With the turbulence in the credit and equity markets grabbing headlines, community bankers might be tempted to take their focus off the pursuit of tax efficiency. That would be a big mistake because taxes are one of the six drivers of profitability. The other five are net interest margin, noninterest income, noninterest expense, the level of earning assets, and leverage. Most community bankers forget to include tax efficiency.
To understand where your bank stands in the tax-efficiency ratings, it is a good idea to examine the effective tax rate for the community banks nationwide. For our research, we defined community banks as those banks with assets between $100 million and $5 billion and that did not elect Subchapter S status. This includes stock, mutual, and cooperative chartered banks.
High-Performing Banks Boast Lower Tax Rates
Over the past 10 years, high-performing banks—those with return on average equity (ROAE) in the upper 15th percentile of the industry—have steadily become tax efficient. This can clearly be seen in the chart that compares the tax rates of high-performing banks and the industry. Notice that between 1997 and 2000, high-performing banks had a similar average tax rate compared to the average community bank. However, after 2000, tax rates at high-performing banks began a downward slope. (See Figure 1.)
In 1997, high-performing banks had an average tax rate of 31.15% compared with the industry average of 32.26%. By 2006, the tax rate of high-performing banks had dropped to 20.09% compared with the industry average of 30.90%.
This shift suggests that high-performing banks increasingly understood how important it was to be tax efficient as a way to maintain earnings momentum. The industry's average tax burden also declined from 32.26% to 30.90% between 1997 and 2006. Thus, the research suggests that the overall community banking industry has not attempted to be or has not been successful at becoming more tax efficient over the past 10 years.