I had the sneaky feeling markets were underestimating the damage the motor finance mis-selling scandal might inflict on the Lloyds (LSE: LLOY) share price, and now my fears have come true.

The shares have slumped 9.19% to 55.76p in the last week, after a Court of Appeal ruling raised the spectre of a higher compensation bill.

In February, Lloyds sets aside £450m to cover car finance mis-selling claims, a scandal that’s drawn inevitable comparisons with the PPI crisis. That cost Lloyds a staggering £23bn, more than any other bank. While nobody is expecting the same damage this time, investor nerves remain frazzled from before.

Is this FTSE 100 now too cheap to ignore?

Lloyds is on the front line of this scandal too. Its Black Horse subsidiary is the UK’s largest car finance provider, with a third of the market. Bad luck or bad practice?

Either way its shares slumped after another major motor finance player, Close Brothers Group, was hit by a harsher-than-expected court ruling on 25 October. Its shares have crashed 31.94% in a week. Over one year, they’re down 66.89%.

As a Lloyds shareholder, I’m delighted that hasn’t happened here… yet. In fact, the Lloyds share price is still up an impressive 41.16% in the last 12 months.

The board is now “assessing the potential impact of the decisions”, noting that the legal ruling has extended the scope of the Financial Conduct Authority’s review. 

I’m not selling, of course. I plan to hold my Lloyds shares for decades, rather than run at the first sign of trouble. But I’m expecting a bumpy run as the various court decisions and appeals work through the system.

The stock looks good value today

So should I seize the moment and top up my stake in Lloyds? After all, its shares are roughly 10% cheaper. Today’s price-to-earnings (P/E) ratio of 7.38 is just half the FTSE 100 average. Its price-to-book (P/B) ratio has retreated from 0.8 to 0.7. These figures would normally suggest I have a bargain on my hands, but there’s a catch.

FTSE 100 rival NatWest has a P/E of 7.52 and P/B of 0.83. So it’s only a tad more expensive, but with little exposure to the motor finance scandal. The NatWest share price is actually up 3.3% over the last week. And it’s up 103.41% in a year. Wow!

I still think Lloyds is a solid long-term buy-and-hold. Despite the recent share price dip, I’ve made a healthy return so far. I can also look forward to a forecast yield of 5.7%, nicely covered 2.1 times by earnings.

The risk is that shareholder payouts could come under pressure if motor finance claims run into the billions.

A Financial Times report put the likely industry-wide bill at anything between £6bn and £16bn. With a third of the market, Lloyds could end up on the hook for £2bn to £5bn. It seems an extreme scenario but we simply don’t know right now.

I don’t like holding stocks with a court ruling hanging over them. Shares in pharmaceutical giant GSK, another holding of mine, have just taken a battering for that exact reason. Worse, they haven’t recovered even now it’s over. The stink lingers. So I won’t buy more Lloyds. I might take a closer look at NatWest though.