US tax code likely to clip banks’ wings
Banks could be tested against the most extreme change in conditions since the reviews began in 2009
New York — Quirks in the new US tax code are sowing doubts over how much big banks can boost dividends and stock buy-backs in 2018, threatening to take the shine off what are likely to be strong quarterly profits.
Changes in how firms can measure past losses to tax bills and more extreme scenarios in the Federal Reserve’s bank stress tests could make it harder for lenders to secure approval in June to increase payouts.
"The strength of first-quarter results could be overshadowed by disappointing talk about capital returns," Nomura Instinet analyst Steven Chubak said.
Analysts expect JPMorgan Chase, Wells Fargo and Citigroup to report higher first-quarter profit on Friday.
Eight years of US economic growth have been a tailwind for banks, but the Fed has since 2013 made its stress test scenarios more challenging each year. The tests are meant to ensure banks have enough capital in sharp downturns to meet regulatory requirements.
Meanwhile, the new tax law could deliver a one-two punch to capital measured in the stress tests. After first writing down deferred tax assets to account for a lower corporate rate, banks now face being prevented from carrying back losses in stress testing to past profitable quarters to benefit from tax rebates.
First-quarter net income for JPMorgan, Wells Fargo and Citigroup probably increased 34%, 5% and 12%, respectively, according to analysts surveyed by Thomson Reuters.
They see banks boosted by higher interest rates, stronger lending and underwriting and the 14 percentage point cut in the federal corporate tax rate.
Banks are likely to see bigger reductions in projected capital levels in 2018’s exam, a banking industry economist said.
In a March 2 supervisory letter, the Fed cited elimination of carrybacks as one reason the tax law could have "material" negative effects on some banks in the new stress test.
Goldman Sachs said in January that a key measure of capital shrank 0.7 percentage points to 10.7% at December 31 2017 because of one-time tax charges, including marking down deferred tax assets, such as credits against future taxes — known as loss carry forwards.
In stress tests before the tax law change, carry-backs from losses could support capital levels and improve the odds of bigger approved buy-backs. Now, more potential losses would eat into capital. Capital One Financial Corporation in December cited the elimination of carrybacks for the reduction in its buy-back plans.
To be sure, executives could flag offsets to those effects.
Goldman, like other banks with profits kept overseas, picked up deferred tax liabilities for repatriation taxes it booked in the fourth quarter but had not yet paid.
Still, under changes to factors in the Fed’s "severely adverse" financial scenarios, banks could be tested against the most extreme change in conditions since the reviews began in 2009. In 2018’s test the most extreme hypothetical unemployment rate surges almost 6 percentage points to 10%.
The March letter also said changes to several scoring models are likely to reduce capital, with "material effects" in some cases. For example, the Fed will calculate the probability of default on US credit cards differently.