January 24, 2018 / 3:42 PM / 8 months ago

Despite US$33bn hit, US banks lick lips on tax reform

LONDON, Jan 24 (IFR) - Just whisper it among European bank executives, but US bank chiefs reckon changes to US taxes are going to make them stronger and able to more aggressively hire from rivals and invest in technology.

The tax changes cost the big five US banks a combined US$32.9bn in their recent fourth-quarter results, but that did little to dampen their enthusiasm for the new rules.

“Despite the fourth-quarter charge, the direct benefits from forward EPS (earnings per share) and ROE (return on equity) accretion, coupled with the potential for several indirect tailwinds, are material, long-term positives for shareholders,” Goldman Sachs finance director Marty Chavez told analysts.

“Potential benefits could take many forms, including heightened M&A activity, increased financing volumes or the most important indirect benefit to our business - economic growth,” he said.

US banks are already riding high and grabbing business from weaker European rivals, especially in US capital markets, and are seeking to drive home their edge. An easing in some US regulations is also helping their cause.

“There’s opportunity for the large global banks to put more intellectual capital to work, there’s a range of changes that have come about at the same time related to taxes, regulation and interest rate moves,” said Wells Fargo Securities analyst Mike Mayo.

Mayo estimated the changes could save US banks about US$30bn in tax payments a year, improve credit quality and increase loan growth, and could spur more activity in capital markets.

The Tax Cuts and Jobs Act, the most far-reaching tax reforms in the US for 30 years lowers US corporate income tax to 21% from 35% and imposes a repatriation tax on earnings from foreign subsidiaries. Citigroup was hit hardest and took a US$22bn charge, while Goldman took a US$4.4bn hit. Those charges were due to one-off costs from the changes, including the remeasurement of US deferred tax assets.

But US bank chiefs said the benefits could see them step up hiring of bankers, invest more in technology platforms and systems, deliver higher returns, pay higher dividends and buy back more shares.

Marianne Lake, finance director at JP Morgan, said it will help the bank push harder on its investment opportunities, and on Tuesday the bank unveiled a US$20bn investment plan for the next five years.

“So that’s bankers. That’s offices. That’s global expansion to the degree that that’s on the cards. It’s digital capabilities ... it’s across all of our businesses,” Lake told analysts.

CAPITAL MARKETS BOON?

Bankers and analysts said it is too early to predict the full impact of the new rules, but said it should spur more capital markets activity by improving American competitive growth and encouraging deal-making and financing ambitions.

“We think companies are going to be interested in more M&A transactions, and ultimately, are going to be investing and raising capital,” said Paul Donofrio, finance director at Bank of America Merrill Lynch.

There’s already evidence of it happening in M&A: there have been 11 deals of US$5bn or more already this year, a record for January. Eight involved a US target or buyer.

“As a bank we see it, in the dialogue we have with CEOs, we’ve seen a step up in the interest,” Tidjane Thiam, CEO of Credit Suisse, said at the World Economic Forum in Davos, where the impact of tax reform was a hot topic.

The impact on fundraising and trading are less clear, however.

Analysts reckon it should prompt more confidence among companies to launch initial public offerings and equity raisings, but said debt raising may not get a lift and leveraged buyouts could be adversely affected by limits on interest expense deductibility on debt.

It follows a decent year for M&A advisory and underwriting debt and equity deals, where the big five US banks brought in US$31.5bn in revenues, up 18% from 2016. M&A advisory income rose 10%, DCM increased 21% and ECM revenue jumped 41%, helping make up for weaker bond and equities trading.

European banks are expected to show the same trends when they report over the next month, although they are estimated to have lost market share again in 2017.

The biggest six European investment banks had just 14.7% of global investment banking fees last year, down from 19.2% in 2014, according to Thomson Reuters data. That has been lost to North American and Asian rivals and boutique firms.

Bankers said Barclays and Credit Suisse could fare best among the European firms, as both have strong US operations. Indeed, Barclays has narrowed the focus of its investment bank on its two “home” markets of Britain and the US.

There are more concerns about Deutsche Bank, which has lagged rivals in restructuring. Questions about its US strategy have intensified and its share of investment banking fees in the Americas fell to 2.7% last year from 3.5% in 2016 and 4.6% in 2014.

Morgan Stanley CEO James Gorman said some European rivals appeared to be prioritising being national champions amid the high cost of competing globally.

“There are a lot of institutions that do very well in their home market. And from time to time, particularly in good trading markets, they have tried to expand that platform globally and generally, those situations sort of get washed out. There’s a retreat back to their home market,” Gorman said.

His peers in Europe say they are not dead and buried yet, however.

“I do not believe in a world where investment banking is just concentrated in five US banks. That does not exist,” Societe Generale CEO Frederic Oudea said this week at Davos.

He said that would over-concentrate risk, and clients don’t want that either. “It is more a world where in each region, three, four, five, six ... big players, and they will effectively interconnect so that companies can have between 10 and 15 core banks,” he told Bloomberg Television.

STRONGER FOR LONGER

Non-US banks will also benefit from the tax reforms - they will get a lower tax rate on their significant US earnings - and from any upturn in capital markets, but the benefits are likely to widen the edge US banks have over rivals.

JP Morgan, for example, could make an extra US$3.5bn annually from a drop in its tax rate to about 20% (compared with 28% in 2016). Morgan Stanley expects its tax rate to fall to 22%-25% from the near 32% it has been operating under and Citi has a similar expectation.

US bank chiefs said some of their gain will be “competed away”, but said it should lift their returns, which are already ahead of the levels at most European rivals, perhaps by 100-200bp, bankers estimated. That in turn will enable them to step up their dividends and share buybacks.

Morgan Stanley raised its medium-term ROE target to 10%-13% from 9%-11%. (Reporting by Steve Slater)

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