Image Source: Berit Watkin
“Washington Mutual customers withdrew $16.7 billion in cash from the thrift in the past nine days, a huge outflow that led to the largest bank failure in U.S. history, the institution’s regulator said Friday.” — MarketWatch, September 26, 2008
By Brian Nelson, CFA
Let’s get this out of the way. We’re not sensationalistic or bombastic. We’re realistic, and we love focusing on the risks of investing because an investor that knows his downside risks is a much better investor than the one that is only looking at sunshine in the rear-view mirror. I’m going to put it bluntly. We’re starting to hear of some rather serious developments in the UK following Brexit.
If the UK pound hitting 30-year lows isn’t enough to get your attention, we’re starting to see the fallout in the hedge fund business as a result of Brexit. Bloomberg reported July 5 that “three of the U.K.’s largest real estate funds have frozen almost 9.1 billion pounds ($12 billion) of assets after…a flurry of redemptions.” Three funds—M&G Investments, Aviva Investors and Standard Life Investments—don’t have enough money to repay investors that want their money back right now. We believe that we’ve reached the point where asset sales will be necessary by not only these funds but also others, resulting in what we now anticipate will be accelerated falling asset prices in the UK.
This is the foundation for the beginning of the cycle downward. Some are even starting to say that “London office-property values may fall by as much as 20 percent within the three years of the country leaving the European Union.” Others are saying that “retail property values across the country could fall by 10 percent to 15 percent.” Why is this important? Remember George Bailey and the famed Building and Loan. Banks don’t keep 100% of deposits, and even conservative banks are sometimes leveraged 5-10 times on an assets-to-equity basis—meaning that a 10%-20% drop in the value of their loan books could obliterate equity holdings, causing forced capital raises and the like.
We’ve been here before. We’ve seen this all before during the Financial Crisis. We know what we’re looking out for—and widespread redemptions that are causing forced selling are just it. It’s still far too early to tell if this will develop into something much larger, but the UK property market is not small potatoes, and the biggest banks in the US are suffering not only from this uncertainty but also a 10-year Treasury yield that has dipped to a record low. You read that correctly – an all-time record, notching 1.367%, according to the Journal. We’re not overreacting but our eyes are wide open, and we’re looking forward. We don’t like what we’re seeing, particularly with the US equity markets still near all-time highs.
Stay tuned. Something tells me that this isn’t the last we’re going to hear about the struggling UK property market, its implications on the UK/European banks, and counterparty risk in America. We hold diversified banking exposure in the Best Ideas Newsletter portfolio (XLF, KBE) for reasons just as these. Opportunities for net interest margin expansion at the domestic banks are becoming more and more limited. Banking investors may be in for some surprises in coming months…and not good ones.
Related firms: BCS, RBS, LYG