Bti 2015-e 11-5-general-banking-update

Presented by:

Bank Tax InstituteGeneral Banking Update

November 5, 2015

Presented by:

TAX RISK AND BASEL III

Presented by:

• DTAs impose a heavy cost on banks beginning this year and increasingly so through 2017, with a large cost increase scheduled for 1/1/18

• DTAs have largely been financed by low cost short‐term funding sources; but with Basel III rules, the capital costs make yesterday’s “mere timing differences” very pricey assets with a zero yield

• Banks with DTAs from “bad” sources (NOLs and credits) should seek to lower the cost of those DTAs through conversion mechanisms

• Banks with taxable income should seek to grow DTLs• All of this demands a re‐thinking of the tax “risk curve” – the cost of not

converting NOLs into temps or not harvesting DTLs while income is bountiful could outweigh the tax‐related risks

• Thesis: No bank should resign itself to the status quo of risk‐aversion in the new Basel III environment

Thesis

Presented by: Presentation title

Carryforward DTAs

Temp Diff DTAs

DTLs

Book

Equ

ity

CET1

Reg Adj’s(GW, Int, MSRs)

Add’l Tier 1

Allocation

Subtracted in full from CET1

Limited to 10% of CET1

Basel III Limits on DTAs

Presented by:

Types of Cost Capital Charges M&A Costs

► Funding costs to cover the cash outflow.

► Capital costs to cover the risk‐weight differential

► Capital costs can include: risk weighting, subtraction from CET1 and subtraction from AT1

► Opportunity cost: DTAs are a zero yielding asset!

► NOL and tax credit carryovers incur a full charge = marginal cost of issuing common equity

► Temp DTAs might incur a similar charge above the 10% threshold

► However, any temp DTA makes a bank more likely to someday exceed the 10% limit and in that sense can attract a cost, particularly in stress tests

► Allowable DTAs bear a potential 21% capital charge (250% risk weighting)

► Prior to 2018, some of these deductions are made from Add’lTier 1

► Capital charges increase “cost” of acquiring a target with net DTAs

► DTAs make a seller less attractive

► Section 382 (limits on use of NOL carryovers) also can impose an indirect, long‐term capital cost that exceeds the value of the DTA

► DTLs interact with other intangibles established in purchase accounting and create a complex formula for measuring the cost of acquired DTAs

Presentation title

Cost of Carrying a DTA

Presented by:

0% ~20%

Temp DTAs supported by PY tax; 100% RWA x 7% CET1 target x

~20% marginal cost of CET1 + 14 bps = 1.54%

NOL DTAs fully subtracted in full from CET1

in 2018

Other scenarios

• Temp DTAs with 250% RWA x 7% = 17.5% capital requirement

• NOL DTAs offset by DTLs bear a decreasing cost

• Transition rules between now and 2018 impact preferred capital (Add’l Tier 1), and thus the charges are less severe

• Bank w/ leverage constraint ‐ costs are higher, e.g., 9% x RWA factor

Annual Cost of Carrying a DTA


Facts New Facts• Bank has $110 of assets, including $10 of

NOL DTA• Bank has $91 of deposits and $19 of

common equity GAAP capital• Bank must maintain a minimum 9%

leverage ratio under its existing capital plan

• Bank has $110 of assets, including $10 of Temp DTA

• Bank has $91 of deposits and $19 of common equity GAAP capital

• Bank still must maintain a minimum 9% leverage ratio under its existing capital plan

Result New ResultGAAP Equity 19.00$ Less: NOL DTAs (10.00)$ CET1 9.00$

GAAP Assets 110.00$ Less: NOL DTAs (10.00)$ Reg. Assets 100.00$

Leverage Ratio 9.00%

GAAP Equity 19.00$ Less: Temp DTAs (8.10)$ CET1 10.90$

GAAP Assets 110.00$ Less: Temp DTAs (8.10)$ Reg. Assets 101.90$


Example, Part 1: NOLs‐to‐Temps

Presented by:

Before After

Presentation title

BALANCE SHEETAssets 110.00$ Deposits (91.00)$ Equity (19.00)$

LEVERAGE RATIOGAAP Equity 19.00$ Less: Temp DTAs (8.10)$ CET1 10.90$



BALANCE SHEETAssets 129.20$ Deposits (110.20)$ Equity (19.00)$

LEVERAGE RATIOGAAP Equity 19.00$ Less: Temp DTAs (8.10)$ CET1 10.90$



Example, Part 2: Effects of Freed Up Capital

Presented by:

