Information on Selected Issues Concerning Banking Activities
Gao ID: GAO-07-593R April 30, 2007This letter responds to Congress's request for information on (1) selected federal expenditures, policies, and programs that affect the U.S. banking industry and (2) certain banking industry trends. These include the savings and loan industry crisis, trade finance, tax policies, and profits and executive compensation. Congress's letter also asked us for information on bank fees; as agreed with Congressional staff, we will discuss this topic in a separate report. On December 11, 2006, we briefed Congressional staff on information gathered during our preliminary work. This letter summarizes and updates the information presented at the briefing.
Since 1996, when we reported that the total estimated cost of resolving the savings and loan industry crisis was $160.1 billion (equivalent to $198 billion in 2006 dollars), there have been limited additional costs associated with litigation expenses; however, our 1996 estimates of tax benefit costs and the interest expense on certain bonds issued to provide financing are consistent with recent Federal Deposit Insurance Corporation (FDIC) and Federal Housing Finance Board data. Litigation costs have arisen from cases against the government regarding both the use of accounting practices by institutions that acquired failing thrifts and the tax benefits associated with certain FSLIC-assisted acquisitions. FDIC data indicate that since 1996, these cases have resulted in judgments, settlements, and related litigation expenses that total $2 billion ($2.1 billion in 2006 dollars). We could not determine the precise extent to which U.S. banks use the Export-Import Bank of the United States (Ex-Im) products because Ex-Im records do not specifically distinguish between banks and nonbank lenders. However, relatively few U.S. commercial banks appear to use Ex-Im products or participate in trade finance. Ex-Im officials and industry participants noted that transactions involving Ex-Im products generally result in high internal administrative costs and low profit margins for banks. However, officials and participants also identified a number of factors that might prompt bank use of Ex-Im products, including risk mitigation through Ex-Im's loan guarantees and insurance and increased liquidity through the sale of certain Ex-Im products in the secondary market. Furthermore, Ex-Im officials and industry participants said that using Ex-Im products offers U.S. banks the opportunity to develop broader relationships with their customers and, in turn, offer them other services. According to IRS data and officials, banks and thrifts use tax deductions, credits, and other provisions that are generally available to all corporations. Treasury considers only one tax provision--the deduction of excess bad debt reserves--a tax expenditure available exclusively to banks and thrifts and estimates revenue losses for this tax expenditure at $10 million in 2007. The profits of U.S. depository institutions have grown over the last 15 years, accompanied by changes in sources of income. The industry's growth in profits has been accompanied by a gradual shift toward greater reliance on noninterest income--investments, fees, and service charges, among other things. Although publicly available information on executive compensation in the banking industry is limited, several studies that we reviewed identified an increase in bank executives' compensation over the past decade, and some generally attributed the increase to the elimination of interstate banking barriers and competitive pressures. The federal banking regulators routinely collect information about salaries and wages at depository institutions, but the information is not specific to the institution's executives.
GAO-07-593R, Information on Selected Issues Concerning Banking Activities
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April 30, 2007:
The Honorable Bernard Sanders:
United States Senate:
Subject: Information on Selected Issues Concerning Banking Activities:
Dear Senator Sanders:
This letter responds to your request for information on (1) selected
federal expenditures, policies, and programs that affect the U.S.
banking industry and (2) certain banking industry trends. These include
the savings and loan industry crisis, trade finance, tax policies, and
profits and executive compensation. Your letter also asked us for
information on bank fees; as agreed with your staff, we will discuss
this topic in a separate report. On December 11, 2006, we briefed your
staff on information gathered during our preliminary work. This letter
summarizes and updates the information presented at the briefing.
The U.S. banking industry encompasses different types of federally
insured depository institutions, including over 8,000 state and
national banks, over 860 savings and loan associations (known as
"thrifts"), and nearly 8,700 federally insured credit unions. Five
federal banking regulatory agencies are collectively responsible for
supervision of the industry: the Federal Deposit Insurance Corporation
(FDIC), the Office of the Comptroller of the Currency (OCC), the Board
of Governors of the Federal Reserve System (the Federal Reserve), the
Office of Thrift Supervision (OTS), and the National Credit Union
Administration (NCUA). During the 1980s, many thrifts experienced
severe financial losses. In response to this crisis, Congress took a
number of steps, including augmenting the Federal Savings and Loan
Insurance Corporation's (FSLIC) insurance fund through the issuance of
bonds and ultimately creating new insurance funds administered by FDIC.
Congress also established new organizations to resolve the failing
thrifts, and incentives were offered for financially healthy banks and
thrifts to take over the troubled ones. These incentives included
certain tax benefits administered by the Department of the Treasury's
Internal Revenue Service (IRS).
Banks engaged in financing international trade may participate in
programs offered by the Export-Import Bank of the United States (Ex-
Im), which helps finance exports of goods and services.[Footnote 1]
Among other things, Ex-Im guarantees loans--including loans made by
U.S. banks--to private companies engaged in exporting and provides
credit insurance.
As discussed with your office, this letter provides information on (1)
the cost of resolving the savings and loan industry crisis; (2) the
extent of U.S. banks' use of Ex-Im products, and factors affecting
banks' use of these products; (3) federal tax deductions, credits, and
other provisions available to banks and thrifts and their use of
transactions that IRS has found to be abusive; (4) trends in depository
institutions' profits and income; and (5) trends in executive
compensation in the banking industry. This letter summarizes these
issues; further details can be found in enclosures II through VI.
To accomplish our first objective, we reviewed relevant past GAO
reports, obtained and analyzed information from FDIC and the Federal
Housing Finance Board,[Footnote 2] and interviewed FDIC officials
regarding costs associated with resolving the savings and loan industry
crisis that have been identified since 1996.[Footnote 3] For the second
objective, we obtained and analyzed available data from Ex-Im on the
trade finance activities of U.S. lenders between 2000 and 2005 and
interviewed officials from Ex-Im and the federal banking regulators. We
also interviewed industry representatives and participants about
changes in trade finance over the past decade and reviewed past GAO
work on various aspects of Ex-Im. For the third objective, we analyzed
IRS data on tax deductions and credits claimed by depository
institutions in 2004--the most recent year for which data were publicly
available--and used Treasury's tax expenditure list to identify tax
expenditures available to banks and thrifts.[Footnote 4] We also
interviewed IRS officials, attended IRS briefings on tax issues
affecting the banking industry, and reviewed relevant past GAO work.
For the fourth objective, we analyzed data from FDIC and NCUA on
profits, retained earnings, and income for depository institutions from
1996 to 2006. We also interviewed officials from the federal banking
regulatory agencies about trends in the data and the potential causes
of these trends. For the last objective, we performed a literature
search for relevant professional or academic papers, articles, or
studies on executive compensation in the banking industry. We reviewed
relevant past GAO work that addressed executive compensation issues in
the credit union industry and results from a recent survey of community
banks on compensation issues. We also reviewed congressional testimony
regarding executive compensation and relevant sections of the Internal
Revenue Code. We conducted this work from August 2006 to April 2007 in
Washington, D.C., in accordance with generally accepted government
auditing standards. See enclosure I for a detailed description of our
scope and methodology.
Summary:
Since 1996, when we reported that the total estimated cost of resolving
the savings and loan industry crisis was $160.1 billion (equivalent to
$198 billion in 2006 dollars), there have been limited additional costs
associated with litigation expenses; however, our 1996 estimates of tax
benefit costs and the interest expense on certain bonds issued to
provide financing are consistent with recent FDIC and Federal Housing
Finance Board data.[Footnote 5] Litigation costs have arisen from cases
against the government regarding both the use of accounting practices
by institutions that acquired failing thrifts and the tax benefits
associated with certain FSLIC-assisted acquisitions. FDIC data indicate
that since 1996, these cases have resulted in judgments, settlements,
and related litigation expenses that total $2 billion ($2.1 billion in
2006 dollars). FDIC's current estimates of realized and future tax
benefits for institutions that acquired failed thrifts generally
correspond with our 1996 estimate of $7.5 billion ($9.3 billion in 2006
dollars) for the total cost of these tax benefits. Specifically,
according to FDIC, through tax year 2005, acquiring institutions have
received approximately $6.51 billion in tax benefits and will receive
an estimated $609.24 million in such benefits in subsequent tax years.
In addition, while the Gramm-Leach-Bliley Act of 1999 changed the
method of determining the annual interest amounts the FHL Banks pay on
certain bonds issued to provide financing to FSLIC, our estimate of the
total interest expense on these bonds remains unchanged.
