-
Down the line, observers say, if banks do not start minting money, accounting for the assets could actually delay or reduce profits and cut into already tenuous capital levels.
September 21
An increasing number of banking companies are exploring ways around a tax code provision that has constricted past capital infusions.
Outside investment has been stymied by a part of the tax code that restricts the use of certain tax benefits if there is a change in control. Industry observers said the code has impeded several potential recapitalizations, which often result in changes of control.
"This layer of complexity has come much more to the surface in capital raises," said Richard Thornburgh, the vice chairman at the New York private-equity firm Corsair Capital LLC, which invests in banks.
Corsair has evaluated a number of deals over the past year, Thornburgh said, but the restriction has blocked his firm from finalizing "a lot" of bank transactions.
The tax code involves deferred tax assets, which occur when there are discrepancies between a company's financial results and its taxable income. Companies can use such assets to reduce future taxes as long as they report pretax profits.
Certain events, including prolonged periods of reported losses or a change of control, can force banks to remove deferred tax assets from the balance sheet and record a charge to the income statement, industry observers said. An expense item called a valuation allowance may be added if there is uncertainty about realizing the deferred tax assets, which can accentuate losses.
"You don't want to raise capital in a fashion that puts the deferred tax asset in jeopardy," Thornburgh said.
United Community Inc. in Blairsville, Ga., however, was able to work around the tax code, paving the way for a deal in which Corsair is to buy a 22.5% stake in United Community for $380 million. Earlier this month the company's board approved a tax benefit preservation plan for five years to safeguard itself from new or existing shareholders who may violate the tax code.
Since anyone can accumulate shares, the plan was implemented "to alert people so they don't accidently" run afoul of the code, said Rex Schuette, United Community's chief financial officer. Absent the safeguard, "we could have an ownership shift without even issuing capital."
The code is violated when a single shareholder or a combination of shareholders that own more than 5% of a company, as determined by the Internal Revenue Service, boosts ownership by more than 50 percentage points over a rolling three-year period.
This typically excludes certain institutional investors such as mutual index funds with smaller stakes in multiple funds. (Corsair's pending investment in United Community is also considered exempt.)
The preservation plan is especially crucial for banks such as United Community that incurred years of losses and had other capital raises over the past three years.
Tax benefits from deferred tax assets would equate to more earnings once they return to profitability. That helps retained earnings and lifts capital.
"If I lose that [tax benefit], I have to reduce capital," Schuette said.
To investors such as Thornburgh, it means a more valuable company. In the case of United Community, it had about $167 million in deferred tax assets at Dec. 31. The $7.4 billion-asset company had a net operating loss from continuing operations of $143.4 million in 2010 and $139.1 million in 2009.
Thornburgh said United Community's deferred tax assets should eventually generate enough capital to allow the company to repurchase its $180 million in preferred shares from the Troubled Asset Relief Program.
Though difficult to pull off a tax preservation plan due to the complexities of IRS tax codes, a handful of other banking companies have implemented similar programs before raising capital.
Central Pacific Financial Corp. in Honolulu adopted such a plan in November, coinciding with a $325 million capital raise, including $196 million from Carlyle Group and Anchorage Capital Group LLC.
Sterling Financial Corp. in Spokane, Wash., and Anchor BanCorp Wisconsin Inc. in Madison adopted shareholder rights plans in 2010 to protect taxable assets, including deferred tax assets.
Dan Trigg, a partner at McGladrey & Pullen, said several clients have looked into setting up preservation plans, but they are "very easy to stub your toe with" because the tax code "is very rule-driven."
Potential investors want assurances that future tax benefits will remain in place when they become an investor.
The benefit often equates to hundreds of millions in dollars for a community bank over the long run, which is why it has become a critical aspect for groups looking at investments now.
