Motor finance industry in crisis mode after landmark court ruling
As lenders face an avalanche of compensation claims over a brewing motor finance scandal, Lars Mucklejohn asks whether the industry is headed for a PPI-scale disaster.
Motor finance providers are scrambling to avoid a full-blown market meltdown after a London court ruling on “secret” car loan commissions sparked chaos across the sector this week.
A Court of Appeal ruling last Friday has forced some major lenders to pause new business, shake-up their systems and push for urgent talks with government.
Judges ruled that a broker could not lawfully receive a commission from the lender without obtaining the customer’s fully informed consent to the payment.
The decision has made it more likely that the Financial Conduct Authority (FCA) will implement a redress scheme for lenders as part of its review into the so-called discretionary commission arrangements (DCAs), potentially exposing banks to billions in extra compensation costs.
Lloyds Banking Group has abolished commission payments for new loans at its motor finance arm Black Horse, the UK’s biggest auto lender.
William Chalmers, the group’s chief financial officer, held an urgent call with analysts and investors on Tuesday to explain its reaction to the court ruling, Morning Wire understands.
He provided no details on whether Lloyds would make further provisions beyond the £450m it set aside in February to cover potential costs.
However, Chalmers did say the variables that will go into the bank’s provisioning model are now wider than when it was just trying to estimate the impact of the FCA’s review.
Lloyds’ share price has tumbled 14 per cent since the ruling. RBC Capital Markets estimates that Lloyds could take a £3.9bn hit to its profits in a worst-case scenario.
Close Brothers, considered the most exposed bank to the FCA’s probe in relative terms, made plans to bolster its finances by £400m earlier this year and has since sold its wealth arm for £200m.
But the situation has gone from bad to worse for the 146-year-old merchant bank.
Close Brothers, which was involved in last week’s test case, has paused new car loans since the ruling. Its share price, which had already been hammered earlier this year, has cratered 37 per cent since last Friday and is now trading at a three-decade low.
RBC has modelled a worst-case scenario where Close Brothers takes a £387m hit from compensation, interest and administration costs. That figure is greater than the company’s current market capitalisation of £343m.
Elsewhere, Santander UK has delayed the publication of its full third-quarter results to digest the ruling. RBC estimates a downside impact of £1.8bn.
Exits loom
A slew of smaller auto lenders also paused loans, including Zopa, Secure Trust Bank, MotoNovo, Mann Island, V12 and Northridge.
Analysts have warned the fallout could push some firms out of the sector entirely, given judges have effectively overruled previous guidance from the FCA.
“Banks will quickly adapt their contracts and processes to comply with the new rules,” Benjamin Toms, an analyst at RBC, told Morning Wire.
“However, in the medium term, some lenders will decide that lending in this sector is no longer for them.”
Several of the firms which have paused lending, like Secure Trust, had said in the months before the ruling that they were not significantly exposed to the FCA’s probe.
An executive at one auto lender told Morning Wire they had previously doubted analysts’ estimates that banks could be on the hook for billions in compensation, given that the FCA has estimated DCAs passed on £165m in extra charges to consumers per year.
The FCA’s probe is focused on DCAs between 2007 and 2021, when they were banned. The agreements were industry standard and included in some three-quarters of car loans during the period.
The wider banking sector has been inundated with historic complaints as consumers look for compensation and claims management firms take advantage of the situation.
Within just four months of the FCA announcing its probe, the Financial Ombudsman Service – which resolves disputes between consumers and financial services companies – received 20,000 complaints over car finance.
An executive at one motor finance provider told Morning Wire that when MoneySavingExpert.com founder Martin Lewis listed their bank on television earlier this year as one that had never used DCAs, the firm still received more than 2,000 complaints.
Ministers scramble
On Tuesday, Treasury ministers held urgent talks with FCA officials and representatives from the Finance and Leasing Association (FLA), which represents auto lenders, to discuss the ruling.
The FLA is now urging the regulator to extend its pause on the eight-week deadline firms have to respond to DCA complaints, currently in place until December 2025. FCA boss Nikhil Rathi said in a speech on Tuesday that the regulator would consider taking this step.
A Treasury spokesperson told Morning Wire: “The Treasury is working closely with the regulators and industry to understand the impact of this judgement.”
Judges ruled that lenders must inform customers about all payments to dealers – meaning not just bonuses but flat fees as well. The precedent set by the decision could even go beyond car loans and apply to a range of consumer finance commissions, lawyers have argued.
Toms said: “Three examples of the many questions which have been left outstanding include: Does this decision extend beyond motor finance? Which years are now in scope? And do all commissions paid need to be returned to customers?”
The FCA was originally due to set out its next steps on the review in September, before delaying to May 2025 in July. But given last week’s ruling, analysts now expect it to take even longer.
That is partly because Close Brothers and South African bank First Rand have both said they will appeal last week’s judgement at the Supreme Court.
The court is expected to expedite the appeal given its commercial sensitivity but it is considered unlikely that a conclusion will come soon enough for the FCA to incorporate it into its update in May. Banks are also unlikely to be able to fully measure the potential impacts before announcing annual results in February.
Instead, RBC expects the regulator to push back its announcement to the summer. The FCA did not respond to a request for comment.
Big business
A freezing of the motor finance industry could rattle the UK economy by clogging up the car market and dragging on sales.
Lenders issued £16.9bn in car loans last year, with an estimated 80 per cent to 90 per cent of new vehicles being purchased with finance.
“Ultimately this will lead to lower supply of motor finance products, which will inevitably result in a higher cost of motor finance for the customer,” Toms said.
A redress scheme could become the UK banking sector’s biggest since the infamous payment protection insurance (PPI) scandal, which saw banks hand back more than £38bn between 2011 and 2019 over missold insurance policies.
Analysts’ estimates for banks’ combined exposure have topped out at around £16bn so far. This figure does not include the finance divisions of motor companies themselves, which perform the majority of auto lending in the UK.
Honda and BMW paused sales to customers after the ruling and have since resumed deliveries.