An Overabundance of Optimism
It wasn’t just the heat from a mid-winter sun last month in Phoenix, Arizona, that made the crowd of bank officers and directors resolutely happy during Bank Director’s Acquire or Be Acquired Conference in late January. There was also the fact that almost everything seems to be going right in banking right now.
The election of Donald Trump in November 2016 preceded a run-up in bank stock prices, fed in part by enthusiasm about rising interest rates, tax cuts and a strong economy. The KBW regional bank index was up 32 percent in early February compared to October 2016. The end of 2017 brought a massive tax cut for corporations, including banks. (See cover story in this issue.) Many banks will see their effective tax rate fall from close to 30 percent to 19 or 20 percent. Speakers at the conference, attended by more than 1,100 people, were enthusiastic about the prospect that a cut in the corporate tax rate will spur investments and spending, and the one quintessential fact about banking is that it’s an industry that does well when the economy does well.
And the economy already is doing well. The nation saw jobless claims hit a 45-year low Jan. 13. The unemployment rate in January was 4.1 percent, nearly half the rate it was five years ago.
But it’s important to strike a note in caution in all of this. Banks will get a windfall, no doubt, when their taxes fall, but the tax break is nearly universal, so investors will expect heightened profitability as a result. While the industry return on average assets for small and mid-sized banks was an estimated 1.01 percent in 2017, the 2018 average likely will be closer to 1.21 percent, Tom Michaud, president and CEO at investment bank Keefe, Bruyette & Woods, said at the conference.
Investors will expect dividend increases and share buybacks. Some banks have already announced plans to invest some of the savings in technology. But the threat for all banks is that they will compete away many of the gains of the tax break by offering loans at a lower rate of interest or deposits at higher rates. Competition in commercial real estate and commercial and industrial lending is already tough, so that’s not an unreasonable threat.
Another potential wrinkle is the fact that the tax bill reduces some of the tax benefits of interest financing, including mortgages, and how bank clients react to that could be influenced by complicated decisions about raising equity versus debt. It will be important to keep listening to you customers, ask about their problems and plans, and have a strategy to stay competitive with other banks in your market.
By and large, it’s been a good 12 months for banks. But it’s important not to get too carried away by the sunny weather.