(Bloomberg) The six largest U.S. banks could see annual profit jump by an average of 14 percent if President Donald Trump delivers on his promise to cut corporate taxes.
The lenders, which stand to benefit more than other industries because they typically have fewer deductions, could save a combined $12 billion a year, according to data compiled by Bloomberg. Trump has called for cutting the corporate tax rate to 15 percent from 35 percent.
While investors have focused on Trump’s campaign pledge to relax bank regulations, tax cuts could happen faster and their impact could be greater. The effective federal tax rate for the biggest banks averaged 28 percent for the three years ending in 2015, data compiled by Bloomberg show, twice the 14 percent rate paid by all large companies. Bank shares have rallied since the election, with the KBW Bank Index up 29 percent and Goldman Sachs Group Inc. hitting record highs this week.
“Tax reform is difficult, but raising or cutting taxes is easy,” said Fred Cannon, head of research at Keefe, Bruyette & Woods. “A lower tax rate would be a boon for banks, more so than other sectors, because banks don’t get many of the deductions industrial or retail firms get and end up paying a higher effective rate.”
Wells Fargo & Co.’s savings in 2015 would have been $3.8 billion had the tax rate been 15 percent and existing deductions were disallowed. The San Francisco-based bank is poised to reap the biggest benefit because its earnings are overwhelmingly in the U.S. and taxed at the 35 percent rate. The savings could boost Wells Fargo’s earnings by 16 percent. JPMorgan Chase & Co., the nation’s largest lender, would save about $3 billion a year and see net income go up by 14 percent.
Citigroup Inc. would save less because more of its earnings are outside the U.S. Bank of America Corp. currently pays a lower effective tax rate in the U.S. and would benefit less if existing deductions no longer applied. Goldman Sachs and Morgan Stanley would see profit jump at rates similar to Wells Fargo and JPMorgan, even though the dollar amount of their savings is smaller. Spokesmen for all six banks declined to comment.
While bank deregulation faces opposition from Democrats, who can block changes because Republicans lack the 60 Senate votes needed to pass most legislation, tax cuts can be done within the budget process, which requires only a simple majority. Trump said on Feb. 9 that he’ll be releasing a tax overhaul outline within weeks—an effort that’s said to be led by his chief economic adviser, former Goldman Sachs President Gary Cohn.
Taxes have been high on lobbyists’ agendas as well. The Financial Services Roundtable, which brings together chief executive officers of the biggest banks, listed “fixing a broken tax system” on top of its 2017 wish list published last week. Leaders of the Securities Industry and Financial Markets Association talked more about potential tax reform than regulatory changes in its state-of-the-industry meeting in December.
Trump’s campaign pledge to lower corporate taxes goes further than a plan put forward by House Republicans last year that would cut the rate to 20 percent.
Trump said last week that he was working with House Speaker Paul Ryan and Senate Majority Leader Mitch McConnell on potential tax measures. Ryan was an author of what’s known as the House blueprint, which also calls for eliminating companies’ ability to deduct the interest they pay on deposits and other debt. Although the House plan exempts financial firms, KBW’s Cannon says there’s a risk banks will be included if Republicans decide they need to raise revenue to counter other cuts to keep tax revenue neutral.
Eliminating that deduction would hurt banks because their business model relies on borrowing from depositors and markets, and then lending to companies and consumers. The interest banks pay is typically one of their biggest costs, and disallowing that expense would inflate taxable income and threaten their ability to make money by lending.
While the cost of borrowing has been low since 2008, interest expenses can be much higher. Banks incorporate net-interest income—interest earned on assets less interest paid on deposits and other debt—in their revenue calculations. Revenue would balloon if interest expenses were excluded from this calculation.
“Without the interest-expense deduction, many mainstream banks would go out of business,” said Mark Roe, a professor at Harvard Law School. “They’d be paying tax on gross revenue, not profits.”
For that reason, it’s hard to imagine lawmakers eliminating the deduction, said Alan Cole, an economist at the Tax Foundation, a nonprofit organization analyzing tax policy.
It “would be too disruptive,” he said.
In 2006, JPMorgan’s income before taxes was $20 billion. If interest expenses were excluded, it would have almost tripled to $58 billion.
Roe and others have argued that interest-expense deductions from taxes have wrongly encouraged public companies to rely more on debt than equity. While a company can deduct the interest it pays on its debt, it can’t deduct dividends paid to shareholders. In a June paper, Roe suggested eliminating that incentive to borrow by allowing banks to deduct their cost of equity as they do interest expenses.
For some large banks, a rate cut would mean a one-time loss because of a reduction in the value of their deferred-tax assets. Those are benefits that build up because losses are recognized earlier in public company accounting than they can be in tax returns. Citigroup and Bank of America, which had the largest losses in the financial crisis, still have large amounts of such benefits that they can’t fully use in a lower tax-rate environment.
Citigroup has estimated its hit would be about $12 billion. KBW’s estimate for Bank of America’s upfront loss is $4 billion, and about $1 billion each for Goldman Sachs and Morgan Stanley.
While those writedowns could wipe out the potential benefit from a lower tax rate, the elimination of deferred-tax assets would bring reported profits for some banks closer to what analysts and investors already look at, according to KBW’s Cannon. They generally ignore the impact of deferred-tax assets on earnings, adjusting reported figures to understand the true nature of a firm’s profitability. Writedowns on deferred-tax assets would be considered cosmetic, while the benefit from lower tax bills will be seen as concrete and permanent.
- Yalman Onaran