Irish Banks Battered as Disorderly Brexit Looms

Some of the stocks worst hit by Brexit uncertainty aren’t in the U.K.: They are Irish banks.

The Republic of Ireland’s two largest lenders are among the worst-performing European banks this year, according to FactSet data. Shares in

AIB Group

PLC and

Bank of Ireland Group

PLC began a sharp decline when Boris Johnson took over as the U.K.’s prime minister at the end of July. His determination to pull out of the European Union by Oct. 31 fueled investors’ concerns that he would engineer the exit even without a trade deal in place.

That has left AIB stock hovering near a record low, while Bank of Ireland has risen slightly in recent days from its weakest level in almost six years.

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The Irish and British economies are closely tied—Ireland is the U.K.’s fifth-largest export market and ninth-largest source of imports—and any economic turmoil that ensues if the U.K. crashes out of the EU without a deal is likely to have a contagion impact on Ireland. Shares in the two banks have been a barometer for investors’ expectations about Irish growth prospects.

Bank of Ireland shares recently hit their weakest level in almost six years.


Photo:

Artur Widak/Zuma Press

“It’s purely the Brexit effect,” said

Simon Adamson,

senior European bank analyst at CreditSights. “It’s more the fear that any economic weakness on the back of Brexit would push itself onto the banks’ balance sheets.”

Shares of AIB, commonly known as Allied Irish Banks, have fallen about 34% this quarter, in their steepest descent since the three months ended June 2016. Bank of Ireland has fallen about 17%.

The uncertainty surrounding Brexit is already weighing on banks’ profitability as businesses take out fewer loans, according to Daragh Quinn, a European bank analyst at Keefe, Bruyette & Woods Inc.

“You’re not seeing a lot of top-line growth because of some of the macroeconomic forces,” Mr. Quinn said.

The souring outlook comes just as the banks showed signs of finally emerging from the 2008 financial crisis, which weighed the lenders down with bad debts as Ireland’s property market crashed, and forced them to take a government bailout.

While both AIB and the Bank of Ireland have reduced their nonperforming loans, they remain under pressure from the European Central Bank to pare their exposure further. Representatives for both banks declined to comment or didn’t respond to requests.

“Obviously, the big unknown is Brexit,” said Mr. Adamson. “It is well seen as potentially stalling or reversing that recovery.”

Historically low borrowing costs—which appear poised to dip even lower—have also dampened investor appetite, said Anastasia Turdyeva, an analyst at

S&P Global
Inc.

As central banks cut rates, it becomes more difficult for lenders to generate money from lending operations.

The market expects the ECB to cut rates by 10 basis points later week, with another 20 basis points’ reduction likely over the following year, according to forecasts from Swiss bank

UBS
.

However, the underperformance of Irish banks looks more tied to political uncertainty than anything else, and investors are waiting to see what happens, Mr. Quinn said.

“A lot will depend on what happens in the U.K.,” he said.

Write to Caitlin Ostroff at caitlin.ostroff@wsj.com

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