A brewing scandal over potentially mis-sold motor finance has intensified after Lloyds Banking Group set aside £450 million to cover costs and possible compensation.
Lloyds, which is one of the biggest motor finance providers through its Black Horse business, is the first bank to make a provision for the Financial Conduct Authority’s inquiry into the car loans industry. It is likely to fuel speculation that the wider industry will face a hefty redress bill.
The merchant bank Close Brothers, another provider of vehicle financing, cancelled its dividend to bolster its balance sheet last week in the face of the FCA’s investigation, which the watchdog announced last month.
William Chalmers, Lloyds’ finance chief, said the provision, which was disclosed in the lender’s annual results on Thursday, was its “best estimate” for the hit it might suffer, but that the actual financial impact could be higher or lower.
Jefferies, the stockbroker, has estimated that Lloyds may face a £1.8 billion liability overall from the regulatory inquiry, while RBC Capital Markets, another broker, has forecast a £2.5 billion blow. Analysts at the broker KBW told clients “it is highly unlikely that the £450 million charge will be the end of the story” for Lloyds.
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The provision covers the bank’s operational and legal expenses arising from the FCA’s work as well as possible compensation. Chalmers said it was “safe to say that each of the components is significant” in the £450 million figure.
There has been speculation that the FCA’s inquiry, which will review commission arrangements on financing deals between April 2007 and January 2021, could result in a scandal on a scale akin to the payment protection insurance (PPI) affair that left banks shouldering about £50 billion in costs and customer redress. Jefferies has forecast that the industry-wide hit from the motor finance investigation could reach £13 billion.
It was Lloyds that opened the floodgates on PPI in 2011 when Sir António Horta-Osório, the bank’s previous chief executive, broke ranks with other lenders that were fighting compensation and declared that paying redress to customers was “the right thing to do”.
At the time the bank had taken a £3.2 billion charge to cover the cost of PPI compensation. Its final bill came to about £22 billion.
Charlie Nunn, who succeeded Horta-Osório in 2021, sought to play down comparisons with PPI on Thursday, arguing: “We think this is a very different situation.”
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He said vehicle loans were a “very different service to some previous remediations”, partly because financing had become the main way people had bought cars in recent years.
Nunn also said that “the number of customers is materially lower than some other prior remediations” and that the average time that a consumer had car financing was shorter.
Lloyds executives declined to say how many motor finance customers the bank had served in the near 14-year period under review, or give the scale of the loans it had extended in that time. Its motor finance loan book stands at more than £15 billion.
The FCA banned discretionary commission structures on vehicle loans at the beginning of 2021. The trigger for its market-wide inquiry was two recent decisions by the Financial Ombudsman Service.
The ombudsman found that Lloyds’s Black Horse business and Barclays Partner Finance had each treated two different customers “unfairly” with their discretionary commission arrangements. While there have already been complaints against motor finance providers, the regulator believes the volume of complaints is set to grow as a result of the ombudsman’s decisions and began its review to assess whether there has been widespread misconduct. It will update the industry on its findings in the third quarter.
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Chalmers said Lloyds believed it had “complied at all times with relevant regulations”.
“So far we’ve had one financial ombudsman judgment and we’ve had a series of county court cases, most of which have been decided in our favour,” he said.
The motor finance charge has been reflected in bonuses at Lloyds. It disclosed in its annual report that last year’s group bonus pool, which fell to £384 million from £446 million in 2022, “includes the impact” of the provision.
Close Brothers had said last week that its board had decided “it is currently not required or appropriate to recognise a provision” because the impact of the FCA’s inquiry “cannot be reliably estimated at present”. Cancelling its dividend, which will save it about £100 million this year, caused its shares to fall sharply.
Black horse gallops to £7.5bn profit
Lloyds Banking Group has forecast that the tailwind it has enjoyed from higher interest rates will weaken after its profits jumped last year on the back of rising borrowing costs.
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Annual results showed pre-tax profits at Britain’s biggest domestic lender climbed by 57 per cent year-on-year to £7.5 billion last year, better than the £7.4 billion expected by analysts.
As a result, Lloyds announced it would reward stock market investors by returning £2 billion through a share buyback. This is on top of a final dividend of 1.84p a share, which is equivalent to £1.17 billion, and sent its shares up by 2¾p, or 6.2 per cent, to 46p. Charlie Nunn, chief executive of Lloyds, was paid almost £3.7 million, down slightly from £3.8 million in 2022.
Lloyds has been buoyed by higher rates, which allowed the bank to expand its margins by passing on rate increases to borrowers faster than to its depositors. Its net interest margin, which measures the difference between what it charges for loans and pays to savers, climbed to 3.11 per cent last year from 2.94 per cent in 2022.
Yet expectations that the Bank of England will cut rates this year, mortgage market competition and savers moving their cash into higher interest accounts will push down margins in the coming months.
Lloyds said it expected to report a margin of greater than 2.9 per cent for this year, which William Chalmers, its finance chief, noted was a “quite material reduction” on last year. Its margin has fallen from 3.08 per cent in the third quarter last year to 2.98 per cent in the fourth.
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Chalmers said the bank, considered a bellwether for the economy, had made “modest positive revisions to our outlook”, partly because of its forecast that the Bank of England would cut its base interest rate to 4.5 per cent by the end of the year from 5.25 per cent at present.
Lloyds now expects house prices to fall by only 2.2 per cent this year, down from its forecast of 2.4 per cent at its third-quarter results. It stuck with its forecast for the economy to grow by 0.5 per cent this year.
