Tax Cut Will Cost BofA, Citi Billions. Here's Why They Still Win.

Bank of America Sign RTR FBN

A cut in the corporate tax rate will involve immediate pain for some big banks, namely Citigroup Inc. and Bank of America Corp., but an eventual earnings boost should more than make up for that.

A corporate tax cut from the current 35% to 15%, which the White House is expected to propose Wednesday, would lower companies' tax bills and fatten their bottom lines. Banks like Citigroup and Bank of America will have to take some sour with the sweet: A lower tax rate would mean they will have to take billions of dollars in charges against earnings to write down the value of their giant piles of "deferred tax assets."

These assets consist of tax credits or deductions that typically spawned from big losses, like those the banks experienced during the financial crisis. They are essentially IOUs the banks can use to defray future tax bills.

If those tax bills are reduced in the future by a rate cut, the deferred tax assets will be worth less. That could lead Citigroup to write down their value by anywhere from $6 billion to $12 billion, based on some figures the bank has provided and analysts' calculations and depending on the ultimate contours of a tax-rate overhaul. Bank of America's hit could be around $4 billion.

Citigroup had $46.7 billion of net deferred tax assets as of the end of 2016, while Bank of America had $19.2 billion.

The hit to earnings will be a one-time event, though. The offset is that the banks "are going to make more money for life," said John McDonald, a bank analyst at Sanford C. Bernstein. "What the market does care about is earnings and their earnings would be permanently improved."

In fact, the gain to the banks' bottom lines from lower tax rates means they could potentially recoup the value of the write-downs in a year or two.

The banks "should be willing to make the trade off," said Michelle Hanlon, an accounting professor at the Massachusetts Institute of Technology's Sloan School of Management.

What's more, deferred tax assets are complex and it will take time to gauge just how much of a write-down banks will have to take.

Much of Citigroup's net deferred tax assets, for example, consist of state or foreign deductions and credits or other assets that wouldn't be affected by a cut in the U.S. federal tax rate. John Gerspach, the bank's chief financial officer, told analysts last November that a drop to a 25% corporate tax rate could translate into a charge of roughly $6 billion.

A reduction in the rate to 15% could raise the write-down to $10 billion, Bernstein analysts estimated.

Changes to the overall system for levying corporate taxes could also have an impact. Currently, the U.S. taxes corporate profits no matter where in the world they are earned. But there is debate about shifting the system to a so-called territorial one, where taxes are only levied on profits generated in the U.S.

Citigroup's Mr. Gerspach has said that a move to such a system, coupled with a reduction in the tax rate to 25%, could lead the bank to take a $12 billion write-down.

The magnitude of a write-down could also depend in part on how quickly a tax-rate reduction is put into effect. "There's a lot of moving pieces," Mr. Gerspach said, adding that to the extent the tax rate is reduced over time, a write-down "would likely be lower."

At Bank of America, only about $7 billion of the firm's net deferred tax assets is in the U.S. and subject to revaluation. That would lead to a write-down of around $4 billion if the tax rate is lowered to 15%, a person familiar with the situation said.

Such write-downs wouldn't only affect profits. They would also cut into a bank's book value, or net worth. Some measures of a bank's regulatory capital could also be affected, though the impact there would be limited because only a slice of the tax assets can be counted toward regulatory capital to begin with.

And any reduction could be made back fairly quickly. Based on Bank of America's 2016 net income and effective tax rate, the firm would likely recoup nearly all of its write-down within a year through higher net income.

At Citigroup, Chief Executive Michael Corbat said on a conference call in January that while corporate tax reform could lead to a tax-asset write-down, it would "result in higher net income and improved returns."

Bernstein estimated Citigroup's 2018 earnings per share could jump by 84 cents with a 15% tax rate, and its return on tangible common equity could rise to 9.9%.

An added bonus: investors for years have questioned the value of the deferred tax assets, which has weighed on the stock's valuation. "They're not getting a lot of credit in the stock price for their DTA," Mr. McDonald said. So, a reduction in the tax rate would lift that uncertainty.

By Michael Rapoport and Telis Demos