We could not determine the precise extent to which U.S. banks use Ex-Im
products because Ex-Im records do not specifically distinguish between
banks and nonbank lenders. However, relatively few U.S. commercial
banks appear to use Ex-Im products or participate in trade finance. In
fiscal year 2005 (the most recent year for which Ex-Im could provide
data), U.S. lenders--including both banks and nonbank lenders--
accounted for about $1.8 billion in Ex-Im loan guarantees and over $2
billion in Ex-Im insurance products. However, U.S. lender participation
in trade finance, including Ex-Im programs, has generally been
declining in recent years, and Ex-Im data show that for fiscal years
2000 through 2005, only about 100 U.S. lenders (both banks and nonbank
lenders) participated in Ex-Im programs annually. Trade finance
industry participants noted that most U.S. banks involved in trade
finance are large, money center banks, along with a limited number of
regional and small banks. Ex-Im officials and industry participants
noted that transactions involving Ex-Im products generally result in
high internal administrative costs and low profit margins for banks.
However, officials and participants also identified a number of factors
that might prompt bank use of Ex-Im products, including risk mitigation
through Ex-Im's loan guarantees and insurance and increased liquidity
through the sale of certain Ex-Im products in the secondary market.
Furthermore, Ex-Im officials and industry participants said that using
Ex-Im products offers U.S. banks the opportunity to develop broader
relationships with their customers and, in turn, offer them other
services.
According to IRS data and officials, banks and thrifts use tax
deductions, credits, and other provisions that are generally available
to all corporations. Treasury considers only one tax provision--the
deduction of excess bad debt reserves--a tax expenditure available
exclusively to banks and thrifts and estimates revenue losses for this
tax expenditure at $10 million in 2007. IRS data indicate that the
largest deductions banks and thrifts took in 2004--the most recent year
for which data were available--were for business expenses, such as
interest paid, as well as salaries and wages. The largest tax credits
banks and thrifts claimed in 2004 were for the general business credit
and foreign tax credit. To bypass federal corporate income taxation,
some eligible banks and thrifts also have taken advantage of the option
to elect Subchapter S tax status (companies that elect this option are
referred to as S-corporations). Instead of being taxed directly at the
entity level, an S-corporation's income is passed through to its
shareholders, who are then taxed (as individuals) on their portion of
the corporation's income. As of December 2006, 2,356 depository
institutions, including 31 percent of banks, had elected Subchapter S
status, according to FDIC data. IRS officials also noted that some
banks have participated in tax shelters and transactions the IRS
considers to be abusive. For example, in a January 2007 summary
judgment decision, a U.S. district court ruled in favor of IRS in
disallowing over $9 million in tax deductions associated with a bank's
participation in a certain transaction in 1997 that IRS considered
abusive.[Footnote 6]
The profits of U.S. depository institutions have grown over the last 15
years, accompanied by changes in sources of income. FDIC data indicate
that in 2006, banks and thrifts reported a total of $146 billion in net
income, representing an inflation adjusted 7 percent average growth
rate over the previous 10 years. NCUA data indicate that credit unions,
which are not-for-profit organizations, reported $6 billion in net
income in 2006, representing a 3 percent average annual inflation
adjusted growth rate over the previous 10 years. The industry's growth
in profits has been accompanied by a gradual shift toward greater
reliance on noninterest income--investments, fees, and service charges,
among other things. Since the early 1990s, banks, thrifts, and credit
unions have all experienced an increase in noninterest income relative
to net operating revenue. For example, as of 2003, noninterest income
at banks accounted for 43 percent of net operating revenue, up from 32
percent in 1990.
Although publicly available information on executive compensation in
the banking industry is limited, several studies that we reviewed
identified an increase in bank executives' compensation over the past
decade, and some generally attributed the increase to the elimination
of interstate banking barriers and competitive pressures. Federal
banking statutes limit executive compensation in certain circumstances-
-for example, the compensation of senior executive officers at
significantly undercapitalized institutions. The federal statutes also
place limitations on golden parachute agreements, which generally,
provide executives with significant benefits in the event that the
executives' employment is terminated. The federal banking regulators
routinely collect information about salaries and wages at depository
institutions, but the information is not specific to the institution's
executives.
Agency Comments:
We provided a draft of this report to OCC and FDIC for comment. We also
provided selected portions of a draft of this report to officials at
IRS, the Federal Reserve, OTS, NCUA, the Federal Housing Finance Board,
and Ex-Im for their technical comments. All of the agencies except the
Federal Reserve provided technical comments, which we incorporated
where appropriate.
As agreed with your office, we plan no further distribution of this
report until 30 days from its issue date unless you publicly release
its contents sooner. We will then send copies of this report to
interested congressional committees, the Commissioner of IRS, the
Chairman of FDIC, the Comptroller of the Currency, the Chairman of the
Board of Governors of the Federal Reserve System, the Director of OTS,
the Chairman of NCUA, the Chairman of the Federal Housing Finance
Board, and the Chairman of Ex-Im. We will also make copies available to
others on request. In addition, the report will be available at no
charge on GAO's Web site at http://www.gao.gov.
If you or your staff have any questions on matters discussed in this
report or need additional information, please contact me at (202) 512-
8678 or woodd@gao.gov. Contact points for our Offices of Congressional
Relations and Public Affairs may be found on the last page of this
report. GAO staff who made major contributions to this report are
listed in enclosure VII.
Sincerely yours,
Signed by:
David G. Wood:
Director, Financial Markets and Community Investment:
Enclosure I:
Scope and Methodology:
To provide information on the estimated total cost of resolving the
savings and loan industry crisis and estimated future tax benefits, we
followed the approach for updating the cost estimates presented in our
audit of the Resolution Trust Corporation's 1995 and 1994 financial
statements.[Footnote 7] We reviewed our annual audits of the Federal
Deposit Insurance Corporation's (FDIC) financial statements from 1995
through 2006 to identify information on litigation against the
government for breaches of contract regarding (1) the use of
supervisory goodwill in calculating regulatory capital and (2) tax
benefits associated with Federal Savings and Loan Insurance Corporation
(FSLIC) agreements. We also analyzed data from FDIC on expenses
associated with this litigation, including expense payments made to the
Department of Justice (DOJ), and adjusted these data for inflation
using a gross domestic product price index.[Footnote 8] In addition, we
interviewed FDIC officials about litigation expenses and tax benefits
and analyzed information from FDIC on tax benefits received and
estimated future benefits stemming from FSLIC agreements. We also
examined relevant banking statutes and court rulings. Finally, we
reviewed our past work to identify information on the interest expense
of bonds issued to finance the resolution of failed savings and loan
institutions. We reviewed relevant legislative amendments since 1996 to
identify changes affecting the interest obligation of those bonds. We
also obtained information from the Federal Housing Finance Board on the
interest obligation.
To determine the extent to which U.S. banks use the Export-Import Bank
of the United States (Ex-Im) products, we obtained and analyzed
information from Ex-Im regarding its products used by U.S. lenders.
Specifically, we analyzed Ex-Im's data on loan guarantees and insurance
products for fiscal years 2000 through 2005 and reviewed Ex-Im annual
reports from the same time period. We obtained available information
from Ex-Im on claim payments to guaranteed lenders and insured parties,
as well as recoveries, for fiscal years 2002 through 2006, and
determined the amount of payments made to U.S. lenders. In addition, we
interviewed officials at the federal banking regulatory agencies, Ex-Im
officials, and trade finance industry representatives and participants
about U.S. banks' participation in trade finance, use of Ex-Im
products, and participation in the secondary market for certain Ex-Im
products. We also attended Ex-Im's trade financing seminar. To
determine the reliability of data provided by Ex-Im's data systems, we
reviewed the reliability assessment of the same Ex-Im systems performed
for one of our recent reports and confirmed with Ex-Im officials that
the information obtained remained valid.[Footnote 9] We are confident
that for purposes of describing Ex-Im product authorization levels and
the proportion attributable to U.S. lenders in this report, these data
are similarly reliable.
