March 6, 2017 / 5:39 PM / 5 months ago

Fitch: Corporate Tax Changes May Aid US Bank Earnings

11 Min Read

(The following statement was released by the rating agency) NEW YORK/CHICAGO, March 06 (Fitch) Potential federal corporate tax cuts may aid US bank earnings over the long run, according to Fitch Ratings. However, they could also result in deferred tax asset (DTA) and liability (DTL) revaluations, causing one-time earnings and capital impacts. While some of the one-time noncash charges from DTA revaluations could be significant, the potential earnings benefit from lower taxes over time could mitigate the one-time capital impact. The timing and nature of any corporate tax changes remains uncertain; whether any tax savings would be retained is unclear. Under pro forma assumptions, ROAs would increase to varying degrees, as illustrated with 25% and 20% effective tax rate scenarios - see table below. The effective tax rate for all US bank holding companies was 30% as of 3Q16. <iframe src="//e.infogr.am/estimated_earnings_under_corporate_tax_scenar ios?src=embed" title="Estimated Earnings Under Corporate Tax Scenarios" width="550" height="499" scrolling="no" frameborder="0"> Any DTA reductions would be reflected as a charge through income tax expense in the revaluation period, which would have a negative effect on earnings and equity. Conversely, downward adjustments to DTLs would decrease income tax expense and have a positive effect. Therefore, banks with net DTL positions may benefit the most from a change in the federal tax rate. DTAs at US banks ballooned in the post-crisis period due to net operating losses, although DTA balances have declined steadily as banks have returned to profitability. For most banks, DTAs represent an immaterial portion of their equity, and the median of DTAs as a percentage of total equity was 2.5% among Fitch-rated banks. <iframe src="//e.infogr.am/dtas_as__of_equity_for_fitch_rated_us_banks?s rc=embed" title="DTAs as % of Equity for Fitch-Rated US Banks" width="550" height="791" scrolling="no" frameborder="0"> DTLs are much less common among US banks, although some Fitch-rated banks do have sizable DTLs relative to total equity. Fitch expects that any DTA revaluation charges will lower bank tangible common equity ratios. However, regulatory capital ratios and Fitch Core Capital (FCC) will experience less impact. DTAs relating to net operating loss carryforwards are already deducted in their entirety from regulatory capital, and DTAs relating to timing differences over 10% of CET1 capital are also deducted. FCC is Fitch's primary capital metric and excludes DTAs from losses carried forward that rely on future profitability to be realized (DTAs relating to timing differences are not deducted from FCC). On the other hand, a DTL revaluation will likely result in improved tangible common equity and regulatory capital ratios for banks with net DTL positions. This is because the reduced DTL will flow through as a benefit to retained earnings. <iframe src="//e.infogr.am/dtls_as__of_equity_for_fitch_rated_us_banks?s rc=embed" title="DTLs as % of Equity for Fitch-Rated US Banks" width="550" height="686" scrolling="no" frameborder="0"> Not all DTAs and DTLs would be affected because changes to the federal corporate tax rate would not affect DTAs and DTLs arising from state, local or foreign government taxes. Fitch believes that any tax reform changes will likely be rating neutral, although specific proposals and responses from the banks to such changes are required to analyze the ultimate impact. Any capital impact from DTA/DTL revaluations is expected to be manageable given its limited effect on FCC. Whether banks will retain the earnings benefit or return it to shareholders to fully assess any rating impact also remains to be seen. Contact: Michael Shepherd Associate Director Financial Institutions +1 212 908-9138 Fitch Ratings 33 Whitehall Street New York, NY Julie Solar Senior Director Financial Institutions +1 312 368-5472 70 West Madison Street Chicago, IL Justin Patrie, CFA Fitch Wire +1 646 582-4964 Media Relations: Hannah James, New York, Tel: + 1 646 582 4947, Email: hannah.james@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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