How could it possibly be good news that an Irish bank is facing an even bigger financial-scandal bill than the tracker-mortgage crisis?
Bank of Ireland revealed before the Dublin stock market opened on Monday that it faces having to set aside a total of £350 million (€403 million) to cover compensation and other costs in relation to its role in the UK car loans debacle.
That’s £207 million more than it had previously ring-fenced – and about £80 million more than what analysts had marked in for Bank of Ireland after the UK Financial Conduct Authority (FCA) estimated this month that the UK car-loan sector would need to spend £11 billion to clean up the mess. Bank of Ireland’s Northridge Finance unit has a 2 per cent share of the UK car finance market.
It also eclipses the total €340 million costs Bank of Ireland stomached for its role in the tracker mortgage controversy – the biggest overcharging affair in Irish banking history.
Yet, on Monday, Bank of Ireland’s stock rose as much as 2.1 per cent on the day.
The advance was partly driven by a broader global rally in banks following a sell-off late last week, which was sparked by renewed concerns over US regional banks after Arizona-based Western Alliance Bank and Utah’s Zions Bank reported losses due to bad or fraudulent loans.
It also shows the bank has learned from the corrosive drip-drip effect of it – and other Irish lenders – repeatedly hiking provisions in a slow reckoning with the scales of distressed debt after the crash and the tracker scandal.
[ Bank of Ireland still trying to draw a line under UK car finance debacleOpens in new window ]
There are good reasons to try to get ahead as this is far from over.
The FCA set up a review early last year into whether motor finance customers were overcharged because of historical use of discretionary commission arrangements (DCAs) between car dealers and lenders, covering 14 years before such arrangements were banned in 2021 in the market.
These deals gave brokers, typically forecourt salespeople, the discretion to set higher rates, earning them higher commission the more customers paid for their finance.
The FCA had argued, however, that the Court of Appeal in London went too far on a number of test cases when the judges decided last October that motor brokers owed customers a fiduciary duty, an obligation to act in the best interests of consumers.
The watchdog secured permission by the UK’s Supreme Court earlier this year to submit its points, fearing that a ruling along the lines of the lower court would hit not just the firms but consumers if a raft of lenders pulled out of the market.
The Supreme Court agreed with the FCA. The court’s president, Robert Reed, said in August that car dealers who sold the vehicles and arranged the finance did not owe fiduciary duties to customers.
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The problem is lenders – and legal analysts – argue the FCA’s proposals to put the matter right go beyond the scope of the Supreme Court judgment.
Lloyds Banking Group, the largest player in the market, with an estimated 14 per cent share of financing deals, recently hiked its provisions to £1.95 billion. Its chief executive, Charlie Nunn, said this week that the authority’s planned scheme could wipe out the profits made by the industry over the past two decades. He said it could hamper the “investability of the UK”.
Bank of Ireland, led by chief executive Myles O’Grady, is hoping the FCA may rein in its own proposals. BoI says it will engage with the authority on how the FCA’s proposed approach “for assessing unfairness does not align with the legal clarity provided by the recent UK Supreme Court judgment”.
RBC Capital analyst Benjamin Toms warned that “if the FCA do not soften their stance on [discretionary commission agreements], the banks will have the right to ask for judicial review”.
This could drag on.
But by setting aside among the higher levels of provisions relative to market share to date then O’Grady will be hoping he is covered for even adverse scenarios.
This will be key as the bank aims to get its regulators on side to finally start giving rival AIB a run for its money in returning excess capital to shareholders.
Over the past four years Bank of Ireland has returned €2.8 billion to investors by way of dividends and share buy-backs. While that’s the equivalent of more than a fifth of its current market value, it is a little over half of the €5.2 billion AIB has handed over. That said, AIB spent most of the money buying back shares from the State to hasten its exit from the shareholder register.
Toms at RBC estimates that Bank of Ireland could afford to spend €4.2 billion on dividends and buy-backs over the next three years – equating to a third of its current market cap or an annualised return of 11 per cent.
While it’s still below the €5.7 billion the analyst has pencilled in for AIB over the same period, the estimated returns are broadly similar relative to the banks’ respective market values.
If investors believe O’Grady has motor finance costs under control then they can focus on the bank’s potential capital returns – the key investment story for major Irish lenders now that interest rates have fallen sharply from their peak.