To identify tax expenditures available exclusively to depository
institutions, we reviewed Treasury's list of tax expenditures and
revenue loss estimates from the President's fiscal year 2008 annual
budget.[Footnote 10] The Congressional Budget and Impoundment Control
Act of 1974 defines tax expenditures as revenue losses due to
provisions of the tax law that allow special exclusions, exemptions,
and deductions from income or provide special credits, preferential tax
rates, or deferral of tax liability.[Footnote 11] Tax expenditures are
revenue losses resulting from tax provisions granting special relief
for certain kinds of taxpayer behavior or for taxpayers in special
circumstances. These provisions could, in effect, be viewed as spending
programs channeled through the tax system and are classified in the
U.S. budget by budget function. We consulted an official in Treasury's
Office of Tax Analysis to ensure that we included all of the tax
expenditures provided exclusively to depository institutions. Also, we
drew on our past work on economic development tax expenditures to
provide perspective on banks' use of these provisions.[Footnote 12] To
identify tax deductions and credits claimed by depository institutions,
we analyzed publicly available tax data from the IRS Corporation Source
Book of Statistics of Income.[Footnote 13] We used data from tax year
2004, the most current year for which the data were available. We
compared deduction and tax credit amounts and ratios for the industry
classifications "All Corporations" and "Depository Credit
Intermediation." To identify Subchapter S-corporation banks and
thrifts, we analyzed data from the FDIC's Statistics on Depository
Institutions. We calculated the number and assets of S-corporation
banks and thrifts for the years 1997 through 2006. We reviewed relevant
public laws related to changes in S-corporation eligibility. We
interviewed Internal Revenue Service (IRS) officials to identify (1)
common tax provisions and strategies used by depository institutions
and (2) any instances for which depository institutions used tax
provisions that IRS considered abusive. We also reviewed relevant IRS
documents and notices as well as a recently decided court case
involving an abusive tax shelter.
To evaluate the profits and noninterest income of depository
institutions, we analyzed aggregate annual call report (banks and
credit unions) and thrift financial report data provided by FDIC and
National Credit Union Administration (NCUA) for 1990 through 2006. We
identified potential causes for trends in the data by interviewing bank
regulators and reviewing their documents and reports.
To identify trends in executive compensation in the banking industry,
we reviewed publicly available research papers from academic
researchers and various Federal Reserve Banks. We reviewed relevant
banking regulations that included limits or controls on certain
executive compensation in the banking industry as well as sections of
the Internal Revenue Code and Securities and Exchange Commission (SEC)
regulations regarding limits on the deductibility of and disclosure
requirements for executive compensation. We also interviewed officials
at the federal banking regulatory agencies and banking industry
representatives about executive compensation issues. We did not review
annual proxy statements of 10-K annual reports or other filings that
may contain information on executive compensation made by companies
with securities registered with SEC, because they do not necessarily
distinguish the salary information of executives associated with a
company's depository institution from that of executives associated
with other parts of the organization.
We conducted this work from August 2006 to April 2007 in Washington,
D.C., in accordance with generally accepted government auditing
standards.
Enclosure II:
Developments in Costs Associated with Resolving the Savings and Loan
Crisis Represent Limited Changes to Estimated Total Cost:
Developments in litigation associated with resolving the savings and
loan industry crisis resulted in limited changes to the $160.1 billion
($198 billion in 2006 dollars) total cost we estimated in
1996.[Footnote 14] In 1996, we determined that these costs, which were
associated with litigation against the government (called supervisory
goodwill litigation) regarding contracts with institutions that
acquired failing thrifts, were uncertain. FDIC data indicate that since
1997, $1.34 billion ($1.39 billion in 2006 dollars) has been paid for
judgments and settlements in these cases. FDIC reports that an
additional $274 million ($276 million in 2006 dollars), has been paid
in judgments and settlements in separate litigation (called Guarini
litigation) against the government for breaches of contract regarding
benefits associated with acquiring institutions' tax benefits. In
contrast to this change, FDIC's estimates of tax benefits related to
FSLIC agreements generally correspond with estimates we made in 1996.
Similarly, while the Gramm-Leach-Bliley Act of 1999 changed the method
of determining the annual interest amounts the Federal Home Loan Banks
(FHL Banks) pay on certain bonds issued to provide financing to FSLIC,
the total annual interest payments made by the FHL Banks and other
sources correspond with the $2.6 billion in annual expense that we
reported in 1996.
Costs Associated with Supervisory Goodwill and Guarini Litigation
Represent Slight Increases to Total Estimated Costs:
FDIC data on judgments and settlements associated with litigation that
arose from cases against the government regarding the use of accounting
practices by institutions that acquired failing thrifts and tax
benefits associated with certain FSLIC-assisted acquisitions, represent
a limited increase to the $160.1 billion ($198 billion in 2006) total
cost that we estimated in 1996. FDIC data indicate that from 1997
through January 2007, institutions that acquired failed thrifts were
paid $1.34 billion ($1.39 billion in 2006 dollars) in judgments and
settlements have been paid in litigation against the government
involving the use of favorable accounting treatment for intangibles,
such as goodwill, in calculating regulatory capital.[Footnote 15]
Supervisory goodwill is an accounting measure that refers to the excess
of a purchase price over the fair value of all identifiable assets
acquired. Upon FSLIC's insolvency, the Federal Home Loan Bank Board
(FHLBB), the former thrift industry regulator, embarked on a
forbearance program to induce new investors to purchase or merge with
failed thrifts. The program not only permitted the acquiring
institutions to count supervisory goodwill toward their reserve
requirement, it also allowed acquiring institutions to amortize
goodwill over many years, up to a 40-year maximum.[Footnote 16] The net
effect of including supervisory goodwill was avoiding the need for the
regulator or the failed institution to transfer tangible assets or cash
to cover the deposit accounts transferred in the transaction.
Several institutions that had entered into agreements with the
government that allowed the use of goodwill, which came to be called
supervisory goodwill, brought suit against the government after
legislative changes eliminated the use of supervisory goodwill in
calculating the amounts of capital that regulators require the
institutions to maintain (referred to as regulatory capital standards
or requirements). Specifically, in 1989, Congress enacted FIRREA,
which, among other changes, mandated new regulatory capital accounting
for depository institutions and provided for the elimination or rapid
phase-out of the use of supervisory goodwill in calculating the
regulatory capital of depository institutions.[Footnote 17] FIRREA also
provided the director of the new thrift industry supervisor, the Office
of Thrift Supervision (OTS), with the authority to take certain actions
against institutions not in compliance with the new capital
standards.[Footnote 18] In 1990, OTS issued guidance indicating that it
was applying the new capital standards to all savings associations,
including those that had been operating under previously granted
capital and accounting forbearances, including supervisory
goodwill.[Footnote 19] As a result, acquiring institutions that had
agreements with the government became subject to OTS-imposed sanctions
under FIRREA for failing to meet the minimum capital requirements.
Plaintiffs subsequently brought suit against the government alleging
breach of contract. In United States v. Winstar Corp., the Supreme
Court held that the government was liable for damages to the acquiring
institutions for breach of contract.[Footnote 20] In the damages phase
of the case, over 120 other claimants who had entered into similar
accounting method agreements with the government, had joined the
original three plaintiffs as of January 7, 1997, in seeking recovery
for contract damages.[Footnote 21] According to FDIC, as of December
31, 2006, there were approximately 26 cases pending against the
government based on alleged breaches of such agreements.
In addition, FDIC data indicate that from 2002 through April 11, 2007,
approximately $274 million ($276 million in 2006 dollars) had been paid
in judgments and settlements in separate litigation regarding tax
benefits that parallels the supervisory goodwill cases. Like the
goodwill cases, the tax benefits involve agreements between investors
and thrift regulators in the context of acquiring failing thrifts. In
the tax benefit litigation--called Guarini cases, after the legislation
that established the relevant tax provisions--the plaintiffs entered
into agreements with FSLIC, providing that the regulators would
reimburse them for the losses that they sustained when disposing of
certain assets that they acquired in the transaction. Under provisions
of the tax law then in existence that were specifically applicable to
FSLIC, the acquirers could take advantage of the losses and were not
required to include the FSLIC reimbursement in calculating their
income.[Footnote 22] A provision of the Omnibus Budget Reconciliation
Act of 1993--popularly referred to as the "Guarini legislation"--
eliminated the tax deductions for these covered losses.[Footnote 23]
According to FDIC, as of April 2007, all of the Guarini cases have been
adjudicated and associated payments made; however, additional claims
for attorney costs are still pending.
