Where oh where, did the Mike Mayo vs Citigroup dispute begin?
The CLSA bank analyst hit headlines last week after Fox Business News revealed Mayo had been “frozen out” by Citi. The reason? None other than Citi’s infamous deferred tax assets (DTAs) :
The analyst, Mike Mayo, of the securities firm CLSA, has been telling investors that Citigroup (C: 3.67 ,-0.08 ,-2.13%) should take a writedown, or a loss on some $50 billion of “deferred-tax assets,” or DTAs. That is a tax credit the firm has on its financial statement that Mayo says is inflating profits at the big bank by as much as $10 billion.
For that critique, Mayo has been denied one-on-one meetings with top players of the firm . . .
And from Mayo’s note to clients, titled “A Matter of Trust” :
“Citi’s deferred tax asset — $50 billion — is more than twice as large as any other US corporation and the largest as a percentage of tangible equity among large banks (39%), but it has not recognized any write-down (or related adjustment) even though most other companies in a similar position (3 years of cumulative losses) have taken write-downs,” Mayo wrote. “This position is further supported by news that the SEC has investigated these issues. In short, the company claims no DTA adjustment is warranted based on its projected earnings over the next couple of decades. More importantly, accounting precedents seem to us to warrant that a write-down is necessary. The stakes are raised since the lack of a write-down could lead to investor lawsuits later on.”
Deferred tax assets, readers of FT Alphaville will know, are basically tax credits that arise after companies take significant losses. It’s a GAAP vs IRS accounting discrepancy, but what’s essential is that in order for DTAs to continue to be valid, and included in regulatory capital, the company has to make enough money to actually use them. If it doesn’t, then it has to take that writedown.
At the end of 2009, Citi had almost $50bn worth of DTAs — of which about $24bn seems to count towards its total Tier 1 common regulatory capital of $105bn. In order to keep all the DTAs, Citi has to prove it can earn enough income ($99bn by some estimates, though the time frame is nebulous). Citi’s auditors and US tax authorities then sign off on the accounts once they’re convinced this will be done.
It’s a sandy form of capital, to say the least, seeing as it relies on a bunch of potential factors. Citi’s 2009 DTAs, for instance, are composed of credit loss deductions, deferred compensation/benefits, restructuring and settlement reserves, unremitted foreign earnings, cash flow hedges, and so on. You can see why Mike Mayo might be of the opinion that one of those many moving parts could fail.
But for an opposing viewpoint you can’t do better than Richard Bove of Rochdale:
The net tax deferred liabilities are just as obtuse. No outsider can hope to guess at the real value of these concepts. Investors either believe that the insiders who prepare and analyze these numbers are doing it correctly or not.
There are a number of groups who have access to these numbers. They include the company, itself, the company’s auditors, the banking regulators, and the IRS. If one assumes that the numbers are manufactured, one must believe that either these observers are incapable of determining the correct information (they have been hoodwinked by the much smarter accountants inside the company) of that they are acting in collusion with each other to defraud the investor.
My assumption is that the outside observers know what they are doing and that they are not in collusion with each other. If this perhaps naïve view is correct then Citigroup’s books are valid.
Regulators certainly know what they are doing, but bear in mind — if they did suddenly make the point of stripping Citi of its DTAs the financial system would be facing something of a problem. Citi would immediately lose about a fifth of its 2009 reported Tier 1 common equity, probably prompting the need for an immediate recapitalisation — and no one (not even the IRS) wants that.
Indeed, the IRS has pretty much been onside in recent Citi DTA controversies. Back in December, the US tax authority exempted Citigroup, and some other bailed-out companies, from rules which would otherwise have led to the troubled bank losing $38bn worth of then-tax credits.
To paraphrase what we wrote then:
The issue here is that these tax credits — Deferred Tax Assets (DTAs) — make up a significant proportion of Citi’s capital. Yanking them because of a change in ownership, one caused by the bank repaying the Tarp no less, would have defeated the purpose of them paying back the Tarp in the first place, and probably ended up costing the US taxpayer more US taxpayer in terms of lost Tarp monies and potential support costs.
Even without IRS or governmental involvement, Citi has some tricks up its sleeve.
Back in early 2009 there was plenty of speculation that selling off assets such as Smith Barney was one way Citi could convince regulators it would generate enough income to make good on the DTAs. Clearly these DTAs are very important to the bank, and it will try to retain them as best it can.
What’s amazing about the Citi-Mayo scandal then, is that revelations over the bank’s use of DTAs are at all surprising at this point — or that they would be enough to prompt the company to cut off communication. Since late 2008, Citi’s DTAs have been criticised ad nauseum. Indeed, Citi’s capital shenanigans helped renew interest in tangible common equity (something Bove, incidentally, dislikes).
Perhaps something has changed to make Citi — or at least Mayo — more nervous.
We would suggest it is the regulatory and legal environment. Basel has already moved to blow out DTAs from banks’ regulatory capital, while rating agencies like Fitch have made worrying noises over the capital fodder. Meanwhile, there’s this little event occurring down in Puerto Rico:
Earlier this month, a U.S. District Court in Puerto Rico rendered an opinion largely against the banking firm of Popular Inc.1 At issue was whether the bank, a publicly-traded bank holding company headquartered in Puerto Rico, violated U.S. generally accepted accounting principles with respect to booking deferred tax assets, and did not fully disclose that its U.S. subsidiary – Banco Popular North America Inc.-was undercapitalized.
So far, the Mike Mayo-Citi DTA blow-up has ended with the bank agreeing to meet Mayo.
Let’s see what happens next.
The DTA dodge – FT Alphaville
The Deferred Tax Asset Disaster – FT Alphaville
Citi and some capital dilemmas – FT Alphaville
The rise of deferred tax assets in Japan – University of Chicago paper (via SSRN)