Tax cuts, de novos and gridlock: What bankers can be thankful for this year

ByAndy Peters, Laura Alix, Kristin Broughton, Hilary Burns

November 21, 2018 6:30 AM

There is a surprising amount of pessimism in the air among bankers, including fears of another recession and resurgent House Democratic activism against the industry. But there are also lots of reasons financial institutions should be feeling grateful. Following is a detailed look at a few:

The 'blue wave' didn't swamp the Senate

Rep. Maxine Waters, D-Calif., is slated to take over as House Financial Services Committee chairman next term, a prospect that has some across the banking industry anxious. Waters, who has often been critical of the industry, particularly the country's largest banks, is likely to pursue an oversight-heavy agenda that could include examining ties between the Trump Organization and Deutsche Bank along with the ongoing problems at Wells Fargo. She's also likely to keep a close eye on the actions taken by Trump-appointed regulators at the federal banking agencies, especially the Consumer Financial Protection Bureau, which are expected to pursue additional deregulation.

But many bankers are relieved that Republicans have maintained their control of the Senate, as well as the White House. That means that while there could be a slew of negative headlines for the industry emerging from the House, that's unlikely to translate into broad legislative wins. The divided government is likely to limit any significant efforts by House Democrats to impose tougher standards on the industry, with the banking agencies expected to drive the majority of regulatory changes. That's not so bad for the financial sector, all told, especially after the passage of sweeping regulatory relief this spring.

American Capital Building in Washington DC at Dusk.

W.Scott McGill - stock.adobe.com

Tax reform — the gift that keeps on giving

The banking industry received a gift last Christmas that’s provided enjoyment all throughout 2018 — the federal income tax cut.

The corporate tax rate was cut to 21% from 35% in December. It was a big reason why banks’ profits soared this year. The industry’s total profit in the third quarter rose 29% to $62 billion, compared to a year earlier, according to the Federal Deposit Insurance Corp.’s Quarterly Banking Profile, released Tuesday. That followed another big jump in profits in the second quarter.

A quick look at taxes shows why.

Total income taxes paid by all banks fell 25% to $16.3 billion in the third quarter from a year earlier, according to FDIC call report figures compiled by BankRegData.com.

The average income tax rate for banks dropped 1,056 basis points to 20.85% in the same period.

“Lower taxes and higher interest rates [have] significantly enhanced our return and profitability profile,” BJ Losch, chief financial officer of the $40 billion-asset First Horizon National in Memphis, Tenn., said in an April conference call.

The tax cut wasn’t just helpful to shareholders. Many banks used the federal tax cut to bestow raises and bonuses to employees; Dollar Bank in Pittsburgh, as one example, gave a $2,000 raise to all employees earning salaries below $60,000.

While the tax cut was a nice boost for 2018, many investors may start asking “What have you done for me lately?” in 2019. If lower taxes are the primary driver of profit growth again next year, and commercial loan demand remains soft and deposit costs continue to climb, investors might lose their enthusiasm for the sector.

Then again, 2018 has been a poor year for bank stocks. The KBW Bank Index had dropped 6.2% this year through Nov. 19.

Perhaps bank executives should also be thankful for the sector’s decline in the stock market. Bank stocks in 2019 arguably have nowhere to go but up.

Taxes paid by banks as of third quarter 2018

They have a friendly interest rate environment

Rising interest rates are fattening up net interest income and margins, providing another boost to banks' bottom line.

The average net interest margin rose 15 basis points to 3.45% in the third quarter, according to the FDIC’s latest quarterly banking report. Even banks with flat or declining loan growth in the third quarter still boosted profits at least partly on rising net interest income.

The $71 billion-asset Comerica in Dallas, for example, saw net interest income rise 10% even though loans remained pretty much flat compared with the year-earlier quarter. It was a similar story for the $116.8 billion-asset M&T Bank in Buffalo, N.Y. Rising interest income helped M&T to boost overall net income by 50% despite a slight decline in overall loans.

Rising interest income also helped to offset declining fee income for some banks, as mortgage banking income in particular has sagged across the industry. Fee income and several lending categories declined at SunTrust Banks in Atlanta, for instance, but net interest income helped to boost third-quarter profits all the same.

Until now, many banks have kept deposit costs at bay, too. The FDIC said that on average, asset yields increased by 44 basis points from last year, outpacing a 29-basis-point increase in funding costs.

To be sure, this situation can’t last forever, and as the Federal Reserve continues to raise rates, banks will inevitably have to start paying up for deposits. Some regional banks have already launched digital-first offerings aimed at drawing in consumers with higher rates, but without the added cost associated with more bricks and mortar. But for now, banks are in an enviable position.

Consumers are spending a lot — and managing their debts

For anyone looking for a bright side to the ongoing increases in household debt, consider this: Consumers appear to have a handle on their loan payments.

After paying off debt following the financial crisis, consumers have grown more comfortable with leverage. Household debt — a category that mortgages, student loans, car loans and credit cards — soared to a record $13.5 billion as of Sept. 30, according to a recent report from the Federal Reserve Bank of New York.

