How Trump's Tax Plan Could Favor Some Banks Over Others
The Republican sweep in the elections has put corporate tax reform within reach for the first time in decades, but some banks stand to benefit far more than others.
There are a number of reasons tax savings could vary widely among banks, with tax-planning strategies first among them, analysts say. Smaller regional banks — such as the $43 billion-asset Silicon Valley Bank or the $21 billion-asset PacWest — could see the biggest upside to earnings. That is because they currently pay high effective rates, and have fewer strategies in place to lower their total tax bill.
Bigger banks, however, could find themselves in a bind. Many have invested in municipal securities that provide federal tax benefits, or have made heavy use of tax-saving tools such as special credits and bank-owned life insurance. Whether those benefits will remain intact or hold the same value as lawmakers begin tinkering with the tax code is an open question.
"If all of those things are eliminated, what does it do to our banks?" said John Kinsella, vice president of tax policy at the American Bankers Association. "I think the key thing it comes down to is: If those go away … there would be some implications."
The debate could push large regionals, in particular, to look at whether tax-advantaged lines of business will continue to drive profits higher over time.
"There is definitely a law of unintended consequences," said Chris Marinac, an analyst with FIG Partners. He said he will be listening closely to investor presentations in the coming weeks, looking for details on how bank executives are thinking about looming tax changes.
To be sure, it's too soon to tell how tax reform will play out in Washington, though Republicans have signaled it will be a priority in the coming year. President-elect Donald Trump made tax cuts a cornerstone of his campaign; he has proposed to lower the corporate tax rate to 15% from the current 35% and to eliminate many deductions.
In some ways, House Republicans got a head start on the effort this summer, when they introduced a blueprint for overhauling the tax code. The proposal differs slightly from the Trump tax plan, including by calling for a 20% corporate rate. It would also eliminate special credits and deductions.
Projections about legislative details are difficult.
Deductions for business-interest expenses could be on the chopping block. There is also the possibility that progressive lawmakers propose penalties on big banks, such as the tax on Wall Street trading that Democratic presidential candidate Hillary Clinton proposed during her campaign.
Still, investors are riding a wave of optimism, hoping that policymakers will hammer out the details in the coming year and that lower corporate rates will take effect in 2018.
"The market is way ahead of this," Marinac said, noting that investors haven't yet accounted for the slow and uncertain nature of legislative action. "It's a little concerning because people are so excited."
The Keefe, Bruyette & Woods Bank Index this week hit its highest point since before the 2008 financial crisis, led in part by a sharp rise in the shares of regional banks. The index has risen about 15% since the Nov. 8 election.
Analysts say that across-the-board tax cuts could be a significant boon for smaller regional banks. Many have chosen to maximize profits in recent years by simply focusing on asset growth, rather than investing in ways to lower their tax bill. As a result, they currently pay a higher effective rate than their larger peers.
If the corporate tax rate is lowered to 20% in 2018, midsize banks — such as Silicon Valley or the $59 billion-asset Zions Bancorp. — could see their earnings per share jump more than 25% during the calendar year from previous estimates, according to a recent report from Evercore. That assumes all other factors are held equal.
Larger regionals — such as the $433 billion-asset U.S. Bancorp — could also receive a smaller but still significant boost to earnings of 18.6%.
"Corporate tax reform is going to be a significant benefit," said John Pancari, an analyst with Evercore, in a Nov. 21 video message to investors. "Banks that may not have been using their securities portfolio, through municipal bond investments, to lower their tax rate will see some incremental relief to a greater degree."
Investors may of course be overly optimistic. Plans for a splashy tax overhaul could be tempered by a range of other factors, including the impact of lower tax revenue on the deficit.
But even if lawmakers settle on a smaller corporate tax cut, or if a large cut is phased in slowly over time, the banking industry will still come out ahead.
For instance, lowering the corporate rate to 30% in 2018 would increase earnings at small regional banks by about 8% from prior estimates, according to a recent report from FIG. The report included banks such as the $21 billion-asset TCF Financial.
A KBW report issued Wednesday, which presumed a 25% corporate rate in its estimates, said small banks would enjoy the biggest jump in earnings. Yet big banks could feel a pinch from reductions in the value deferred tax assets, the report said.
No matter how you slice it, banks across the industry face major changes in the coming years in the way they manage their tax bills, observers said.
"I think, at a minimum, it will change the financial calculation when determining what a rate of return is to the shareholders," Kinsella said.
Whether the market remains as enthusiastic about tax reform in the coming months, as lawmakers begin the messy process of negotiations, is another mystery.
"The devil is in the details," Marinac said.