S• Since 2014 market conditions have become less favourable as regulation has become much firmer, with revenues having halved from 2013 to 2015.
– Increasingly, regulations define what loans may be offered and how profitable they can be – and hence the attractiveness of the market and, ultimately, its size.
– The key move was the introduction of a price cap by the FCA from January 2015. This limited the total level of interest and fees that lenders can charge to 0.8% of the loan amount per day, capped default fees at £15 per loan and capped the total costs (interest + fees) at 100% of the sum borrowed.
The top 8 lenders had 2016 revenues of £453m, up from £430m in 2015, but still less than half of the peak of £1,073m in 2013.
The top three are:
– CashEuroNet UK, a subsidiary of the US firm Enova International, which operates as QuickQuid and Pounds to Pocket in the UK.
– Instant Cash Loans, formerly a subsidiary of the US firm Dollar Financial Corporation, sold in March 2018 to Polish firm Aurajoki Holdings..
– Elevate, subsidiary of the US firm Elevate Credit, which operates the Quick.co.uk and Sunny brands in the UK.
The tightening in regulations led to several significant lenders and a large number of smaller companies exiting the market.
Value drivers for HCSTC lenders
A key driver of profitability is market positioning, in terms of size of loans offered and length of loans
– The effect of the FCA price control is to make shorter payday loans unprofitable.
– The most attractive loans are those over £300 for between 3 and 7 months, which is reflected in the positioning of newer entrants.
Success in HCSTC lending also depends on the following:
– Effectiveness of marketing and advertising in driving high volumes
of traffic to operators’ websites at low average costs.
– Low cost back-office processes involving a high degree of automation.
– Accurate credit assessment processes to enable loans to be offered without incurring high collections costs and write-off rates
– Compliance with FCA Handbook regulations and other relevant laws to ensure that FCA authorisation is retained, penalties are avoided and agreements are legally enforceable.
Following recent FCA regulation, the economics of HCSTC have shifted significantly:
– Default levels have reduced greatly, as FCA rules require firms to consider affordability of loans more carefully.
– As volumes have fallen by up to two-thirds, many existing providers have struggled to reduce their staff costs and overheads at the same pace, resulting in significant losses.
– The shift in the market away from payday to (longer) short-term instalment loans has the potential to reduce marketing costs, although this is not yet apparent from accounts for year ends in 2015 or early 2016.
Government austerity policies and further benefits cuts associated with the roll-out of Universal Credit appear likely to lead to sustained demand for HCSTC.
As mainstream lenders are unlikely to target sub-prime borrowers, there will still be an opportunity for the HCSTC sector to recover and grow at a modest pace as consolidation leads to lower average costs for lenders.
When it set the price cap, the FCA expected the market to consolidate to four main providers. It noted last year that had not happened and there were signs of increased competition. Nonetheless, we consider it is realistic to expect further consolidation in the next few years.