Banks Sidestep a Big Tax-Plan Pitfall

Banks do pretty well under the tax bill unveiled Thursday: it puts them on track for big tax cuts yet lets the firms avoid some of the biggest potential downsides of the overhaul.

At a 20% corporate tax rate, banks stand to be the among the biggest winners from tax reform, according to S&P Global Market Intelligence. The five biggest diversified U.S. banks alone might have had tax savings of $11.5 billion in 2016 at that rate, the biggest sum for any sub-industry group tracked by S&P.

That is because those big banks, such as Wells Fargo & Co., typically pay higher effective tax rates than companies that are much more profitable, such as Apple Inc. Banks in the S&P 500 pay an effective 25% rate, versus an 18% rate for information technology firms, the data provider said.

Aside from the overall corporate tax rate, bank investors were also concerned with how legislators would limit the deductibility of interest costs. On the face of it, that could upend the banking model since financial firms are highly leveraged, deploying huge amounts of debt to themselves, make loans or buy instruments like bonds. Given that, interest expense for banks is akin to nonfinancial companies' cost of goods sold.

The legislation proposed by the House Ways and Means Committee appears to let banks sidestep that issue, though. It does so by limiting the deductibility for companies that spend more money on interest than they take in, said Mark Roe, a professor at Harvard Law School. Banks by and large bring in far more in interest than they pay out.

The upshot is that the change shouldn't affect banks or result in them paying more for debt that ranges from deposits to long-term bonds.

The bill's clampdown on interest expense deductibility also spares some of banks' important borrowers -- commercial real-estate firms. They were excluded from the provision, a relief for banks and the companies themselves since they are already under pressure as their retail tenants get squeezed by online competitors.

Still, the tax plan does strike a few sour notes for banks, especially the biggest. Banks with assets exceeding $50 billion would no longer get a deduction for certain payments to the Federal Deposit Insurance Corporation.

The FDIC collected $10 billion in such payments from banks in 2016 and big banks paid a large share of that. Citigroup Inc., for instance, paid $936 million in deposit insurance fees and charges in the first nine months of this year, according to the bank.

As well, diminished tax incentives around some loan products like mortgages or business loans could also lessen borrowers' demand at a time when broader loan growth is flagging.

A number of banks, notably Citigroup, will also take a short-term hit on what are called "deferred tax assets." These are created by losses, in many cases huge ones racked up during the financial crisis, and act as IOUs that can be used to offset future tax bills. Those will lose value.

Write to Rachel Louise Ensign at rachel.ensign@wsj.com and Telis Demos at telis.demos@wsj.com

(END) Dow Jones Newswires

November 02, 2017 15:59 ET (19:59 GMT)