Bank profits surge in first half of 2018: Lower tax rate spurs 26% gain in net income

Local bank profits surged 26 percent during the first half of the year, buoyed by a lower effective tax rate, increases in assets, high fee income and higher interest-rate margins. The increase in net income matched the 26 percent gain reported nationally, according to a BizWest study of mid-year data released by the Federal Deposit Insurance Corp.

Banks based in the Boulder Valley or Northern Colorado recorded profits of almost $52.9 million in the first two quarters of 2018, compared with $42 million in the same period a year ago, with the bulk of the 2018 profits coming from one institution, Bank of Colorado.

The Fort Collins-based bank recorded net income of $37.8 million in the six months ended June 30, or 71.4 percent of the profits recorded by 10 institutions based in the region. That profit was up from $26 million in the first half of 2017.

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“We’re fortunate in Colorado to have a strong economy,” said Shawn Osthoff, president of Bank of Colorado. “I attribute it to the economy and just the growth in assets for all of the local banks.”

Osthoff agreed with an FDIC quarterly profile that attributed some of the increased profits nationwide to benefits derived from the Tax Cuts and Jobs Act of 2017.

A quarterly report from the FDIC shows that banks nationally recorded $60.2 billion in profits in the second quarter, topping the $56 billion in profits from the first quarter. First-half profits of $116.2 billion compared with $92 billion in the first half of 2017, an increase of 26 percent.

Bank profits have been helped by a lower effective tax rate, according to the FDIC report.

Tax reform is one reason that Bank of Colorado converted from an S corporation to a C corporation as of July 1. With an S corp, profits are passed down to individual shareholders, who pay taxes as high as 37.5 percent. With a C corp, the tax rate can be as low as 24 percent for the corporation; however, individual shareholders would still pay individual income tax on any income derived from the corporation.

Overall, Osthoff said, tax reform is “a significant tax savings for most of these banks.”

“The tax savings, for us anyway, were good [even as an S corp],” he added. “It was a positive for us regardless of whether we went to a C corp or not, but it was more advantageous for us to move to a C corp.”

While Bank of Colorado recorded the biggest profits among local banks, other banks based in the region fared well, with all recording profits. Local institutions tracked by BizWest included Advantage Bank, Loveland; AMG National Trust Bank, Boulder; Bank of Colorado; Bank of Estes Park; Cache Bank and Trust, Greeley; Farmers Bank, Ault; First FarmBank, Greeley; Flatirons Bank, Boulder; Points West Community Bank, Windsor; and Verus Bank of Commerce, Fort Collins.

Local banks recorded an average return on assets of 1.46 percent, well above the industry benchmark of at least 1 percent — a traditional standard of bank health.

ROA ranged from 2.3 percent for AMG National Trust Bank, with $4.6 million in net income, to 0.34 percent for Cache Bank and Trust, with $233,000 in profits. Cache Bank doubled its net come from the first half of 2017.

Byron Bateman, president and CEO of Cache Bank, said he focuses on liquidity, rather than chasing margins. While that can lead to lower profitability, he said, it allows the bank to preserve its cash to weather any downturn.

“We drive our business plan with capital and liquidity,” Bateman said. “Most banks, they drive with earnings because they have demand from shareholders. We’re a closely held company, so I don’t have a lot of demands from a lot of shareholders.

“We tend to stay very liquid,” he added.

Bateman said larger banks are able to grow significant loan volume, with larger loans returning higher profits. But if the economy begins to struggle, banks that have focused on chasing those margins through loan volume — and which have built a high loan-to-deposit ratio — will seek to lower their balance sheet.

“A lot of these banks have run their loan to deposits fairly high,” he said. “There’s a lot of jockeying for these deposits.”

By focusing on liquidity, Cache Bank should be well-served if the economy enters a downturn, possibly in the second or third quarter of 2019, he said.

“I think there’s a lot of challenges right now in the national geopolitical environment,” he said, noting that it could put “some heat” on community banks and banking generally.

Focusing on liquidity, he said, “takes stresses and pressure off of shrinking the balance sheet.”

One contributing factor in increasing profitability among the region’s banks has been asset growth, with the booming Colorado economy and population increases. Bank of Colorado’s assets grew to $3.66 billion, up from $3.3 billion as of June 30, 2017, and deposits increased as well. [See related story.]

National and regional banks operating in the Boulder Valley and Northern Colorado also recorded healthy profits. Bank of America, which operates a branch in Boulder, recorded net income of $13.9 billion in the first half of the year, just ahead of JPMorgan Chase’ $13.6 billion.

First National Bank of Omaha, a regional bank with an 11.71 percent market share in Boulder, Broomfield, Larimer and Weld counties, recorded $20.2 billion in assets as of June 30, up from $19.5 billion a year ago. Net income grew to $123.8 million, up 45.6 percent from $85 million through the first half of 2017.

“We’re off to a good start,” said Mark Driscoll, Colorado market president for First National.

“It’s a  combination of things: first, improving margins with the Fed rate increases, plus good healthy loan demand.”

He said interest revenue on loans made by banks has been increasing, especially with loans tied to floating interest rates, “so it helps the margins.”

Net interest margins — the difference between a bank’s interest income and the interest it pays out on deposits, CDs, etc. — has helped drive profitability. As interest rates have increased, banks have been able to charge higher interest rates on loans, but there’s been a lag on what they’ve paid out.

That could be about to change.

Driscoll said that competition for deposits — and depositors demanding higher returns — will shrink net interest margins for banks.

“The depositors have not been getting great rates for a long time,” Driscoll said, adding that a September rate hike by the Fed will largely be passed on to depositors.

“Depositors will ask for and get higher rates, because of competition and increasing rates,” he said.

Driscoll said tax reform has been a boon for the banking sector, but other factors driving profitability include solid credit quality among banks, higher fee income from wealth management and other services, and — up to now — good net interest margins.

“The old saying is, you make money by not losing money,” Driscoll noted, referring to solid loan performance among banks. The key to bank profitability right now is that balance sheets are in good shape, and loan volume is good. It’s a pretty good time for banks right now.”

Osthoff agreed that net interest margins likely will be squeezed in the coming months.

“These deposits are more competitive than they’ve ever been,” he said. “We’re starting to see these deposit rates increase.”

Despite that challenge, both Osthoff and Driscoll predict a good second half of the year.

“The economy in Colorado has been strong, so there’s lots of opportunity for banks to make good loans,” Osthoff said. “The deposit growth has also been good. I think the loan growth has been good.

“I think bank profitability will be very good the second half of the year,” he added, “and we’re looking forward to good profits in 2019 as well.”