BREXIT

Brexit’s First 100 Days Promise Chaos, Fear, Damage Limitation

As the dust settles, the hard bargaining would begin.

June 14, 2016 — 2:01 AM EEST

There’s no road map for European authorities facing the prospect of a British exit from their 28-nation union – by design.

Officials in Brussels are under orders not to commit any scenarios to paper to avoid alarmist leaks, according to a senior official from one European government tasked with making preparations.

Given the potential political and financial shockwaves surrounding a Brexit vote, it’s not clear a map would do much good. Global markets are already sputtering as anxiety mounts about the impact on the world economy. EU President Donald Tusk goes so far as to say that it could spell the end of “western political civilization itself.”

Brexit Watch:

Tusk’s exaggeration highlights the task in self-preservation awaiting European officials as they confront the potential departure of a country from the EU – something that was inconceivable when the union was established. The mechanism for an exit was only written into law in 2009.

The first 24 hours

Before dawn on June 24, if an exit vote becomes clear, the EU’s top brass from Berlin to Brussels will be forced into damage control. In echoes of the Greek debt crisis, euro-area finance ministers may hold an emergency meeting as soon as that evening. Wild swings in the pound, more aggressive interventions by the Swiss National Bank and a ratcheting up of global instability rank as likely market reactions.

Currency markets haven’t priced in the U.K.’s exit from the EU, so if it happens, “a crash is pretty likely,” Lothar Mentel, chief executive officer of Tatton Investment Management in London, said on Bloomberg Television. “We would have to brace ourselves for quite a rough awakening on that Friday.”

The political fallout may be even more fraught. Europe’s traditional counterweights, France and Germany, whose enmity the EU was set up to banish, will seek to gain some of the initiative. They are planning a response as early as June 24 that could include a commitment to deeper euro-area integration as well as a declaration that the EU dream remains alive, according to three people familiar with the plans.

“The European Union will need to have a credible strategy,” said Guntram Wolff, of the Brussels-based policy group Bruegel. “To avoid a gradual disintegration of the EU, political leaders will need to strengthen the attractiveness of the EU and especially the Franco-German alliance.”

The first week

As the weekend begins and the reality dawns in the U.K. that it has voted to leave the world’s largest trading bloc, the rest of Europe will have their own questions to answer.

Amid fears that a “Leave” vote could further fuel populist and anti-establishment sentiment throughout Europe, the EU’s leaders could choose to take the unprecedented step of calling an emergency summit without British representation as early as Saturday, June 25.

The reason would be two-fold: send a message to Spanish voters who go to the polls June 26 that the EU remains strong; and to work out what to offer – or, more likely, what not to offer – the U.K. in areas such as free movement of people and access to the EU’s single market.

There will be divisions to overcome even without the British. In France, where opinion polls say the euroskeptic National Front may make it through to the runoff in next year’s presidential elections, President Francois Hollande will have cause to show the electorate that leaving the bloc carries negative consequences. Other leaders, such as those of the Netherlands and Denmark, where anti-EU feeling is also growing, may consider it more politically beneficial to offer support to Britain, their traditional ally.

Marine Le Pen, leader of the French National Front. A British “Leave” vote could add further fuel to populist and anti-establishment sentiment throughout Europe.

Photographer: Christophe Morin/Bloomberg

Nations outside the euro area, especially those where anti-EU sentiment has been on the rise, such as Hungary, Poland and Sweden, could form a group of countries resisting any French and German attempts to move the EU in a more integrationist direction. With Britain’s exit, non-euro countries would lose their crucial partner – they would represent only 14 percent of the EU’s gross domestic product.

David Cameron is scheduled to meet the other 27 EU leaders at a summit in Brussels the following week. It’s at this gathering that the prime minister is likely to trigger the EU’s Article 50 – the never-before-used law that catapults nations out of the club.

That would set a deadline of two years – until the end of June 2018, during which time the U.K. would have to negotiate its exit. Will Cameron want the U.K. to become like Norway or Iceland and maintain a close working relationship with the bloc as part of the European Economic Area? Or could there be another set-up that means the U.K. would have to trade with the EU under the World Trade Organization framework?

