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Jim Young and Rollie Tillman sit down to talk through the new tax cuts and how they will affect banks. You'll learn what you can do to capitalize on the cuts and how you can change your approach to lending for better outcomes.
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Jim Young: Hi, and welcome to The Purposeful Banker, the podcast brought to you buy PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm your host, Jim Young, Director of Communications at PrecisionLender. I'm joined today by Rollie Tillman, Managing Director for Regional and Community Banks on our Client Success Team.
Today, Rollie and I are going to dip into current events a little bit and talk about the recent tax cut and what it might mean for commercial lending or what it might mean for your bank. Please take note that we are going to avoid any partisan landmines and keep this strictly to commercial banking. Any complaints that may arise about this can be sent directly to Rollie. We will include his email in the show notes.
Rollie, you've had a long career as a banker. Was there any sort of, form your memory, a comparable-like tax cut during your tenure?
Rollie Tillman: Well, you're right, Jim. I've been working in and around banks for a lot of years, and no. I think history would say we had a drop in the '80s. I was still in high school then. Then prior to that, probably, you'd have to look prior to World War II to see a corporate tax rate at the level that's being proposed today.
Jim Young: Then we're in some uncharted territory, then, it's safe to say. There have been a lot of theories out there about what this tax cut is going to mean for commercial banks. For example, Bruce Van Saun, CEO of Citizens Financial, in an article, I believe in American Banker ... We're going to post links to the articles that we reference here in our show notes. His quote was, "If the economy's stronger, more money in circulation, more demand for loans, the volumes are gonna go up in terms of loan demand, deposit, and circulation. It's all positive in our ability to make income."
Then you've got someone on the other side like Bill Demchak from PNC, the CEO there, who says, "Look, these provisions to enhance the deduction for capital expenditures likely encourage companies to invest more, but it's really optimistic to assume that companies were just sitting there, waiting there, not doing anything until they knew about the tax cut, and now they're gonna jump all in." Then Tim Sloan from Wells Fargo was like, "The interest rate's going up, so a lot of companies may have already done the business they wanted to do in terms of this." I know you're not the CEO of a large bank, Rollie, but can you sort out where you think things fall in terms of what the impact would be?
Rollie Tillman: Well, Jim, I think you've kind of put three fence posts out there and pointed out what you often hear from economists, and these are super smart guys who have econometric geniuses working for them. I think what that tells you is that it's uncertain. It could go any number of ways. I think, without a doubt, the reduction in corporate tax rate changes the dynamics of companies. It well could spur lending growth as they invest in capital expansion of their business, and growth, and things of that nature. A lot of the comments are focused around the impacts to businesses and then, in turn, the loan volume that would occur for banks. The way I've been thinking about it more is about the banks themselves because they are corporate entities as well, and banks are going to have a reduction in the marginal corporate tax rate.
We work with a lot of banks, and we focus solely on pricing and profitability management with those banks. We've been talking a lot with our clients about how they would change their pricing strategy, because that's really what we're talking about. You go back to Marketing 101, and they teach you the Ps of marketing: product, price, promotion, placement. Those are all the things that businesses are considering, "Do I invest in product? Do I invest in placement, marketing?" Those are the conversations we have with banks as well. A reduction in the corporate tax rate means they need to be mindful of that and how they price their loans.
Jim Young: First off, kudos, Rollie, to sidestepping my attempts to pin you down to making a prediction on what the industry is going to do, but you actually ... You turned us in an interesting direction that I want to pursue. You mentioned you need to think about pricing now in the context of these tax cuts. Delve a little deeper into that. Think about pricing how so?
Rollie Tillman: Well, I think, first off, banks ought to look at their own income statement and balance sheet and what they're going to do with their tax savings. You hear a lot about digital banking. Some of the quotes you referenced talk about the investments they're going to make in innovation within the bank. There's also shareholder value, all different elements of how a bank needs to be mindful of what they're going to spend their tax savings on. One thing, of course, that we focus on at PrecisionLender is pricing and profitability management. Whatever the answer is to that bank and how they're going to invest their tax savings, they need to be mindful of how they price their individual loans.
Jim Young: How so?
Rollie Tillman: Yeah, so what I mean by that, if you think about a company, they have a balance sheet and an income statement. In banking, largely a service organization, that balance sheet and income statement is comprised of individual loans, deposits, and other fee-based business. If you break it down to, in essence, the account level, that is what banks have to offer.
Many of the banks that we work with think about all the elements that go into pricing a transaction. A significant line item is taxes. Anyone who's listening to this and has any familiarity with how banks approach pricing ... We often talk about risk-adjusted returns. A line item in that return evaluation is taxes. Right off the bat, 15% of the income is going to go up as a result of the tax reduction. Banks need to look hard at do they adjust their expected returns or do they pass that along to the borrower in terms of more competitive pricing?
What I think we're seeing in the media is that some banks are going to make significant investments in digital banking and other innovations, BotChain, whatever it is that you read about in the press. If they're going to spend their tax savings in those innovative ways to keep up or enjoy all the new technologies, then they need to adjust their pricing. That's what we spend our time taking with with the best of breed out there is how will they be very precise and use pricing as an asset and reflect the pricing offered in the market that includes an element of the tax rate?
Jim Young: That's interesting. What you're saying, in essence, with this is we talk ... I know I tend to think of the pricing more in terms of, okay, directly with the customer. But what you're saying is you got to put it in that bigger context of what you're doing as a bank overall.
