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Citigroup: Tax Reform Perspective
Citigroup forecasts a large upfront hit from the proposed domestic tax cut. All of the charges are non-cash and have limited impacts to key financial ratios. Mo
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Summary
Citigroup forecasts a large upfront hit from the proposed domestic tax cut.
All of the charges are non-cash and have limited impacts to key financial ratios.
Most importantly, the stock will remain cheapest among the peer group and will still return billions to shareholders.
At an investor conference this week, Citigroup (C) management appeared to catch the market off guard with regard to the tax reform impact. The stock took a minor dip on the news, but some of the concerns are off basis.
Citigroup still trades near the multi-year highs at $75. Plenty of reasons exist to expect more upside despite this minor bump in the road from tax reform.
Tax Impact
What caught investors off guard was the mention of a one-time $20 billion hit from the current Senate version of the tax reform bill. CFO John Gerspach discussed the impact as follows:
But if you stay with the Senate bill and the Senate bill is the one that has 20% tax rate for corporations, beginning in 1/1/19; it has moved to the territorial system, and it's got the deemed repatriation at a - probably a higher rate than most of us had assumed, it was going to be.
...our best estimate would be in the year that bill get signed, we would probably have a upfront hit of $20 billion. Now that $20 billion of the combination of the write-off of DTA - again we built the DTA at 35% tax rate. If we’re going to a 20% tax rate that those losses are going to be worth less than they were when we put them on the balance sheet; so that drives probably somewhere around $16 billion $17 billion of the $20 billion. The deemed repatriation, we would estimate costing another three to four.
So you add those two together, it will be a $20 billion - again non-cash, we believe, because we should be able to use FTCs in order to cover the repatriation cost. So it’s a non-cash hit that would be a one-time hit to the P&L. Then of that $20 billion now, you asked about capital, because most of our DTA is disallowed for regulatory purposes, while we would take a GAAP hit or a hit to our GAAP income of $20 billion and we would certainly reduce our TCE by $20 billion, the hit to our CET one capital we will probably be a much more manageable $4 billion.
Investors expecting to hear about the benefits of a lower effective income tax rate where instead smacked with this big tax bill. The tax bill really falls into two categories that the company lists as both non-cash.
$16 to $17 billion DTA write down from the 35% rate to 20%.
$3 to $4 billion tax on repatriated cash.
The DTA was never valued highly by the market in the first place so this write down of up to $17 billion isn't meaningful. Instead of saving on domestic income taxes at 35%, Citigroup will now only save the taxes at a 20% rate. Either way, the large financial won't pay income taxes on the related income.
The only real impact comes from the one-time tax repatriation on foreign income. The current Senate bill lists a 14.5% repatriation rate that again is non-cash as Citigroup will use utilize DTAs to avoid actual tax payments.
As the slide from the Q3 report highlighted, the DTA asset sat at $45.5 billion and CET1 Capital was $153.5 billion.
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