Banks, Brexit, and DFAST Too

By Chris Marinac | June 24, 2016

We started a summer Friday with surprising news: 52% of Great Britain electorate voted to leave the European Union and engage the “Brexit” scenario feared by the capital markets.

BrexitThis has triggered a flight-to-quality to U.S. Treasuries and lowered interest rates significantly. At a minimum, bank stock investors should anticipate a flatter yield curve, which we see as a negative for most banks’ operating models (i.e., incremental dilution of Net Interest Margins (NIM).*

Along with most equities worldwide, bank stocks are unfortunately not immune to the sell-off. The Brexit news is a negative for short-term pricing. This could create near-term opportunities for patient investors. We continue to feel 2Q-2016 EPS reports should be solid given loan growth, better fees on mortgage (plus routine service charges and SBA-related earnings) plus expense discipline at a majority of financial institutions.

NIM pressure is likely to continue at most banks of all sizes. Certain large banks experienced temporary NIM benefits in 1Q-2016 from the mid-December 2015 Fed rate hike, but this improvement was short-lived. We expect stable to moderate growth in Net Interest Income (NII).

Finally, the DFAST Stress Test results issued after-the-close on Thursday, June 23, were largely positive for the largest U.S. banks. While the adverse scenario creates the doomsday outlook for credit and other losses, capital ratios still hold up well at all institutions. This should trigger positive expectations on increased cash dividends and share repurchase approval for many of the large bank stocks after the June 29th CCAR Stress Test results are released by the joint regulatory agencies (Fed, FDIC, OCC).

*Click here for our June 6, 2016 analysis.

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