The first 100 days

EU chiefs fear the referendum will spark similar demands across the continent. With elections due in the Netherlands, France and Germany in 2017, there’s reason to discourage others from following the U.K.’s course, and this could weaken Britain’s hand in negotiations. It could also divert the EU’s attention away from other issues, including Greek finances, the refugee crisis and tackling instability in Ukraine, according to Michael Leigh, senior fellow at the German Marshall Fund.

By this time, the political mist in the U.K. may be clearing. The EU could find itself dealing with another prime minister – someone like former London Mayor Boris Johnson, who supported Brexit and whom bookmakers have installed as the favorite to lead the Conservative Party. Whoever it is, the new British leader would probably have to extricate the U.K. from the EU while facing the prospect of a further referendum, on Scottish independence.

Donald Tusk: "I fear that Brexit could be the beginning of the end"

Photographer: Jasper Juinen/Bloomberg

The U.K. would start talks to renegotiate EU agreements in areas as diverse as fishing quotas, financial-services legislation and health and safety standards established over more than 50 years, simultaneously having to start negotiating its own trade deals with the rest of the world. Talks would also have to begin on the relocation of EU bodies headquartered in the U.K., such as the European Banking Authority.

Each step of the way must be agreed upon by the EU’s other members and the European Parliament, a process lasting at least seven years and with no guarantee of success, EU President Tusk told Germany’s Bild newspaper.

“No one can predict the long-term consequences,” Tusk said in the interview. “I fear that Brexit could be the beginning of the end not only of the EU, but of the entire western political civilization.”

U.K.’s Upstart Lenders Face Brexit Shock in First Downturn

Richard Partington RJPartington

June 14, 2016 — 9:13 AM EEST Updated on June 14, 2016 — 12:46 PM EEST

Concerns weigh on smaller banks’ shares in run up to vote
Analysts predict rising bad loans in event of a recession

Investors contemplating how London could look outside the European Union have already identified some potential victims: fast-growing British lenders that might have to face their first economic downturn as public companies.

Brexit Watch: The pound, the polls, and the probability of Brexit, all in one place

Billionaire Richard Branson’s Virgin Money Holdings UK Plc and small lenders like OneSavings Bank Plc have ridden the recovering economy of recent years to help them win market share from the nation’s entrenched players. With the U.K. Treasury and some analysts predicting that a British vote to leave the EU on June 23 could cause the worst drop in house prices since the financial crisis, the banks could see their progress reversed as they’re saddled with bad debts.

“I’m still hoping common sense will prevail and we’ll remain in the European Union,” OneSavings Bank Chief Executive Officer Andy Golding said by telephone. “I’m not necessarily certain if anyone knows what the result will be of an exit. But I am pretty certain it creates a slowdown in economic growth and creates less demand for new property.”

The J.C. Flowers & Co.-backed lender is financially secure enough to withstand a downturn, but would “not grow at the same rate,” Golding said. “If growth slows, we’ll find it harder to keep growing.”

Chancellor of the Exchequer George Osborne is warning a vote to leave the EU may cause a “DIY recession” with rising unemployment and an 18 percent drop in house values. Share prices of five of the so-called challenger banks have dropped an average of 14 percent in June, as polls showed increasing support for a Brexit.

Shawbrook Group Plc fell 4.3 percent to 229.7 pence at 10:32 a.m. in London trading, bringing the company to its lowest value since its April 2015 initial public offering. Virgin Money was 2.8 percent lower, while Aldermore Group Plc and OneSavings Bank lost 4.6 percent and 2.3 percent respectively.

QuickTakeWill Britain Leave the EU?

Home prices have already fallen in central London, according to the Royal Institution for Chartered Surveyors. Even at bigger banks like Royal Bank of Scotland Group Plc, Chairman Howard Davies has noted a slowdown in loan demand he attributed to the referendum.

To be sure, pro-Brexit campaigners say EU rules are stifling the British economy and that local companies will fare better if they’re severed from the continent’s requirements. And not every challenger is certain that they’ll be hurt by a vote to leave.

“I don’t think this Brexit is going to have an impact on us,” Metro Bank Chairman Vernon Hill told analysts on a first-quarter results call. “There’s such gigantic market share to take, I don’t think we’re going to be affected by any macro event like that.”

