Bramwell’s Lunch Beat: BofA Makes ‘Weird’ Capital Blunder

Pfizer sees tax savings from AstraZeneca deal
Liz Hoffman of the Wall Street Journal reported yesterday that Pfizer Inc.’s nearly $100 billion offer to buy British rival AstraZeneca PLC, if accepted, would allow the pharmaceutical giant to move its official headquarters overseas, saving the company billions in taxes over the next decade.

Company executives were outspoken about how their attempted takeover of AstraZeneca, which was confirmed early Monday, would help Pfizer slash its tax bill, saving $1 billion or more each year by one estimate.

Pfizer would follow in the footsteps of several other US companies that have used foreign deals to establish new legal homes in lower-tax regimes abroad. These transactions, known as “inversions,” require companies to transfer at least 20 percent of their shares to foreign ownership, Hoffman wrote.

A Pfizer inversion would also allow the drug maker to deploy cash accumulated overseas without incurring a hefty US tax bill. And it would relocate largely in name only, keeping its operational headquarters in New York City.

Pfizer paid a 27.4 percent effective tax rate last year, compared with 21.3 percent for AstraZeneca, according to regulatory filings. Every percentage point in tax reduction could add $200 million to Pfizer's net income, Barclays estimated in a note Monday, according to the article.

[Click here to read a Forbes article on Pfizer’s expected deal with AstraZenica.]

Bank of America finds a mistake: $4 billion less capital
Bank of America Corp. said yesterday that it was suspending its share buyback program and a planned increase in its dividend after it discovered flaws in the information it submitted to the Federal Reserve as part of the stress test process, Michael Corkery and Peter Eavis of the New York Times reported.

In a statement, the bank attributed the error to an incorrect adjustment related to the treatment of structured notes assumed in its acquisition of Merrill Lynch in 2009. As a result of the error, the bank said, its capital levels are lower than what it had disclosed to the Federal Reserve. Bank of America must now resubmit its capital plan and suspend planned increases in capital distributions.

According to Corkery and Eavis, Bank of America had planned to buy back $4 billion in stock and raise its quarterly dividend to 5 cents a share from 1 cent. The bank said it would resubmit a capital action plan but warned that it would most likely be less than the one it was just required to suspend, suggesting that investors could expect a smaller dividend increase or stock repurchase plan.

The news represents a blow for Bank of America, which had passed the stress test easily and was given authorization to increase its dividend for the first time since the financial crisis, they wrote.

Particularly concerning for regulators and shareholders, the bank had been making the accounting error for more than four years, potentially inflating its true level of capital during that period. Most recently, it caused Bank of America to inflate a crucial measure of capital by $4 billion, the article stated.

Explaining the BofA error: Debt accounting rule bites again
Michael Rapoport of the Wall Street Journal wrote yesterday that Bank of America’s error in calculating its capital levels is an indirect consequence of an accounting rule that has caused headaches for banks for several years.

The accounting rule that granted banks a “fair value option” forces companies to record “debit valuation adjustments” (DVAs) that repeatedly have distorted their earnings, Rapoport noted.

“Counterintuitively, banks must add to their profits when their debt looks riskier to investors, and subtract from their profits when their debt looks safer,” he added. “It was BofA’s apparent failure to account for those DVAs properly when computing the bank’s capital for regulatory purposes that caused the problem.”

Bank of America properly factored the gains and losses of structured notes like Merrill Lynch’s into its earnings, but regulatory capital excludes unrealized gains and losses – and Bank of America stripped out more of those changes than it should have.

“When making the calculation to get from its capital under accounting rules to its regulatory capital, BofA stripped out ‘unrealized’ changes on those structured notes – i.e., the paper gains and losses on notes it still held,” according to Rapoport. “But the bank also stripped out ‘realized’ losses on structured notes that had matured or been redeemed – and it wasn’t supposed to do so.”

Bank of America’s bad accounting
More on the accounting rule that tripped up Bank of America from Floyd Norris of the New York Times: “That accounting rule, which has been around since 2007, has vexed investors in financial institutions ever since it began to be applied,” he wrote yesterday. “The banks greatly enjoyed it at first because it had the seemingly perverse result of increasing their reported profits – or at least reducing their reported losses – at a time when the banks seemed to be in dire straits in 2008 and 2009.

“Since then, the banks have liked it less because it reduced profits as their chances of survival appeared to increase,” Norris added.

The rule has been criticized so much that the Financial Accounting Standards Board last week tentatively agreed to end that practice at a date to be determined.

“People should not hold their breath. Changes in accounting rules happen at a glacial pace. The board has been discussing this change since 2010,” Norris noted.

Bank of America lost $2.7 million in a maze of accounting
Bloomberg View columnist Matt Levine said he sympathizes a little with Bank of America over the error.

“They totally messed this up and should be made fun of: The people doing your regulatory capital calculations really ought to know how to do regulatory capital calculations!” he wrote. “‘The rules are hard’ is not a good excuse for a $2 trillion bank. But it's a genuinely weird situation: Every bank has unrealized own-credit gains and losses, but big realized losses are less common. And it seems to me that their (wrong!) approach might better reflect economic reality than the correct regulatory capital (and GAAP) approach.