But credit quality has remained strong. Sure, delinquencies in areas such as credit cards and auto loans have begun to tick upward, but bankers say they’re not yet worried about the overall state of consumers’ financial health.

“It feels to me that the economy is in a really good space,” JPMorgan Chase’s Gordon Smith, who is co-president, co-chief operating officer and CEO of the consumer and community bank, said at an industry conference this month. “I don’t see any, from a consumer perspective, particular hot spots.”

Smith pointed to the strength of the U.S. job market, noting that the unemployment rate recently hit its lowest level point since 1969. Consumers are simply more likely to stay current on their loans if they have a steady income.

Still, for those consumers who are binging on debt — and for the banks that are lending them money — there will likely be consequences down the road.

Consider the warning signs sent by Discover Financial Services’ recent move to pull back on personal loans. In a recent interview with American Banker, CEO Roger Hochschild described a tendency among consumers to run up credit card balances, even after refinancing debt with lower-cost personal loans.

“It’s very tricky to underwrite, because you get one decision,” Hochschild said of personal loans, a market that several big banks, including HSBC and BBVA Compass, have recently entered.

Responding to the Fed’s latest report on household debt, Moody’s took a notably pessimistic view. While the average delinquency rate on household debt has remained steady over the past year, fluctuating between 4.52% and 4.67%, the credit rating firm said it expects that figure to increase in the months ahead.

“We believe delinquencies are now above their cycle low and that the effects of gradually loosening underwriting standards as well as rising interest rates will begin to weigh on loan performance in the coming quarters,” Moody’s said in a recent note to clients.

All but one of the Trump administration's regulators are now in place

President Trump won the election two years ago, but it's only been in the past few months that most of his regulatory appointments have been in place. That includes Federal Deposit Insurance Corp. Chairman Jelena McWilliams, Fed Vice Chairman of Supervision Randal Quarles and Comptroller of the Currency Joseph Otting.

And though Mick Mulvaney has been running the Consumer Financial Protection Bureau in an acting capacity for the past year, a permanent replacement will be at the helm very soon. Kathy Kraninger, Trump's pick for the CFPB, is expected to be approved by the full Senate when it returns from recess for its final session of the year.

Meanwhile, the final chief regulator of the Obama administration is almost out the door. Mel Watt's term as director of the Federal Housing Finance Agency is due to expire in January. Trump has yet to name a successor, and speculation has ranged from outgoing House Financial Services Committee Chairman Jeb Hensarling to retiring Sen. Bob Corker, R-Tenn., to Mark Calabria, the chief economist for Vice President Mike Pence.

Whatever the choice is, the Trump administration will have final control of all the banking and housing regulators early in the new year.

Whether that's quite the boon that banks expected initially after Trump's win is unclear. So far, the banking industry has been disappointed by regulatory proposals to change the Volcker Rule and create a community bank leverage ratio. Still, with the independent agencies under Republican control, there's little doubt that the regulators have a more pro-deregulatory bent than their predecessors.

Jelena McWilliams, chairman of the Federal Deposit Insurance Corporation (FDIC), listens during a Senate Banking Committee hearing in Washington, D.C., U.S., on Tuesday, Oct. 2, 2018. The hearing focused on implementation of a new law easing Dodd-Frank Act rules on community and midsize banks. Photographer: Andrew Harrer/Bloomberg

Andrew Harrer/Bloomberg

Regulators are opening their arms for de novos

De novo bank efforts around the country have made headway in 2018.

Industry watchers cite an improved economy, industry consolidation, tax reform and a friendlier regulatory environment as factors. The FDIC has approved 10 de novo bank applications for insurance in 2018, up from eight approvals in 2017 and two in 2016.

The agency has received 21 de novo insurance applications this year and five new banks have so far opened their doors, as of Sept. 30.

“From a bank regulatory perspective, the environment for de novo charters is the best it’s been in decades,” David Freeman, who oversees Arnold & Porter's financial services practice, said in an interview earlier this year.

Regulators have approved de novo efforts in Massachusetts, New York, Florida, Oklahoma, Tennessee, Alabama, Nevada and Michigan. There are also several groups in states including North Carolina, Georgia and Arizona that are in the early stages of planning new banks.

Many of the de novo banks currently in the works have carved out niches in business banking, the innovation economy and military veterans. Most of the groups have also recruited experienced CEOs who have started a bank or two before, said Lee Bradley, senior managing director at Community Capital Advisors.

Still, organizing groups and de novo consultants have complained that starting a new bank is a long, meticulous process. The process is particularly challenging for groups trying to disrupt the traditional banking model.

Jelena McWilliams, the new FDIC chief, has indicated that the agency will make changes to speed up the process.

“In order for us to replenish the ranks of the specialty community banks, we need to encourage de novo application,” McWilliams said before the Senate Banking Committee in October.

The FDIC aims to approve de novo bank applications in 120 days, according to the agency’s website.