‘Twas the night before Brexit, and Lloyds Banking Group (LSE: LLOY) was trading at 72p. Within a fortnight, it had crumbled to just 47p, having lost a third of its value. That same fateful referendum night, Barclays (LSE: BARC) topped out at 187p, then plunged a catastrophic 32% to a low of 127p. Royal Bank of Scotland Group (LSE: RBS) flew to 250p, then dropped an almighty 40% to 149p.
What goes down…
For many investors, this will have put the tin lid on years of dismal underperformance, but I hope you didn’t make the mistake of selling at the bottom, because you’ll have locked yourself out of the subsequent rebound. Today, Lloyds trades at 56p, while Barclays at 148p and RBS at 182p are still well below their pre-Brexit highs, but also far above their post-Brexit lows.
The crash was driven by fears the UK economy would slump into recession as it unpicked its EU ties, hitting bank lending and profits, and the banks would lose their passporting rights to the single market, hurting London as a global financial centre. With Bank of England governor Mark Carney freeing them to unleash £150bn of lending and assuring markets there will be no credit crunch, as well as non-doctrinaire Prime Minister Theresa May taking the reins with astonishing speed, these fears are ebbing.
String theory
The referendum result was a shock but markets are waking up to the fact that Brexit will be a slow process. Foreign Secretary Philip Hammond reckons it could take six years. Nobody can sustain a state of panic for such a lengthy period. The danger is the uncertainty will deter domestic and international investment, hitting GDP growth and banking profitability, and I question whether interest rate cuts and more QE are the right solution. We’ve been pushing at this piece of string long enough, and zero interest rates could also squeeze the banks’ net lending margins.
Barclays reckons the UK has already entered recession, forecasting Q3 growth at -0.2%, falling to -0.3% in Q4 then deepening to -0.4% in Q1 2017. If correct, confidence will be further damaged, hitting consumption and possibly house prices. Sterling’s plunge has done less for domestic UK banks than the rest of the globally-focused FTSE 100. However, the hard work of repairing bank balance sheets over the past seven or so years should now pay off and investors can assume the Bank of England will step in if troubles deepen.
The Italian job
The pledge by US investment banks JP Morgan, Morgan Stanley, Bank of America Merrill Lynch and Goldman Sachs to stand by London will also bolster confidence. The Square Mile and Canary Wharf’s history in finance, deep capital markets and skilled workforce gives the capital a fighting chance of maintaining its pre-eminence. Investors should also beware foreign threats. Although UK exposure to troubled Italian banks is “modest“, according to Carney, there’s still the risk of EU contagion.
Banking investors face uncertainty upon uncertainty upon uncertainty, and their dividend forecasts can no longer be relied on. On the other hand, with Lloyds trading at just 6.62 times earnings and Barclays at 8.95 times, these worries are priced-in and both look tempting for long-term investors. But even at 6.23 times earnings, I would struggle to make an investment case for RBS right now.