Regulator’s car loan review entangles banks

Foresight: A Lloyds Bank branch in London. The UK’s biggest auto finance provider has set aside US$570mil for possible compensation and other costs linked to the review, becoming the first major firm to take a charge. — Bloomberg

LONDON: United Kingdom banks gave investors reasons to be optimistic about their earnings over the past few days. But one key unknown won’t go away anytime soon: the ultimate cost of potentially mis-sold car finance.

The Financial Conduct Authority’s (FCA) review of commissions for car loans remains a major drag on domestic lenders’ valuations, according to UBS analyst Jason Napier.

Uncertainty around the application of UK rules on this issue is one of the reasons that UK banks trade at lower valuations than their peers in the eurozone, Napier said in an interview.

Lloyds Banking Group Plc, the UK’s biggest auto finance provider, last Thursday set aside £450mil (US$570mil) for possible compensation and other costs linked to the review – the first major firm to take a charge.

Barclays Plc, which exited its motor finance business in 2019, hasn’t taken a provision due to “uncertainty” around the FCA investigation’s outcome and the “very low” level of complaints the bank got, finance director Anna Cross told reporters on a call.

Close Brothers Group Plc has a smaller total car loan book than Lloyds but it represents a larger portion of its business.

The firm has cancelled its dividend amid the FCA review, and this week got downgraded by credit rating firm Fitch to BBB+ from A-.

Its shares have shed more than half their value since the beginning of the year as hedge funds Millennium Capital and Marshall Wace held and then exited short positions in the stock.

Smaller non-listed players expected to be affected by the FCA review include private equity-owned Blue Motor Finance, whose corporate lenders included Goldman Sachs Group Inc.

The FCA has said it will update on its review in September. The uncertainty has stirred speculation in the industry that some lenders might be forced to exit the market.

In an era of near-zero interest rates that made credit plentiful, nearly 90% of new car purchases in the United Kingdom were made on finance, according to the FCA when it examined the industry in 2018.

Car dealers could often earn thousands of pounds for themselves, and the bank, by pushing up the interest rate they offered buyers, in a practice known as discretionary commission arrangements.

Before the FCA banned this approach in 2021, every loan rate would have its own assigned commission rate, a person with direct knowledge of the practice said.

This setup systematically incentivised dealers to pick a higher rate, the person said, declining to be identified discussing private information.

The FCA has estimated that its ban is saving customers £165mil a year.

Now, though, it’s been forced to take further action after a spike in complaints to the Financial Ombudsman from customers who were sold these loans.

It’s reviewing loans dating as far back as 2007.

The legal industry is already compiling multiple country court cases to construct a class action case, according to Henry Farris, partner at law firm Withers LLP.

“The class action has a much broader scope than what Lloyds has set aside,” Farris said in an interview.

He estimated that 50,000 to 100,000 people could be enough to build a substantial class action, which was until recently a rarity in English law.

Pogust Goodhead, another law firm, has set up a portal for customers to submit claims.

Global managing partner Tom Goodhead said it was a “watershed moment” for borrowers.

“It’s high time that lenders are held to account over unfair practices that have left consumers unnecessarily out-of-pocket,” he said in a statement.

Along with the regulatory review, a mix of high interest rates and falling used car prices might spell trouble for banks, especially those who lend to less affluent customers.

“In the pandemic, interest rates were low, people got loads of stimulus and delinquencies were very low too,” said Aidan Rushby, founder and chief executive officer of Carmoola, a London-based car finance firm that lends directly to consumers, rather than through dealers.

“Now we’re in a recession, delinquencies will go up and car prices will go down. This means some lenders will recoup less value when a borrower defaults.”

Some industry watchers see banks potentially slowing down lending, which could lead to fewer used car sales.

Banks might also decide to further trim their workforces in this space.

To be sure, Lloyds reported this week that motor finance continued to grow last year, and it now has £15.3bil on its loan books.

“Undoubtedly the future products and services of banks and non-bank lenders may be influenced by the FCA’s decision,” said Isabelle Jenkins, who leads the financial services practice at PwC UK.

But “it remains to be seen what this may look like”. — Bloomberg

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