FirstRand is preparing to exit its UK consumer finance business, saying it will work towards an “orderly ownership transition” of Aldermore Group after a sharp increase in expected compensation costs related to motor finance lending.
The lender issued a voluntary update to shareholders late on Tuesday, following the publication of a final redress scheme by the Financial Conduct Authority (FCA) on 30 March.
FirstRand says the FCA’s redress scheme necessitates a further provision of £510 million (about R11.9 billion), bringing its total provision to £750 million (R17.7 billion).
The magnitude of the provision and the regulatory environment have significantly altered the investment case for its UK operations.
“[The] UK as a consumer finance jurisdiction will not deliver the returns the group requires,” it notes, adding that “the business case for FirstRand to own and operate a UK consumer finance entity… is not within the group’s risk appetite”.
While FirstRand stopped short of formally confirming an exit, Keagan Higgins, investment analyst at Anchor Capital, says the direction is clear. “While FirstRand did not outright state their exit plans for Aldermore – it looks like they’re effectively exiting it and, more broadly, UK consumer finance.”
The group previously warned that the outcome of the FCA process would determine its future in the UK.
Chief executive Mary Vilakazi told Bloomberg earlier this year that if key concerns were not addressed, the lender’s business “is not going to have the capital resources that are needed to support lending in motors”.
Meanwhile Investec, responding to an email query from Moneyweb, said it had assessed the implications of the FCA’s proposed redress scheme following the Supreme Court judgment, noting that it had already modelled a range of scenarios to account for regulatory uncertainty.
“Based on the FCA consultation in its current form, the group has concluded that the existing £30 million provision (R671,2 million), including both redress and operational costs, remains appropriate based on information currently available,” it said.
However, it cautioned that “the redress exposure is still uncertain”, with outcomes dependent on any changes to the final scheme, customer take-up and associated operational costs.
Redress scheme drives provision surge
At the core of FirstRand’s decision is the FCA’s redress scheme, which requires lenders to compensate customers for historical commission arrangements on vehicle loans.
FirstRand says although some changes were made to the final scheme, “any mitigation arising from these changes has been more than offset by other amendments”, resulting in a financial impact above expectations.
The group flagged three key concerns:
- A broader interpretation of “unfairness”, which significantly expands the number of eligible claims;
- An “unsubstantiated hybrid redress calculation” that is not loss-based, meaning lending may not cover operational costs, bad debts and funding costs; and
- A higher interest component, with a minimum 3% rate applied over long historical periods.
These factors have materially increased the overall cost of compensation.
The scale of the provision has also raised concerns.
Higgins notes that the additional R11.9 billion provision “came in well ahead of expectations” and now far exceeds the £275 million generated from FirstRand’s UK motor finance activities over more than a decade.
“That entire earnings pool has effectively been wiped out,” he says.
He adds that the composition of the provision is equally significant.
“Given that a ‘considerably larger-than-expected’ portion of the incremental provision relates to post-2021 business, it reinforces that regulatory risk is higher than was previously assumed. This suggests the issue is not just a legacy clean-up, but more structural in nature.”
Industry-wide, the FCA estimates the scheme will cost lenders about £7.5 billion (roughly R168 billion), with around 12.1 million loans potentially eligible for compensation.
Against this backdrop, Higgins says the strategic rethink is rational.
“Management is essentially saying the UK consumer finance market no longer meets their return thresholds, especially given the risk of retrospective regulatory intervention.”
Lower earnings expected
Despite the sizeable provision, FirstRand says its capital position remains adequate.
The capital ratios of FirstRand Limited, FirstRand Bank and Aldermore all remain above target levels, and the group still has sufficient capital to fund its growth strategies.
It also reiterates that it expects to continue paying dividends.
“Given its strong capital position, should the provision meet its worst-case scenario it will still be able to pay a dividend calculated on earnings before the post-tax impact of the provision and within its cover range,” it notes.
“This position has not changed, and the group’s pre-motor provision normalised earnings guidance remains intact.”
Higgins says this should reassure investors.
“For shareholders, capital ratios across the group remain strong and the dividend policy is unchanged. Despite the earnings impact, the group’s capital position provides sufficient flexibility to absorb the provision without compromising the dividend.”
However, the earnings outlook has deteriorated. The group now expects full-year normalised earnings, after the provision, to decline by between 10% and 15%, with return on equity falling below the bottom end of its target range.
In addition, the need to recapitalise its UK operations – particularly its MotoNovo business – will constrain capital available for growth in that market.
From an investment perspective, Higgins says the longer-term implications may be more positive.
“The UK has been a drag on group returns for some time. It has been a minor contributor to earnings with a disproportionate amount of capital tied up and has materially lower ROEs than the rest of the group.
“So while the near-term earnings impact from the provision is negative, we expect the strategic exit to be perceived positively from the broader market.”
Legal challenge on the table
FirstRand has also signalled that it may challenge the FCA’s approach.
The FCA scheme “significantly and inappropriately diverges” from the position of the UK Supreme Court, and the group reiterates that its legal rights remain reserved.
On 1 August last year, the court found in FirstRand’s favour on several key issues – including that motor dealers do not owe fiduciary duties to customers. However, it ruled that the bank’s relationship with one claimant was nonetheless unfair under the UK’s Consumer Credit Act.
FirstRand argues that the regulator’s approach departs from this case-by-case assessment, instead applying broad criteria that significantly expand the scope of claims, while using a compensation model that is not based on actual loss and incorporates elevated interest assumptions.
This article was republished from Moneyweb. Read the original here.
