Banks to Get Accounting Change to Avert Earnings Hit From Tax Law

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By Denise Lugo

Banks, insurers and others will get an accounting rule change to eliminate an inadvertent hit to their earnings from applying income tax accounting to the corporate tax reduction rate under the law President Donald Trump signed Dec. 22.

The tax law ( Pub. L. No. 115-97) lowers the corporate tax rate from 35 percent to 21 percent.

Rather than an initial boost in 2017 financial statements, strong, well-capitalized community banks said they could inadvertently be deemed to be lacking in regulatory capital because of current income tax accounting.

Some reported a hit to initial earnings. Pentucket Bank, for example, told accounting rulemakers its 2017 earnings would be about $500,000 less under current accounting, which represents about 10 percent of its 2017 earnings.

Alarming to Banking Sector

“The earnings impact of these adjustments can be alarming for those community banks that carry high-quality investment securities on the balance sheet designated available-for-sale,” James Kendrick, first vice president of accounting and capital policy of Independent Community Bankers of America, told Bloomberg Tax about the new law’s effects. The group represents more than 5,700 community banks nationwide that hold $4.9 trillion in assets, $3.9 trillion in deposits and $3.3 trillion in loans.

U.S. accounting rulemakers Jan. 10 voted to propose the quick changes to their standard on reporting comprehensive income. The changes will permit all companies to reclassify the effects of the tax rate change related to items in accumulated other comprehensive income to retained earnings. The changes would rectify the unintended consequences of applying the rules.

Companies will have 15 days after publication of the proposal to comment on the Financial Accounting Standards Board’s decision. The changes will be effective for fiscal years after Dec. 15, 2018, and interim periods within that period, FASB unanimously agreed. Earlier application would be allowed.

Today’s rules require the adjustment of deferred taxes stemming from the corporate tax rate reduction to 21 percent to be included in income from continuing operations, even if the deferred taxes were originally charged directly to other comprehensive income. Because of that, the tax effects of items within other comprehensive income don’t reflect the appropriate tax rates.

“It’s going to affect the number we report from an earnings standpoint,” Derek Williams, president and chief executive officer of Century Bank and Trust, told Bloomberg Tax.

Difficult Explanation to Shareholders

Williams said it would be hard to explain to shareholders why the bank might appear to have taken a step back this year and showed less income on its income statement, when it doesn’t make logical sense to have to do so. “I don’t want to stand before my shareholders and say ‘we would have made this much money but because of a paper transaction—we’re making less,’” he said.

The accounting changes are being made in response to concerns raised to FASB by banking trade groups, banks and insurance trade organizations about the effects of current requirements when paired with the corporate rate change. The organizations felt the accounting effects would be alarming to companies in their sector because it would result in misleading balances in financial statements and cause analysts and investors to be confused.

“This is a big deal for most companies, especially banks and insurance companies because certain investment and hedging adjustments—after tax—are recorded in additional other comprehensive income,” Peter Vinci, a consultant at Resources Global Professionals, the operating subsidiary of multinational company Resources Connection Inc., told Bloomberg Tax. “The tax impact for these items is stranded in AOCI,” he said.

Additional or accumulated other comprehensive income (AOCI) is classification in the equity section of the balance sheet. It’s used to accumulate unrealized gains and losses on items in the income statement that are classified in the other comprehensive income category.

A number of community banks and other financial institutions earlier this week signaled potential effects of the corporate rate changes in their 8-K filings with securities regulators—hinting at knock-on effects stemming from financial reporting..

Filers included Legg Mason Inc. and Home BancShares Inc., parent company for Centennial Bank; Provident Financial Holdings Inc., which operates Provident Savings Ban;, Hancock Holding Co., the holding company for Whitney Bank; and Peoples Bancorp Inc.

Legg Mason said the lower corporate rate reduces the value of its tax shield, which is its estimate of future tax benefits based on current earnings projects and tax rates, from $1.16 billion to about $930 million.

Home BancShares said revaluing its deferred tax assets and liabilities to account for the future impact of lower corporate tax rates on these deferred amounts would negatively impact its fourth quarter results.

To contact the reporter on this story: Denise Lugo in New York at dlugo@bloombergtax.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bloombergtax.com

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