European Banks Strategy – Close to pricing in full Brexit

European Banks have dropped c.19% post the Brexit vote – this is the biggest 2-day drop since 1995

The largest 5-day drop, since 1995, is 27%, w/o 6 October, 2008, post multiple rescues of Icelandic and UK banks, after the Lehman default. We highlighted pre the vote (EU Banks – Brexit not in the price, 23 June), that at sector CoE of 9.0%, investors did not price in a Leave scenario. At CoE c.11.0% (vs 10yr ave. 10.5%) and 0.69x TBV, 2017E, sector is priced for c.7.6% ROTE. This is close to our stressed scenario (c.20% EPS downside risk) of c.7.5% sector ROTE, 3 years out. Bank shares fell c.80% in the 2008/9 banking crisis, but the starting point (2.4x TBV), was very different from today’s c.0.7x TBV.
This suggest, the market could already be close to pricing contagion of a full Brexit. Given the sell-off, policy makers are more likely than not to act.

Risks I: Systemic and liquidity risks. We note Bank sub debt has widened materially (34bp), while bank snr spreads are only 7bp wider and concentrated to UK-related names. There are numerous tools for the ECB to help banks with liquidity (the MRO, the TLTRO and the ELA).
CSe that Eurozone banks have c.EUR3.8tn in eligible and available collateral (c.14% of total assets). In addition, the ECB could include resi mortgages in the TLTRO2; CSe this would increase banks’ TLTRO2 eligible loans from c.EUR1.5tn to c.EUR2.1tn (providing banks with incremental four year money) taking any liquidity concerns off the table.

Risk II. Earnings risk. Our stress test of European Banks in a Leave scenario suggested risk of c.200bp drop in ROTE, over 3 years. This implies c.11% de-rating of the sector, taking the TBV to c.0.7x. Our stress test does not include MtM losses, but we would expect poor H2 results, as we argue banks were not positioned for current volatility (equity sell-off, wider spreads, ccy moves and lower primary mkt activity).

We remain selective. Look at EU banks along the lines of (i) weak/strong capital, (ii) weak/strong economy and (iii) EU/non-EU exposure. We favour well capitalised names and/or a business mix geared outside the Euro area. This points us to UK/Asia banks and dollar earners with large international footprints. Nordic names see limited impact Danske (OP, TP DKK209) and SWED (OP, TP SEK195). Eurozone banks less vulnerable in our stress test (7-10% EPS risk) are Benelux. Names sensitive to a Leave outcome are euro earners; Italian banks and SAB (N, TP EUR1.70) all with close to 100% of revenues inside the EU; as well as SAN (N, EUR4.40), 14% of revenues in UK. DB (N) already underperformed peers by c.10%, YTD and look less sensitive to a Leave outcome vs European IBs geared to both UK and IB. Flow Traders (OP, TP EUR45.0), could benefit from volatility.

Equity Research – Credit Suisse