A rational response to the Brexit vote. Image source: iStock/Thinkstock.
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Investors in Bank of America and Citigroup can relax. Close your brokerage account, get a beer, and go binge watch something on Netflix.
There's no question that the United Kingdom's economically and politically unconscionable decision to separate from the European Union is bad for bank stocks (not to mention the Western world). Since the ballots were counted on June 23, shares of Bank of America and Citigroup have lost 10% of their respective values.
At the same time, though, this is no Lehman Brothers moment. In the week after the investment bank's failure in September 2008, Bank of America and Citigroup's stock prices dropped by more than twice that amount.
The difference this time around is that the threat to most U.S.-based banks is a threat to their earnings, not their solvency. Their profitability will suffer, in other words, but you needn't worry about their ability to survive, which was a legitimate concern eight years ago.
The problem in 2008 was that the credit markets came to a grinding halt. Even the most stable companies in the United States -- companies like General Electric -- couldn't sell commercial paper to cover payroll and other short-term obligations.
This was particularly problematic for banks, which relied on short-term credit markets to fund meaningful portions of their balance sheets.
At the end of the first quarter of 2008, Bank of America borrowed $191 billion in the commercial paper and other short-term credit markets (excluding Fed funds and repos). That figure today is down to $31 billion -- and, mind you, Bank of America is a third larger now than it was back then.
The same is true for Citigroup, which has seen its short-term borrowings (again, excluding Fed funds and repos) drop by $110 billion since the financial crisis.
On top of this, both of these banks have much more liquidity today than they did in 2008. Bank of America's latest 10-Q shows $525 billion in global excess liquidity, consisting of cash and high-quality, liquid, unencumbered government securities. Citigroup's shows $418 billion.
Even if the credit markets froze, in turn, these banks could still fund their operations without having to sell assets at large losses, which is what leads to bank failures.
It's worth noting as well that both of these banks have much more capital on their balance sheets than they did going into the financial crisis. We got a sense of this from the latest stress tests, the results of which were published over the past two weeks.
The test presupposes something akin to the 2008 financial crisis combined with the 2011 European sovereign debt crisis. The Federal Reserve nevertheless projected that these two banks would emerge from such an event with tens of billions of dollars' worth of excess capital above their regulatory minimums -- an estimated $55 billion for Bank of America, and $58 billion for Citigroup.
This isn't to say these banks won't be impacted, because they will be. But the consequences will be limited to a reduction in their profitability. As I discuss at length here, lower interest rates will keep their interest incomes stagnant, while lower revenues from their capital markets businesses will hit their noninterest incomes.
On top of this, it isn't unreasonable to assume that economic output in the United States will fall, triggering a recession, given the impact of uncertainty on business investment as well as the deleterious effect of an even stronger dollar on U.S. exports and profits earned abroad by American multinational corporations. For banks, this would translate into higher loan losses.
But the fact that both of these bank stocks trade for substantial discounts to their tangible book values -- 22% in Bank of America's case, and 35% in Citigroup's case -- more than makes up for these headwinds. This is why I believe bank investors needn't obsess over Brexit's impact on bank stocks.
The vote in favor of Brexit was ignorant and incited by the false claims of self-interested politicians who have since admitted to misleading their electorates, but it nevertheless isn't another Lehman Brothers.
The article Dear Bank of America and Citigroup Investors: Brexit Ain't No Lehman Brothers originally appeared on Fool.com.
John Maxfield owns shares of Bank of America. The Motley Fool owns shares of and recommends Netflix. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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