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Big Banks: Embattled, But Getting Bigger

3 October 2014 in Trading Ideas

The recent news flow regarding “Too Big to Fail” banks hasn’t been entirely positive in the context of judging corporate behavior – but there’s also little doubt that the companies’ profit-generating capabilities are in high gear.

Earlier this week, the Wall Street Journal reported that large banks are generating more than $1 billion in revenue by helping hedge funds and other clients cut taxes through a complicated trading strategy called “dividend arbitrage.”1

The technique, which the Journal said is mostly centered in London, lets banks temporarily transfer ownership of a client’s shares to a lower-tax jurisdiction around the time when the client expects to collect a dividend on those shares.


This maneuver, according to the Journal, typically allows a bank’s client to reduce taxes from as much as 30% of the dividend payment to 10% or so – and sometimes to zero. The savings are then divided between the client, bank, and entities that take ownership of the shares.

Bank of America, for instance, estimated that trades aimed at helping clients cut withholding taxes on stock dividends generated $1.2 billion in revenue for the bank between 2006 and 2012, according to the Journal.

However, the Journal also reported that the bank was also just recently questioned about the practice by US regulators regarding the potential legal and reputational risks of dividend arbitrage.

It’s not specifically clear what concerns regulators may have had, but the Journal pointed out that banks’ tax-cutting moves are facing broad criticism, while the Obama administrations is attempting to also crack down on so-called inversion mergers that help companies avoid taxes. Meanwhile, Swiss banks have reined in offshore accounts.

But recent days haven’t exactly elicited high expectations that the federal government is even willing to more closely examine large US banks. The increased scrutiny of dividend arbitrage dovetailed with a recent disclosure by Pro Publica and This American Life that recordings made by a former New York Federal Reserve bank examiner suggested that regulators have been reluctant to confront Goldman Sachs on issues that examiners had with the firm.2

All of this comes amid a heady time for the bottom line of the banking industry as a whole. The Journal recently reported that banks are lending to companies and individuals at the fastest pace since the financial crisis, helping propel profits to near-record levels.3

US banks posted $40.24 billion in net income during the second quarter, the industry’s second-highest profit total in at least 23 years, according to data from research firm SNL Financial, the Journal said. The latest profits are just below the record $40.36 billion recorded in the first quarter of 2013.

The rebound comes even as bank executives say rising costs of regulation are hurting their businesses, according to the Journal.

Banks set aside less money to cover soured loans, helping to boost profits. At the same time, overall loan growth increased at its fastest quarterly pace since the financial crisis, topping $8 trillion in total loans outstanding for the first time since SNL began tracking the data in 1991.

Commercial lending, meanwhile, rose at an annualized 12.6% rate in the second quarter.

The improved financial performance has appeared to contribute to the stocks of large banks. The Too Big to Fail motif has gained 18.7% over the past 12 months. During that same time frame, the S&P 500 is up 17.1%.

Over the past month, the motif is off 1.1%; the S&P 500 has declined 2.6%.

1Jenny Strasburg, “Fed Questions Bank Maneuver to Reduce Hedge Funds’ Dividend Taxes,” wsj.com, Sept. 28, 2014.

2Justin Baer, “New Fed/Goldman Tapes Emerge With Familiar Allegations,” wsj.com, Sept. 26, 2014.

3Robin Sidel and Saabira Chaudhuri, “US Bank Profits Near Record Levels,” wsj.com, Aug. 11, 2014.

  1. Jack
    4 Feb at 8:03 pm

    Interesting article!

  2. mchavez
    8 Feb at 5:03 am



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