At the start of the year, I was relatively optimistic in relation to the outlook for the Lloyds (LSE: LLOY) share price. The stock looked cheap and I saw the potential for an upward valuation re-rating.
Today however, I’m a little less bullish on the shares. That’s because there’s a risk that could significantly impact the bank’s near-term profits.
The FCA’s motor finance investigation
The risk I’m talking about is the Financial Conduct Authority’s (FCA) investigation into motor finance mis-selling.
Recently, the financial regulator announced that it will be reviewing historical motor finance commission arrangements and sales across several firms in the UK.
It believes that some customers may have been charged too much on car finance loans made before January 2021.
As a result of this investigation, UK banks could be on the hook for billions of pounds in compensation. And Lloyds could be one of the hardest hit.
Indeed, according to analysts at RBC, the bank could be looking at a fine of up to £2bn. That kind of fine could have a substantial impact on Lloyds’ near-term profits (for reference, the bank’s pre-tax profit for 2022 was around £6.9bn).
And there could potentially be implications for the dividend payout and share buybacks. I don’t expect Lloyds to scrap its dividend like smaller merchant bank Close Brothers did last week. But we could see less growth in the payout in the near term.
It’s worth noting that since the FCA’s investigation was announced, several brokerage firms have lowered their price targets for Lloyds shares.
For example, Jefferies has lowered its target from 62p to 59p, while HSBC has gone from 47p to 45p.
That price target from HSBC is only a few percentage points higher than the current share price.
There are still reasons to be bullish
Now, I’ll point out that RBC has noted that a conclusion that historical motor finance commission arrangements were unfair or unlawful is not a “done deal”.
So we may not be looking at such a large fine for Lloyds (we won’t know until the third quarter of 2023).
And looking beyond this issue, there are still several reasons to be bullish on the shares. For example, Lloyds is expected to report an increase in its annual profits on the back of higher interest rates when it posts its full-year profits for 2023 tomorrow (22 February).
Meanwhile, the dividend yield looks attractive right now. At present, it is over 5% on a trailing basis. The stock is also trading at a low valuation currently. So the FCA investigation may already be priced in.
However, the investigation definitely adds some uncertainty to the investment case. In my view, it has reduced the appeal of owning the shares. I don’t plan to buy them any time soon.