Costs associated with supervisory goodwill and Guarini litigation also
involve expenses incurred by DOJ. Because the supervisory goodwill and
Guarini lawsuits are against the United States, DOJ defends the
government. According to FDIC data, since 1998, approximately $374
million ($427 million in 2006 dollars) has been paid to DOJ in
litigation expenses.[Footnote 24]
Estimated Cost of Tax Benefits and Interest Expense on REFCORP Bonds
Remain Unchanged:
FDIC's estimates of the tax benefits received by institutions that
acquired failing thrifts under certain FSLIC assistance agreements
generally correspond with the $7.5 billion ($9.3 billion in 2006
dollars) we estimated in 1996 (including $3.1 billion that had already
been realized through December 31, 1995). According to FDIC, through
tax year 2005, institutions that acquired failed thrifts received
approximately $6.51 billion in tax benefits associated with FSLIC
assistance agreements, and approximately $609.24 million remain in tax
year 2006 and future benefits. Tax benefits included treating
assistance paid to an acquiring institution as nontaxable and, in some
cases, reducing the tax liability of the acquiring institution by
carrying over certain tax losses and tax attributes of the troubled
institutions.[Footnote 25] The effect of these special tax benefits was
to reduce the amount of FSLIC assistance payments.
Similarly, our estimates of the interest expense associated with
certain bonds used to help finance resolution of the savings and loan
crisis have not changed.[Footnote 26] These bonds were issued by the
Resolution Financing Corporation (REFCORP) and the Financing
Corporation (FICO). Congress established REFCORP by the enactment of
FIRREA in 1989 primarily to provide funds for RTC, which was created
during the savings and loan crisis as a means of liquidating insolvent
institutions. Beginning in 1989, REFCORP issued six series of 30-and 40-
year bonds with fixed coupon rates. From the proceeds of these bonds,
REFCORP purchased a special domestic series of long-term, zero- coupon
bonds issued by Treasury that are pledged to pay the principal amount
of the REFCORP bonds. The zero-coupon bonds are the primary source for
repaying of the principal of the obligations at maturity. FIRREA also
provided that if REFCORP income from other sources was insufficient to
pay the interest due on the bonds, the FHL Banks would be required to
annually contribute up to $300 million. FIRREA further provided that
the U.S. Treasury would cover any interest shortfall between the total
interest on REFCORP bonds and the FHL Banks contribution. In 1987,
Congress also created the FICO as a financing mechanism for FSLIC. FICO
provided funding for FSLIC-related costs by issuing bonds to the
public.[Footnote 27]
Section 607 of the Gramm-Leach-Bliley Act of 1999 (GLBA) revised the
obligations of the FHL Banks to pay annual interest payments on REFCORP
bonds, from approximately $300 million annually to 20 percent of the
FHL Banks' annual net earnings, after deducting certain
expenses.[Footnote 28] To ensure that the FHL Banks pay their entire
obligation, GLBA requires the Federal Housing Finance Board, which
oversees the FHL Banks, to determine annually the extent to which the
value of their aggregate payments under the 20 percent regime exceeds
or falls short of an annuity of $300 million per year, commencing on
the issuance date of the REFCORP bonds and ending on the final
scheduled maturity date of those bonds.[Footnote 29] According to the
Federal Housing Finance Board, as of March 2007, the FHL Banks had paid
approximately $6.2 billion in interest payments on REFCORP bonds.
REFCORP's 2006 financial statements and reports indicated that $2.6
billion was paid in interest on REFCORP's long term obligations in 2005
and 2006. Annual interest expenses will continue through maturity of
the REFCORP bonds in the years 2019, 2020, 2021, and 2030.
Enclosure III:
Relatively Few U.S. Commercial Banks Appear to Use Ex-Im Products or
Participate in Trade Finance for Various Reasons:
Because Ex-Im records do not specifically differentiate banks from
nonbank lenders, we could not determine precisely the extent of bank
participation in Ex-Im's programs. In fiscal year 2005 (the most recent
year for which Ex-Im could provide data), U.S. lenders--including both
banks and nonbank lenders--accounted for about $1.8 billion in loan
guarantees, $2.4 billion in insurance products, and $1.1 billion in
working capital guarantees. However, U.S. lender participation in trade
finance has generally declined in recent years, and some evidence
suggests that Ex-Im programs are used by relatively few banks. Trade
finance industry participants noted that most U.S. banks involved in
trade finance are large, money-center banks, along with a limited
number of regional and small banks. Ex-Im officials and industry
participants noted that transactions involving Ex-Im products generally
result in high internal administrative costs and low profit margins for
banks compared with other bank product lines. Nevertheless, officials
and participants identified a number of other factors that might prompt
banks to use Ex-Im products, including risk mitigation through Ex-Im's
loan guarantees and insurance, and increased liquidity through the sale
of certain Ex-Im products in the secondary market. Furthermore, Ex-Im
officials and industry participants said that using Ex-Im products
offers U.S. banks the opportunity to develop broader relationships with
their customers and, in turn, offer them other services.
Ex-Im's mission is to help U.S. companies create and maintain American
jobs by financing exports of goods and services and filling gaps in the
availability of commercial financing for creditworthy export
transactions.[Footnote 30] Ex-Im also helps American exporters meet
government-supported financing competition from other countries so that
American exports can compete for overseas business on the basis of
price, performance, and service. To accomplish its mission, Ex-Im
offers a variety of financing instruments, including the following:
* Loan guarantees and direct loans for buyer financing. Under its loan
guarantee program, Ex-Im agrees to guarantee loans made by other
lenders to help buyers in other countries obtain financing to purchase
U.S. exports. Guarantees are offered to qualified lenders, primarily
commercial banks.
* Export credit insurance. This product protects U.S. exporters against
nonpayment by their customers. Ex-Im provides this insurance either
directly to exporters, or to banks that in turn, finance U.S.
exporters.
* Working capital guarantees for pre-export financing. Ex-Im guarantees
to working capital lenders making loans to U.S. companies who would
like to export but need funds to produce or market their goods or
services for export.
These guarantees and insurance programs reduce some of the risks
involved in exporting by insuring against commercial or political
uncertainty. Given Ex-Im's mission of encouraging U.S. exports, Ex-Im
officials and trade finance industry representatives and participants
commented that the role of lenders--including U.S. banks--in
transactions involving Ex-Im products is that of an intermediary.
Data Indicate That a Small Number of U.S. Lenders Participate in Ex-Im
Programs:
Ex-Im data that we obtained on lenders participating in Ex-Im
transactions did not specifically differentiate banks from nonbank
lenders. Further, the data did not consistently provide lender domicile
information (indicating whether or not the lender was a U.S.-
headquartered lender) until fiscal year 2000; accordingly, we confined
our analysis to data for fiscal years 2000 through 2005.[Footnote 31]
As shown in figure 1, Ex-Im data indicate that a fairly small number of
U.S. lenders--generally around 100 annually representing both banks and
nonbank lenders--participated in its programs. Nevertheless, this small
number of U.S. lenders constituted a majority of Ex-Im's top lenders
since fiscal year 2000.
Figure 1: U.S. Percentage of Total Ex-Im Lenders, Fiscal Years 2000-
2005:
[See PDF for Image]
Source: GAO analysis of Ex-Im data.
[End of figure]
Ex-Im officials attributed the problems in identifying lenders within
Ex-Im data primarily to consolidation within the banking industry. They
noted that in Ex-Im's software systems a lender and its subsidiaries
could each be coded as individual lenders, making comparisons over time
difficult. However, according to the officials, Ex-Im is undertaking a
multiyear program to reengineer and automate its primary business
processes--including short-and medium-term export insurance and loan
guarantees--through an online computer system.[Footnote 32]
Ex-Im data show that while U.S. bank and nonbank lenders represented
the largest percentage of Ex-Im's top lenders, their participation
level in terms of lenders and authorizations varied among the products.
Specifically, participation in the loan guarantee and insurance
programs significantly declined while the working capital guarantee
program saw increased participation. Figure 2 provides authorization
levels for Ex-Im products from fiscal years 2000 through 2005.
Figure 2: U.S. Participation in Ex-Im's Products, Fiscal Years 2000-
2005:
[See PDF for Image]
Source: GAO analysis of Ex-Im data.
[End of figure]
It is important to note that these loan guarantee and insurance
programs are credit programs, and the amounts shown in the figure do
not necessarily represent costs to Ex-Im or the U.S. government. Ex-
Im's loan guarantee and insurance programs essentially reimburse
guaranteed lenders and insureds in the event of an eligible
default.[Footnote 33] According to Ex-Im officials, low rates of
default on its loan guarantees and insurance claims, and a high rate of
recovery on assets involved in these products, have resulted in
generally low costs in Ex-Im programs. Figures 3 and 4 illustrate
claims paid to guaranteed lenders and insureds and recoveries from
fiscal year 2002 through 2006, respectively.[Footnote 34]
Figure 3: Ex-Im Claims Paid to Guaranteed Lenders and Insureds, Fiscal
Years 2002-2006:
[See PDF for Image]
Source: GAO analysis of Ex-Im data.
