Lloyds shares feel the heat after car finance ruling

Just over a year ago the Lloyds Banking Group share price fell to a one year low just below 40p on concerns over a slowdown in net interest margins, as well as concerns over the outlook for the UK economy, despite the business having some of the highest margins in the sector.

The consistent underperformance of the Lloyds share price relative to its peers has been a consistent source of puzzlement over the past 10 years, when you consider the bank is in much better shape than at any time since the aftermath of the financial crisis.

Not much fundamentally has changed since the start of the year, although the shares have undergone a decent rebound to as high as just above 63p last month, which was also their highest levels since Covid, and a pre-Covid peak of 69.9p on the 13th December 2019 in the wake of the Conservative election win at the general election the day before.

The previous post financial crisis highs, of just below 90p, that we saw under the leadership of previous CEO, Antonio Horta-Osorio back in 2015 remain elusive, despite the fact that the bank is in much better shape on almost every level since those days almost 10 years ago, when the bank was still struggling to shake off quite sizeable PPI provisions.

As of 2019 it has been estimated that Lloyds had set aside £22bn in respect of these PPI provisions, with the deadline for claims closing in August of that same year.

Now it would appear that Lloyds could be in the eye of another storm, this time when it comes to car financing, after a sharp drop in the share price last month in the wake of concerns about the banks role in providing finance to the car industry, and the payments of commission to motor dealers.

There had already been some concern over this in the early part of this year when Bank of America downgraded the bank over its exposure to the car financing industry before 2021, and the investigation into commission payments.

Lloyds management had already started to recognise this, starting to set aside millions of pounds in respect of a possible negative outcome, with a further £118m, on top of the £127m added in the same period last year, taking the total set aside to £450m.

In any case, the high court ruling in October against FirstRand Bank and Close Brothers that stipulated that it was unlawful for lenders to pay hidden discretionary commissions to car dealers without the knowledge of the borrower appears to have stirred up a hornet’s nest of concerns over possible large scale compensation payments, with some numbers being bandied about being as high as £3bn.

This is because Black Horse Finance is one of the biggest lenders to the UK car industry, with loans totalling up to £16bn. The case has gone to appeal against a backdrop of concerns that the payment of all types of commission could well be deemed illegal, meaning a spillover to other consumer products with all the attendant risks that might bring to consumers as well as the UK economy, when it comes to credit availability.

The hope is that the appeal to the Supreme Court will clarify what is covered, and what isn’t and bring this whole sorry episode to a conclusion.

Consequently, we’ve seen Lloyds shares fall back sharply on concerns that the share buyback announced in February could well be scaled back from the £2bn originally announced, although there don’t appear to be any concerns about the dividend, which is a currently healthy 6%, or an expected 3.4p per share for 2025.

These concerns overshadow what looks like a fairly healthy business, despite net interest margins that have stabilised just below 3%, down from 3.1% a year ago.

When the bank reported in Q3, statutory profits after tax fell to £1.3bn, due to these lower margins, prompting a modest decline in net income to £4.34bn, from £4.5bn, although the profit number was still the best quarter since the same quarter last year.

Over the 9 months operating costs rose by £338m, to just shy of £7bn, and were £50m above the same quarter a year ago at £2.29bn.

This narrowing of margins came about despite a £4.6bn increase in both underlying loans and advances to customers over the quarter to £457bn, while loans and deposits also rose by £1bn to £475.7bn.

Both of these numbers were a decent increase from the end of last year, suggesting a decent performance from the UK economy in the first half of this year, although Q4 could well be a different story given the slowdown in the economy in the second half.

With consumer confidence and business confidence undergoing a sharp fall in the last few weeks the journey into year-end could be a bumpy one for Lloyds given its close affiliation to the fortunes of the UK economy, as well as the current uncertainty around the car financing industry.

This remains the biggest obstacle to a rally back to the levels we saw in 2015, and is likely to act as an obstacle to a return to the highs this year. If these clouds were to lift then perhaps, we could well see a move higher towards levels last seen 10 years ago, although any compensation is unlikely to be anywhere remotely close to PPI levels.

On all available metrics Lloyds does appear to be trading at a steep discount to its peers, especially when you consider the business is in much better shape than it was when Horta-Osorio was in charge, however markets are fickle beasts, and just because a share appears undervalued, it doesn’t mean that situation will eventually correct itself.

After all, one person’s undervalued share is another person’s avoid at all costs share.

This material (whether or not it states any opinions) is for general information purposes only and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research