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TESTIMONY OF
DAVID C. COOKE
DEPUTY TO THE CHAIRMAN
FEDERAL DEPOSIT INSURANCE CORPORATION
WASHINGTON, D.C.
ON
TAXATION AND ASSISTANCE TRANSACTIONS
BEFORE THE
SUBCOMMITTEE ON TAXATION AND DEBT MANAGEMENT
COMMITTEE ON FINANCE
UNITED STATES SENATE
9:30 a.m.
March 28, 1988
215 Dirksen Senate Office Building
EXECUTIVE SUMMARY
FDIC's purpose in testifying is twofold:
(1) Reemphasize the need to help the FSLIC enhance its insurance fund by
asking that Congress extend tax provisions for financial assistance
transactions and reorganizations of troubled thrift institutions by the FSLIC
that now expire 12-31-88.
(2) Ask that Congress extend these provisions to comparable transactions of
FDIC.
Enactment of these provisions should result in a yearly reduction in budget
outlays for the FDIC of between $435,000,000 and $870,000,000.
FDIC insures deposits in over 14,000 commercial and savings banks nationwide.
Record bank failures in the last few years have placed stress on the banking
system. FDIC attempts to reduce bank payoffs, in which the bank is
permanently closed, by giving direct assistance to keep a bank from failing or
by finding a purchaser to buy the failed bank's assets and assume its
liabilities.
The FSLIC tax provisions that should be extended to the FDIC include:
(1) Section 597 Assistance payments are not included in income and no
reduction of basis of assets transferred is required.
(2) Section 368(a)(3)(D)(ii)
assistance transactions.
(3) Section 382(1 )(5)(F)
failed banks.
Tax free reorganization status is allowed for
Allows preservation of net operating losses of
Important results to the FDIC from extending these provisions to the FDIC
include:
(1) Reduction of confusion in the tax treatment of FDIC assistance to
prevent bank failures and to sell banks after they have failed.
(2) Reduction of cost of such transactions to the FDIC and in FDIC outlays,
thus preserving the insurance fund.
(3) Ensure continuation of banking services in all communities, and enhance
stability in the banking system.
In closing, mention the consolidated return issue now facing the FDIC, in hope
that it can be addressed.
Good morning, Mr. Chairman and members of the Subcommittee.
I am David
Cooke, Deputy to the Chairman of the Federal Deposit Insurance Corporation
("FDIC").
I appreciate the opportunity to testify today on an issue of
importance to this nation's federal deposit insurance funds.
My appearance here today is for two purposes.
First, I urge the
Congress to extend the tax provisions governing the tax treatment of financial
assistance transactions and reorganizations of troubled thrift institutions by
the Federal Savings and Loan Insurance Corporation ("FSLIC").
working diligently to solve the serious problems it faces.
The FSLIC is
The stability of
our financial system and public confidence in that system requires that every
effort be made to minimize the cost to the FSLIC insurance fund.
Extending
these tax provisions will provide a significant benefit for the FSLIC as it
proceeds with its important task.
Second, I also recommend that those same provisions be extended to
comparable transactions of the FDIC.
Extension of these provisions to the
FDIC will eliminate present confusion concerning the tax treatment of these
transactions and permit the FDIC to more effectively perform its role in the
financial system.
This can be done, we believe, while producing a net
positive impact on the budget due to the reduction in outlays for the FDIC.
The FDIC was established by Congress in 1933 for the primary purpose of
restoring public confidence in banks by establishing a system of federal
deposit insurance.
The FDIC fund currently insures the deposits of millions
of Americans in over 14,000 commercial and savings banks.
The FDIC has served
the nation and this nation's bank depositors well throughout the 55 years of
its existence.
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We now are facing the greatest challenge in the history of the FDIC.
During 1987, 184 banks failed and 19 more required assistance in order to stay
open.
This is the greatest number of bank failures and assistance
transactions in any single year since the FDIC began operation.
The record
184 failures in 1987 eclipsed the prior record of 138 bank failures in 1986,
which was up from 116 in 1985.
