While U.S. banks plan to share some of the windfall created by tax reform with their employees and customers, the industry stands to retain more than 75% of the savings.
S&P Global Market Intelligence projects that a lower U.S. corporate tax rate will push the banking industry's earnings nearly 13% higher in 2018 than results would have been under the previous statutory tax rate. Community bank earnings, meanwhile, will receive a 5% boost in 2018 due to the lower tax rate. The community bank group, which includes institutions with less than $10 billion in assets, operated with a lower aggregate tax rate even before tax reform due to the inclusion of many S-corporations that pass income to their shareholders.

Banks, large and small, have already announced plans to pass some of the savings from tax reform on to their employees through higher wages and bonuses. There are also hopes that tax reform will stoke economic growth and lead to stronger loan demand. While the certainty brought by the legislation should support stronger loan growth in 2018, banks seem just as likely to bring more customers to the table by using portions of their cash windfall to offer more favorable rates.
Banks passing on some tax reform savings
A number of banks, including industry giants like Bank of America Corp., Wells Fargo & Co., U.S. Bancorp, Capital One Financial Corp. and PNC Financial Services Group Inc., have announced plans to use some of the expected windfall to increase the hourly minimum wage they pay to $15. Some of those institutions and others are paying one-time bonuses to certain employees and have unveiled plans to make sizable charitable donations.
S&P Global Market Intelligence estimates that the total cost of such plans will amount to just 1.75% of the banking industry's noninterest expenses in 2018. We believe expenses could remain elevated in the years after that, when compared to our prior outlook published in December 2017, as banks reinvest in their franchises.
Even with the increased expenses, we project that the banking industry's earnings will rise by 16.0% in 2018, compared to a 19.3% increase before accounting for the investments. Community bank earnings, meanwhile, stand to increase by 2.3% this year, compared to the 6.0% growth estimated before considering higher expenses.
While planned wage hikes and bonuses could help employee morale, some banks might use the savings to make a splash with their customers. Customers Bancorp Inc., for instance, announced plans to market a checking account at an above-market 2% rate.
Customers Chairman and CEO Jay Sidhu encouraged consumers to ask why other banks have not increased checking and savings rates even as the Federal Reserve has raised short-term rates over the last few years.
"Perhaps high taxation, above-average regulatory burden or simply greed by many banks have kept deposit rates this low; but this cannot continue if America is to reap the full benefits of the improving economy," Sidhu said in a release announcing the product.
The marketing effort is clever, but it should be noted that Customers' funding needs might be different than those of its peers since it boasts a loan-to-deposit ratio that stands nearly eight percentage points higher than the 85.29% ratio reported by the community bank group at Sept. 30, 2017. The institution also has a higher concentration of CDs in its deposit base.
Tax reform to have modest impact on loan growth
Other banks could follow Customers' lead, but many more hope tax reform will spur loan growth. We have incorporated some of the potential benefits in our loan growth assumptions, largely due to greater certainty brought by the legislation and building optimism in the business community.
Tax reform will have different impacts on specific lending segments. Tax reform will serve as a negative for mortgage lending, particularly in higher-income states where borrowers will no longer be able to deduct the full amount of their property taxes. The tax plan is also expected to increase the federal deficit and has led to higher long-term interest rates. Since mortgage rates are based on longer-term rates, the cost of mortgage credit has increased modestly in recent weeks.
The tax plan limits interest deduction at businesses, which could serve as a negative to commercial real estate and commercial loan growth. However, tax reform could also increase risk appetite as many corporates will find themselves newly flush with cash.
Banks will find themselves even more flush with capital, and the push to lever their already healthy capital bases could lead to pressure on loan yields as institutions could become more willing to attract borrowers at lower rates.
If loan growth fails to rise to desired levels, bankers might look to acquisitions to bolster growth and put excess capital to work. The market's strong response to the tax plan over the last two months has left many buyers in a stronger position as well, with bank stocks now trading at higher multiples. The expansion has increased the buyers' currencies since they now can issue fewer shares and offer targets the same takeout value.
Still, if bank stock currencies are stronger across the group, sellers likely will think they are worth more, particularly since their earnings stream will be higher. The increase in earnings at potential targets could serve as a headwind to M&A activity since it might leave some would-be sellers satisfied with their returns.
Aspects of tax reform could push bank M&A activity and loan demand in both directions. Overall, the policy should leave bank balance sheets in a stronger position and give institutions the opportunity to invest in talent, new products and strategies in the coming years.