Before After

Presentation title

EARNINGSEarning assets 100.00$ Times: WAC% 4.00%Interest income 4.00$

Deposits (91.00)$ Times: WAC% 0.30%Interest expense (0.27)$

NIM 3.73$ Efficiency 50.00%After‐tax rate 65.00%Net Income 1.21$

STOCK VALUATIONNet income 1.21$ P/E ratio 16.00Stock value 19.38$

EARNINGSEarning assets 119.20$ Times: WAC% 4.00%Interest income 4.77$

Deposits (110.20)$ Times: WAC% 0.30%Interest expense (0.33)$

NIM 4.44$ Efficiency 50.00%After‐tax rate 65.00%Net Income 1.44$

STOCK VALUATIONNet income 1.44$ P/E ratio 16.00Stock value 23.07$

Example, Part 3: Earnings and Stock Price

Presented by:

GRAPHS AND PICTURES


$(20,000)

$(10,000)

$‐

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

JPM WFC BAC C USB PNC

GAAP Net DTA

Attribute DTAs Disallowed

Temp DTAs D'allowed by 10% Rule

DTAs Allowed

June 30, 2015 Big Bank DTAs ($mils)


The Big 6 banks are: JPM,WFC,BAC,C,USB,PNC; GECC,MS,GS,BNYM were left out of this analysis because those companies are not traditional banking institutions but are included in the top 10 BHCs.

$(20,000)

$‐

$20,000

$40,000

$60,000

$80,000

$100,000

2015 2010

Big 6 Banks Net GAAP DTAs

Disallowed DTA

Allowed DTA

Net DTL Banks

Top 6 BHC DTAs: 2015 vs. 2010


DTAs as a Percent of Tier 1: June 30, 2010


DTAs as a Percent of Tier 1: June 30, 2015


$‐

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000


6/30/2015

6/30/2010

Market Cap of the Big 6: 6/30/10 to 6/30/15


$‐

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000


Market Cap

CET1

Market Cap to CET1 at 6/30/15


JPM, $257 WFC, $‐

BAC, $26,950

C, $48,470

USB, $‐ PNC, $‐

Share of Net GAAP DTAs at 6/30/15


JPM, $250,581

WFC, $288,700 BAC,

$178,175

C, $166,264

USB, $76,428

PNC, $49,126

Share of Market Cap at 6/30/15


$(40)

$(20)

$‐

$20

$40

$60

$80

$100

$120

$140

$160

CATY IBOC TRMK ONB

GAAP Net DTA

Attribute DTAs Disallowed

Temp DTAs D'allowed by 10% Rule

DTAs Allowed

BHCs #98 ‐ #102: DTAs at 6/30/15


$(100)

$(50)

$‐

$50

$100

$150

$200

$250

$300

$350

2015 2010

BHC #98‐102 DTAs

Disallowed DTA

Allowed DTA

Net DTL Banks

BHCs #98 ‐ #102: DTAs 6/30/15 vs. 6/30/10


BHCs #98 ‐ #102: DTAs/Tier 1 6/30/10


BHCs #98 ‐ #102: DTAs/Tier 1 6/30/15


$‐

$500

$1,000

$1,500

$2,000

$2,500

$3,000

CATY IBOC TRMK ONB

6/30/2015

6/30/2010

BHCs #98 ‐ #102: Market Cap


$‐

$500

$1,000

$1,500

$2,000

$2,500

$3,000

CATY IBOC TRMK ONB

Market Cap

CET1

BHCs #98 ‐ #102: Market Cap‐to‐CET1


Stock Price Performance


$(5.00)

$‐

$5.00

$10.00

$15.00

$20.00

JPM WFC BAC C USB PNC CATY IBOC TRMK ONB

DTAs/Share6/30/10

DTAs/Share6/30/15

DTAs Per Share


‐50.00%

0.00%

50.00%

100.00%

150.00%

200.00%

250.00%

JPM WFC BAC C USB PNC CATY IBOC TRMK ONB

5‐Yr Change in SharePrice

5‐Yr Change in DTAsper Share

Stock Price v. DTAs Per Share


BHCPRs for 6/30/15>10BB 3‐10BB 1‐3BB

Tax rate 29.67 29.66 23.05Leverage ratio 9.86 10.24 10.12NIM 2.83 3.24 3.32Effeciency ratio 65.81 64.98 70.18