Rollie Tillman: That's right. I think that's what's going on in the economy at large. I think that's why it's so hard to put your finger on the pulse of what the direct result of the tax cut will be, because every boardroom and every CEO of every company is sitting down and saying, "Okay, we've got a windfall. How do we invest this in growth of the company and more prescribed pricing or do we return it to shareholders?" I think that's why there's 50 shades of gray out there, so to speak, and it's hard to put your finger on what the direct result will be. There will be impact, but it will be the decisions that are made in those boardrooms as to how each company is going to make the investment of their tax savings in their company.
Jim Young: I would think, if you are managing a team of relationship managers at your bank, that at least one part of it is going to be like, "Look, this is ... Depending on where the conversation goes is one thing, but this is a conversation you need to be going on and having with your clients and with potential prospects out there is you need to putting it front and center on them, 'Okay, hey, this has happened. What are you going to do?' Maybe the answer is nothing, but you at least need to be having that conversation."
Rollie Tillman: Well, I think the best relationship managers at banks will be doing that. From a sales perspective, they call it demand creation, and so for bankers to get out in front of their client. Some may not have the tax break top of mind, and they need to sit down and think about, "What is my strategic plan? How am I gonna reinvest my excess income?" It may be a relationship manager pointing out we have capital expenditure lines of credit and provide to them innovate ways to borrow that they can invest in their business. Some of that loan growth will come from the proactive sales efforts of the relationship managers and being good ... exactly that, good relationship managers to understand their customers' business and provide opportunities for them to grow that business.
Jim Young: That's on the relationship manager on the individual account basis. Let's back it back up, take it up a level or two to sort of that more overarching strategy. What are some of the things that you're seeing some of the better banks doing, some of our savvier clients, the discussions they're having in relation to this?
Rollie Tillman: Well, Jim, what we see our best clients doing is taking a step back, acknowledging that they're going to have a windfall to their income statement as a result of a reduction in the tax rate, and then being very thoughtful and prescribed about how they're going to spend that savings. We talked about in the Ps of marketing how you have product, price, promotion, and placement. Those are all areas where you can invest. Our clients are determining, "Are we gonna put a small slice of the pie through as preferred pricing on our products to boost volume in the market? Are we gonna invest in innovation like digital banking, and BotChain, and things of that nature we talked about?" Whatever they do, they need to have a firm grip on their pricing strategy because that's what banks have to offer, loans and deposits. They price those individually, and they all have return characteristics including a tax rate.
Many banks will have a hurdle rate. What we're seeing, through the conversations we're having with our clients, is that, by lowering the tax rate, the returns are boosted and, all of a sudden, they're exceeding the hurdles that they've had for many years, and they need to rethink about the targets they have in respect to the tax changes. That's getting down in the weeds, but it's a extremely important part of the long-term viability of a bank is how they price their services. The conversations we're having is how they tailor their expectations, their evaluation of the profitability of the new business they're putting on the books so that they're please with the portfolios they build at the end of the day.
I had a credit risk manager one time who used to always tell me that his worst fear was that he would wake up one morning and look into his portfolio and, all of sudden, there was an Island of Misfit Toys in the portfolio, so very timely for our conversation. That's what you don't want. You want to be very open-eyed and thoughtful about how you're pricing your loans and what their yield characteristics are so you'll be happy with your portfolio at the end of the year when you look back on it.
Jim Young: Yeah, so what you're talking about, really, is that ability to be nimble and agile and say, "Okay, the environment has now changed, and now ... Yeah, we're exceeding our hurdle rates. That doesn't mean we go, 'Hooray, we're exceeding our hurdle rates. Now it's okay.'" Does that mean we have to lift them up or should we alter something else now to change things since we don't feel like we need to go higher than that so we can ... you said go for more volume, that sort of thing?
Rollie Tillman: I would say, Jim, that's an important point because if you're exceeding your hurdle rates, what it tells your relationship managers is that they can dig deeper on price, which makes them more competitive in the marketplace, which may be a great outcome, but it should be the planned outcome. Otherwise, your volumes being boosted, they're cutting their price, and you're going to see the overall yield on the portfolio decline. These are serious problems that bankers need to think about and need to communicate very clearly to their relationship managers what the strategy is, particularly from a pricing perspective.
Jim Young: It's something, like you said, you've got to be on it. It can't be something that, at the end of a quarter, you go back and go, "Oh, wow. Looks like we did this, and this is what happened," as opposed to, "This is what's happening, and this is what we need to do now."
Rollie Tillman: Right. You've hit the nail on the head. There's two important parts. You can always look back and evaluate what you've done. That's easy to do. The numbers are on the books. You can add them up and analyze them. We always have good views of what's occurred in the past. What bankers need to be mindful of is, "How do I communicate to my relationship managers what's important to me now?" We have to deal with today's tax code and today's problems and make our pricing decisions in relation to those elements so that the balance sheet we build today, that we'll enjoy for years to come, we're happy with. No Island of Misfit Toys of mispriced loans and things of that nature.
Jim Young: Absolutely. Well, this has been an interesting one. Rollie, I appreciate you diving into the tricky realm of sort of trying to analyze a big, big issue like this and all the potential impacts of it.
That'll do it for us today. Thanks for listening. If you'd like to learn more, visit our resource page at explore.precisionlender.com. If you like what you've been hearing, make sure to subscribe to the feed in iTunes, SoundCloud, Google Play, or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this has been Jim Young with Rollie Tillman, and you've been listening to The Purposeful Banker.
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