In IRS Ruling, an Acquirer Window of Opportunity? Many See Tax Benefit on Losses Spurring Distressed-Bank Deals

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Byline: Bonnie McGeer

There is no telling how long the Internal Revenue Service will keep in place a new tax change aimed at encouraging bank acquisitions, so banking lawyers are advising their clients to hurry up and deal.

The change, which allows buyers to shelter their own earnings from taxes using an acquired bank's losses, is already considered to have played a role in one big deal -Wells Fargo & Co.'s agreement to buyWachovia Corp. for $15.1 billion- and many industry watchers say they expect it to spur much more consolidation.

Some even suggest that it could effectively mute the impact of new accounting rules that bankers had said would discourage them from doing deals.

"We think this is massively significant," Neal J. Curtin, co-head of the financial institutions and regulatory practice at the law firm Bingham McCutchen LLP, said of the tax change. "It makes an acquisition of a company with questionable assets a much more attractive proposition."

Before the IRS issued its notice Sept. 30, the built-in loss a buyer could use to offset future income after an acquisition was capped at 5% of the purchase price a year for a five-year period. That limit has been removed for banks, thrifts, industrial loan companies, and trust companies, meaning strong institutions have more of an incentive to buy weaker ones, said Jeffery Harte, an analyst at Sandler O'Neill & Partners LP.

The great unknown is whether the IRS means for the change to be temporary or permanent. There is also the possibility that Congress could intervene. Some lawmakers have questioned whether the Treasury can make such a change and expressed concern that the government could lose billions of dollars in taxes.

The notice from the IRS - quietly issued the day after the House initially rejected President Bush's $700 billion economic rescue plan - had no effective date and no expiration date.

The notice said that it could be relied upon "unless and until" additional guidance is issued, which lawyers say leaves open the possibility that this tax benefit could be modified or reversed later. (When contacted Friday, Treasury would only repeat the wording in the notice, with no further elaboration.)

In a commentary to help explain the notice to its clients, the law firm Jones Day said it would expect any future changes to apply on a prospective basis only. But given that a bank acquisition normally takes three to six months to get regulatory approval, it urged those that want to take advantage of this tax benefit to "accelerate" their plans.

Jones Day estimates that the industry could save up to $140 billion in taxes just on bad housing loans.

Any losses in loan portfolios and investment securities in an acquired bank would count toward tax savings for a buyer, as long as it is making a profit itself.

Jones Day also said that the notice appears to apply even to transactions that have already taken place, meaning that buyers with eligible losses could get a tax refund for at least the past few years.

Most observers agree that the tax break helped Wells to outbid Citigroup Inc. for Wachovia, but it remains to be seen how it might affect consolidation among smaller banks.

Some bankers say the tax break would not be enough to encourage a healthy community bank to buy a troubled one.

"In the community bank space you typically don't see 'Bank A' pick off 'Bank B' when they are weak," said Ron Farnsworth, the chief financial officer of the $8. …