Banks’ deferred tax assets during the financial crisis

Prior studies have demonstrated that the net deferred tax liabilities of industrial firms are valued by market participants in a manner consistent with an expected net present value. In this study, using a sample of bank holding companies, we address several issues not directly addressed in the prior studies. First, do market participants value a firm’s net deferred assets similarly to how they value net deferred tax liabilities? Second, can a regulatory environment that provides incentives to defer recognition of deferred tax assets impact the valuation of net deferred tax assets? Third, does the valuation of net deferred assets change during an economic downturn? Fourth, can explicit or implicit government guarantees impact how firms’ deferred tax assets may be valued? Using a sample of 433 banks from 2006 to 2010, we find that prior to the financial crisis of 2008 the components of net deferred tax assets of banks, other than those deferred tax assets related to NOLs, were viewed as valuable assets, similar to the deferred tax assets of industrial firms. The coefficient on deferred tax assets related to NOLs is negative throughout the period examined. Also, post-crisis, even the coefficients on the other components of deferred tax assets either became significantly negative or lost any positive association with stock prices, consistent with the assets being viewed primarily as an indicator of bankruptcy risk. We also find that, consistent with a market perception that a too-big-to-fail policy continues to exist, the valuation of large banks’ deferred tax assets is less affected by the financial crisis.