European Banks' Credit Surviving the Brexit Storm
June 28 2016 - 3:35PM
Dow Jones News
By Margot Patrick and Christopher Whittall
LONDON -- While European bank stocks have plunged after the
Brexit vote, bank credit is holding up comparatively well, a sign
that investors believe banks can ride out even the steep falls in
profits predicted by some.
Since Thursday's U.K. vote to leave the EU, European banks'
riskiest type of debt, bonds that convert to equity in extreme
financial stress, is trading only around 7% lower. Yields on
sterling-denominated bank bonds actually dropped since the vote,
mirroring a fall in the yields of U.K. government bonds as
investors seek safety. Falling yields mean rising prices.
Stock prices, on the other hand, have fallen sharply. The STOXX
Europe 600 banks index is down 19% since Thursday. Barclays PLC,
Royal Bank of Scotland Group PLC and Lloyds Banking Group PLC have
fallen even more on fears that their earnings will weaken and bad
loans will rise in the fallout from a Brexit.
"On the credit side, you have more resilience," said Filippo
Alloatti, a senior analyst at Hermes Credit. "Banks are better
capitalized than before the crisis and there are better liquidity
provisions."
The markets remain highly volatile, as Barclays shares gained
3.4% on Tuesday and Lloyds was up 7.4% amid a broad recovery in
global stocks. The pound rose against the dollar and was at
$1.3341, up 0.8%, in late European trading.
To be sure, substantial risks remain for Europe's banks. The
most severe would be a return of concerns about the eurozone's
coherence, since worries that Greece or others might fall out of
the currency union had driven enormous stress in bank-funding
markets, at times cutting whole countries' banking systems off from
funding.
During the eurozone crisis and the financial crisis of 2008,
bank credit took a central role in investors' fears. This time, "we
don't think [bank credit] will face really dramatic price
adjustments like we saw in the post-Lehman crisis," CreditSights
senior analyst Simon Adamson told clients on a call Tuesday.
For one thing, global central banks have kept funding and
liquidity lines open since the crisis. The European Central Bank
has pledged to conduct massive bond-buying if needed to keep
government yields from spiraling out of control. On Tuesday, the
Bank of England said U.K. lenders bid for GBP6.3 billion ($8.4
billion) of cash in a special auction and took GBP3.1 billion, no
more than at other recent auctions.
In anticipation of markets slowing down before the Brexit vote,
U.K. banks earlier in the year issued much of the debt they needed
to refinance maturing bonds. One big deal still outstanding: a
planned GBP2 billion bond from RBS. That deal is an "additional
Tier 1" issue, a risky type of debt that can convert to shares and
is also known as a CoCo, or contingent convertible bond. An RBS
spokesman declined to comment Tuesday.
Investors in bank credit said their main focus will continue to
be on banks' solvency and capital, which in most cases are in good
shape after years of rebuilding and higher regulatory requirements
since the financial crisis. Worries that flared up in February over
risks in additional Tier 1 bonds have also died down, bank credit
investors said. The bonds can be written off or converted into
equity if a bank's capital levels dip too low.
"Banks have more capital, most have enough liquidity and they
have central bank facilities in place. It doesn't look like there's
a subset of banks having funding problems," said John Raymond, a
senior banks analyst at CreditSights.
One reading of the differing signals from stock and bond markets
is that funding conditions are good but the economic forecast is
not. It's "understandable that the equity market is going to be
very cautious about the earnings prospects of U.K. and European
banks," Mr. Raymond said.
On Tuesday, analysts at Goldman Sachs added to a chorus of doom
around European bank earnings. They estimated EUR10 billion ($11.05
billion) will be wiped from U.K. banks' net profit in the 2016-2018
period, and EUR32 billion across all the European banks they
cover.
Stock analysts have slashed their ratings on U.K. and European
banks to reflect a darker picture for lenders' profits and
dividends.
"Probably some equity analysts got ahead of themselves in the
previous month and are looking for excuses to bring down earnings
estimates," Mr. Alloatti said.
--Jason Douglas contributed to this article.
Write to Margot Patrick at margot.patrick@wsj.com and
Christopher Whittall at christopher.whittall@wsj.com
(END) Dow Jones Newswires
June 28, 2016 15:20 ET (19:20 GMT)
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