What Tax Reform Means to Banks

In this episode of Industry Focus, host Michael Douglass joins contributor Matt Frankel to talk tax reform. Most of the big U.S. banks took big charges in the fourth quarter because of the new tax law. However, this is a temporary setback that accompanies a permanently lower tax rate. Here's why the banks had to take massive charges and what it means for investors.

A full transcript follows the video.

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This video was recorded on Jan. 22, 2018.

Michael Douglass: The headline thing that I think everyone was talking about was tax reform. One-time hits but long-term benefits to the banks. That one-time hit is because they had to write down some expected tax benefits.

Matt Frankel: Yeah. I actually wrote an article about a week before bank earnings came out that they would pretty much universally look worse than you thought, just because of these big charges they were taking. And some took a lot bigger charges than others. The reason for this is, a lot of banks, on their balance sheet, carry what are called deferred tax assets. In, say, Citigroup's case, this stems from losses that they incurred from the financial crisis fallout. Theirs is something to the tune of $100 billion. So these are pretty valuable things.

The way to think about it is, if you're assuming a 35% corporate tax rate, and all of a sudden the tax rate drops to 21% like it just did, these deferred tax assets lose 14% of their value. So banks had to take a one-time writedown on these assets. You can't continue to carry them on your balance sheet and call them a value that they're not. But these were generally in the $2 [billion]-$4 billion range for the big banks. Citigroup's was a big exception. They took a $22 billion hit that actually worked out to over $8 a share. But Morgan Stanley took $1 billion, [JPMorgan Chase] took $2.4 billion, Bank of America took $2.9 billion.

[Goldman Sachs] actually took a $4.4 billion hit for another reason. Most of theirs came from their repatriation, which also hit a few of the banks. That's when, in the new tax bill, they passed the thing where, all the money that you're holding overseas is deemed to be repatriated at a 15.5% tax rate, and Goldman had a lot of money sitting overseas.

Douglass: Right. You see this also hitting some of big tech giants as well, notably Apple. But first off, of course, when you hear "big tax writedown," that sounds not great. Obviously, wiping $22 billion out of net income isn't exactly awesome. But when you think about it, this is a great problem to have. "Oh, no, our deferred tax assets aren't worth as much because our tax rates have gone down!" Long-term, that's going to be a big benefit for the banks. I think that's the other piece that they really highlighted. All of them were saying, "This is going to make operating more profitable over the long term.

Frankel: Right. Generally, the banks run at effective tax rates of between 29% and 31%. So a 21% corporate tax rate is definitely going to benefit them over the long run. You have to factor in state taxes into that. But most of them are projecting 2018 effective tax rates in the low 20s. This will definitely be a big help over the long run. It would be like me saying, "OK, Michael, you pay me $2,000, but your taxes are $1,000 per year for forever."

Douglass: Right. I would take that deal.

Frankel: Right. And the banks are happy to do it as well.

Matthew Frankel owns shares of Apple and Bank of America. Michael Douglass owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.