- Citigroup, Goldman Sachs, and other banks are announcing multibillion-dollar write-downs because of the new tax rules that take effect next week.
- There are two main reasons for the losses: a provision in the plan taxing overseas profits and a revaluation of tax assets that for some banks date back to the financial crisis.
- Despite these announced losses, which are comparatively small, banks are still thrilled about the tax changes.
- “It’s a very, very small price to pay for what they got out of this,” Isaac Boltansky, the director of policy research at Compass Point, told Business Insider.
Like most businesses, banks should be pleased with President Donald Trump’s new $1.5 trillion tax law. It will cut corporate tax rates to 21% from 35%.
Banks are expected to benefit even more than most companies because they tend to pay the full tax rate to begin with and because potential economic and inflationary stimulus from the law could give their lines of business a shot in the arm. They are expected to see earnings grow in the neighborhood of 15% as a result of the law, according to the research firm Compass Point.
So why have the big Wall Street banks been announcing giant losses in December?
Goldman Sachs reported Friday that its fourth-quarter and 2017 earnings would take a $5 billion hit because of the tax law; Citigroup earlier this month said it expected the tax plan to cost it $20 billion.
Other bulge-bracket banks are also expecting billion-dollar losses from the law, though not as large as at Citi and Goldman Sachs.
There are two primary reasons banks are reporting some big losses in the fourth quarter from the tax plan: the repatriation provision and the necessity to revalue some assets on their balance sheet that, in some cases, connect all the way back to the financial crisis.
Overseas profits are getting taxed, whether you bring them home or not
First, repatriation, which is fairly straightforward.
In part to help pay for some of the tax cuts to corporations and individuals and to encourage companies to bring profits back to the US, the new rules levy taxes on earnings that corporations have sitting overseas.
Today, companies pay taxes on overseas profits only when they bring them back to US soil – a process they can delay and drag out.
Under the new law, corporations will pay a 15.5% tax on their overseas cash earnings, whether they bring them back or not.
“That’s why you’re seeing large multinational companies taking into account a new tax on their earnings overseas,” Isaac Boltansky, the director of policy research at Compass Point, told Business Insider.
Goldman Sachs attributed two-thirds of its $5 billion loss to this provision.
A tool to defray tax costs is getting a haircut
Taking the corporate tax rate down to 21% from 35% is a major boon for the banks, which tend to pay closer to the full tax rate than other businesses. But that also means revaluing some assets kept on their balance sheets intended to help defray tax costs.
What we’re referring to are deferred tax assets, an accounting procedure that can get a bit wonky, but for these purposes it functions like this: When a business takes a big loss in a given year, it can use the size of that loss to lower its tax burden in future years. Since it can lower what you pay in taxes and thus increase profits in the future, it’s considered an asset – but you have to estimate it fairly given the current tax code and report that asset on your balance sheet.
This is what’s primarily going on with Citigroup, which took massive losses during the financial crisis that it has since used as deferred tax assets.
But if the overall corporate tax rate drops, the value of those tax assets drops as well.
“A lot of banks put up large losses during the crisis,” said Jesus Bueno, a vice president at Compass Point and the firm’s bank expert. “If you’re going from a 35% tax rate to a 21% tax rate, the value of those losses becomes less over time.”
Banks now have to adjust their valuation of their tax assets, “impairing” a large chunk on their balance sheets to account for the tax rate falling by 14 percentage points.
As Bueno put it, a $35 million tax asset would now need to be written down to $21 million.
The law requires that companies do this during the period when the legislation is enacted, which is the quarter we’re in right now – hence why you’ve got a rash of banks announcing losses after the tax legislation passed this December.
It’s important to keep in mind: None of this was a surprise to banks, and they’re not upset about it, either.
“This was very much expected,” Bueno said. “The benefit from the ongoing corporate tax rate more than offsets the hit to deferred tax assets.”
Boltansky added: “It’s a very, very small price to pay for what they got out of this.”