When Wells Fargo Bank (WFB) won the right last week to acquire Wachovia Bank, it issued a statement that the acquisition
requires no financial assistance from the Federal Deposit Insurance Corporation or any other government agency.
Ahh, but the catch is in the phrase "financial assistance." Although WFB was not requiring "financial assistance" from "any other government agency" (since changed with the new stock purchase plan ), they did in fact receive non-financial assistance from the Internal Revenue Service in the way of a favorable ruling which would allow WFB and similar acquiring banks to recognize tax losses (of the acquired bank) up front.
Under IRC Sec. 382 corporations are subject to limitations in recognizing pre-acquisition losses (net operating losses as well as unrealized built-in losses) incurred by any corporation they acquire. Such rules are in place to make it less tax beneficial for a corporation to just go around buying up corporations solely for their tax losses with little or no business purpose to the acquisition. The limitations may not preclude a corporation from recognizing all of the pre-acquisition losses of the target company, but it will spread such recognition over a longer period of time.
With loan losses rapidly mounting, but no one really knowing just how to tabulate all those losses, seems "healthy" banks needed more incentive than even Henry Paulson could give them with cash infusion (which had some strings attached.)
Enter the IRS to the rescue. It issued Notice 2008-83 (pdf) on Sept. 29, four days before WFB first announced its plan to merge with Wachovia Bank. The Notice grants exceptions to the Sec. 382 limitations on built-in losses specifically for banks acquiring other banks (in their entirety, not just select assets.)
The key portion of Notive 2008-83 is Section 2, which states -
For purposes of section 382(h), any deduction properly allowed after an ownership change (as defined in section 382(g)) to a bank with respect to losses on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts) shall not be treated as a built-in loss or a deduction that is attributable to periods before the change date.
The rule change was huge for Wells Fargo. Willens said the present-value benefit for the bank is about $20 billion.
"It basically offsets the entire purchase price," Willens said. "They're basically getting Wachovia for nothing."
Wells Fargo, though, can sell its bad Wachovia loans to the federal government and then, using the new IRS rule, write off any losses.
This article includes a timeline showing the merger battle in conjunction with the IRS Notice issuance.
The above figures are for Wells Fargo Bank. Who knows what the total benefit will be when Bank of America and other acquiring "banks" are included, but it could reach $100 billion or more.
If it is true that there are $1 trillion in housing-related losses in the U.S. banking system, and if only $585 billion of them have been taken into account to date, that suggests there may be as much as $400 billion in built-in losses still in the system. At a corporate statutory rate of 35 percent, that suggests a net nominal tax savings potential of something like $140 billion.
Hey, what's another $100 or so billion in taxpayer underwriting of the bank bailout?