It's still early innings for banks making use of deferred tax assets, and for some institutions it's an open question as to whether these tax benefits will ever be fully realized.
DTAs reflect the value of prior losses and can be used to reduce future tax bills. But these assets had been written down by more than $5 billion as of the second quarter. That's substantially less than the $6 billion in writedowns seen a year earlier, but still far above the roughly $200 million in the second quarter of 2008, when large numbers of banks began to rack up losses that put their viability in doubt.
Banks record DTAs to bridge the gap between the way they keep their books and the way authorities assess tax bills. The principal component is the amount set aside for loan losses: provisions count as expenses that reduce net income when they are made, but credit expenses only reduce taxable earnings when loans are charged off, often with a time lag. DTAs also encompass historical losses that can be used to offset subsequent earnings for tax purposes-a factor that became increasingly important due to the recession.
Accounting rules require companies to record valuation allowances against deferred tax assets when it looks as though they'll go unused-for instance, if operating losses and piles of bad debt make it unlikely that a company will earn enough to take advantage of the credits.
It's hard to say exactly when valuation allowances peaked across the industry. Most publicly traded banks appear to report such amounts once annually, at yearend. The fourth quarter total increased from $1 billion in 2007 to a high of $15 billion in 2010, and fell to $13 billion in 2011, according to data compiled by SNL Financial.
Valuation allowances frequently are not associated with firm-wide stress, however. For instance, U.S. Bancorp reported a $51 million allowance at Dec. 31 because of legal factors that could cause some "state and foreign net operating loss carryforwards" to expire unused.
The table on the facing page covers publicly-traded banks that reported valuation allowances at June 30 and posted a negative return on average assets in either the past three years or in the first half of this year. Synovus Financial, which had the second largest valuation allowance at $800 million, or about one third of its tangible equity, is poised for a giant but temporary surge in earnings and capital when it recaptures its allowance, since the reversal would mean a negative tax expense of the same amount. The company, which posted four consecutive quarters of net profits through June 30, has said it expects to recover the allowance once it meets certain criteria, including a return to sustainable profitability. (This issue went to press just before banks began to report third quarter earnings.)
Recoveries of valuation allowances are kind of a sugar high, however, reflecting paper adjustments to a company's accounts, not new tax breaks that deliver real economic relief. Still, they imply an endorsement from auditors that an enterprise whose future profitability had been uncertain has regained its footing, and shares sometimes rally on the news.
Taylor Capital's stock vastly outperformed the rest of the industry in the weeks and months after it announced in January that it had reversed its $73 million valuation allowance, for example. The move drove a 40 percent jump in equity during the fourth quarter, and almost a tenfold increase in earnings per share from the prior three months.
On the other hand, the grim appraisals behind some of the valuation allowances could hold. Capitol Bancorp, which had a $200 million valuation allowance at June 30, filed for bankruptcy protection in August, though it is still striving to preserve its tax assets.