From Scratch

Started in the ashes of the financial crisis, some of Britain’s challenger banks are built on the remnants of lenders that failed, while others were created from scratch. Their executives are typically former senior bankers with experience at firms such as RBS and Barclays Plc.

Until now, the challengers have enjoyed a robust housing market with Bank of England’s key interest rate at a record low. Lending increased by 32 percent last year for a group of the smaller banks studied by KPMG LLP in a report last month, compared with 4.9 percent fall for the country’s five-largest banks. That has led to higher profitability, with an average return-on-equity of 19 percent for the five smaller firms that traded publicly last year, which could be derailed by an economic downturn.

The challengers have “neither gone through a full credit cycle nor had their books fully seasoned,” analysts at Citigroup Inc. led by Ian Sealey and Andrew Coombs wrote in a note to clients last month. “This is likely to put upward pressure on loan losses.”

While Britain’s largest lenders and global investment banks in the country have said they may relocate staff elsewhere in Europe in the event of a Brexit, the challengers, typically focused on the U.K., lack such diversification. None have more than 40 billion pounds ($58 billion) in total assets, a fraction of Lloyds Banking Group Plc’s 807 billion-pounds.

‘More Mature’

“Big banks are more able to withstand volatility compared to the challenger banks, especially those who do not have diverse products and more mature, substantial balance sheets,” said Richard Iferenta, a partner at KPMG LLP.

Brexit may lead to higher prices for customers on loans and less certain business investment, Virgin Money CEO Jayne-Anne Gadhia told analysts last month. Executives from other challenger banks from Shawbrook to Aldermore have said the potential effects are unclear.

Many of the smaller banks have focused on buy-to-let lending to landlords, a sector under close scrutiny from the Bank of England and U.K. government over fears that the market could be overheating.

“Impairments are at record-low levels, and they will rise,” said Jonathan Goslin, an analyst at Numis Securities in London. “It’s just a matter of when and who’s got the right controls in place. That will be the real test.”

Negative Equity

Asset quality for most challengers is stronger than lenders had in previous cycles. Virgin Money’s average loan-to-value is about 55 percent, indicating house prices would need to fall 45 percent before most borrowers were in negative equity. OneSavings Bank, has the highest average loan-to-value ratio among challengers at 66 percent. That compares with 56.3 percent at Lloyds, Britain’s largest mortgage lender.

“They are very, very differently positioned to banks that failed in the past,” said Ian Gordon, an analyst at Investec in London. “Even if Osborne does crash the economy, the consequences for the challenger banks with their prudent positioning of their portfolios, relative to the likes of Lloyds and RBS going into the 2008 crunch, puts them in a far, far better place.”

Banks have also tightened lending criteria. Gadhia said Virgin Money “pulled back a bit’ from buy-to-let lending while OneSavings Bank’s Golding said his bank started asking landlords to show higher levels of rental cover on borrowing at the end of last year.

“Credit standards are high generally,” Nigel Terrington, CEO of specialist lender Paragon Group said in an interview. “We would rather prioritize credit and pricing, and if that means sacrificing volumes then so be it.”

Volatile Market?

A recession coupled with rising loan impairments could make it harder for U.K. lenders to access wholesale market funding, compounding potential market volatility in the wake of a Brexit vote. Many lenders front-loaded their annual funding requirements to protect against tougher conditions, with Virgin Money selling two tranches of mortgage-backed securities to raise about 1.3 billion pounds of funding.

The challengers predominantly finance their lending from consumer deposits, which are more resilient in a downturn than wholesale market funding. Virgin Money, Aldermore, OneSavings Bank and Shawbrook had an average loan-to-deposit ratio of 102.9 percent at the end of last year, compared with 322 percent for Northern Rock before it collapsed in the financial crisis. Still, their reliance on housing loans could weigh on their profitability.

British “banks are exposed to U.K. property to varying degrees, so yes they would be impacted if there was a downturn in the U.K. property market,” said George Barrow, an assistant fund manager at Polar Capital in London, who helps to oversee about $10.4 billion. “That would be inevitable.”