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Big US banks get boost from tax cuts, but analysts look for new catalysts

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Big US banks get boost from tax cuts, but analysts look for new catalysts

A federal corporate tax cut passed late last year bolstered the U.S. banking sector's profits in the first quarter of 2018, and the biggest U.S. banks boasted some of the largest benefits.

JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc. showed lower effective tax rates in the first quarter than they did for previous years. It is difficult to pinpoint the exact impact lower tax rates had on the industry. While banks are pushing some of the tax savings to their bottom lines, they are reinvesting other portions and returning some to shareholders. Regardless, analysts say, the savings are notable.

The top corporate tax rate was lowered to 21% from 35%. Previously, the biggest banks had often reported effective tax rates of around 30%. For the first quarter, the average rate for the four megabanks was just under 20%, according to S&P Global Market Intelligence data.

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That amounts to hundreds of millions of dollars in savings. BofA's effective tax rate, for example, declined by nine percentage points following tax reform. It paid $1.48 billion in income taxes in the first quarter, down from $1.98 billion a year earlier.

While analysts say the change gives banks a positive jolt to start this year, Wall Street also has already baked tax reform into profit estimates for future quarters. Analysts have started looking ahead to new earnings drivers for the remainder of 2018.

The hope now is that lower tax burdens will encourage banks' commercial clients to borrow more and use that money to invest in expansions. That would drive loan growth at a time when higher interest rates lift lending profitability. It could also propel the economy broadly, analysts say, and banks' fortunes tend to mirror the economies in which they operate.

As this happens, big banks can use their sprawling footprints and array of products to track national economic growth, analysts say. In turn, as they earn more, banks will generate more internal capital because they will be paying less taxes.

Greater capital generation could mean even more money returned to shareholders in the form of higher dividends or greater stock buybacks, Scott Siefers, a Sandler O'Neill & Partners analyst, said in an interview. He said greater capital could prove an important catalyst for big-bank stocks generally, and it could provide a vital boost for shares of Wells Fargo in particular. Siefers has covered Wells Fargo for several years.

Wells, under heavy regulatory scrutiny amid the fallout of a late 2016 sales fraud debacle that exposed widespread risk management weaknesses within the bank, has struggled to increase lending and revenue over the past several quarters. Among other penalties, federal regulators this year fined Wells $1 billion and ordered it to keep its total asset size under $2 trillion indefinitely.

Wells executives have taken steps to reduce total size — including running off certain commercial deposits from other financial institutions — to create room for loan growth. If Wells can harness the breadth of its national footprint alongside a growing economy, it could finally turn a corner with loan growth, Siefers said.

That could play into the Comprehensive Capital Analysis and Review, or CCAR, a yearly Federal Reserve exercise that tests whether banks have sufficient capital to weather severe downturns. If Wells can get the Fed to allow it to pay higher dividends or buy back more of its stock, it would mark a very important development for the bank, Siefers said. It would benefit shareholders, of course, but it also would represent a positive nod from a key regulator.

"So the capital return story is a big deal for Wells especially," Siefers said.

FIG Partners analyst Christopher Marinac, who covers Wells and oversees his firm's research coverage of the banking sector, agreed. Wells "is in the middle of a gut-wrenching period," he said in an interview. "But they have a great footprint, great depth and breadth of products. If they can just get some distance" from the sales scandal, "they can show that they are a cash flow machine, and investors would take notice."

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