Britain’s banking sector would face serious challenges and risk ruin in the event of Brexit, according to a new report out from research firm Bernstein.
In a note from analysts Chirantan Barua, Daniel Lasry, and Mark Burrows, Bernstein sets out a doom-laden forecast of what could happen across British banks should the country choose to back Brexit next week. Bernstein points to three direct impacts of Brexit on the UK economy that would spill over into the banks, and cause big problems.
Those spillovers are: the big drop in the pound expected after Brexit, a big rise in unemployment — as much as 2% — and a big drop in prices in the UK’s overheated property market.
Here’s the key quote from Bernstein:
“Employment is full and house prices are in bubble territory in the South. There is nothing idiosyncratically brilliant that is happening in the country that could help it stem an inevitable global slowdown. Enter Brexit. As we have written in this note, things could get materially worse in the near-term — especially in the South. But that’s where the bulk of the bank’s books are.”
Bernstein analysts argue that in the event of Brexit, falling employment and house prices, as well as the tanking pound, would make pretty much all the debt lines banks issue — credit cards, loans, mortgages etc — would become substantially riskier, which could signal serious problems in future. Here is more from the analysts (emphasis ours):
“The biggest downside to the “risk line” of the banks are the historically low impairments that they have been printing of late…meaning any marginal deterioration is a spike. Credit Cards, Personal Loans and Buy-to-Let (BTL) mortgages are the three books that have shown signs of life in the UK in the past 3-4 years…but these three are the ones which are likely to take the biggest hits in a Brexit scenario.”
“BTL has been the biggest driver of growth in mortgages and has been mostly concentrated in the South, driven off strong employment momentum and affordability constraints of potential buyers. It will hurt in the next two years if we see unemployment spike in London — occupancies will fall at the same time as capital values erode and that too off a surge in recent supply.”
Bernstein also adds that in terms of investment banking, UK banks would get slammed in the event of Brexit. Revenues, it argues, are already dropping, and could fall by as much as 30% in the near term after a Brexit. Mortgage income would also tank. Here is Bernstein again (emphasis ours):
On the income side, the immediate hit will be on Investment Banking on a global basis — not only in the UK. We are already in the middle of a downturn in IB and in the case of Brexit, we are talking IB revenues down 30% this year and forecast the cycle lasting deep into next year. If the market gets Brexit wrong, it’s hard for us to see capital being put to work globally before the US presidential elections. On the loans side, we believe Unsecured should fall sharply by 6-8% within the next 18 months on the back of unemployment ticking up and derisking. Mortgages should fall 3-4% as well, as the front book dries up with a house price correction.
“Affordability [British houses are less affordable than ever before] is the only reason we are not modelling a full blown mortgage crisis,” Bernstein adds.
All this would obviously send share prices in British banks crashing, which is why the research firm has lowered its price target for every major UK bank this year, as this chart illustrates:
While the sector as a whole will take a big hit according to Bernstein, individual banks would be affected differently, with Barclays and Lloyds, two stalwarts of the high street, taking the biggest hits. Bernstein notes that Lloyds has the highest proportion of UK exposures of any bank, while Barclays has the highest exposure to London, which Bernstein argues will be hit hardest by Brexit.
Here is what the analysts have to say:
Lloyds — “With 95% of their exposures in the UK and the richest valuation amongst the UK banks, the stock is set up for a sharp correction if Brexit comes through. Pain points on risk will be the BTL [buy-to-let] book, and the recently built-up Auto Finance and Credit Cards books as well. Negative operating leverage on mortgages will also be a big earnings drag.”
Barclays — “Simply put, the bank has the highest gearing to London in terms of their UK portfolio. It also has the highest gearing to Investment Banking revenues which we believe are going to tank. It’s also the biggest Cards player in the UK with more than 25% market share.”
HSBC, Bernstein notes, would be relatively unscathed thanks to having just 35% of its exposure in the UK market. Here’s Bernstein’s breakdown of exposures by bank, showing just why Lloyds could be in such trouble after Brexit.
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