BHCPRs for 12/31/12>10BB 3‐10BB 1‐3BB

Tax rate 27.20 24.02 21.27Leverage ratio 9.38 10.17 9.73NIM 2.90 3.26 3.38Effeciency ratio 69.11 66.61 71.61

Category

Category

BHC Peer Reports

Presented by:

ACCOUNTING FOR INCOME TAX: TRENDING ISSUES

Presented by:

• Eliminate exception that requires deferral of the income tax effects of intercompany sales/transfers of assets – Recognize income tax expense in the period of the sale/transfer– Recognize deferred tax effects of difference between the tax basis in the buyer’s

jurisdiction and the book basis after elimination of the intercompany profit– Modified retrospective transition approach– For public business entities, FASB expects proposed amendments effective for annual

periods, and interim periods within those annual periods, beginning after 15 December 2016

– For nonpublic business entities, FASB expects proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018• Early adoption permitted, but not before the effective date for public business entities

Comment period ended 29 May 2015

FASB Income Taxes Simplification

Presented by:

• Require the classification of all deferred tax assets and liabilities as noncurrent – Companies no longer required to allocate valuation allowances between current and

noncurrent – No change to jurisdictional offsetting requirements– Prospective transition approach– For public business entities, FASB expects proposed amendments effective for annual

periods, and interim periods within those annual periods, beginning after 15 December 2016

– For nonpublic business entities, FASB expects proposed amendments effective for annual periods beginning after 15 December 2017 and interim periods in annual periods beginning after 15 December 2018• Early adoption permitted, but not before the effective date for public business entities

Comment period ended 29 May 2015

FASB Income Taxes Simplification (cont.)

Presented by:

• FASB proposed that all excess tax benefits and tax deficiencies be recognized in the income statement.– Prospective transition

• FASB proposed elimination of the requirement that excess tax benefits not be recognized until they are realized.– Modified retrospective transition with a cumulative catch‐up

adjustment to retained earnings

• FASB proposed that excess tax benefits be presented as an operating activity on the statement of cash flows.

Comment period ended 14 August 2015

FASB Share‐based Payment Project

Presented by:

• FASB tentatively decided to require additional disclosures related to foreign earnings and indefinite reinvestment assertions:– Pre‐tax income disaggregated between domestic and foreign earnings, with

foreign earnings disaggregated for any country that is significant to total earnings

– Domestic tax expense recognized on foreign earnings– Undistributed foreign earnings that are no longer indefinitely reinvested with

an explanation of the circumstances that caused the company to change its assertion and separate disclosure for any country that represents a significant portion of the disclosed amount

– Foreign earnings that are indefinitely reinvested for any country that represents at least 10% of the company’s total foreign earnings that are indefinitely reinvested

FASB Income Taxes Disclosure Project

Presented by:

• Related to foreign earnings and indefinite reinvestment assertions, the FASB decided not to require disclosure of:– Deferred tax liabilities recorded for unremitted foreign earnings by

country– Estimates of unrecognized deferred tax liabilities on the basis of

simplified assumptions for companies that have made indefinite reinvestment assertions

– Past events or current conditions that have changed management’s plans with respect to undistributed foreign earnings

FASB Income Taxes Disclosure Project (cont.)

Presented by:

• FASB tentatively decided to add requirements that public entities disclose as part of the tabular rollforward of unrecognized tax benefits the following: – Settlements disaggregated between those that are cash and noncash (e.g., an

existing net operating loss carryforward used to settle with the taxing authority)

– A breakdown of the total amount of unrecognized tax benefits by the balance sheet line item in which the amounts are presented

• FASB also tentatively decided to eliminate for all companies the requirement to disclose certain information when it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within 12 months of the reporting date.


Presented by:

• FASB indicated that it will discuss income tax disclosures related to other income tax topics (e.g., deferred taxes, effective tax rate reconciliations, taxes paid) at a later date.

• FASB previously made tentative decisions to add disclosure requirements related to foreign earnings and indefinite reinvestment assertions.

