political and economic uncertainty in the trump presidency

Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending

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POLITICAL AND ECONOMIC

UNCERTAINTY IN THE TRUMP

PRESIDENCY

An Excerpt from “2017 Industry Insights:

Perspectives from the Front Line”

by RMA’s Credit Risk Council


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The 2017 Industry Insights:

Perspectives from the Front

Line was first published in the

spring of 2017.


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The election of Donald Trump as

president has introduced a new level of

uncertainty into the economic landscape.

This may impact borrowing customers

and the level of risk associated with both

their business models and associated

credits.

Trump = Uncertainty


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REFORM FAILURE RAISES UNCERTAINTY

The administration’s failure to

pass healthcare reform has only

raised the level of uncertainty.


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KEY AREAS OF IMPACT

This slide deck will touch on a few of the key areas where policy decisions may

have significant impact.

Tax reform

Trade policy

Interest rates

However, the agenda continues

to be a moving target.


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Tax Reform


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One of the cornerstones

of the Trump

administration’s plan is

tax reform and,

specifically for

corporations, a reduction

in the corporate tax rate

from 35% to 20% or

even 15%.

TAX REFORM

35%

20%

15%


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TAX REFORM IMPACT WILL VARY

At the same time, Trump’s plan

includes cutting nearly all business

tax credits, deductions, and other incentives.

So while a corporation’s top line tax rate may be considerably

reduced, its effective tax rate

might remain relatively

unchanged.

The problem is that the impact will

likely vary widely across sectors, but to be sure, there

will be winners and losers.


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TAX-ADVANTAGED DEAL STRUCTURES

One key area will be tax-advantaged deal structures with tax credits such as:

Low income housing (LIHTC)

New markets (NMTC)

Historic (HTC)

Renewable energy investment (ITC)

Production (PTC)


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While the credits

are not likely to

be repealed, the

decrease in the

tax rate will

clearly impact the

valuation of the

tax credit

$1.15

per

investor

capital

$1

of tax

credit


(CONT.)

In some areas, for

example,

affordable housing

developers are

getting as much as

$1.15 of investor

capital for every $1

of tax credit

offered.


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(CONT.)

With lower tax rates, investors have less incentive to pay top dollar for LIHTCs which can create funding gaps

for developers.

It is not clear how these gaps will be filled, whether it comes from:

More credits provided by the state per deal (likely

than fewer deals)

Or from finding another source of soft money.


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(CONT.)

In the meantime, most investors are taking a wait

and see approach to buying tax credits to avoid a loss should the tax rate

decline.

Given the pressure on the banking industry to fund affordable housing, tax

reform may make it more difficult to find

opportunities in an already competitive

market.


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REDUCTION OF TAX ADVANTAGES FOR REITS

The tax cut also reduces the

tax advantages of structures

such as real estate investment

trusts (REITS).


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(CONT.)

However, another potential

reform—the election to expense

capital investments and disallow

current deduction for interest

expense—would have a

dramatic impact on REITs and

the real estate industry.


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(CONT.)

This could result in more volatile taxable

income for REITs as opposed to the

current system of predictable and fixed

annual depreciation deductions.


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(CONT.)

This may also render unnecessary

Section 1031 transactions

(for like-kind exchanges of real estate),

which currently allows REITs to defer the

payment of taxes on gains made on the

exchange of property.


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Trade Policy


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TRADE POLICY

The expectation is that tax

reform on its own will be

revenue negative, so it will

likely be combined with a

change in trade policy.


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02There are

two possible options:

Border

tariff

Border

adjustment

tax

TRADE POLICY (CONT.)


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BORDER TARIFF

The tariff is

simply a tax on

imported

goods at the

border.

• It is considered more

unpredictable because it could

discourage trade altogether and

create possible retaliation.


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BORDER TARIFF (CONT.)

The border adjustment tax

would exempt revenues

generated from export

sales, while the cost of

imports would not be

deductible as a business

expense for tax purposes.


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$120MM

$600MM

while the tax impact

on imports, which

are a larger part of

our economy, would

increase by

$600MM…

generating a net

$120MM gain

annually.

$480MM

The theory is that

exempting exports

would reduce taxes

by approximately

$480MM…



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The theory also projects that the dollar would

increase in value in an amount sufficient to

effectively reduce the cost of imports, such

that it becomes neutral to prices in the U.S.


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BORDER ADJUSTMENT TAX

It is difficult to determine if the

border adjustment tax could

achieve an equilibrium as

presented without unintended

consequences.


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BORDER ADJUSTMENT TAX (CONT.)

It is unlikely that the impact would be felt

equally across all:

• Industries

• Companies

• Geographies


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The potential winners are

likely to be companies with a

majority of their input costs

contained within the U.S. and

those that are primarily

exporters.


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Examples would be:

Health care service

providers

U.S. cable/telecom

Oil refiners that source

from the U.S.

U.S.-based manufactur

ers

Consumer staples

providers


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Potential

losers

include:

• Automakers

• Semiconductors

• Oil and gas

• Chemicals

• Retailers, particularly apparel


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If the administration pursues the

border adjustment tax

there is also concern that inflation will

increase

because exports do not affect the CPI, but the cost of imports does.


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Interest Rates


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INFLATION

Inflation is a key driver of

interest rates, and there are

already signs of growing

inflation due to lower

unemployment and higher

growth expectations.


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INFLATION (CONT.)

The Federal Reserve accelerated a

quarter point interest rise in the first

quarter of 2017, escalating expectations of

more increases in the future.


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CHANGE IN RATES

While the anticipated

change in rates is not

too onerous,

it is going to be an

adjustment for many

borrowers who have

not experienced this

type of rate increase in

over a decade.


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CHANGE IN RATES (CONT.)

Rising rates will not only

impact the cost to business,

but may affect the ability to

refinance.


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BE PROACTIVE

As an industry, we need to proactively

discuss interest rate protection strategies,

such as swaps, with our borrowers to offset

the potential impact.


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STRESS TESTING

Stress testing of

interest rates on

customers

individually and

portfolios as a

whole will

become a more

critical tool

should these

trends continue.


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RISE IN THE COST OF FUNDS

Along with encouraging

borrowers to hedge interest rate increases,

banks must be mindful of the rise in cost of

funds.


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Pressure to

Raise the

ECR Rates

Commercial clients

Money market

CD.

As banks enjoy the interest

rate hikes, we are seeing

increased pressure to raise

the ECR rates offered to

commercial clients and money

market and CD rates for both

consumer and commercial

clients.

RISE IN THE COST OF FUNDS (CONT.)


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Conclusion


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REFORM FAILURE RAISE UNCERTAINTY

As noted before, the

administration’s

inability to pass

healthcare reform

(although not

necessarily dead

yet) could impact its

ability to:

• Pass meaningful tax

reform.

• Modify trade policies in the

future.


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BANKS SHOULD REMAIN NIMBLE

It is imperative that banks remain nimble and diligent in

monitoring the political climate to respond to changes that

might impact their loan portfolio’s credit risk profile.


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The Credit Risk Council supports

professionals who are responsible for

establishing, maintaining, or carrying

out credit risk management policies.

The council focuses on funded and

off-balance-sheet risk management,

including capital markets activity, and

other forms of credit intermediation

and risk mitigation.

ABOUT RMA’S

CREDIT RISK COUNCIL


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For additional information about

credit risk management,

visit

www.rmahq.org/credit-risk/

LEARN MORE

http://www.rmahq.org/credit-risk/


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political and economic uncertainty in the trump presidency

Economy & Finance