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This is an important week for Bank of America (BAC 1.53%), with the stress test results as well as the Brexit vote in the United Kingdom scheduled to occur on Thursday. If Bank of America has problems on the stress test, there's little doubt that its stock will fall, as we've seen in the past. But what will happen if a plurality of U.K. voters cast their ballots in favor of leaving the European Union?
To cut to the chase, it's reasonable to think that a vote for Brexit would cause Bank of America's share price to drop, given the expected impact on its bottom line. In the first case, the North Carolina-based bank would likely have to relocate a portion of its operations in the U.K. to the European continent. As a recent note by analysts at KBW explained:
The UK subsidiaries for the U.S. Universal Banks are generally the gateway into the EU due to the passporting privileges that these subsidiaries enjoy. The passport authorizes a bank located in one European Economic Area (EEA) state to conduct business in the other EEA states (the 28 members of the EU, as well as Norway, Iceland, and Liechtenstein). Therefore, all of the banks may eventually need to bolster or even establish operations in the EU should the UK leave the EU.
This would likely consist of boosting operations in Germany or France. But regardless of the destination, it's safe to assume that relocating would lead to higher expenses. In Bank of America's case, nearly 1,400 of its estimated 5,545 U.K.-based employees could be impacted, according to KBW's analysis.
Data source: KBW. Chart by author.
The second reason that Bank of America's profit would suffer from a vote for Brexit is because it would likely cause trading revenues to fall. We saw this in the first quarter, when it was originally announced that the U.K. would hold a referendum. Combined with fears about an economic slowdown in China and higher loan losses from borrowers in the energy industry, Bank of America saw its trading revenue decline by 16% compared to the year-ago period.
Why this happens is counterintuitive. The uncertainty surrounding the U.K.'s departure combined with fears that it might incite other countries to follow suit would presumably boost volatility in the markets. But far from being good for a firm like Bank of America, which earns trading commissions from making markets, excess volatility causes its clients to stay on the sidelines. Bank of America would therefore generate less revenue from executing their orders.
"A vote for Brexit would lead to macro uncertainty and this would likely result in higher volatility (sometimes unhealthy), but also lower capital markets activity as companies stop transacting due to uncertainty in law and markets," reads the KBW report. "We would also expect the British Pound and Euro to depreciate versus the dollar and this would cause FX headwinds for select companies."
The net result is that Bank of America would likely see its earnings per share drop over the next two years, during which it would be transitioning its operations. KBW predicts that they would drop by 3.1% this year and by 6.1% next year. As a consolation, KBW expects the long-term impact from a potential vote for Brexit to be a wash.
