Auto financing sector in crisis after historic court ruling

Friday November 1, 2024 6:00 am
| Updated:

Thursday, October 31, 2024 7:11 PM

The precedent set by the decision could apply to a range of consumer finance commissions, lawyers have argued.

As lenders face a flood of compensation claims over a growing car finance scandal, Lars Mucklejohn wonders whether the sector is heading for a PPI-scale disaster.

Car finance providers are scrambling to avoid a total market collapse after a London court ruling on ‘secret’ car loan commissions has caused chaos the sector this week.

A Court of Appeal ruling last Friday has forced some major lenders to halt new business, shake up their systems and push for urgent talks with the government.

Judges ruled it was a real estate agent could not lawfully receive a commission from the lender without the customer obtaining fully informed consent for 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 investigation into the so-called discretionary commission arrangements (DCAs), potentially exposing banks to billions in additional compensation costs.

Lloyds Banking Group has abolished commission payments on new loans at its car finance arm Black Horse, Britain’s largest car lender.

William Chalmers, the group’s chief financial officer, made an urgent appeal to analysts and investors on Tuesday to explain his response to the court ruling. City AM understands.

He gave no details on whether Lloyds would make further provisions beyond the £450 million was set aside in February to cover potential costs.

However, Chalmers did mention the variables that will be included in the bank’s supply model are now broader than when it was merely trying to assess the impact of the FCA review.

Lloyds’ share price has fallen by 14 percent since the ruling. RBC Capital Markets estimates that Lloyds could taking a £3.9 billion loss to its profits at worst.

Close Brothers, which is considered the most exposed bank in relative terms to the FCA’s investigation, made plans to do so boost its finances by £400m earlier this year and since sold its asset class for £200 million.

But the situation has gone from bad to worse for the 146-year-old commercial bank.

Close Brothers, which was involved in the test case last week, has suspended new car loans since the ruling. The share price, which was already under pressure earlier this year, has fallen by 37 percent since last Friday and is now trading at a three decades low.

RBC has modeled a worst-case scenario in which Close Brothers takes a £387 million hit through compensation, interest and administration costs. That figure is greater than the company’s current market capitalization of £343m.

Elsewhere, Santander UK has postponed publication of its full third-quarter results to process the ruling. RBC estimates a downward impact of £1.8 billion.

Loom outputs

A slew of smaller car lenders have also canceled lending, including Zopa, Secure Trust Bank, MotoNovo, Mann Island, V12 and Northridge.

Analysts have warned that the fallout could push some companies out of the sector entirely, as judges have effectively overruled previous guidance from the FCA.

“Banks will quickly adapt their contracts and processes to comply with the new rules,” says Benjamin Toms, analyst at RBC. City AM.

“However, in the medium term, some lenders may decide that lending in this sector is no longer for them.”

Some of the companies that have stopped lending, such as Secure trusthad said in the months before the ruling that they had not been significantly exposed to the FCA’s investigation.

A director at a car lender told me City AM they had previously doubted analysts’ estimates that banks could receive billions in compensation, as the FCA has estimated that DCAs have passed on £165 million in extra costs per year to consumers.

The FCA’s investigation focuses on DCAs between 2007 and 2021 they were forbidden. The agreements were industry standard and were included in about three-quarters of auto loans during that period.

The broader banking sector has been flooded with historical complaints as consumers seek compensation and claims management companies take advantage of the situation.

Within just four months of the FCA announcing its investigation, the Financial Ombudsman Service – which settles disputes between consumers and financial service providers – received 20,000 complaints about car financing.

This was said by a director of a car finance company City AM that when Martin Lewis, founder of MoneySavingExpert.com, listed his bank on television earlier this year as one that had never used DCAs, the company still received more than 2,000 complaints.

Ministers are in turmoil

On Tuesday, finance ministers held urgent talks with FCA officials and representatives of the Finance and Leasing Association (FLA), which represents car lenders, to discuss the ruling.

The FLA is now urging the regulator to extend the pause on the eight-week deadline firms have to respond to DCA complaints, which is currently in place until December 2025. FCA boss Nikhil Rathi said in An speech on Tuesday that the regulator would consider this step.

A spokesperson for the Ministry of Finance said this City AM: “The Treasury is working closely with regulators and industry to understand the impact of this judgment.”

Judges ruled that lenders must inform customers of all payments made to dealers – meaning not just bonuses, but also fixed fees. The precedent set by the decision could even go beyond auto loans and apply to a range of consumer finance commissions, attorneys have argued.

Toms said: “Three examples of the many questions still outstanding are: Does this decision go beyond car financing? Which years are now included in the scope? And should all commissions paid be returned to the customers?”

The FCA was originally due to set out the next steps under the review in September, before postponing until July 2025. But given last week’s ruling, analysts now expect it to take even longer.

That’s partly because Close Brothers and South African bank First Rand have both said they will appeal last week’s ruling to the Supreme Court.

It is expected that the court will expedite the appeal given its commercial sensitivity, but it is considered unlikely that a conclusion will be reached quickly enough for the FCA to include it in its May update. It is also unlikely that banks will be able to fully gauge the potential impact before announcing their annual results in February.

Instead, RBC expects the regulator to delay its announcement until the summer. The FCA did not respond to a request for comment.

Big business

A freeze in the car finance sector could rock the UK economy by clogging the car market and slowing sales.

Lenders issued £16.9 billion on car loans last year, with an estimated 80 to 90 percent of new vehicles purchased with finance.

“Ultimately, this will lead to a lower supply of car financing products, which will inevitably result in higher costs of car financing for the customer,” said Toms.

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 £38 billion over mis-sold insurance policies between 2011 and 2019.

Analyst estimates for banks’ combined exposure to date are around £16 billion. This figure does not include the finance departments of car companies themselves, which handle the majority of car lending in Britain.

Honda and BMW halted sales to customers after the ruling and have since resumed deliveries.