Shares in Lloyds Banking Group (LSE: LLOY) closed down 7% on Friday. The inventory’s down an additional 2% as I write on Monday (28 October). That’s a fall of 9% in two buying and selling days – fairly a giant drop for a FTSE 100 inventory.

The financial institution’s share price droop was triggered by information of a Courtroom of Attraction ruling that might probably result in greater compensation prices for the motor finance trade.

Why this issues

Lloyds’ Black Horse subsidiary is the UK’s largest automobile finance supplier, with round a 3rd of the market. And it’s one among a number of UK companies presently concerned in an investigation by the Monetary Conduct Authority (FCA) into historic motor finance fee funds.

Briefly, the FCA’s reviewing whether or not fee funds made by finance suppliers to used automobile sellers weren’t accurately disclosed to automobile patrons. Friday’s information associated to a case involving Shut Brothers Group, one other large UK motor finance supplier.

The case associated to a single grievance. However the worry amongst lenders is that the FCA might use this ruling to take a stricter strategy on compensation than beforehand anticipated. This might result in a lot greater compensation prices for all affected lenders.

Lloyds has already put aside £450m to cowl compensation. However in a press release this morning, the financial institution stated the ruling “set a higher bar for disclosure” than “had been understood … prior to the decision”.

Consequently, Lloyds says it’s now “assessing the potential impact of the decisions”.

What occurs now?

Shut Brothers has stated it intends to enchantment final week’s choice to the UK Supreme Courtroom. It’d but be reversed.

Lloyds has round £15bn of motor finance loans, giving it round a 3rd of the UK market. Whereas it is a large quantity, it’s solely a small a part of the group’s general mortgage e-book of round £450bn – principally dwelling mortgages.

I’m assured Lloyds can deal with any potential compensation payouts which may turn out to be crucial. However the query for potential buyers – together with me – is how the price of this would possibly have an effect on shareholder returns.

Is that this one other PPI?

Skilled buyers might keep in mind the PPI scandal. The massive UK banks have been pressured to pay out greater than £50bn in compensation for mis-sold fee safety insurance coverage. Lloyds was the largest payer, shelling out greater than £20bn in compensation.

Some Metropolis analysts consider the FCA’s motor finance probe might be the subsequent PPI. Estimates reported within the Monetary Instances from main brokers have pegged the potential complete value for motor finance lenders at between £6bn and £16bn.

Purchase Lloyds at below 60p?

Nothing’s sure but. The FCA isn’t anticipated to supply one other replace on its progress till Could 2025.

For now, Lloyds’ latest third-quarter replace suggests present buying and selling’s stable sufficient. The forecast dividend yield of 5.6% appears to be like protected to me, correctly lined twice by 2024 earnings.

The danger, for my part, is that the motor finance evaluate might result in a multi-year drag on profitability and shareholder returns. That’s what occurred with PPI.

I choose to keep away from this sort of regulatory danger, so I’d look elsewhere if I used to be shopping for a banking inventory immediately.