Court’s motor finance judgment gives some UK banks pause in a strong third quarter
S&P Global Ratings said that even as major UK banks maintained their strong earnings trajectory in the third quarter of 2024, attention has shifted toward a growing scale of remediation over historical commissions in the motor finance industry. Rated UK banks with material exposures to motor finance include Lloyds Banking Group PLC, Santander UK Group Holdings PLC, and to a lesser extent, Barclays PLC.
Net interest margins (NIM) rose sequentially in the third quarter as recent headwinds from deposit migration and mortgage repricing have faded, even if Lloyds reported a 4 basis point (bp) sequential drag on NIM from its mortgage book in the quarter. The key factor in the improvement is the programmatic reinvestment of structural hedges at higher yields. For example, the gross return on Barclays’ hedge stood at 2.1% in third-quarter 2024, rising from 1.5% for full year 2023.
Impairments remained subdued and asset quality well contained in the quarter. NatWest saw a sharp rise in its impairments for individually assessed corporate exposure, with the impairment rate on its commercial and institutional book at 31 bps in third-quarter. Otherwise, major banks continue to see a steady flow of assets into arrears and nonperformance as UK and international asset quality steadily normalize after an extremely benign period. At Lloyds, the quarterly impairment rate of 15 bps of average gross lending is a clear step toward the bank’s through-the-cycle level of 20-30 bps.
Rising quarterly income, subdued impairments, and tight cost control saw the major UK banks deliver a simple average return on tangible equity of 14.5% for the nine months to 30 Sept. This was up 20 bps for the six months to 30 June, 2024. While down by about 70 bps from the same period in 2023, the long-term improvement remains strong, with returns more than 300 bps above full-year 2022 (which includes the impact of restatement for IFRS 17 on Lloyds and HSBC). From here, we expect positive earnings momentum to continue as hedging yields rise sequentially and lending picks up, while cost inflation and asset quality remain under control.
Even so, rated UK banks Lloyds, Santander UK, and Barclays will now have to deal with sizing their liability related to potential repayment of past motor finance commissions – denting their strong earnings in the process. On 25 Oct, 2024, the Court of Appeal ruled that motor dealers who arrange financing must clearly disclose to customers the commissions they receive from lenders, and that lenders are liable for any failure to disclose. In one instance, the court ruled that the lender in question was liable to repay the commissions plus interest from the date on which the commission was paid–although the lenders that were party to the court’s decision have appealed to the Supreme Court. The judgment has seen some participants pause new lending and Santander UK Group Holdings delay the release of its third-quarter results as it considers the magnitude of remediation. Actions like these, and Lloyds’ provisions in its 2023 results related to the Financial Conduct Authority’s investigation into the practice, are just the start of a long-running process.