These numbers are in clear contrast to an
average of about 10 closings per year throughout most of the post-World War II
period.
The FDIC is experiencing another record or near record year in 1988
and does not foresee a significant reduction in its responsibilities in the
foreseeable future.
Let me briefly explain the FDIC's role in a bank failure.
The
determination of whether an insured bank is insolvent is made by the
Comptroller of the Currency in the case of national banks and by the state
banking authority in the case of state chartered banks.
Typically, after such
a determination has been made and the bank is closed, the FDIC is appointed
receiver for the failed bank.
When a bank's failure is imminent, the FDIC must consider how it will
discharge its obligations as both the insurer of the bank's deposits and the
likely receiver of the failed bank.
Although the response of the FDIC to each
possible bank failure has its own unique characteristics, there are generally
three categories of alternatives available.
First, the FDIC can consider
direct financial assistance to keep the bank from failing.
This approach is
available only if the Board of Directors of the FDIC finds that the assistance
required is less costly to the FDIC fund than any other alternatives available
to the FDIC or that continued operation of the bank is essential to provide
adequate banking service in the community.
When financial assistance is
- 3 provided to keep a bank open, outside investors usually join with the FDIC in
recapitalizing the bank to insure its continued viability.
The second alternative available to the FDIC is a direct payoff of the
insured deposits.
receiver.
In this situation the bank is closed and the FDIC is named
The depositors are paid off up to the $100,000 limit of insurance
protection and the institution is liquidated.
Depositors above the insurance
limit are paid, to the extent possible, only after the failed bank's assets
are liquidated.
A variation of a direct payoff is when insured deposits are
transferred to another bank which acts as paying agent for the FDIC.
A direct
payoff is the least desirable, and usually most costly, alternative.
It
results in an interruption of vital banking services to the community served
by the failed bank.
In addition, because the failed bank's main office and
branches are permanently closed, virtually all of the failed bank's employees
lose their jobs.
The third and most prevalent alternative is a "purchase and assumption"
transaction.
Under this alternative, which can be structured in several ways,
a healthy bank assumes all of the failed bank's deposit liabilities, including
uninsured deposits, and agrees to acquire some or all of the failed bank's
assets.
The assuming bank receives an infusion of cash from the FDIC to make
up the difference between the value of the assets and the liabilities
assumed.
The current FDIC policy is to try to arrange, wherever possible,
so-called "whole bank" transactions where the assuming bank acquires all of
the assets of the failed bank, including the bad loans.
- 4 A new temporary solution now available to the FDIC is a "bridge bank."
In this case, the FDIC can operate the failed institution, for up to three
years, until a buyer can be found.
Under current law, these various categories of assistance transactions
have uncertain, but significant, tax consequences.
The Congress has
under consideration an extension of several tax provisions which apply to
financial assistance payments and reorganizations of failed or failing thrift
institutions by the FSLIC.
December 31, 1988.
These provisions are scheduled to expire
The FDIC strongly supports legislation to either extend
or make permanent those provisions for the FSLIC.
The FDIC performs a role with respect to the banking sector that is
comparable to the FSLIC's responsibilities relative to the thrift industry.
Like the FSLIC, the FDIC now faces serious stresses due to the record volume
of bank failures.
Thus, to the extent that the Congress extends the FSLICs
tax provisions, the FDIC recommends that these same provisions be made
applicable to the FDIC.
We believe that extending these provisions to the FDIC would have
important and positive ramifications for the FDIC, the banking system and the
nation.
The provisions would reduce the confusion relating to the tax
treatment of FDIC assistance, thus facilitating the most efficient resolution
to a bank insolvency.
They would reduce the cost of assistance and purchase
and assumption transactions, thereby helping to preserve the insurance fund.
The resulting increased use of assistance or purchase and assumption
transactions would enhance the stability of the banking system and help insure
adequate banking services to all communities.
- 5 The FDIC is very aware that cost is an important concern.
Extending
these provisions to the FDIC will have the net effect of reducing the deficit,
because the benefits largely would accrue to the deposit insurance fund.
