On Wednesday, Morgan Stanley adjusted its stance on Lloyds Banking Group Plc. (LON:LLOY:LN) (NYSE: LYG), downgrading the stock from Overweight to Equalweight. The firm also revised the price target for Lloyds to GBP0.65 from the previous GBP0.70. This change reflects growing concerns about the size of motor finance liabilities following a recent legal development.
Last Friday, an Appeals Court decision went against Close Brothers and First Rand, with the ruling stating that car dealers owe a fiduciary duty to buyers and cannot lawfully accept a commission from lenders without the customer's fully informed consent. The court found that even when commission possibilities were disclosed, the level of disclosure was insufficient.
The Financial Conduct Authority (FCA) had previously reviewed the fairness of these fees, but the new judgment challenges the lawfulness of the fees and demands greater disclosure. This shift has led Morgan Stanley to anticipate an increased potential liability for Lloyds. The analyst from Morgan Stanley has now raised the base case provisions for potential liabilities to £2.1 billion.
The previous base case estimate was between £700 million and £1.5 billion, based on assumptions regarding the percentage of contracts at risk since 2007 and the proportion of fees that might be claimed. Initially, the estimate considered that 50% of the commission fees might need to be repaid.
However, in light of the recent court ruling, the new assumption is that 100% of the fees will need to be returned, prompting the analyst to double the expected base case litigation charge to £2.1 billion.
In other recent news, Lloyds Banking Group has reported a strong third-quarter financial performance, with an 11% rise in underlying pre-tax profit to £1,853 million, which surpassed market expectations. The bank's total income saw a 2% increase, counterbalanced by a 4% rise in lease depreciation.
Lloyds also reported a statutory profit after tax of £3.8 billion for the first nine months of 2024, with its net interest income rising to £3.2 billion in Q3, marking a 2% increase. In light of these results, UBS has raised its price target on Lloyds from GBP0.61 to GBP0.63, while Goldman Sachs maintains a neutral stance with a price target set at GBP0.73.
The bank's lending balances grew, primarily due to a £3.2 billion increase in mortgages, reaching £457 billion. Meanwhile, Goldman Sachs expressed cautiousness due to the UK Court of Appeal's recent judgments on historical motor finance arrangements, which could influence the banking sector.
The final impact of the court's decisions and the Financial Conduct Authority's (FCA) ongoing review cannot be fully determined yet, adding to the current market ambiguity.
Despite a 5% year-on-year rise in operating costs, Lloyds continues to demonstrate strong capital generation with a CET1 ratio of 14.3%. These are recent developments that investors should take note of.
InvestingPro Insights
In light of Morgan Stanley's downgrade of Lloyds Banking Group (NYSE: LYG), recent InvestingPro data provides additional context for investors. Despite the potential increase in liabilities, LYG's P/E ratio of 7.77 suggests the stock may still be undervalued compared to its peers. This is further supported by a price-to-book ratio of 0.72, indicating that the market values the company at less than its book value.
InvestingPro Tips highlight that Lloyds has raised its dividend for 4 consecutive years, with a current dividend yield of 3.85%. This could be attractive for income-focused investors, even as the company faces challenges. However, another tip warns that the stock has taken a big hit over the last week, which aligns with the recent court ruling and subsequent downgrade.
For a more comprehensive analysis, InvestingPro offers 5 additional tips that could provide valuable insights into Lloyds' financial health and future prospects. These additional tips could help investors navigate the uncertainties surrounding the motor finance liabilities and their potential impact on the company's performance.
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