Its official, the UK is heading for a so-called hard Brexit, which is a headache for investors. If theres one thing the market doesnt like its uncertainty. Unfortunately, over the next two year or so as the divorce is finalised, theres going to beplenty of uncertaintyhanging over the UKs economy.
Some of Londons banks have already said theyre preparing to transferjobs out of the UK as Brexit takes place and there will most likelybe a period of re-adjustment for all of them as they adapt to new trade deals. So, how will a hard Brexit impact the UKs largest lender Lloyds Banking Group (LSE: LLOY)?
Since the financial crisis, Lloyds has been slimming down. After nearly a decade of selling non-core operations, the group has almost no overseas presence. This means its less concerned than its City peers about what sort of trade deal emerges with the rest of Europe after Brexit.
As the UKs largest mortgage lender and one of the largest personal/business retail banks, Lloyds is almost entirelyinsulated from events overseas. That being said, the banks fortunes are closely linked to the health of the UK economy, perhaps more so than most of its peers due to its lack of overseas diversification.
But even if Brexit destabilises the UK economy, Lloyds is well positioned to weather the storm. It has spent the last five years building its capital buffers and now has one of the most impressive tier 1capital ratios in the eurozone. At the end of the third quarter, it reported a tier 1capital ratio of 13.4%.
Soon after, stress tests from the ECB and BoE confirmed that Lloyds capital buffers are now sufficient to weather any storm. Indeed, the ECB revealed Lloyds tier 1capital ratio fell to 10.1% under an EU-wide stress test of 51 banks. While under the BoEs test, Lloyds performed better than Barclays, RBS and Standard Chartered.
Set to plunge?
Ultimately, how shares in Lloyds react during the Brexit negotiationsdependson the health of the UK economy. If economic growth remains robust, Lloyds profits will continue to expand and investors will be happy to buy the shares. However, if slowing economic growth weighs on results, then shares in Lloyds could lurch lower.
Still, at the time of writing shares in Lloyds trade at a relatively low forward earningsmultiple of 9.1, which implies investors arent expecting much from it in the near term. Analysts have pencilled-in a decline in earnings per share of 17% for 2016, 4% for 2017 and 7% for 2018.
If Lloyds manages to beat these downbeat forecasts, then the shares could rally as investors re-rate the stock. But if the bank misses City expectations, there could be trouble.
The bottom line
All in all, shares in Lloyds may fall during the Brexit negotiations if the UKs economic growth starts to falter, although thanks to a robust capital position, the banks long-term financialstability shouldnt be jeopardised and its 4.4% dividend yield looks safe.
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