Tax-Rule Change Fostered Wells Fargo Bid for Wachovia

Last Tuesday, as much of the financial world was reeling from the failure of the $700 billion rescue plan in Congress, the U.S. Treasury Department quietly amended a tax regulation.

Not many people seemed to notice. But Wells Fargo did.
The tax regulation change, intended to promote bank mergers without federal bailouts, ended limitations on tax shelters used to cover losses of a firm that a company acquires. Typically, when a profitable company bought a troubled one, it wanted to shelter its income and profits to be able to absorb its losses.

Originally, the feds found that OK, at least up to a point. Then, last Tuesday, Treasury removed such limits based on the losses of firms a company buys.

Wells Fargo reassessed its intended takeover offer for troubled Wachovia, which then was the bride in a shotgun marriage to Citigroup brokered by the Federal Deposit Insurance Corporation. In that particular wedding, FDIC would have picked up the losses on Wachovia's bad loans using public money.

Had the old tax rule been in place, Wells Fargo would have been able to shelter only about $1 billion a year from Wachovia had it taken over the North Carolina bank. With the change, it appears it could shelter up to $74 billion in profits. No public money would be involved to recoup Wachovia's bad loans.

As the New York law firm of Wachtell, Lipton, Rosen & Katz wrote to clients last week: "In an environment where asset quality concerns are giving potential bank acquirers and investors pause about engaging in acquisitions or supplying badly needed equity capital, these steps are likely to significant enhance the risk/reward calculus by facilitating the deductibility of losses."

So, Wells pounced last week with a counteroffer for Wachovia which sent Citi into a screaming rip. The matter is in court, and the Federal Reserve is trying to get Citi and Wells Fargo to consider a joint split-up of Wachovia.

But the tax rule change is still there. Will anyone else try to use it?