Tax Reform, Bitcoin and the Year Ahead for Financials

Episode Summary

Executive Summary: Richard Ramsden argues U.S. banks entered 2018 from a position of strength, with technology adoption, tax reform, lighter regulation, and a benign credit backdrop supporting earnings. He expects tax cuts to lift profits, but says competition will erode some benefits over time. He also sees more dividends, selective buybacks, stronger loan and M&A activity, and growing disruption from fintech and cryptocurrencies.

Main Topics: Technology reshaping banking (Priority: 5/5): Banks are rapidly adopting consumer technologies, reducing reliance on branch networks and using tech to improve customer experience and operating leverage. Corporate tax reform and earnings (Priority: 5/5): Lower corporate taxes and repatriation rules could materially lift bank earnings, though some gains would be reinvested or competed away. Capital returns and shareholder pressure (Priority: 4/5): With excess capital and lower profitability than in the past, banks face pressure to raise dividends and reassess buybacks. Growth outlook: loans, M&A, and the consumer (Priority: 4/5): Loan growth was weak in 2017, but tax certainty, CapEx, and repatriation could support lending and M&A activity in 2018. Rates, Fed policy, and balance sheets (Priority: 4/5): Higher rates and Fed tightening should have mixed effects on consumers but improve bank securities yields and alter deposit dynamics. Credit quality and the cycle (Priority: 4/5): Credit conditions remain exceptionally strong, and banks do not expect meaningful deterioration absent a macro slowdown. Disruption, fintech, and cryptocurrencies (Priority: 3/5): Payments are already being disrupted by technology firms, and banks are adapting while trying to protect their role in the payment system.

Key Arguments: Tax reform would likely boost bank earnings immediately because banks earn most income domestically and pay relatively high tax rates. Ramsden estimates a roughly 15% short-run uplift to sector earnings from a corporate rate cut to 20%. Repatriated overseas capital would create a one-time tax charge for larger banks, but free capital could then be redeployed into dividends, investment, or growth. Banks are likely to increase dividend payout ratios over time, while buybacks become less attractive as valuations rise. Bank valuations look higher than historical norms, but that is justified by better growth prospects, technology-driven efficiency gains, and strong credit conditions. Loan growth slowed in 2017 because firms delayed investment amid policy uncertainty and because high-yield markets offered cheaper credit than banks. Tax reform and repatriation should encourage CapEx, lending, and M&A, especially large-cap transactions. The consumer should benefit from stronger GDP growth, more jobs, and wage inflation, even if higher rates modestly change saving/spending behavior. Four Fed hikes would likely increase the amount banks pass through to depositors, but the overall consumer effect should be limited in year one. Credit quality is very strong, so default risk should stay low unless unemployment or bankruptcies rise materially. QT should reduce deposits flowing through the system but improve bank securities yields because the Fed will no longer compete as a buyer. Banks are not immune to disruption; they are responding by rapidly copying fintech-like features and giving them away free. Large banks have a growing technology spending advantage that can translate into market-share gains over smaller rivals. Millennials are forcing banks to shift toward digital servicing and simpler pricing, though many still want human advice for major financial decisions. Cryptocurrencies may help a cashless future, but banks are most concerned about losing control of the payment system.

Data Points: U.S. bank index performance: up 50% over the last 12 months - Ramsden cited the rally in bank shares as valuations became more demanding. Corporate tax rate: 35% to about 20% - Proposed reform discussed as a major boost to bank profitability. Bank earnings exposure: 90% domestic earnings - Explains why banks benefit disproportionately from a lower U.S. corporate tax rate. Estimated earnings uplift: about 15% - Short-run uplift to overall sector earnings from tax reform. Largest banks' excess capital: about $100 billion - Capital not needed for regulatory purposes across the largest U.S. banks. Current bank ROE: 10% to 11% - Compared with roughly 20% historically, used to explain shareholder pressure. Historical dividend payout ratio: about 45% - Historically banks paid out a larger share of earnings than today. Current dividend payout ratio: 30% to 35% - Illustrates room for dividend growth. Bank valuation: around 14.5x earnings - Current trading multiple for banks. Bank valuation vs S&P 500: about 80% of the S&P multiple - Shows banks trading at a discount, though less than historical norms. Historical bank valuation vs S&P 500: around 75% of the S&P multiple - Provides long-run comparison for valuation context. U.S. loan growth: around 2% - Current pace of loan growth, down from the prior year. Prior-year U.S. loan growth: about 4% - Used to highlight the slowdown. Corporate loan demand: 2% now vs 6% to 8% last year - Main driver of slower lending growth in 2017. GDP impact from tax reform: 50 basis points higher GDP growth in 2018 - What several banks expected from corporate tax reform. Interest-rate pass-through to depositors: 20% to 25% of the last 75 bps move - How much banks had passed along after rates rose over the prior year. Expected pass-through on next hikes: 30% to 45% - Estimated pass-through over the next three to four rate hikes. Rate increase over prior year: 75 basis points - Used to frame deposit pricing behavior. Credit quality: best in 30 years - Banks see loan performance as exceptionally strong. Top-four bank tech spending: $8 billion to $10 billion per year each - Illustrates the scale of technology investment among the largest banks. Discretionary tech spend at top four banks: $2 billion to $3 billion per year each - Investment that can be directed toward innovation and customer experience. Fifth-largest bank tech spending: about $1 billion per year - Shows the widening technology gap between large and smaller banks. Podcast recording date: December 11, 2017 - Closing disclaimer notes the date of the episode.

Pivotal Quotes: "technology is really reshaping the financial services sector" — Richard Ramsden: Opening theme from the Goldman Sachs Financial Services Conference. "banks are looking for opportunities to grow their dividends as a way of providing a better yield to shareholders" — Richard Ramsden: Discussion of capital returns and shareholder pressure. "we've seen more innovation on the technology side in the last 12 months than he's seen in the last 30 years as a banking professional" — Richard Ramsden (quoting a conference participant): Illustrates the speed of change in banking technology.

Implications: Banks may enjoy near-term profit gains from tax reform and rising rates, but long-term winners will be those that invest fastest in technology, keep credit strong, and return capital efficiently while defending payments and customer relationships.