Some of the biggest casualties of Brexit have been British and European banks, with Lloyd’s (LSE:LLOY) falling 23%, Bank of Ireland (ISE:BIR) down 32% and ING (ENXTAM:INGA) falling 11%. Declines in sterling and the euro have only added to the pain for Australian investors in these banks. But are these falls justified?
I’m not an economist and think that macroeconomic forecasts are pretty much worthless. So while there are some negatives from Brexit, it’s unlikely to prove the British economy’s downfall.
In the short term, the uncertainty created by Brexit may lead to a recession as consumers and businesses postpone their spending and investment decisions respectively. As a result, fears over falling residential and commercial property prices and increased provisions are some of the reasons behind British banks’ share price falls.
Over the longer term, however, I think Britain will be fine. Due to the reforms made since 1979, its economy is more productive and dynamic than its European cousins and so it should bounce back quickly from any downturn. A better regulatory and tax environment is why London rather than Frankfurt became the financial capital of the EU.
As long as these reforms aren’t watered down or reversed, Britain is much better placed to succeed outside the EU than, say, a France or an Italy.
Moreover, while the potential loss of preferential access to the EU free trade block has been cited as proof that Britain faces a less prosperous future, you can actually have free trade without the vast – and massively expensive – bureaucratic apparatus that came with EU membership. Importantly, it will now be in British politicians’ self-interest – both pro and anti-Brexit – to pursue favourable trade deals with both the EU and other countries, although whether they are successful remains to be seen.
By contrast, the generally slower-growing economies of Europe could actually benefit from Brexit if it finally galvanises continental politicians to replicate the hard decisions made by Britain in recent decades and similarly reform their economies.
The bull case
The bull case for British and many European banks is similar: after the traumas of the GFC, they’ve simplified their busineses and are now much more highly capitalised and hence less leveraged. They also have higher quality assets, more stable sources of funding (retail deposits rather than wholesale funding) and face less competition.
Many are already paying decent dividend yields which should increase as their balance sheets grow along with their underlying economies. It’s worthwhile noting that the EU economy is growing – albeit slowly – while it’s likely that the British economy will quickly bounce back from any recession.
Moreover, the post-Brexit falls mean that many British and European banks are much more reasonably priced than their Australian equivalents such as CBA (ASX:CBA) and Westpac (ASX:WBC). For example, Lloyd’s has a price-to-book ratio of 1 and a PER of 8 whilst ING has a price-to-book ratio of 0.8 and a dividend yield of 8%.
They’d be even more attractive if central banks including the European Central Bank did away with their – in my view – counterproductive experiment with very low or even negative interest rates and started normalising interest rates (as I’ve suggested previously). But you can't have everything.