[End of figure]
Figure 4: Ex-Im Recoveries, Fiscal Years 2002-2006:
[See PDF for Image]
Source: Ex-Im data.
Note: According to Ex-Im officials, the recovery figures include
repayments of claims that were rescheduled under the Paris Club, an
informal group of creditors that meets, as needed, to negotiate debt
rescheduling and relief efforts for public or publicly guaranteed
loans, The large amount in fiscal year 2006 was the result of one
country prepaying its Paris Club debt, which was $592 million of the
total.
[End of figure]
In 2006, Ex-Im's chairman testified before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs that the overall loss rate
throughout Ex-Im's history has been less than 2 percent. Further,
information that we reviewed on Ex-Im's program subsidy rate from
fiscal year 2001 to fiscal year 2007 indicated a general downward
trend.
Although U.S. Banks' Involvement in Trade Finance Appears Limited,
Banks May Use Ex-Im Products for a Variety of Reasons:
According to Ex-Im and Office of the Comptroller of the Currency (OCC)
officials and trade finance industry representatives, U.S. bank
involvement in trade finance is limited and has generally declined in
recent years. Nevertheless, they noted several factors that prompt
continuing bank involvement in trade finance transactions and in Ex-Im
programs. Ex-Im officials and trade finance industry representatives
noted that most U.S. banks involved in trade finance are large, money
center banks, along with a limited number of regional and small banks.
OCC officials said that only a small group of OCC-supervised banks
participate in international lending, comprising large banks and some
institutions located along the U.S. border. According to FDIC
officials, FDIC supervises fewer than 10 institutions that hold more
than 25 percent of their capital in trade finance activities.
Ex-Im officials and trade finance industry representatives and
participants described several factors that had contributed to a
decline in U.S. bank participation in trade finance, including the
industry's continuing consolidation activity and increased competition
from nonbank lenders and foreign banks. According to Ex-Im officials,
U.S. bank participation in trade finance has declined over the past 25
years. Additionally, an OCC official noted that lending survey data
indicate that the trade finance activities of U.S. banks remained
relatively stable over the past decade, decreased during the late
1990s, and increased near the end of 2005.[Footnote 35] A
representative of a U.S. trade finance industry association said that
the association membership had decreased by one-half. Ex-Im officials
and industry experts noted that competition from nonbank entities and
foreign banks was also a contributing factor to the decline in U.S.
bank participation in trade finance. Other factors cited included
capital requirements and competition from foreign banks. One Ex-Im
official posited that under the Basel Capital Accord, the capital
requirements for assets involved in emerging markets could have caused
U.S. banks to move out of medium-and long-term trade financing
activities into lines of business requiring lower capital.[Footnote 36]
Furthermore, according to the official, European banks are subject to
the same requirements but achieve greater operational efficiency in
trade finance transactions because of the borders of European countries
are closer and the countries have a much larger volume of trade
financing. The Ex-Im official also noted that foreign bank
participation in trade finance also increased as they began providing
services to corporate customers in the United States through their U.S.
correspondents.
Ex-Im officials and industry participants noted that although trade
finance transactions are associated with relatively high administrative
costs and low returns, they can also foster relationship banking, help
mitigate risk, increase liquidity, and thus prompt U.S. bank
involvement. Ex-Im officials and a trade finance participant
characterized bank returns on transactions involving Ex-Im products as
low relative to other business lines and noted that these transactions
typically involved high labor and administrative costs. Ex-Im officials
explained that trade finance generally is not the key profit-making
business line for banks relative to other business lines and, as a
result, banks approach it as a vehicle for relationship banking--that
is, as a way to offer additional services to customers.
Banks also use Ex-Im products to reduce risk associated with
uncertainty about overseas buyers and increase liquidity through a
secondary market, according to Ex-Im and trade finance industry
participants. Ex-Im officials indicated that Ex-Im's guarantees of
commercial loans to international buyers of U.S. capital goods and
services protect lenders against nonpayment due to commercial and
political events. Through these medium-and long-term guarantees, Ex-Im
covers 100 percent of the loan principal and interest.[Footnote 37] Ex-
Im officials also indicated that their export credit insurance policies
limit lenders' exposure to country and credit risks. A trade industry
participant explained that if a country's creditworthiness is a concern
or the country has not provided for defaults and other contractual
disagreements in law, the use of an Ex-Im product can be the deciding
factor in a bank's willingness to help a new or existing customer.
Enclosure IV:
Banks and Thrifts Lower Their Federal Taxes Primarily by Using Tax
Deductions, Credits, and Other Provisions that Are Generally Available
to All Corporations:
According to IRS data and officials, banks and thrifts use tax
deductions, credits, and other provisions that are generally available
to all corporations. Treasury considers only one tax provision--the
deduction of excess bad debt reserves--to be a tax expenditure
available exclusively to banks and thrifts and estimates revenue losses
from this tax expenditure at $10 million in 2007. IRS data from 2004--
the most recent year with available data--indicate that the largest
deductions that banks and thrifts took were for business expenses, such
as interest paid and salaries and wages, while the largest tax credits
they claimed were the general business credit and foreign tax credit.
To bypass federal corporate income taxation, some eligible banks and
thrifts have also taken advantage of the option to become S-
corporations, which pass their income through to shareholders, who are
then taxed as individuals on that income. As of December 2006, 2,356
depository institutions, including 31 percent of banks, had elected
Subchapter S status, according to FDIC data. IRS officials also noted
that some banks have participated in tax shelters and transactions the
IRS considers to be abusive.
Banks and Thrifts Receive Few Industry Specific Tax Expenditures:
Like other corporations, banks and thrifts use general corporate tax
deductions, credits, and other tax provisions to lower their federal
income taxes. Some of these tax provisions are considered tax
expenditures. Tax expenditures result in forgone revenue for the
federal government due to preferential provisions in the tax code, such
as deductions, credits, and deferral of tax liability. These provisions
grant special tax relief for certain kinds of taxpayer behavior or for
taxpayers in special circumstances.[Footnote 38] Both the congressional
Joint Committee on Taxation and Treasury annually compile lists of tax
expenditures and estimate their cost. Treasury's estimates are included
as an informational supplement to the annual federal budget.[Footnote
39] Tax expenditures are considered exceptions to the normal structure
of the individual and corporate tax base. Determining whether an
individual provision should be characterized as a tax expenditure is a
matter of judgment about what should be included in the income tax
base. The income tax base includes most corporate deductions for
general business expenses which reflect costs of earning income.
In the President's fiscal year 2008 annual budget, Treasury lists only
one tax expenditure that is available exclusively to banks and thrifts-
-the deduction of excess bad debt reserves.[Footnote 40] Commercial
banks, mutual savings banks, and savings and loan associations with
less than $500 million in assets may generally deduct additions to bad
debt reserves in excess of actually experienced losses. This tax
expenditure will cost $10 million in revenue losses in 2007, according
to Treasury's estimates.[Footnote 41]
In addition to the one tax expenditure available exclusively to banks
and thrifts, other tax expenditures result when banks invest in certain
specific activities, including certain school improvements and the
economic development of low-income communities and economically
depressed areas. The tax credit for qualified zone academy bonds--whose
proceeds are used to renovate or improve schools in low-income school
districts--is available only for banks, insurers, and other
corporations in the business of lending money.[Footnote 42] Banks also
use economic development tax expenditures such as the new markets tax
credit (NMTC) and the empowerment zones and renewal communities (EZ/RC)
tax benefits.[Footnote 43] As investors in these community development
projects, banks can claim the tax credits and lower their tax
liability.[Footnote 44] The communities benefit from the increased
investment. Banks and other regulated financial institutions made up 38
percent of total NMTC claimants through 2006 and also accounted for the
majority of the investment funds.
Banks and Thrifts Use Tax Deductions and Credits That Are Available to
All Corporations:
Like other corporations, banks and thrifts lower their tax liability by
claiming tax deductions and credits. IRS categorizes banks, thrifts,
and similar institutions as depository credit intermediation
corporations. As shown in table 1, IRS data indicate that depository
credit intermediation corporations represent 0.55 percent of total
receipts for all corporations and 2.67 percent of total income taxes
paid by all corporations. These calculations are based on IRS data for
the 2004 tax year, the most recent year for which data are publicly
available.
