While bank stocks are getting pummeled on Friday, after the United Kingdom voted yesterday to separate from the European Union, one bank is hanging in there better than the rest: Wells Fargo (NYSE:WFC). Shares of the nation's third biggest bank by assets are down 3.7% halfway through the trading day, compared to a 5.9% decline in the KBW Nasdaq Bank Index, which tracks 24 of the nation's biggest bank stocks.
Generally speaking, the vote in favor of Brexit is nothing to celebrate if you're a bank investor. This is primarily because it's pushing the value of the U.S. dollar up versus other currencies. This will weigh on our exports, reduce foreign sales of U.S.-based multinational conglomerates, and add a further disincentive for American companies to repatriate income earned abroad. It isn't unreasonable, in fact, to think that a recession could materialize. This is particularly true when you consider that domestic jobs growth in May was the lowest in five years, leading the Federal Reserve to shelve its previously stated intention to raise interest rates in June.
This hurts banks in a number of ways. First, loan losses increase in recessions, as companies and individuals find it harder to service their debts. Second, because interest rates are even more likely now to stay lower for longer, banks will earn less interest income from their asset portfolios. And third, investment banks will presumably see a sharp drop in sales and trading revenues, as well as investment banking fees more generally, due to elevated volatility in debt and equity markets.
Even for Wells Fargo, in turn, there will be a negative impact on earnings. A report issued last week by Keefe, Bryette & Woods (KBW) estimates that a Brexit will cause Wells Fargo's earnings per share to decline by 0.5% this year and 2% next year. That's less than its universal banking counterparts -- JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), and Citigroup (NYSE:C)-- which KBW believes would see earnings per share drop by between 5.1% and 6.7% in 2017.
Wells Fargo nevertheless has two things going in its favor. The first is that it operates largely as a commercial bank, as opposed to a universal bank that generates substantial revenue from trading and investment banking activities. It's the latter that will be hit especially hard from the United Kingdom's decision to part ways with the European Union given the anticipated impact on sales and trading revenue.
We got a glimpse of this in the first quarter. JPMorgan Chase's trading revenue dropped 11% on a year-over-year basis, while Bank of America's was down 16%. Brexit was one of the issues, as the scheduled referendum was announced during the quarter. Investors were also spooked at the time by reports that China's economic growth is moderating, as well as by concerns over growing loan losses tied to the energy sector.
The net result is that all three of the nation's major universal banks saw their top lines contract compared to the first quarter of 2015. JPMorgan Chase's dropped by 3%, Bank of America's by 7%, and Citigroup's by 11%. Meanwhile, Wells Fargo's net revenue grew by 4%. The same will be true in the wake of the Brexit vote. That is, even if Wells Fargo's revenue declines, it's reasonable to assume that it will drop by less than that of its competitors, which, in turn, would add to the California-based bank's already sizable competitive advantage.
The second thing that Wells Fargo has in its favor is its industry-leading position in the mortgage market. If Brexit has a silver lining, it's that borrowing costs will decline even further. The yield on the 10-year Treasury is down 10% today and approaching levels not seen since the Fed's successive rounds of quantitative easing pushed the benchmark rate below 1.5% four years ago. This will hurt the value of banks' securities portfolios, as security prices are inversely correlated to interest rates, but it could also ignite a mortgage refinance boom.
The last time long-term interest rates were this low, in 2012, Wells Fargo underwrote $524 billion worth of home loans. Three quarters of these related to applications to refinance an existing mortgage as opposed to purchase a home. The runner-up was JPMorgan Chase with $181 billion, followed by Bank of America at $79 billion. Citigroup's mortgage volume that year was $59 billion. Thus, if any bank is positioned to offset the negative impact from lower interest rates, Wells Fargo is the one.
As a final point, it's worth noting, as Rafferty Capital Markets' Dick Bove pointed out to me this morning, that all of America's biggest banks were certified yesterday by the Federal Reserve as being able to handle a severely adverse economic event without collapsing -- read about Wells Fargo's stress test results here. The assumptions underlying this year's stress test are almost certainly far worse than what we'll face in Brexit's wake. It assumed, for instance, that unemployment would more than double, to 10%, and that stock prices would be cut in half. By contrast, while the S&P 500 is down by a non-negligible 3% right now, that pales in comparison to a 50% decline presupposed in the stress test.
These results should help bank investors appreciate that there's no reason to fear times like these. This is when great buying opportunities present themselves. Just ask Warren Buffett, who purchased 10% of Wells Fargo in the early 1990s, as analysts and commentators were predicting its demise from a commercial-real-estate-induced banking crisis. His stake has since returned more than 3,200%.