British Banks: 2016’s Greatest Bargain (HSBC, LYG, BCS)

British banks - British Banks: 2016’s Greatest Bargain (HSBC, LYG, BCS)

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On the off chance you literally just got back from a mission to Mars a few moments ago, here’s a news flash — the U.K. has voted to leave the European Union. The knee-jerk reaction is the one you’d expect. That is, panic selling of stocks, and a rather dramatic plunge in the value of the British pound.

British Banks: 2016's Greatest Bargain (HSBC, LYG, BCS)

One group of stocks has been hit especially hard, however … British banks. Barclays PLC (BCS) is down 20%. Shares of Lloyds Banking Group PLC (ADR) (LYG) are nearly 25% lower. The country’s biggest and arguably most sound bank, HSBC Holdings plc (ADR) (HSBC), was down 8% as of the most recent look on Friday, still easily outpacing the 3.1% dip the FTSE has logged so far today.

It’s not all that difficult to rationalize why British banks are taking on more than their fair share of water. But, in the midst of all the bank carnage, are investors overlooking what’s actually an incredible buying opportunity?

What Gives?

It’s not a matter that’s readily recognized or relevant to most U.S. consumers, but it’s not entirely unusual in Europe to buy goods or services from a nearby but foreign supplier.

For items like clothing, it’s not an issue. For matters like banking or investment services, however, borders matter … that is, they matter except for EU members, who enjoy a privilege called “passporting,” allowing them to sell financial services to anyone within the EU without bumping into licensing or authorization rules.

With Britain leaving the EU, that privilege could be revoked, making it tougher to do business outside the country.

That’s not to say British banks are dead in the water. Barclays CEO Jes Staley made a point of saying:

“This is a significant decision and there will be many questions asked in the coming days and weeks about what happens next. The answers are complex but our position is not: we will not break our stride in delivering the Barclays of the future. We have stood in service of our customers and clients for over 325 years. We have been here for them through equally profound changes before.”

What he didn’t say is exactly what that meant in terms of reconfiguring the company, though odds are good BCS will do what peer and rival JPMorgan Chase & Co (JPM) has been more forthcoming about. That is, JPM is already looking at ways it can relocate offices in accordance with new rules to not give up business.

Even without the absence of a passporting allowance though, stymied trade activity runs the risk of a diminished need for banking services altogether. It’s entirely possible the nation’s top banks could tighten up lending standards, exacerbating the potential problem rather than resolving it.

In these lights, the big losses being taken by HSBC, LYG, and BCS today make sense.

What Investors Aren’t Seeing

The basic premise of the logic makes sense. That is, between British banks being cut off from the world with an EU exit plus the simple fact that the region’s economy could slow the pace at which capital changes hands, the nation’s banks don’t have a lot to look forward to.

There’s a flaw in the logic, however. That flaw is, while the European Union’s passporting privileges granted to Britain may soon be revoked, that’s not to say they can’t or won’t be replaced by a comparable allowance. After all, London has spent decades becoming the financial center for the continent as a whole. It won’t be easily replaced.

It’s also likely that fears of an induced economic malaise adversely impacting Britain itself are overblown.

The actual impact the Brexit will have on Britain’s — and the continent’s — economy is unknown. The U.K. Treasury as well as the Centre for Economic Performance expect strong headwinds for GDP growth, while Economists for Brexit believe it will actually boost the economy by scrapping EU-sponsored import tariffs.

Though the alarmist views are grim, the bulk of them ignore the fact that ultimately costly migration would be all but quelled.

While the worst-case scenarios paint a dire picture for the British economy and by extension for British banks, the truth — like most truths in the shadow of a heated debate — is somewhere in the middle.

It’s also worth noting that Britain, and the United Kingdom for that matter, were never really firmly committed members of the European Union; the United Kingdom as a whole enjoys an inordinate number of EU rule exemptions. This isn’t going to be as financially disruptive as the “Remain” camp has suggested it will be.

Bottom Line for British Banks

None of this is to suggest British banks like Lloyds, Barclay’s and HSBC Holdings will fly through the storm unscathed, nor is it to say stocks like HSBC, LYG and BCS won’t reach lower lows before making higher highs again.

It is to say, however, that with HSBC, LYG and BCS all priced at or near single-digit forward-looking price-to-earnings ratios, the market has priced in a worst-case scenario that’s well beyond plausible.

It could take a while for these and other British banks to recover, as the world will be slow to believe these names aren’t hanging by a thread.

It will be worth the wait though.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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