Table 1: Tax Deductions, Credits, and Payments for Depository Credit
Intermediation Corporations Compared with All Corporations, 2004.
All tax returns (with and without net income).
Total receipts[A];
All corporations (Dollars in millions): $22,711,864;
Depository credit intermediation (Dollars in millions): $125,388;
Depository credit intermediation as a percentage of all corporations:
0.55.
Deductions;
All corporations (Dollars in millions): -$21,636,156;
Depository credit intermediation (Dollars in millions): -$108,474;
Depository credit intermediation as a percentage of all corporations:
0.50.
Adjustments[B];
All corporations (Dollars in millions): -$218,316;
Depository credit intermediation (Dollars in millions); +$684;
Depository credit intermediation as a percentage of all corporations:
N/A.
Taxable income;
All corporations (Dollars in millions): $857,392;
Depository credit intermediation (Dollars in millions): $17,598;
Depository credit intermediation as a percentage of all corporations:
2.05.
Tax rate;
All corporations (Dollars in millions): =35%;
Depository credit intermediation (Dollars in millions): 35%;
Depository credit intermediation as a percentage of all corporations:
[Empty].
Income tax before credits;
All corporations (Dollars in millions): $299,555;
Depository credit intermediation (Dollars in millions): $6,197;
Depository credit intermediation as a percentage of all corporations:
2.07.
Tax credits;
All corporations (Dollars in millions): -$75,120;
Depository credit intermediation (Dollars in millions): -$200;
Depository credit intermediation as a percentage of all corporations:
0.27.
Total income tax;
All corporations (Dollars in millions): $224,435;
Depository credit intermediation (Dollars in millions): $5,997;
Depository credit intermediation as a percentage of all corporations:
2.67.
Source: IRS, Statistics of Income Division, Corporation Source Book of
Statistics of Income, Publication 1053 (Washington, D.C.: 2004.
[A] Total receipts equal the amount of gross receipts and other forms
of positive income before deductions.
[B] Includes constructive taxable income from related foreign
corporations, statutory special deductions; excludes Interest on
government obligations: state and local, applicable S-corporations,
regulated investment companies, and real estate investment trusts.
[End of table]
Deductions claimed by depository credit intermediation corporations
consist largely of deductions for business expenses.[Footnote 45] As
shown in table 2, IRS data indicate that in 2004, these corporations
claimed deductions totaling about $108 billion. The largest deductions
claimed were for interest paid and salaries and wages.
Table 2: Depository Credit Intermediation Corporations Deductions,
2004:
2004 total receipts and deductions.
Depository credit intermediation.
Dollars in thousands.
Total receipts;
$125,387,897.
Deductions: Cost of goods;
$198,898.
Deductions: Compensation of officers;
$2,522,529.
Deductions: Salaries and wages;
$19,400,167.
Deductions: Repairs;
$1,289,065.
Deductions: bad debts;
$3,163,894.
Deductions: Rent paid on business property;
$2,116,502.
Deductions: Taxes paid;
$3,117,885.
Deductions: Interest paid;
$45,422,737.
Deductions: Charitable contributions;
$222,564.
Deductions: Amortization;
$1,133,415.
Deductions: Depreciation;
$4,314,159.
Deductions: Depletion;
$2,427.
Deductions: Advertising;
$1,316714.
Deductions: Pension, profit sharing, stock annuity;
$1,080,607.
Deductions: Employee benefit programs;
$2,406,261.
Deductions: Net loss, noncapital assets;
$1,437,789.
Deductions: Other deductions;
$19,328,600.
Total deductions;
$108,474,210.
Source: IRS, Statistics of Income Division, Corporation Source Book of
Statistics of Income, Publication 1053 (Washington, D.C.: 2004).
[End of table]
As shown in table 3, in 2004, depository credit intermediation
corporations claimed about $199 million in tax credits, the largest
being the general business credit (1.5 percent of total income taxes)
and foreign tax credit (1.1 percent of total income taxes).[Footnote
46]
Table 3: Depository Credit Intermediation Corporations Tax Credits,
2004:
2004 income tax and credits depository credit intermediation.
Total income tax before credits;
$6,196,984.
Tax credits: Foreign tax credit;
$65,267.
Tax credits: Nonconventional source fuel credit;
$20,718.
Tax credits: General business credit;
$95,180.
Tax credits: Prior year minimum tax credit;
$17,248.
Tax Credits: Other tax credits*;
$1,300.
Total tax credit;
$5,997,271.
Source: IRS, Statistics of Income Division, Corporation Source Book of
Statistics of Income, Publication 1053 (Washington, D.C.: 2004).
* Includes qualified zone academy bond credit.
[End of table]
Some Banks and Thrifts Bypass Corporate Income Tax by Electing S-
corporation Status:
FDIC data indicate that in recent years, an increasing number of banks
and thrifts have taken advantage of the option to elect Subchapter S
tax status and therefore bypass federal corporate income tax.[Footnote
47] Subchapter S tax status, which is available to corporations with
less than 100 shareholders, is a common corporate tax structure
appearing in every industrial sector.[Footnote 48] In contrast to
Subchapter C corporations, which pay taxes as a corporate entity, an S-
corporation elects to pass through its income to shareholders.
Corporations that elect Subchapter S status generally are not subject
to federal corporate-level income tax, as Subchapter C corporations
are. S-corporation shareholders are taxed at their individual income
tax rates on their portion of the corporation's taxable income,
regardless of whether they receive a cash distribution. The net effect
of electing subchapter S status is to lower the total amount of tax
assessed on corporate income by avoiding the double taxation of
corporate dividends, as shown in figure 5.
Figure 5: Federal Tax Rates of C-and S-Corporations:
[See PDF for Image]
Source: GAO analysis.
[A] Corporate income tax rate on earnings over $18,333,333.
[B] Maximum tax rate on qualified dividends. Dividends are taxed in the
year they are distributed. Capital gains are taxed when an individual
realizes gains from the sale of an asset, such as a corporate stock.
[C] Maximum individual income tax rate.
[End of figure]
As of December 31, 2006, FDIC and IRS data indicate that there were
2,356 S-corporation banks and thrifts, accounting for less than 1
percent of the total U.S. S-corporation population (based on 2003
data).[Footnote 49] As shown in figure 6, the number of S-corporation
banks and thrifts has grown steadily since 1997, the first year
financial institutions were allowed to elect Subchapter S
status.[Footnote 50]
Figure 6: Number and Assets of Subchapter S Corporations (1996-2006)
Compared to All FDIC-insured Institutions (Banks and Thrifts):
[See PDF for Image]
Source: GAO analysis of FDIC data.
[End of figure]
Banks comprise the majority of Subchapter S depository corporations. As
of 2006, approximately 31 percent of banks have elected S-corporation
status, compared to 7 percent of thrifts. S-corporation banks and
thrifts are generally smaller institutions with average assets of $175
million, but a couple of the largest S-corporation thrifts have over
$10 billion in assets.
Some Banks Have Participated in Tax Shelters IRS Views as Abusive:
According to IRS officials, they have found a number of instances in
which some banks have participated in tax shelters and transactions
that they view as abusive.[Footnote 51] Abusive tax shelters are
generally characterized as transactions that exploit tax code
provisions and reap unintended tax benefits rather than engage in any
meaningful economic activity. By their nature, abusive tax shelters are
varied, complex, and difficult to detect and measure.[Footnote 52]
IRS officials said that some banks have participated in abusive lease-
in/lease-out (LILO) transactions along with other tax
shelters.[Footnote 53] Unlike the traditional lease transactions that
banks and other companies commonly engage in, a LILO is merely a
transfer of tax benefits. Figure 7 illustrates a simplified structure
of a LILO tax shelter. In a LILO transaction, a U.S. taxpayer (i.e., a
corporation) purportedly leases an asset (such as subway trains, power
plants, or sewer systems) from a tax-exempt entity, such as a
municipality or tax exempt organization (shown as A in figure 7).
Because the taxpayer then leases the asset back to the same entity, the
use and possession of the asset is, in substance, unaltered by the
transaction (shown as B in figure 7). The transaction is structured to
eliminate any risk to the U.S taxpayer or the tax-exempt entity. The
U.S. taxpayer benefits from the transaction by claiming tax deductions
for rental payments, transaction costs, and interest income.
Figure 7: Simplified Structure of a LILO Tax Shelter:
[See PDF for Image]
Source: GAO analysis of IRS information.