“And, y'know, the Fed missed it too – which I suspect means less that the Fed also independently got this accounting question wrong and more that the Fed did not review Bank of America's capital calculations in any detail. Which is – really weird? Like, the banks and the Fed run independent parallel calculations of the stress tests, getting very different numbers for the banks' stressed capital ratios,” Levine continued. “But they each start with the banks' calculations of their current capital ratios, apparently without too much in the way of checking by the Fed. If the banks get those wrong, the Fed's inputs are wrong too. Don't you feel great about the rigor of the stress tests now?”

Lois Lerner’s lawyer: Holding her in contempt would be ‘un-American’
The lawyer for ex-IRS official Lois Lerner is requesting a chance to plead her case against a planned House vote to hold her in contempt of Congress, John D. McKinnon of the Wall Street Journal reported yesterday.

On April 25, Majority Leader Eric Cantor (R-VA) said in a memo to members that the House of Representatives would vote in May to hold Lerner in contempt of Congress for twice refusing to testify before the House Oversight and Government Reform Committee about the IRS targeting conservative groups. Lerner, who is at the center of congressional investigations, headed the IRS Exempt Organizations division, which handled groups’ applications for tax-exempt status.

Lerner’s lawyer, William Taylor III, said on Monday in a letter to GOP leaders that holding Lerner in contempt of Congress “would not only be unfair and, indeed, un-American, it would be flatly inconsistent with the Fifth Amendment as interpreted by the Supreme Court.”

He cited legal precedents – including some from the McCarthy era, when Congress went after alleged communists – to show that courts have refused to uphold contempt-of-Congress citations against witnesses who decline to testify, citing their Fifth Amendment privilege, according to McKinnon.

Taylor requested “an opportunity to present to the House the reasons why it should not hold Ms. Lerner in contempt.”

US SEC has accounting probes in the works, White says
US Securities and Exchange Commission Chair Mary Jo White is expected to tell lawmakers today that a task force formed last year to police for accounting fraud has launched a series of new investigations, Sarah N. Lynch of Reuters reported yesterday.

“A number of new investigations and inquiries are underway, including matters focused on both traditional and emerging financial fraud issues,” said White in prepared congressional testimony before the House Financial Services Committee, according to the article.

White did not elaborate on what the SEC has been finding, or what defines “emerging financial fraud,” Lynch noted.

During her tenure with the SEC, White has been working to refocus the agency’s Enforcement Division back onto accounting issues – an area that has featured less prominently on the SEC's docket of cases over the past few years as regulators turned their attention to insider trading by hedge funds and financial crisis-era frauds, Lynch wrote.

Part of that renewed focus has centered on an increasing use of specialized technology that can scan public filings for potential accounting abuses.

The sanctity of a tax break
A hodgepodge of religious organizations are siding with the IRS in a case likely to make its way to the US Supreme Court over whether ministers and other clergy can take advantage of tax-free cash to cover housing, Kelsey Snell of Politico wrote yesterday.

The case pits those who say stripping the tax break away would force the feds to decide what counts as protected religion against atheists and others who say the break violates the constitutional separation of church and state.

The IRS won the backing of more than a dozen groups as it defended the exemption before a federal appeals court this month, Snell noted. The appellate court review is expected to take months, but legal experts say the case could find its way to a Supreme Court appeal as early as this year. Jewish, Catholic, Protestant, Muslim, and Hindu organizations are among those seeking to keep the break.

Courts have been grappling with the use of the tax break for more than a decade, but the fight grew heated last November when a federal court judge in Wisconsin struck down the tax break, according to the article. The Freedom From Religion Foundation, which says it represents “atheists, agnostics, and skeptics,” claimed their constitutional rights have been violated because their leaders are not able to claim the exemption.

Quick Links:

  • Now that he’s sentenced, Scott London plans for the future (Going Concern)
  • This off-kilter accounting firm just launched a new website begging to be judged (Going Concern)
  • A misguided approach to tax extenders (Off the Charts)
  • 6 corporate tax extenders get Ways & Means review (Don’t Mess With Taxes)
  • The most expensive tax extenders (Forbes)
  • Tax Geek Tuesday: Tax planning for mergers and acquisitions, part II (Forbes)
  • Toyota’s California Texas two-step’s tax savings for employees too (Forbes)
  • Reform the IRS (The Detroit News)
  • GOP-connected ‘social welfare organization’ sues IRS over illegal targeting in Dallas federal court (The Dallas Morning News)
  • Two SEC commissioners call for stay of conflict minerals rule (Journal of Accountancy)
  • First conflict minerals report filed with SEC (Compliance Week)
  • Companies test money-fund alternatives (Wall Street Journal)
  • Confessions of an indexed-annuity insider (MarketWatch)
  • 5 common money mistakes small businesses make (Business News Daily)
  • Pa. judge upholds sale of widow’s home over $6 tax bill (USA Today)

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