After a year of battling the Internal Revenue Service over a complicated tax issue, National City Corp. warned the market Tuesday that it will take a $40 million charge for the first quarter and could take further charges this year if it fails to reach some resolution with tax authorities.
Analysts said the earnings warning, the first of the quarter, relates to an unusual case and so does not herald a widespread new problem for banks.
The charge, which the Cleveland banking company said may knock 7 cents from its per-share earnings for the quarter, is part of an ongoing accounting issue involving interest deductions that National City claimed on corporate-owned life insurance.
Companies sometimes buy whole life insurance containing an investment component for employees, then borrow money from the insurer against the policies in the anticipation of gaining dividends and getting a tax deduction on the premium.
However, in 1999 the IRS told the company that it would disallow $200 million of National City's deductions. In the first quarter of 2000 the company paid taxes and interest attributable to the life insurance, but decided to take the charge only after learning that another corporation lost a trial over a similar case.
"This has certainly been hanging over our heads," said Derek Green, vice president of investor relations at National City. "This charge represents a light at the end of the tunnel. It gets our reserve up to a level where we hope to resolve this."
Other companies that have done battle with the IRS over this issue include Winn-Dixie Stores Inc. and American Electric Power Co.
National City said that the charge should cover the estimated expense of settling the matter with the IRS. But company officials said in a prepared press statement that if a settlement is not reached in negotiations with the IRS, the company would take another $40 million charge this year.
"In a worst-case scenario, it might be another $40 million charge," said Jennifer Thompson, an analyst at Putnam Lovell Securities Inc. "It is unclear how long it will take to work its way through the courts."
Denis Laplante, an analyst at Fox-Pitt, Kelton Inc., said the first-quarter charge is the latest development in National City's battle with the IRS over tax exposure on corporate-owned life insurance. "They disclosed in early 2000 that they had this potential liability," he said. "They took an aggressive stance on the corporate-owned life insurance."
National City's payments covered federal income tax returns from 1990 through 1995. The company is not the only corporation to have tax exposure issues with the IRS over this issue, Mr. Laplante said. "This is all a gray area in terms of tax law."
Executives at National City said they would continue to seek refunds on the $200 million plus interest through litigation. If a court rules in favor of National City, its net income could increase, company officials said.
Ms. Thompson said the charge is not a big surprise, because National City began paying the taxes and interest last year. "I guess what prompted them to take the charge was the unrelated court case," she said.
And the problem is not likely to be a common one, she said. "There aren't too many companies that have corporate-owned life insurance that is a meaningful portion of their earnings."
And Ms. Thompson said she was skeptical that the 7-cent drop in per-share earnings would have a major impact on the company. "It will hit the interest expense line. But most investors will look at this as a one-off event. I'm not sure it would impact valuations."
The news did not inspire a huge selloff. National City shares rose 0.56% Tuesday to close at $27.15. Its 52-week high is $30.31.
Separately, the $89 billion banking company announced several executive changes. William E. MacDonald 3d, a 33-year veteran of the company, was named vice chairman this week. He will succeed Vincent A. DiGirolamo, who has announced his retirement.
This month Michael Gonsiorowski was promoted to executive vice president of National City Bank.