The Tax Cut and Jobs Act of 2017 (TCJA) presented banks with a rare windfall. Of all the industries in America, banking is one of the most rewarded. Because of where banks sit in the economy, the gift of leverage, and the current strength in the economy, banks now have an extremely rare opportunity to place this new found wealth for long-term good. It is an opportunity not to be squandered. Being Valentine’s Day, there is little doubt your bank would like to show all of its stakeholders some love with your tax savings. The question is – where can it do the most good? In this article, we propose some ideas on what and what not to do with tax savings earnings.
The Laws of Capital Have Not Been Repealed
A prominent Cleveland banker recently said this to the press when asked about Tax Reform gains - “Higher dividends are a top priority.” Really?
This is the exact opposite of proper capital management. Higher dividends should be your LAST priority. Paying dividends out is what you do when you have no use for the capital, and you can’t invest with a risk-adjusted return above your cost of capital. Maybe the CEO that said this had completed all her major capital initiatives, has exhausted all acquisition targets and has a clear view of what the banking future holds, but we doubt it. The more likely reality is that with recent improvements in technology, cybersecurity threats, economic growth opportunities, underappreciated employees and a changing economic landscape, we think it is way too early to conclude that you should make increasing your dividend a top priority. Dividends are a priority when you see economic growth slowing.
The answer to the question “What do you do with your Tax Cut Windfall?” is simple. Unless your industry view has negatively changed because of reform, banks should be investing their new found wealth the same way as they always have. What you now do with two dollars of capital is exactly the same answer as what you would have done with one dollar of capital. That said, there is one profound difference of why the TCJA has changed your capital strategy.
How To Deploy Capital – Giving It Back To The Employees
Capital should be deployed where it can give stakeholders the best return on investment.
Giving a return to all your stakeholders is not a widely held concept as most bankers would argue that it is a bank’s shareholders that should be the focus of the majority of the return. The enlightened view of capital would argue that your employees, regulators, vendors, and customers are also stakeholders in the bank and their well-being and return on their capital (be it human capital, trust capital or other) should be a collective target of economic return.
Since your employees are by far a bank’s most profitable asset, investing in your employees is never a bad idea.
Many banks are giving $1,000 to each employee which is a nice gesture and shows some level of direct gratitude. However, for the sake of the organization, the economic and even psychological return is probably limited. That $1,000 probably isn’t going to increase productivity or make employees feel materially different about their job.
From an economic point of view, that money is better spent reinvesting in the bank in order to generate more future profits and pay the employees more in bonuses. If employees thought about it, had a say and had assurance from management that they could get the return on that money, that $1,000 could achieve a 15%+ compounded return if done right.
Instead of a one-time payment to employees, the better move would be to increase employee compensation or benefits by $1,000 or more PER YEAR to the extent that bank management thought it would help retention and attract better talent. Investment to attract talent over the long term is one of the best moves a bank can make and should be any bank’s first stop for Tax Reform windfall consideration. While a good loan generates an 18% return and a good deposit generates a 300% return, a good employee can generate 3,000% or more.
Despite the economic argument, paying your employees a one-time $1,000 is a good first move plus it has positive marketing ramifications. Just keep in mind that the average bank is generating about $15,000 per annum in tax savings per employee so that $1,000 isn’t significant to the bank’s investment/capital strategy.
Other Investment Choices
In Part Two of this two-part series, we will tackle where banks could get the best investment for their capital next to investing in their employees but before paying dividends. This isn’t an exact science, but we will compare the returns on some popular tech investments to several promotions that drive business. We will also highlight that while investing this Tax Reform windfall is no different than any other investment plan; there is one material difference that makes this decision unique. Check in with us next week to find out more and until then, be sure to spread Valentine’s love to all stakeholders today.
Submitted by Chris Nichols on February 14, 2018