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Alex Cho

Which Banks Will Bleed The Most from Brexit?

So, the banks tanked today in response to Brexit. It’s not really surprising really, which kind of explains why the financials were so out of favor as a sector.

But, I wanted to tie into some commentary from Barclays PLC, the guys who are based out of London to talk about London economics.

Barclays mentions that Brexit negatively affects the cross-border investment bank/finance transactions due to bilateral agreements prior to the event:

Currently UK-based firms have the right to provide services in other European Economic Area (EEA) countries. It is unclear if the UK would be able to negotiate an agreement for its financial services firms to do business in the EU.

They then go onto mention these firms as being most exposed:

Looking at total UK cross-border outstandings as a percent of total assets places GS (12%) and MS (10%) at the top of our coverage followed by STT, NTRS, and C (7-8%).

So, it’s not surprising that Goldman Sachs and Morgan Stanley led the large cap decline today. The two declined by 7% and 10% respectively. What’s surprising is that JPM and BAC had less exposure and still performed relatively similarly to Goldman Sachs as it was mentioned in the report that both JPM and BAC have 3% to 5% exposure. As such, investors should be value investors on JPM and BAC as there is value arbitrage in those two names. Wells Fargo still has excessive consumer bank exposure, which puts it at risk of further debt-value readjustment charges down the road, so I wouldn’t use the mitigated decline of WFC as a re-entry signal as business fundamentals don’t line up with today’s price action.

I also want mention the other findings in the report by Barclays:

In addition, UK banks could be barred from the ECB’s TARGET2 interbank payment system for the real-time clearing of cross-border transfers throughout the EU, any reduction in the availability of currency swaps between the ECB and the Bank of England could make it more difficult for central counterparties doing large volumes of euro business to continue to operate in London.

Basically, exclusion from the ECB interbank system reduces transaction efficiency and also reduces liquidity of currency between ECB and BOJ. The large scale transactions coming out of London will be diminished and investment banks will have to re-position their banking businesses closer to other EU-specific cities thus excluding London (potentially) depending on the outcome of political terms of an orderly exit from the EU.

As such, I still like JPM and BAC as strong core franchises paired with cost reductions make them appealing on just the fundamentals alone. For now, Morgan Stanley and Goldman Sachs remain risky and Wells Fargo’s lack of exposure to EU reduces complications, but the future DVA of WFC’s consumer portfolio (still) puts it at risk of fundamental deterioration.

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