By Margot Patrick and Christopher Whittall 

LONDON -- While European bank stocks have plunged after the Brexit vote, bank credit is holding up comparatively well, a sign that investors believe banks can ride out even the steep falls in profits predicted by some.

Since Thursday's U.K. vote to leave the EU, European banks' riskiest type of debt, bonds that convert to equity in extreme financial stress, is trading only around 7% lower. Yields on sterling-denominated bank bonds actually dropped since the vote, mirroring a fall in the yields of U.K. government bonds as investors seek safety. Falling yields mean rising prices.

Stock prices, on the other hand, have fallen sharply. The STOXX Europe 600 banks index is down 19% since Thursday. Barclays PLC, Royal Bank of Scotland Group PLC and Lloyds Banking Group PLC have fallen even more on fears that their earnings will weaken and bad loans will rise in the fallout from a Brexit.

"On the credit side, you have more resilience," said Filippo Alloatti, a senior analyst at Hermes Credit. "Banks are better capitalized than before the crisis and there are better liquidity provisions."

The markets remain highly volatile, as Barclays shares gained 3.4% on Tuesday and Lloyds was up 7.4% amid a broad recovery in global stocks. The pound rose against the dollar and was at $1.3341, up 0.8%, in late European trading.

To be sure, substantial risks remain for Europe's banks. The most severe would be a return of concerns about the eurozone's coherence, since worries that Greece or others might fall out of the currency union had driven enormous stress in bank-funding markets, at times cutting whole countries' banking systems off from funding.

During the eurozone crisis and the financial crisis of 2008, bank credit took a central role in investors' fears. This time, "we don't think [bank credit] will face really dramatic price adjustments like we saw in the post-Lehman crisis," CreditSights senior analyst Simon Adamson told clients on a call Tuesday.

For one thing, global central banks have kept funding and liquidity lines open since the crisis. The European Central Bank has pledged to conduct massive bond-buying if needed to keep government yields from spiraling out of control. On Tuesday, the Bank of England said U.K. lenders bid for GBP6.3 billion ($8.4 billion) of cash in a special auction and took GBP3.1 billion, no more than at other recent auctions.

In anticipation of markets slowing down before the Brexit vote, U.K. banks earlier in the year issued much of the debt they needed to refinance maturing bonds. One big deal still outstanding: a planned GBP2 billion bond from RBS. That deal is an "additional Tier 1" issue, a risky type of debt that can convert to shares and is also known as a CoCo, or contingent convertible bond. An RBS spokesman declined to comment Tuesday.

Investors in bank credit said their main focus will continue to be on banks' solvency and capital, which in most cases are in good shape after years of rebuilding and higher regulatory requirements since the financial crisis. Worries that flared up in February over risks in additional Tier 1 bonds have also died down, bank credit investors said. The bonds can be written off or converted into equity if a bank's capital levels dip too low.

"Banks have more capital, most have enough liquidity and they have central bank facilities in place. It doesn't look like there's a subset of banks having funding problems," said John Raymond, a senior banks analyst at CreditSights.

One reading of the differing signals from stock and bond markets is that funding conditions are good but the economic forecast is not. It's "understandable that the equity market is going to be very cautious about the earnings prospects of U.K. and European banks," Mr. Raymond said.

On Tuesday, analysts at Goldman Sachs added to a chorus of doom around European bank earnings. They estimated EUR10 billion ($11.05 billion) will be wiped from U.K. banks' net profit in the 2016-2018 period, and EUR32 billion across all the European banks they cover.

Stock analysts have slashed their ratings on U.K. and European banks to reflect a darker picture for lenders' profits and dividends.

"Probably some equity analysts got ahead of themselves in the previous month and are looking for excuses to bring down earnings estimates," Mr. Alloatti said.

--Jason Douglas contributed to this article.

Write to Margot Patrick at margot.patrick@wsj.com and Christopher Whittall at christopher.whittall@wsj.com

 

(END) Dow Jones Newswires

June 28, 2016 15:20 ET (19:20 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.
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