UK motor finance sector faces potential crisis after court ruling on hidden commissions

A brewing storm in the motor finance industry is bracing itself for a potential crisis, with lenders facing a flood of compensation claims following a recent court ruling. Lars Mucklejohn examines whether the sector is on the cusp of a disaster akin to the PPI scandal.

A London court's decision on "secret" car loan commissions has sent shockwaves through the industry, prompting major lenders to halt new business, overhaul their systems, and seek urgent talks with the government, as reported by City AM.

The Court of Appeal's ruling, handed down last Friday, determined that brokers cannot lawfully receive commissions from lenders without obtaining customers' fully informed consent.

This development has increased the likelihood of the Financial Conduct Authority (FCA) introducing a redress scheme for lenders as part of its review into discretionary commission arrangements (DCAs), potentially exposing banks to billions in additional compensation costs.

In response, Lloyds Banking Group has eliminated commission payments for new loans at its motor finance arm, Black Horse, the UK's largest auto lender.

On Tuesday, William Chalmers, the group's chief financial officer, held an emergency call with analysts and investors to discuss the court ruling's implications, according to City AM.

However, he did not provide details on whether Lloyds would set aside additional provisions beyond the £450m allocated in February to cover potential costs. However, Chalmers did mention that the factors influencing the bank's provisioning model have broadened beyond just estimating the impact of the FCA's review.

Since the ruling, Lloyds' share price has plummeted by 14 per cent. RBC Capital Markets predicts that in a worst-case scenario, Lloyds could suffer a £3.9bn blow to its profits.

Earlier this year, Close Brothers, deemed the bank most vulnerable to the FCA's investigation in relative terms, made arrangements to strengthen its finances by £400m and has since offloaded its wealth division for £200m.

However, the circumstances have deteriorated significantly for the 146 year old merchant bank.

Close Brothers, which participated in last week's test case, has suspended new car loans following the ruling. Its share price, already severely impacted earlier this year, has plunged 37 per cent since last Friday and is now at a thirty-year low.

RBC has projected a worst-case scenario where Close Brothers suffers a £387m loss from compensation, interest, and administrative costs. This figure surpasses the company's current market capitalisation of £343m.

In other news, Santander UK has postponed the release of its complete third-quarter results to assess the ruling. RBC anticipates a downside impact of £1.8bn.

Several smaller auto lenders have also halted loans, including Zopa, Secure Trust Bank, MotoNovo, Mann Island, V12, and Northridge.

Analysts are flagging concerns that the recent legal developments could see several companies exiting the market as a result of judges essentially overturning prior guidance from the Financial Conduct Authority (FCA). Benjamin Toms from RBC remarked to City AM, "Banks will quickly adapt their contracts and processes to comply with the new rules," but warned, "However, in the medium term, some lenders will decide that lending in this sector is no longer for them."

Noticeably, firms like Secure Trust, which have ceased lending operations, had previously in