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The A/LM Implications of Tax Reform

February 9, 2018

While it could take years to quantify and understand the full impact of the recent Tax Cuts and Jobs Act, it is not too early to start thinking through the potential A/LM implications.  There are several intriguing changes, embedded within hundreds of pages of legislation.  The focus here will be on a few key highlights, including the evaluation of potential opportunities and challenges to credit union financials under new tax reform.

The ALM implications of tax reform legislation for credit unions.

Corporate Tax Rate

Corporations, including banks, are expected to have a lower tax bill going forward.  Since banks are a key competitor of credit unions, this area has the potential to be quite impactful.  Under the new tax reform law, the advantages of having a tax-exempt status will narrow.  What will banks do with the extra profits?  One possibility is to pay shareholders in the form of dividends.  Another possibility is that banks become more competitive.  Perhaps banks will try to increase market share, increase deposit rates, or decrease loan rates, which could create more competition for credit unions on both sides of the balance sheet.  These additional deposit pressures could come at a time when Americans are saving at a 12-year low and the cost of funds is already on its way up, due to increasing market interest rates and liquidity pressures.1

Increased competition in lending could delay the expected increase in loan revenue from a rising rate environment.  The outcome is uncertain but what-if analysis in A/LM modeling can better prepare the credit union for these potential pressures.

Mortgage Interest Deduction

Also under the Tax Cuts and Jobs Act, mortgage interest deductions will be capped at a lower principal balance than in years past.  Many credit unions may not be materially impacted because the new limit is on mortgage principal amounts of $750,000.  However, there are many credit unions in areas that have recently experienced significant appreciation in home prices or are in markets where the median home price is currently close to $750,000.  As a result, there have been several credit unions recently that are keeping a keen eye on their high balance mortgage loans.  There is speculation of potentially higher prepayment speeds on the higher balance mortgages, particularly if the same member has a high-balance deposit account from which to pay down the mortgage loan.  The credit union can begin using its business intelligence to start tracking this information, and likewise consider what-if analysis to determine the impact of accelerated prepayment speeds.

Individual Tax Rate

The impact of lower individual tax rates is extremely difficult to predict.  There are several moving pieces–most notably itemized deductions versus standardized deductions, potentially resulting in an individual paying more taxes.  But if it saves individuals money, the economy could continue to benefit and create a significant opportunity.  Loan growth might accelerate, deposit growth could increase and credit unions could benefit.

Internal discussions surrounding the Tax Cuts and Jobs Act are perfect 180-second exercises for management teams.  Also, testing out the potential balance sheet impacts in the A/LM model is essential to long-term planning.

We will follow up with another blog in a few weeks to discuss other key highlights of the Tax Cuts and Jobs Act.  Stay tuned.


1With Stocks Surging, Americans Are Saving at 12-Year Low, WSJ, 2/08/18.


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