Banking on Lower Tax Rates
January 18 2018 - 3:21PM
Dow Jones News
By Michael Rapoport
Now that big banks have finished reporting fourth-quarter
earnings filled with noise from the new tax law, how much do they
expect to actually pay in taxes going forward? A lot less than in
the past.
That is just what markets were hoping to hear. In response,
investors have kept already buoyant big-bank stocks inching
upward.
While some firms will pay higher rates than others, a number of
big banks indicated they expect their effective tax rates would
decline significantly to around 19% or 20% in 2018, as the
corporate tax rate gets reduced. JPMorgan Chase & Co. and Wells
Fargo & Co. both said their tax rates would be around that
level.
That is significant because financial companies have tended to
pay taxes at higher rates than big companies in other industries,
since so much of their business is centered in the U.S. What is
more, some of the big banks, such as Goldman Sachs Group Inc., Bank
of America Corp. and Morgan Stanley, explicitly said they expect
lighter tax bills to boost their earnings performance.
That is keeping investors optimistic despite some big,
short-term hits in fourth-quarter earnings that were related to the
tax law.
Banks took charges as high as $22 billion, at Citigroup Inc, to
reduce the value of their deferred tax assets and account for a
one-time tax on foreign earnings. Bank of America Corp.'s charge
was $2.9 billion; Goldman $4.4 billion. On the other side, Wells
Fargo had a gain of $3.35 billion, largely because the tax-rate
reduction made its deferred tax liabilities -- taxes it owed --
less onerous.
Investors looked through this noise, though, because it will
give way to greater earnings power down the road as the
corporate-tax rate falls to 21% from 35%. Indeed, the possibility
and then reality of lower tax rates has been a big driver in this
latest leg of the bank stock rally.
Financial shares surged in the wake of President Donald Trump's
election. They foundered in mid-2017, as the new administration's
legislative agenda stumbled. But in September, prospects for a
tax-code overhaul brightened, and that marked a renewed upward turn
for bank stocks.
Now that investors have a sense of how much banks' tax bills may
fall, they are more confident about their earnings power going
forward.
Bank of America, for example, said it expects its tax rate to be
about 20% absent unusual items, compared with an expectation before
the tax law was passed of about 29% for 2018. Its effective rate in
2016 was nearly 29%. (Banks said 2017 rates are skewed by one-time
gains and losses related to the tax law.)
Assuming all of the benefits go to the bottom line, that would
mean a boost of more than 1.5 percentage points to Bank of
America's return on tangible common equity and more than 0.1
percentage point on its return on average assets, Chief Executive
Brian Moynihan said on the bank's earnings call.
Morgan Stanley said it expects an effective tax rate of 22% to
25% in 2018, though it will have quarter-to-quarter volatility,
compared with a nearly 31% rate in 2016. With more than two-thirds
of the firm's pretax income coming from the U.S. "we expect to see
a meaningful reduction in our effective corporate tax rate," said
CEO James Gorman on the firm's earnings call Thursday.
Goldman, meanwhile, expects the lower tax rate to have "a direct
effect" in driving earnings growth and return on equity, Chief
Financial Officer Martin Chavez said on the bank's conference call
Tuesday. Goldman expects its effective tax rate to decline to about
24% as a result of the new tax law, compared with a 2016 rate of
28.2%.
The prospect of higher returns on equity also has helped keep
bank valuations inching higher. Price-to-book value multiples for
all the big banks, save Goldman, have risen over the past year.
Bank of America and Citigroup were the primary gainers, rising 45%
and 40% respectively.
Citi has gotten a double boost in this regard. Even though it
expects to have a higher rate than other big banks, its bottom line
should still increase. And the bank slashed its deferred tax assets
by $19 billion. That lowers its book value, helping to boost its
multiple.
But that isn't just a numbers game. Many investors were giving
Citigroup scant credit for the value of its deferred tax assets and
adjusting their own view of its multiple accordingly. Now, its
multiple is more reflective of the bank's balance sheet -- and this
week Citigroup's market valuation climbed above its book value for
the first time since September 2008.
--Christina Rexrode contributed to this article.
Write to Michael Rapoport at Michael.Rapoport@wsj.com
(END) Dow Jones Newswires
January 18, 2018 15:06 ET (20:06 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
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