So here we go again: another potentially significant UK consumer finance mis-selling scandal and another regulatory review by the Financial Conduct Authority (FCA). This time a review of motor finance.
Sometimes I just throw up my hands in utter bewilderment. How can it ever have been legally possible for car dealers and credit brokers to arbitrarily add whatever they wanted to the financing costs offered to consumers by motor finance lenders (banks and non-banks) purely so those added costs could be siphoned off by said car dealers and credit brokers in the euphemistic guise of commissions? Invariably without customers even knowing.
Merely describing what the so-called discretionary commission arrangements (DCAs) are that allowed intermediaries in the car sales chain to ramp up motor financing costs from as far back as 2007, they just sound dodgy. I read that as much as 40% of all UK car finance pre-2021 – that was when the FCA banned this shady practice – came with some sort of hidden commission arrangement.
And let’s be clear: motor finance in the UK is no rounding error: it amounted to almost £40 billion (US$51 billion) last year.
I’m not even sure who I most want to blame. Car dealers and consumer credit brokers? (Far too easy.) Lenders? Regulators for allowing something in the first place that was so obviously and blatantly open to abuse? Supervisors for gravely inadequate policing of the supposedly heavily protected consumer finance sector?
Yet again, UK consumer protection turns out to be non-existent and car buyers have their faces ripped off on financing costs because of what for years were legal DCAs. It took more than 10,000 people to lodge formal complaints about motor finance with the Financial Ombudsman Service (FOS), the UK’s statutory dispute-resolution body, before the FCA finally woke up in January and launched its review of financing arrangements taken out before the DCA ban.
Surprise, surprise: motor finance providers have rejected most complaints. But now that the FOS recently found in favour of two rejected cases and some claims have been upheld in the UK civil courts, the FCA and FOS reckon the flow of complaints will turn into a deluge.
PPI 2.0?
Immediate parallels have been drawn with the Payment Protection Insurance (PPI) scandal, an utter mis-selling disgrace that went on for years and culminated in banks and finance providers being forced to pay compensation of more than £38 billion to consumers by the time the FCA stopped counting in 2019 (because of the pandemic).
If the FCA uncovers widespread misconduct in car finance, it will force more compensation payments. The regulator plans to set out next steps in Q3 2024.
Consumer champion Martin Lewis of MoneySavingExpert.com fame reckons motor finance compensation could reach PPI proportions. The sellside analyst community is all over the story too, albeit with less extravagant but still reasonably high estimates. I’ve seen analysts’ estimates of the impacts ranging up to £16 billion – and banks, brokers and dealers will all be on the hook. Mind you, given the level of uncertainty about the depth and breadth of the FCA review, those estimates are something of a stab-in-the-dark exercise.
From a financial perspective relative to earnings power and capital, Scope Ratings says any outcomes of the review will be negligible for Barclays, HSBC, NatWest and Nationwide Building Society as they have no or very limited exposure to motor finance. Analyst Alvaro Dominguez Alcalde believes the impacts on Lloyds Banking Group and Santander UK – which have reasonable motor finance exposures – will be manageable under his base-case scenario.
Lloyds’ exposure to auto lending is more than £15 billion, equivalent to 3.4% of its total loan book, while Santander UK’s exposure is roughly £4.5 billion, 2.2% of its loan book. Lloyds CFO William Chalmers took some analysts’ questions on the recent earnings call about the £450 million provision the bank made for operational and legal costs and potential customer redress relating to this issue.
Morgan Stanley’s Alvaro Serrano asked Chalmers why he thought £450 million was enough, given analyst guesstimates of potential losses of as much as £3.5 billion. KBW’s Perlie Mong asked about how the provision was split between customer redress and operational costs. Deutsche Numis’s Jonathan Pierce asked how the bank is thinking about worst-case scenarios as the market will assume, he surmised, that all of the £42 billion in loan origination by Lloyds’ motor finance subsidiary Black Horse between 2007 to 2020 was linked to discretionary commissions.
Significant uncertainty
While Chalmers wouldn’t be drawn into detailed responses to questions, he did acknowledge that “there remains significant uncertainty, and the financial impact could differ materially from the amount that we have provided”.
Santander UK confirmed it had received county court claims and complaints, but doesn’t think they warrant provisions. One guesstimate of potential impacts on Santander (from RBC Capital Markets) is £1.5 billion. Barclays, which exited the motor finance sector in 2019, said it hadn’t received a material number of complaints, which is why it said it hasn’t provided at this stage. The impact on Barclays has been put at £500 million.
The impacts will not be quite as manageable for smaller banks and non-bank lenders as it is for the UK’s large banks, though. Over time, smaller players will likely be forced to make provisions ahead of any adverse outcomes of the FCA review in terms of compensation and other costs. The UK car finance market is crowded. A number of small and mid-sized UK banks and car finance providers have posted notices about the regulatory review on their websites, mainly giving out factual information but suggesting if nothing else that this is a non-negligible issue.
Close Brothers, the merchant bank and commercial lender with a significant concentration of auto finance in its lending book, has cancelled dividends on ordinary shares in the current financial year and will decide whether to re-instate them in 2025 and beyond after the FCA has completed its review.
The group said in an update to the market that while the board concluded that it isn’t required or appropriate to add provisions in half-year 2024 results, it did recognize a need to plan for a range of possible outcomes. From their 2024 high in early January, Close Bros shares were down 66% to the low reached on February 15th, although they had gained some of that back by March 1st.