• Before amending today’s guidance, the FASB plans to issue an exposure draft on the proposal


Presented by:

TAX EFFICIENT CAPITAL

Presented by:

• TruPS– Dodd‐Frank and Basel III phase out TruPS for banks that are > $15bb in

asset size and banks that go over $15bb in asset size as a result of an acquisition

• Minority Interest– Equity issued by an LLC or CFC may achieve tax‐deductible treatment

and count as capital – Likely only includible in AT1

• Foreign bank structures– Using entity classification rules to bring non‐regulated entities with

high leverage into the US tax group

Presentation title

Relevant Rules

Presented by:

Under section 21(c) and (d), the CET1MI and tier 1 minority interest (“T1MI”) are included in the capital of a banking organization except to the extent of any surplus. Both sections describe the surplus as: The percentage of the subsidiary’s tier 1 capital that is not owned by the [BANK] multiplied by the difference between the tier 1 capital of the subsidiary and the lower of: (i) the amount of tier 1 capital the subsidiary must hold, or would be required to hold …. to avoid restrictions on distributions and discretionary bonus payments under §___.11.... or, (ii)(A) The standardized risk weighted assets of the [BANK] that relate to the subsidiary multiplied by (B) The tier 1 capital ratio the subsidiary must maintain to avoid restrictions on distributions …. Under §___.11 ….

Presentation title

Basel III Rules on Minority Interest

Presented by:

The Rules Example

• To determine the portion of a TIMI that cannot count towards a parent bank or parent BHC’s capital requirements, the capital structure of the subsidiary issuer must be evaluated

• If a subsidiary Tier 1 is > 8.5% of the subsidiary’s RWA, including any TIMI, then the excess capital is allocated among the classes of equity

• The excess amount assigned to the TIMI is not eligible for inclusion in the parent’s Tier 1 amount

• Remember: the NCI is likely to be classified as a liability for GAAP

Type Owner Amount ExcessCommon units Parent 70 10.50Preferred units 3rd Party 30 4.50

Total Tier 1 of subsidiary 100 15.00RWA of subsidiary only 1000Tier 1/RWA Ratio 10%

Excess Tier 1:Actual 100Less: 8.5% of RWA 85Excess 15

Result:Parent Bank/BHC can include $25.50 of its subsidiary’s preferred units as TIMI.

10.50

70%

4.50

30%

Allocated to common

Allocated to preferred

Excess Tier 1 Minority Interest


BHC

Sub

Investor

30%70%

GAAP earnings 10.00$ Less: min int expense (3.00)$ Net earnings 7.00$ Times: rate 40.0%Tax expense 2.80$

Taxable income 10.00$ Less: pref alloc (10.00)$ Taxable to BHC ‐$

Dr. Tax expense 2.80$ Cr. DTL 2.80$

Dr. NCI expense 3.00$ Dr. Cash, net 1.00$ Cr. Tax benefit 1.20$ Cr. DTL 2.80$

Dr. Dividends/equity 3.00$ Cr. Cash 3.00$

Tax Entry

Minority interst Effects

Comprable Priced Noncum Pref

Year 1 ResultsMinority Interest With Pref Features

Presented by:

FINESSING 2016 TAX REFORM: BASEL III STYLE

Presented by:

• DTAs could be worth less than face value if rate reform goes into effect; this is the equivalent of “breaking the buck”

• Right now, your DTAs are an advance to the government with a 0% yield and, at best, a 100% RWA (requiring at least a 7% annual capital charge); if rate reform goes into effect, a portion of that 0% asset’s principal will be lost forever

• Some tax departments are content to dismiss the charge as a non‐cash charge that analysts will remove from evaluation of earnings, etc. That simply misses the mark.

• Thesis: In addition to all the other costs of holding DTAs (financing and capital), the possibility of taking a principal impairment in exchange for no compensation is further reason to consider every alternative means of disposing of this asset class.

Tax Reform and Basel III

Presented by:

• Any decisions about DTA degradation are generally independent of the taxation of foreign earnings

• Proposed domestic corporate tax proposals seem focused on ensuring the US is no longer the country with the highest rate

• Candidates touting “IRS code” and 74,000 pages is simply rhetoric

• Camp’s proposal & Rubio say 25% corporate rate• Donald Trump says 15%• No other proposals that set a specific rate

Presentation title

Proposed Domestic Tax Rate Changes

Presented by:

• Whoever wins, DTAs will likely get haircut• Even if that DTA is currently haircut under Basel III there is a

real, economic loss– The DTA that is currently haircut was likely, someday, to be converted

into cash, thereby creating capital– A rate change alters that future source of capital

• DTLs that undergo a re‐pricing could, however, have a beneficial impact

• What banks did we review that possess net DTLs?

Presentation title

Basel III Considerations

Business

Bti 2015-e 11-5-general-banking-update