Competing with US banks just got harder

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: CHUNT@EUROMONEY.COM

By:
Published on:

Tax changes are likely to boost their performance far beyond US domestic markets.

If the 2017 results announced by the big US banks since the start of the year are anything to go by, 2018 could be shaping up to be a bumper year – certainly in comparison to the most recent quarters. 

Banks often throw in the kitchen sink when times are tough, hoping to bury unpleasantness, like a 20% drop in M&A wallet or plummeting fixed income revenues, under some doubtless necessary but perhaps over-cautious provision, the excess of which can be written back in the future when the dust has settled and when a fillip might really be needed.

This time they didn’t even have to do it themselves.

They were hit by big one-off charges from the US tax reforms announced in December and, sure enough, they didn’t seem too bothered. 

It is easy to see why. Those charges are merely the most immediate piece of a reform that will see them all benefit from substantially lower effective tax rates in the future. 

And contrary to the supposed intentions of the reforms, even some of those one-off charges have rewarded them. 

As JPMorgan helpfully reminded us, deemed repatriation of overseas earnings is just that – deemed. It doesn’t herald actual repatriations that might lessen the banks’ ability to compete around the world; in fact it rewards them by subjecting them to a lesser charge than the one they would face if they did bring the money back home.

Negative outweighed

There was one aspect of the reforms that was negative (quite considerably for some), but even that was easily outweighed by the positives. 

For a firm like Citi, whose heavy crisis-era losses have left it with a huge stock of deferred tax assets (DTAs) that it has been able to use each year to good effect, life gets a little harder – in theory. 

But not really: revaluations of those DTAs might mean it has perhaps $600 million to $700 million less available to deploy each year, but it gets an effective tax benefit of about 900 basis points from a lower effective rate in the future. No wonder CFO John Gerspach calls it “a pretty good trade-off”.

Why such moves have come at a particularly useful time for the US banks is that they – and their international rivals – have seen a shocking period in their fixed income sales and trading businesses. Compared with the post-US election fourth quarter of 2016, 2017 was always going to be a disappointment. But months of record low volatility and lethargic client flows have ground those businesses into the dust. What better time to throw in some one-off tax hits that would make better years look only average?

Firms like Goldman Sachs have been hit so hard in fixed income, currencies and commodities that it has driven them to rethink their business and make it more diverse and more sustainable. 

Others took their pain a few years back and are now seeing the benefit: Morgan Stanley CEO James Gorman is rightly proud of how his shop has fared since cutting back its fixed income franchise a few years ago, only to see it perform better ever since. 

A turning rate cycle and early indications of rising volatility look set to lift all boats in 2018. Trading businesses will surely see a rebound, and here the tax reforms are also likely to stimulate activity among US corporates. 

Pity the European banks then. The US results showed that underwriting and advisory revenues have already been on a tear in 2017, but the prospect of that continuing will come as precious comfort to the Europeans, given that it is the US firms that already lead the way in those businesses. 

As if that were not enough, a further slap in the face comes in the form of the Base Erosion and Anti-Abuse Tax, another tax reform measure and one that will hurt non-US banks operating in the US.

The next 12 months will almost certainly be more rewarding for banks than 2017. But the gains will be far from equally shared. 

“Cracking the US” used to be seen as the yardstick for success in the music industry. That might be less the case in music now, but not in banking. 

The problem for the Europeans is that not only has it got harder for them to compete over there but it has also just got easier for US firms to deploy their firepower over here.