The troubled British lender is preparing for a bailout that analysts estimate could be worth up to £16bn following an investigation into car finance deals following a surge in consumer complaints. Banks are under increased pressure.
When the Financial Conduct Authority launched its investigation in January, it said: “If we find that fraud is widespread and consumers are suffering losses, we will ensure that those who are liable for compensation receive appropriate settlements. “We will identify the best way to do so.”
The stock price of Lloyds Banking Group, which owns Black Horse, the UK's largest car finance company, has fallen about 10% since the announcement, and the share price of City Bank's Close Brothers has almost halved, forcing it to suspend its dividend.
The investigation, which was further reinforced by consumer protection advocate Martin Lewis, includes the payment protection insurance mis-selling scandal, which was initially downplayed by banks but ultimately cost more than £50bn. is reflected.
Arrangement of discretionary fees
Until the FCA banned the practice in 2021, banks offering car financing allowed car dealers to set their own interest rates on repayment plans, a practice known as discretionary fee arrangements. This means that salespeople can undercut the bank's asking interest rate to secure a deal, but they can also exceed it to earn larger commissions.
Two complaints triggered an FCA investigation. One was upheld against Black Horse, relating to a case in which consumers paid 10.5% per annum, and the other was upheld against Clydesdale, which was then owned by Barclays. related to a transaction for which the consumer paid an annual interest rate of 8.9%. In both decisions, the Ombudsman said there was a conflict between the interests of consumers and brokers, noting that lending banks would have accepted lower interest rates.
But experts say these two examples don't tell the whole story. Numis analysis of Lloyds car loan data found that before the 2021 DCA ban, the majority of the company's car loan customers were paying annual interest rates between 5% and 7%.
The Finance Leasing Association, an auto finance trade group, said dealers frequently used the practice to lower interest rates to offer competitive plans. However, dealer commissions are widely calculated as a percentage of the total interest charged to consumers, meaning that dealers had an incentive to secure sales at higher interest rates.
Since the 2021 ban, the industry has adopted a fixed-fee model, with lenders setting a common interest rate that dealers cannot adjust unilaterally. Currently, typical fees consumers pay vary from 6 percent to 12 percent, but could be higher depending on their risk profile.
A 2019 FCA review found that DCA costs consumers £300m more a year than a fixed-rate model, with consumers paying an additional £10,000 loan compared to a typical four-year repayment plan. Paying interest of £1,100. The study also found that the difference between average and maximum fees was greater with DCA arrangements at around £2,000 compared to £700 under a flat fee model.
Costs faced by banks
Experts say it is still too early to gauge the scale of the scandal.
The FCA's approach will include whether it sets out a relief regime, what it considers to be an appropriate difference between the interest rates set by banks and those paid by consumers, and whether it will share costs between financiers and car dealers. Decide how to divide up the charges and whether to refund all affected customers or only the customers who submitted claims. The regulator is expected to provide more clarity in a September update.
Calculating how much consumers have lost will be a complex task. Analysts determined the typical interest rate for the auto financing transactions studied, given that there was no minimum annual interest rate and no commission structure or fees were set at the time the deal was entered into. states that it is impossible to do so. It varies widely depending on the dealership, region, and type of car being sold.
However, analysts have already raised their initial estimates of the bailout costs after the watchdog revealed that the investigation would cover all transactions made between 2007 and 2021. Estimates by Jefferies, JP Morgan, HSBC, RBC and Shore Capital put the size of the banking industry at between £6bn and £16bn.
Meanwhile, bank executives said the FCA's focus on consumer protection through consumer tax regulations last July suggested the regulator could take a tougher stance.
However, while the costs to the UK banking industry could be significant, they do not seem to come close to the costs of the PPI scandal. Car finance accounts for around 5% of household lending, while banks accounted for around 40% of all car finance loans to dealers in the UK as of 2017, according to analysts at JPMorgan. The rest is supported by non-bank financial institutions, including those in the financial sector. A global automobile manufacturer.
“We do not believe the scale of the compensation costs in this investigation is comparable to the scale of the fraudulent sale of payment protection insurance,” said Fitch ratings analyst Hussein Sevink. “Motor finance loans generally account for a relatively small proportion of bank lending in the UK.”
Banks most exposed to scandals
Lloyd's has the absolute greatest exposure to DCA. Experts say the costs are likely to have a significant impact on the large bank, whose stock price has fallen 14% since the beginning of the year. In contrast, NatWest, the country's second largest bank, has virtually no exposure.
Barclays, Close Brothers and Santander UK are also expected to face compensation costs. Analysts at RBC Capital Markets said claims could total £2bn for Lloyds, £850m for Santander, £250m for Barclays and £110m for Close Brothers. We estimate that there is a possibility that
But Close Brothers has faced a significant hit, with JPMorgan seeing its Common Equity Tier 1, a measure of financial resilience, decline by 270 basis points (bp), compared to Lloyds by just 110 basis points (bp). We estimate that it will decrease.
According to Fitch, at the end of 2021, motor finance loans accounted for 22% of total outstanding loans for FTSE 250 financial institutions, compared to just 3.1% for Lloyds. The bank last Thursday suspended its dividend pending the completion of a regulatory review and will decide whether to resume it in 2025 “once the FCA has completed the process and the financial impact on the group has been assessed”. Then he said.
Companies have not yet begun preparing rescue packages, but one JPMorgan analyst said the looming costs meant that Lloyds would buy back just £1.5bn worth of shares when it publishes its annual results on Thursday. It is expected that the price will be lower than the market's previous expectations of 1 pound. 2000000000.
Possible blow to automakers
Auto financing is a lucrative business for manufacturers and can be more profitable than the business of manufacturing cars. According to JPMorgan analysts, most auto loan services are provided by automakers and other non-bank financial companies.
Many manufacturers offer loans directly to customers through their 'captive finance' divisions, which offer drivers attractive lease deals that have become a mainstream part of car buying.
Groups such as Ford and Volkswagen collect healthy profits from their captive finance sectors.
About a quarter of Ford's $1.1 billion profit in the final quarter of last year came from Ford Credit. In 2021, the finance department generated half of Ford's overall annual profit.
Volkswagen's financial services division will report a profit of 5.5 billion euros in 2022, with a profit margin of 14%, higher than the company's car manufacturing division.
More than 90% of new car purchases in the UK utilize a 'private contract purchase' or similar lease arrangement, where the customer is given a contract to cover the expected depreciation of the car's value over a period of time, usually around three years. I am making monthly payments.
However, car manufacturers are huge global companies with revenues often in the hundreds of billions of pounds. UK fines, even if they amount to hundreds of millions of pounds for individual car manufacturers, will be small compared to companies as a whole. For context, VW paid more than $30 billion in the Dieselgate emissions cheating scandal.
