Tax law change benefits Wells

Bank can deduct $74 billion from Wachovia's losses

By David Milstead, Rocky Mountain News (Contact)

Published October 11, 2008 at 12:05 a.m.
Updated October 11, 2008 at 12:34 a.m.

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Photo by Justin Sullivan / Getty Images

Customers use ATM machines outside a Wells Fargo Bank branch in Berkeley, Calif. By buying Wachovia, Wells Fargo is gaining a benefit worth about $20 billion, one tax analyst said.

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Wells Fargo will pay about $12.2 billion for Wachovia, but it's really getting paid nearly $8 billion by the federal government to take the bank for free.

That's because a change in the tax law Sept. 30 will allow Wells Fargo to take roughly $74 billion in tax deductions from Wachovia's losses. Tax analyst Robert Willens estimates the benefit is worth "in the neighborhood" of $20 billion to Wells Fargo.

The Wells Fargo-Wachovia deal cements Wells Fargo's leadership in Colorado, as the combined bank would have roughly 185 offices and about 22 percent of the state's deposits.

For much of the last week, the deal was in doubt as Wells Fargo squabbled with Citigroup over Wachovia's fate.

Federal regulators stepped in Sept. 29 and announced Wachovia's banking operations, but not its securities or mutual-fund businesses, would be sold to Citigroup for $2.1 billion. Citigroup said it would assume $53 billion worth of debt and agreed to absorb up to $42 billion of losses from Wachovia's loan portfolio. The Federal Deposit Insurance Corp. agreed to cover any remaining losses in exchange for $12 billion in Citigroup preferred stock and warrants.

By week's end, however, Wells Fargo stepped up and offered stock worth $15.1 billion for the entirety of Wachovia and said no government help would be needed. (A subsequent decline in Wells Fargo's stock has reduced the value of the deal.)

It was a seemingly small but significant tax policy change in between, however, that explains Wells Fargo's ability to make the purchase. (The change and its effect on Wells Fargo were first reported by The Washington Post.)

On Sept. 30, the day after the Citigroup deal was announced, the Internal Revenue Service reported a change to a tax law that increased banks' abilities to deduct losses of an acquired bank on their tax returns.

Previously, there were limits to the amount of "built-in losses" an acquirer like Wells Fargo could deduct when acquiring a bank like Wachovia. Tax analyst Willens estimates Wachovia's losses could not offset more than about $930 million of Wells' taxable income annually.

The IRS suspended that rule, meaning all Wachovia's losses can now be used by Wells Fargo, meaning its next $74 billion of income is tax-free. (In the four most recent quarters, Wells Fargo had $10.8 billion in pretax income.)

That depended, however, on Wells Fargo buying Wachovia whole. Once Citigroup learned it was being spurned by Wachovia, it launched a flurry of court actions. Citigroup and Wells Fargo spent the week negotiating over carving up Wachovia's branch network into pieces before Citigroup gave up Thursday. (Wells Fargo stock gained 3.9 percent Friday on the news.)

The initial Citigroup deal involved an asset purchase, not a deal to buy the corporation intact, so Citigroup wouldn't have enjoyed the tax benefit. And if Wells Fargo and Citigroup split Wachovia through separate asset purchases, Wells Fargo wouldn't obtain the tax benefit, either.

Wells Fargo declined to comment.

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