[End of figure]
One bank's participation in a LILO tax shelter was the subject of a
recently decided court case. The court granted the government's motion
for a summary judgment, upholding IRS's disallowance of over $9 million
in tax deductions in one taxable year resulting from one bank's LILO
transaction. The bank had entered into an $86 million LILO transaction
with a Swedish pulp mill in 1997 involving the lease and sublease of
the pulp manufacturing equipment. As a result of the disallowance, the
bank paid a tax deficiency (including interest) for 1997 in the amount
of $4.6 million.[Footnote 54] The bank filed a notice of appeal on
March 1, 2007.
Enclosure V:
Recent Growth in Depository Institution Profits Has Been Accompanied by
Changes in Source of Income:
Depository institutions have enjoyed strong profits in recent years. In
2006, banks and thrifts reported a total of $146 billion in net income.
Credit unions, which are not-for-profit organizations, reported $5.7
billion in net income in 2006. As shown in figure 8, the profits of
depository institutions have increased since 1990. Over the past 10
years, net income has increased by an average annual inflation-adjusted
growth rate of 7 percent for banks, 8 percent for thrifts, and 3
percent for credit unions.
Figure 8: Profits of Depository Institutions: Net Income for Calendar
Years, 1990-2006:
[See PDF for Image]
Source: GAO analysis of FDIC and NCUA data.
[End of figure]
One measure of profitability is returns on assets--net income divided
by assets. Using this measure, banks are generally more profitable than
thrifts or credit unions. Figure 9 shows how the profitability of these
institutions has changed since 1990. In 2006, returns on assets were
1.27 percent for banks, 0.96 percent for thrifts, and 0.81 percent for
credit unions.
Figure 9: Profitability of Depository Institutions: Return on Assets
for Calendar Years 1990-2006:
[See PDF for Image]
Source: GAO analysis of FDIC and NCUA data.
[End of figure]
According to a Federal Reserve official, the early 1990s (1990-1992)
were a period of relatively low profitability for the banking industry,
in part because the industry was adjusting to new regulatory capital
standards resulting from the Basel Accord. Banks reduced their lending
activities to meet Basel's new capital requirements. In addition,
according to OTS, thrifts were starting to recover from the savings and
loan crisis of the 1980s during the same time period. After 4 straight
years of losses, the thrift industry posted positive net income in
1991, and credit unions were largely able to avoid the financial
turbulence of the early 1990s due to strong growth over the previous
decade.[Footnote 55]
Since 1992, depository institutions have enjoyed steady growth in net
income. Over the past 10 years, average inflation-adjusted annual
growth rates in net income have been 7 percent for banks, 8 percent for
thrifts, and 3 percent for credit unions. According to Federal Reserve
reports, recent profitability is largely attributable to the favorable
financial and economic conditions of the U.S. economy.
Noninterest Income Is a Growing Source of Revenue for Depository
Institutions:
Depository institutions have gradually shifted toward greater reliance
on noninterest income, such as service charges and fees. As illustrated
in figure 10, FDIC and NCUA data indicate that since 1990, banks,
thrifts, and credit unions have all experienced an increase in
noninterest income relative to net operating revenue. For banks,
noninterest income in 2006 accounted for 43 percent of net operating
revenues, up from 32 percent in 1990. At thrifts and credit unions,
noninterest income in 2006 accounted for 34 and 31 percent,
respectively, of net operating revenues, up from about 22 and 15
percent, respectively, in 1990.
Figure 10: Noninterest Income as a Percentage of Net Operating Revenue:
[See PDF for Image]
Source: GAO analysis of FDIC and NCUA data.
Note: Net operating revenue equals net interest income plus total
noninterest income.
[End of figure]
According to federal banking regulators, the increase in noninterest
income is the result of growth in fee-producing banking services and a
relative decline in net interest income. Net interest margins (the
difference between what banks incur to obtain funds and what they earn
through lending) have narrowed over the past decade because of falling
interest rates on bank loans and rising interest rates on bank
deposits. Banks collect noninterest income from the sale of
investments, fees, service charges, and other sources. FDIC reports
that the largest sources of noninterest income for banks are service
charges on deposit accounts and other noninterest income (see figure
11). We were not able to obtain comparable data for thrifts and credit
unions because they categorize noninterest income sources differently.
Figure 11: Commercial Banks Noninterest Income:
[See PDF for Image]
Source: GAO analysis of FDIC data.
[End of figure]
Enclosure VI:
Limited Information Suggests that Executive Compensation in the Banking
Industry Has Increased:
Publicly available information on executive compensation in the banking
industry is limited. Depository institutions are not required to report
compensation for chief executive officers (CEO) separately from overall
compensation for the institution. Banks, thrifts, and credit unions are
required to provide aggregate information on salaries and employee
benefits in quarterly filings of call reports (and thrift financial
reports in the case of thrift institutions).[Footnote 56] However, this
information is not specific to executives and includes all of an
institution's officers and employees--for example, temporary help,
dining room and cafeteria employees, and guards, among others,
including employees of consolidated subsidiaries. One banking industry
association, America's Community Bankers (ACB), conducts annual surveys
of its membership on compensation issues and survey results are
available for purchase.[Footnote 57]
Although publicly available data are limited, over the past decade, a
number of studies that focused on or included information on executive
compensation in the banking industry noted that compensation at this
level had increased and that its composition had changed over the past
decade, especially for CEOs.[Footnote 58] For example, one study
showed, in part, that from 1992 to 2000 total direct compensation for
bank CEOs steadily increased and average direct compensation for bank
CEOs more than doubled.[Footnote 59] A separate study found that prior
to the enactment of the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (Riegle-Neal), many bank CEOs had limited
investment opportunities and, thus, equity-based compensation was not
typically used to motivate bank CEOs to take on risks that could
increase shareholders' value.[Footnote 60] However, after the act was
passed, the equity-based component of CEO compensation increased
significantly on average for the industry.[Footnote 61]
Another paper focused on banks that reported compensation data for CEOs
and at least one additional executive in 1996. This study analyzed the
components of compensation (base pay, annual bonus, deferred
compensation, and the value of options granted) at approximately 300
publicly traded banks. The study found that the structure of
compensation varied significantly across firms, with firm size being
the most important explanatory characteristic, and that larger firms
relied more heavily on annual bonuses, deferred compensation, and
option-adjusted compensation and less heavily on base pay.[Footnote 62]
Another study synthesized various research on CEO compensation. For
example, the study discussed how various papers measured incentives and
how incentives were determined.[Footnote 63] Another study described
research that noted that bank CEOs, on average, received less cash
compensation, were less likely to participate in stock option plans,
and received a smaller percentage of their compensation in the form of
options than CEOs in other industries.[Footnote 64] Finally, one paper
attributed the disparity in compensation to differences between the
banking industry and other industries, rather than to such factors as
banks being subject to more stringent regulation and have significantly
higher leverage.[Footnote 65]
Two researchers attributed the increase in CEO compensation to the
elimination of interstate banking barriers and increasingly competitive
pressures that ultimately affected executive compensation. Before the
enactment of Riegle-Neal, most banks generally could only branch out
across state lines if the host state permitted this practice.[Footnote
66] Additionally, most banks that wanted to branch across state lines
had to establish a bank holding company and, with certain restrictions,
acquire or charter a bank in each state in which they wanted to
operate. One researcher suggested that efforts to hire managerial
talent after some interstate barriers were removed prior to the
enactment of Riegle-Neal led to increases in compensation during the
1980s.[Footnote 67] According to ACB, its 2006 survey of compensation
and benefits indicated that salary increases at community banks
continued to be linked to individual performance, with bonuses tied to
bank performance.
Federal Banking Statutes Establish Limits on Compensation as Part of
Safety and Soundness:
Federal banking statutes limit the compensation of financial
institution executives in certain circumstances.[Footnote 68] For
example, Section 2523 of the Comprehensive Thrift and Bank Fraud
Prosecution and Taxpayer Recovery Act of 1990 provides FDIC with the
authority to prohibit or limit, by regulation or order, golden
parachute payments.[Footnote 69] In general, an executive's employment
contract may include a clause allowing significant compensation if
employment is terminated, and the benefits can include severance pay, a
bonus, or stock options. In addition, the Federal Deposit Insurance
Corporation Improvement Act of 1991 requires the federal banking
regulatory agencies, among other things, to issue standards prohibiting
excessive compensation, fees, and benefits as an unsafe and unsound
practice.[Footnote 70] Furthermore, Prompt Corrective Action (PCA)
authority provides limitations on executive compensation at certain
undercapitalized institutions.[Footnote 71]
Officials of the federal banking regulatory agencies said that the
agencies had addressed compensation issues indirectly through broader
informal and formal enforcement actions that included other safety or
soundness issues. The officials noted that routine bank examinations
generally do not include a review of executive compensation levels.