We
estimate that yearly reductions in FDIC outlays could range from $435 million
to $870 million.
Moreover, while the reduction in FDIC outlays would be
recognized fully at the time of the transaction, any tax revenue cost would be
stretched out over a number of years.
In the final analysis, we believe the
reduction in outlays will exceed whatever tax revenue cost is associated with
these provisions.
Generally, there are three provisions being sought.
The first
provision, Section 597 of the Code, specifically clarifies that FSLIC
assistance payments, whether provided through a note or other instrument,
are not includable in income of the assisted institution.
In addition,
Section 597 provides that no reduction in the basis of assets of the recipient
institution will occur as a result of the receipt of such assistance.
Section 597 was enacted by the Congress in 1981 to clarify the tax
treatment of FSLIC assistance.
Extending the application of Section 597 to
FDIC assistance transactions will eliminate the confusion that often arises
concerning the tax treatment of these transactions.
The law in this area is
unclear and the transactions frequently are complicated.
The FDIC assistance
may be structured in a variety of forms including, but not limited to, direct
cash infusion, the purchase of notes or the purchase of non-voting preferred
stock.
Because these transactions often must be consummated quickly, parties
to the transaction usually assume the worst-case tax result, thus driving up
the cost to the FDIC of rescuing a bank.
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This provision would facilitate purchase and assumption transactions
and interim bridge bank transactions.
These methods of handling bank failures
are highly preferable to closing the bank and paying off the insured
depositors with the concurrent loss of jobs and banking services in the
community.
Moreover, such an approach minimizes the negative impact on public
confidence in the banking system and thus helps stabilize the banking industry.
The second expiring provision, Section 368(a)(3)(D)(ii) of the Code,
provides that a FSLIC assistance transaction may qualify as a tax free
reorganization provided that certain requirements are satisfied.
FSLIC must
certify that the institution is insolvent, that it cannot meet its obligations
currently or that it will be unable to meet its obligations in the immediate
future.
In addition, substantially all liabilities of the failed institution
must be assumed by the acquiring institution.
This section was originally enacted in 1981 to eliminate ambiguity with
respect to the continuity of interest requirements which apply generally to
tax free reorganizations.
It represents a significant benefit to the FSLIC in
merging troubled thrift institutions with healthy thrifts.
If extended to the
FDIC, it would perform a similar beneficial role by significantly improving
prospects for a purchase and assumption transaction in a given case, rather
than a depositor pay-off and liquidation of the failed bank.
The third expiring provision is Section 382(1)(5)(F).
It provides
rules governing the treatment of net operating losses of a failed thrift
institution with deposit liabilities that have been assumed by a healthy
thrift.
As a general rule, current law provides special rules for the
preservation of net operating losses in Chapter 11 bankruptcy situations.
- 7 The rules provided by Section 382(1)(5)(F) make it easier for the receiver of
failed thrift institutions to preserve the failed thrift's net operating
losses and thereby reduce the cost to the insurance fund.
The FDIC would
propose that if these provisions are to be extended, their benefits also be
made applicable to similar transactions by the FDIC.
Mr. Chairman, I would like to raise one additional issue not
encompassed by the FSLIC provisions.
We would like to suggest that the
Congress consider an administrative proposal to facilitate the access of the
FDIC, as the receiver of failed institutions, to tax refunds to which the FDIC
is entitled.
This proposal addresses a problem which arises where the FDIC
becomes receiver of a bank which was previously part of a bank holding company
filing a consolidated federal income tax return.
Under our proposal, the FDIC
would be permitted to seek directly the refund to which it is otherwise
entitled as receiver for the bank by permitting the FDIC to terminate the
consolidation and file for the refund directly.
This would eliminate a
problem frequently faced by the FDIC when the representatives of the holding
company of a failed bank seek refunds which are properly due to the failed
bank and dissipate them before the FDIC can recover the funds.
Mr. Chairman, thank you for allowing me to testify on this issue.
We
are available to provide whatever assistance you require in considering these
proposals.
@FedFRASER