Brexit: Near-Term Negative for US Banks

28 Jun, 2016

“The surprising Brexit results, coming after recent polls indicated that a majority of UK citizens were in favour of remaining in the European Community, will now likely create several headwinds for US banks.

We now see a further decline in long-term US interest rates, a stronger US Dollar, and low probability that the Fed will raise short-term rates in the foreseeable future. This will further pressure net interest margins at banks, and lead to lower oil prices – with negative credit effects on bank’s energy lending.

Banks have increasingly moved towards an asset-neutral position, as few are willing to risk being asset sensitive precisely because of days like today. They cannot justify an asset-sensitive balance sheet to regulators. Also, net interest margins move slowly, over time, and not in lockstep with US long term rates. We expect the next several days to be as turbulent as other major market shocks of the last 15 years: September 11, the Lehman bankruptcy in 2008, the 2011 US debt downgrade from AAA to AA+, and the 2015 China slowdown.

Once the dust settles, investors will have a clearer view as to the longer-term effects of Brexit. We expect the Fed to tread very carefully with interest rates, and to support the markets, possibly with additional QE programs. However, we do not subscribe to the most dire predictions we have heard about Brexit. The Brexit vote merely sets in motion a long and complicated process of extricating the UK from the European Union. We have no idea of how negotiations will proceed, and how much leverage the UK will have.

Separately, the Fed released the quantitative stress test results yesterday, and all 33 participating banks passed. This means they would hypothetically be able to maintain their capital ratios at a level of at least 4.5%, even after a hypothetical economic firestorm of 10% unemployment, negative interest rates, deflation, etc.

This year the largest banks did surprisingly well, following last year’s results, in which they had a tough capital markets test. The regional banks did not fare as well this year, as they had a difficult test with negative interest rates. Next week will be the more interesting CCAR results, where banks will reveal whether or not the Fed approved their capital plans to buy back additional shares and raise their dividends.”

Written by Erik Oja – S&P Global Market Intelligence

(Source: S&P Global)

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