Three looming worries for bankers in final tax reform plan

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WASHINGTON — Congress is close to the finish line in passing a major tax overhaul, and bankers are still clear winners from the compromise worked out between House and Senate negotiators. But the bill also still includes some caveats that might give certain institutions pause.

The centerpiece of the final reform bill, which was unveiled Friday and which Congress is expected to pass later this week, is a reduction of the corporate tax rate from 35% to 21%. The lower rate will provide a sudden boost to banks' bottom line.

“All things considered, banks are decidedly and unambiguously one of the clearest beneficiaries of the GOP tax reform package,” Isaac Boltansky, an analyst at Compass Point Research & Trading, wrote in a note to clients.

The final bill, unveiled by the conference committee chaired by Rep. Kevin Brady, R-Texas, also addressed concerns that some lenders had about how earlier drafts dealt with the tax treatment of mortgage servicing rights. But the House and Senate conference report left some lingering concerns about the bill's effects on the housing mortgage industry, deposit insurance premiums and the value of certain assets banks hold that accrue when they incur tax losses.

Here are three potential causes for concern from the tax plan.

Deferred tax assets

While banks will benefit from the lower corporate tax rate, many will also have to write down the value of deferred tax assets, which could mean a temporary hit to their capital reserves.

Coming out of the crisis, the losses banks had suffered highlighted the benefits of deferred tax assets, but the value of those assets naturally goes down when banks' tax obligation does down as well, which is the case with the tax overhaul bill.

“The impact of tax reform on bank deferred tax assets would have a one-time and potentially significant effect in lowering profits for banks with large [deferred tax assets] since the value of their [deferred tax assets] would be much lower as a result of much lower marginal corporate tax rates than is currently in place,” said Clifford Rossi, a professor at the University of Maryland business school who has held senior risk management positions at Citigroup, Washington Mutual, Countrywide, Freddie Mac and Fannie Mae.

However, banks are relying less today on deferred tax assets for a boost to their earnings than they did following the crisis.

“Out of the recession, we saw a lot of banks with significant [deferred tax assets] related to loss carried forwards or credit carried forwards" but "I would say that 90% of the banks out there today have gotten through most of their loss carried forward, so primarily what we are talking about is allowance for loan losses, potentially if they have any kind of deferred compensation plans that also creates deferred tax assets," said Pat Tuley, a partner at Porter Keadle Moore.

But the value of deferred tax assets is still exposed to a reduction in the corporate rate. Citigroup has estimated that as much as $20 billion in deferred tax assets will have to be written down against its common equity as a result of the lower corporate rate in the tax reform bill. Analysts estimate that about $7 billion of Bank of America's deferred tax assets will be affected.

Tuley said that the write-down for many financial institutions including community banks is going to be “fairly significant,” but any losses should be able to be made back up in six months to a year as they reap the benefit of the lower corporate rate.

“There is going to be a timing issue in terms of taking the capital hit in 2017 and then earning it back in 2018,” Tuley said.

The losses will also count against banks’ regulatory capital, but in general the industry has enough capital to absorb the losses.

Basel III also limited how deferred tax assets were counted towards regulatory capital, so while banks may take a hit on their balance sheet, the blow to their regulatory capital won’t be as significant.

Deposit insurance deduction

Some industry watchers were concerned that tax legislation authors might try to create some sort of bank tax or financial transaction tax in order to pay for tax cuts. Even though the final plan lacked such a measure, it did ultimately remove larger banks' tax deduction for Federal Deposit Insurance Corp. premiums.

The deal Congress unveiled on Friday would get rid of that deduction for banks with more than $50 billion in assets, and limits the deduction for banks with assets of $10 billion to $50 billion. Banks with assets of less than $10 billion will still be able to write off their deposit insurance premiums.

The provision on FDIC premiums in the tax reform plan is estimated to save the government $14.8 billion, according to the Joint Committee on Taxation.

“We are not happy about that provision. There is really no good reason why a normal business expense like deposit insurance wouldn’t be deductible, so it is kind of a money grab and we are very disappointed that was included in the tax package,” said Paul Merski, executive vice president of congressional relations and strategy for the Independent Community Bankers of America.

A blow to the housing industry?

The original House tax plan would have limited the mortgage interest deduction to loans of no more than $500,000. The Senate plan capped the deduction at $1 million, and the two chambers ended up compromising at $750,000.

Housing groups have opposed the cap from the very beginning, saying it waters down an incentive for homeownership. The effect of the cap is exacerbated, they say, by the doubling of the individual standard deduction from $12,000 and $24,000, which means taxpayers are less likely to want to take itemized deductions such as that for mortgage interest.

However, the housing industry appeared to still welcome the compromise plan, which was less extreme than the original House version.

“We remain concerned that the overall structure of this bill poses problems for homeowners and the broader housing market, but the conference committee has made some important improvements to the House and Senate legislation that ultimately will benefit some homeowners and communities,” said Elizabeth Mendenhall, president of the National Association of Realtors.

Rossi said that, by and large, the $750,000 threshold should mean the majority of homeowners will be able to benefit from the mortgage interest deduction.

“With the average home loan in the U.S. well under the new cap, I would expect the change to have a relatively small effect on the overall housing market going forward,” Rossi said.

But housing finance faces another headwind: The package that was agreed to by the House and Senate also eliminates the deductibility of home equity lines of credit.

“This will inevitably cool the demand for these loan products and decrease overall loan demand from banks,” Tuley said.

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Tax reform Policymaking Community banking Deposit insurance Mortgage interest deduction Tax deferments