After being hit by a surge in last-minute claims, Lloyds Banking Group plc (LYG - Free Report) and Barclays PLC (BCS - Free Report) said that they might have to pay much more than anticipated to compensate customers for mis-sold payment protection insurance (PPI) policies between late 1990 and early 2000.
On Monday, Lloyds said that it is preparing itself for what has become Britain’s costliest scandal. The bank is expected to set aside up to an additional £1.8 billion to settle the PPI claims. In fact, it said that it will suspend its 2019 share buyback program as well.
Barclays said that it will set aside nearly £1.2-£1.6 billion.
PPI was designed as a simple insurance product that was sold along with loans to help borrowers repay in case they fell ill or lost jobs.
However, during the late 1990s and early 2000s, many banks in Britain tried to push the product to as many customers as possible, regardless of whether they were eligible for it or even required it.
While the banks tried to resist any criticism regarding the product for years, in 2011, Britain's High Court ordered that the lenders would have to start compensating customers for the mis-sold policies.
Since Lloyds started taking claims in 2011, it has already paid more than £20 billion as compensation to customers.
Aug 29 was set as the final deadline for consumers to complain. However, because of the sudden surge in consumer inquiries in the run-up to that date, now banks are forced to set aside additional compensation money.
Last week, The Royal Bank of Scotland Group plc (RBS - Free Report) said that it also had to face additional charges totaling £900 million as a result of the rush in last-minute claims.
Clydesdale Bank also made a new provision worth £300-£450 million.
In fact, after Lloyds and Barclays said on Monday that they are making extra provisions, the total cost of the PPI scandal hitting British banks reached almost £50 billion.
Lloyds said that in the final weeks, just before the August deadline, it received nearly 600,000-800,000 requests for information about PPI per week, much higher than its expectations.
During the first half of 2019, Lloyds made PPI provisions worth £650 million. The bank also said that it received a claim submitted by the Insolvency Service's Official Receiver on behalf of bankrupt consumers, which could lead to higher costs this year.
Thus, on the expectation of a decline in profitability, Lloyds no longer projects a return on tangible equity of around 12% this year. In fact, it said that the increase in its capital ratio in 2019 would be below its target of 170-200 basis points.
Nevertheless, Barclays still expects to hold its core capital level at 13% by the end of 2019 mentioned earlier.
Notably, because of the several underlying challenges that Barclays still faces, legal provisions are expected to rise, thereby hurting the company’s bottom line. Also, regulatory reforms in response to the persistent weaknesses in the global financial sector together with increased regulatory scrutiny will require Barclays to maintain an increased capital level. This will likely limit its business flexibility.
While shares of Barclays have lost 3.1% so far this year, shares of Lloyds have gained 1.2%. The industry has gained marginally over the same period.
Currently, Barclays carries a Zacks Rank #4 (Sell) while Lloyds carries a Zacks Rank #3 (Hold).
A better-ranked stock from the finance space is Ally Financial Inc. (ALLY - Free Report) . Its Zacks Consensus Estimate for 2019 earnings has been revised 3.6% upward over the past 60 days. The stock has gained 53% so far this year. It currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
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