UK banks face hefty costs over car loan misselling

UK banks may have to pay clients billions of pounds in compensation as a result of an ongoing regulatory probe into car loan commission arrangements dating back to 2007.

The UK Financial Conduct Authority (FCA) launched the probe earlier in January in response to a high number of compensation complaints for alleged overcharging linked to legacy discretionary commission arrangements (DCAs). The FCA banned DCAs — under which lenders allowed brokers to adjust interest rates on car loans — in 2021, but it is now investigating the extent of the issue as customer complaints continue to pour in.

The Financial Ombudsman Service (FOS) said Jan. 11, at the time the FCA launched the probe, that it had received more than 10,000 complaints, with "many more" expected. The FOS has already ruled in favor of plaintiffs in two legacy cases involving Lloyds Banking Group PLC's car finance arm, Black Horse Ltd., and Barclays PLC legacy car finance service Barclays Partner Finance.

Analysts expect significant costs for Lloyds, Close Brothers Group PLC, Santander UK PLC and Barclays. Lloyds is projected to face the highest absolute charge given the number of loans provided in the past, and Close Brothers is expected to face the largest relative impact given its high exposure to car finance. The latter's share price is down more than 30% since the probe was announced, S&P Global Market Intelligence data shows.

Close Brothers' car finance business accounts for roughly 20% of its total loan book, compared to 3% for Lloyds and Santander UK PLC, UBS analysts have estimated. The potential hit to Barclays is expected to be smaller than the other three banks given that it stopped offering car finance in 2019, when it had a total loan book of some £2 billion, the UBS analysts said in a Jan. 15 note.

Analysts at RBC Capital Markets project a total impact on the sector of £6 billion to £16 billion. Pretax charges are estimated at £2 billion for Lloyds, £850 million for Santander UK, £250 million for Barclays and £200 million for Close Brothers. NatWest Group PLC will not be affected by the review as it has not sold car loans via brokers for decades, Numis Securities analysts said in a Jan. 16 note.

The banks' cost-to-income ratios increased in the fiscal third quarter, with Close Brothers' higher than the others', according to Market Intelligence data.

All banks had common equity Tier 1 buffers above their minimum regulatory requirement of at least 2.23 percentage points. Close Brothers' buffer was 3.81 percentage points as of July 31, 2023.

Loan loss provisions at the banks are projected to grow in 2024 and 2025, but from low levels booked in the previous three years, consensus estimates compiled by Market Intelligence show.

Spokespeople for Lloyds' Black Horse subsidiary, Santander UK and Barclays said they are aware of the FCA review and are cooperating with the authorities to resolve legacy DCA cases, but did not comment on whether the banks have made provisions or estimate the potential impact of a sector-wide compensation scheme. Close Brothers did not respond to a request for comment.

The total impact on the sector and individual banks depends on how far back the FCA review would go, the number of customers who would claim compensation and the rate difference the banks would need to repay, among other things. The FCA said Jan. 24 that it would review DCAs made between April 6, 2007, and Jan. 28, 2021, noting the FOS does not have records on such transactions before 2007.

– Access capital adequacy details for Close Brothers and Lloyds on CapIQPro. – Access income statement details for Close Brothers and Lloyds on CapIQPro.

Close Brothers would take the biggest hit on future shareholder returns, RBC Capital Markets analysts said in a Jan. 25 research note. They have cut their estimated three-year total shareholder returns by 33% for Close Brothers, 10% for Lloyds, 2% for Santander UK and 1% for Barclays.

The FCA has suspended the obligation for car finance firms to respond to DCA-related customer complaints within eight weeks while its investigation is ongoing. The regulator said the response deadline will be on pause until Sept. 25, with next steps regarding the review to be announced in the third quarter of 2024.