Lower tax burden
The implementation of the Tax Cuts and Jobs Act has had an overall positive impact on the banking industry. The corporate tax rates have come down to 21% from 35%. A lower tax rate not only improves a company’s net income but also frees up funds to invest in growth opportunities. The banking industry, a highly taxed industry, has therefore gained from the tax reforms.
In the last two quarters, the majority of the US banks have registered high-double-digit growth in their respective earnings. In their quarterly earnings conference calls, all the banks stated that the lower tax rate was the main reason behind the surge.
Morgan Stanley (MS), Citigroup (C), Goldman Sachs (GS), and Bank of America (BAC) reported earnings per share of $2.75, $3.30, $12.93, and $1.25, respectively, for the first half of 2018. On a YoY basis, the respective companies’ earnings depict growth of 47%, 25%, 42%, and 40%. The four stocks together make up ~18% of the Oppenheimer S&P Financials Revenue ETF (RWW).
Additionally, the new tax law allows companies to repatriate cash held overseas by paying a one-time tax of 15.5%, way below the previous rate of 35%. The reduced cash repatriation tax rate is luring companies to bring back their overseas cash and invest in the domestic market, thereby increasing merger and acquisition activity, which has boosted banks’ investment banking income.
Following the 2007–2009 recession, the Federal Reserve and the government imposed stringent rules for banks, which burdened them with a significant rise in compliance costs. A reduction in strict regulations was one of Trump’s core election promises.
In May this year, Donald Trump signed legislation that exempted banks having below $250 billion in assets from the Dodd-Frank Act, which was enacted in 2010. The government is also considering making it easier for banks to raise capital.
The easing regulations will reduce banks’ regulatory compliance costs, thereby boosting their profitability.