However, they described other ways of addressing compensation issues:
* OCC officials said that, within the enforcement context, OCC has
issued formal orders addressing excessive compensation concerns. OCC
officials said that they had ordered institutions to develop and
implement appropriate policies to reduce excessive compensation to
directors and officers and notified institutions, in some instances,
that paying compensation or fees to some individuals was an unsafe and
unsound practice and a breach of the individuals' fiduciary duties to
the bank.
* Similarly, FDIC officials said that they had addressed compensation
through informal and formal actions that primarily focused on
capitalization issues at undercapitalized institutions and placed
restrictions on future salaries.
* An OTS official reported that between January 1996 and October 2006,
the regulator issued at least 65 directives (e.g., cease and desist,
supervisory agreements, and PCA directives) regarding the executive
compensation regulations and laws. The official reported that the
compilation of these directives noted no violations of the directives.
* A Federal Reserve official said that the Federal Reserve had not
taken any formal action pursuant to these statutes. Similarly, an NCUA
official reported that the administration had not taken any formal
action (e.g., cease and desist order or civil money penalty) against an
institution based on a violation of laws and regulations regarding
employees benefits, including executive compensation.
Enclosure VII:
GAO Contact and Staff Acknowledgments:
GAO Contact:
David G. Wood, (202) 512-8678 or woodd@gao.gov.
Acknowledgments:
In addition to the contact named above, Phillip R. Herr, Acting
Director; Barbara I. Keller, Assistant Director; Emily R. Chalmers;
Gary Chupka; William W. Colvin; Tonita W. Gillich; Alexandra Martin-
Arseneau; Linda Rego; MaryLynn Sergent; and Anne O. Stevens made key
contributions to this report.
Related GAO Products:
Tax Compliance: Challenges to Corporate Tax Enforcement and Options to
Improve Securities Basis Reporting, GAO-06-851T (Washington, D.C.: June
13, 2006).
Financial Audit: FDIC Funds' 2005 and 2004 Financial Statements, GAO-
06-146, (Washington, D.C.: March 2, 2006).
Export-Import Bank: Changes Would Improve the Reliability of Reporting
on Small Business Financing, GAO-06-351 (Washington, D.C.: March 3,
2006).
Financial Audit: Resolution Trust Corporation's 1995 and 1994 Financial
Statements, GAO/AIMD-96-123 (Washington, D.C.: July 2, 1996).
Overseas Investment: The Overseas Private Investment Corporation's
Investment Funds Program, NSIAD-00-159BR (Washington, D.C.: May 9,
2000).
Banking Taxation: Implications of Proposed Revisions Governing S-
Corporations on Community Banks, GAO/GGD-00-159 (Washington, D.C.: June
23, 2000).
(250311):
FOOTNOTES
[1] First established by executive order in 1934, Ex-Im currently
operates as an independent agency of the U.S. government and is the
official export credit agency of the United States.
[2] The Federal Housing Finance Board oversees the system of 12 Federal
Home Loan Banks (FHL Banks), a government-sponsored enterprise that is
cooperatively owned by member financial institutions, typically
commercial banks and thrifts. The FHL Banks have a role in financing
the costs associated with resolving the savings and loan crisis.
[3] GAO last examined costs associated with resolving the savings and
loan industry's financial difficulties in a 1996 report, GAO, Financial
Audit: Resolution Trust Corporation's 1995 and 1994 Financial
Statements, GAO/AIMD-96-123 (Washington, D.C.: July 2, 1996).
[4] Tax expenditures result in forgone revenue for the federal
government due to preferential provisions in the tax code, such as
deductions and credits. These provisions grant special tax relief for
certain kinds of behavior by taxpayers or for taxpayers in special
circumstances.
[5] Where noted, we have adjusted expenditures for inflation and we
report them in 2006 dollars.
[6] BB & T Corp. v. United States, 2007 WL 37798, slip opinion, No.
1:04CV00941 (M.D. N.C. Jan. 4, 2007). A notice of appeal was filed by
BB & T on March 1, 2007.
[7] GAO, Financial Audit: Resolution Trust Corporation's 1995 and 1994
Financial Statements, GAO/AIMD-96-123 (Washington, D.C.: July 2, 1996).
[8] We used a calendar year, chain-weighted GDP price index. Values
through 2006 are averages of quarterly indexes from U.S. Department of
Commerce, Bureau of Economic Analysis, Survey of Current Business, and
National Income and Product Accounts, as of Jan. 31, 2007. Projections
for 2007 values are from Congressional Budget Office, The Budget and
Economic Outlook, (Washington, D.C., 2007).
[9] GAO, Export-Import Bank: Changes Would Improve the Reliability of
Reporting on Small Business Financing, GAO-06-351 (Washington, D.C.:
March 3, 2006). This report found weaknesses in Ex-Im's data systems
and data for calculating its small business support but concluded that
the overall data were reliable.
[10] Office of Management and Budget, Analytical Perspectives, Budget
of the United States Government, Fiscal Year 2008 (Washington, D.C.,
2007).
[11] Pub. L. No. 93-334 § 3, 88 Stat. 297, 299 (July 12, 1974),
codified at 2 U.S.C. § 622(3).
[12] See GAO, Tax Policy: New Markets Tax Credit Appears to Increase
Investment by Investors in Low-Income Communities, but Opportunities
Exist to Better Monitor Compliance, GAO-07-296 (Washington, D.C.:
Jan.31, 2007) and Empowerment Zone and Enterprise Community Program:
Improvements Occurred in Communities, but the Effect of the Program Is
Unclear, GAO-06-727 (Washington D.C.: Sept. 22, 2006).
[13] IRS, Statistics of Income Division, Corporation Source Book of
Statistics of Income, Publication 1053 (Washington, D.C.: 2004).
[14] GAO/AIMD-96-123. We determined that in 1996, approximately $132.1
billion was provided from taxpayer funding sources and the remaining
$28.0 billion was provided from industry assessments and other private
sources.
[15] The FSLIC Resolution Fund (FRF) is the primary source of payments
for judgments and settlements in Goodwill litigation. The Financial
Institutions Reform, Recovery, and Enforcement Act (FIRREA) abolished
FSLIC after it became insolvent, created the FRF, and transferred the
assets and liabilities of FSLIC to the FRF on August 8, 1989. Today,
the FRF consists of two distinct pools of assets and liabilities: one
composed of the assets and liabilities of FSLIC transferred to the FRF
upon the dissolution of the FSLIC and the other composed of the
Resolution Trust Corporation (RTC) assets and liabilities transferred
upon the dissolution of the RTC. See 12 U.S.C. § 1441a(m)(2). The
assets of one pool are not available to satisfy the obligations of the
other. On July 22 1998, the DOJ concluded that the FRF is legally
available to satisfy all judgments and settlements of the supervisory
goodwill litigation involving supervisory action or assistance
agreements. The FRF is also authorized to draw from an appropriation
provided by the Department of Justice Appropriations Act, 2000, Pub. L.
No. 106-113 § 110, 113 Stat. 1501, 1501A-20 (Nov. 29, 1999), the funds
necessary for the payment of judgments and settlements in the Goodwill
litigation. This appropriation is to remain available until expended.
DOJ determined that nonperformance of these agreements was a contingent
liability that was transferred to the FRF on August 9, 1989, upon
FSLIC's dissolution and advised that the FRF was the appropriate source
of funds for payment of judgments in the Winstar-related cases. See 22
Op. Off. Legal Counsel 141, 1998 WL 1180050 (1998). On July 23, 1998,
the U.S. Department of the Treasury determined, based on DOJ's opinion,
that the FRF is the appropriate source of funds for payments of any
such judgments and settlements.
[16] The financial benefits provided to acquiring institutions
associated with supervisory goodwill are described in United States v.
Winstar Corp., 518 U.S. 839, 848-854 (1996).
[17] Pub. L. No. 101-73 § 301, 12 U.S.C. §§ 1464(t)(3)(A).
[18] Although FIRREA significantly altered many aspects of the thrift
industry, the provision most relevant to this litigation was the
requirement that OTS "prescribe and maintain uniformly applicable
capital standards for savings associations" and the phase-out and
elimination of supervisory goodwill in calculating core capital. 12
U.S.C. § 1464(t). Section 301 of FIRREA provided that failure to
maintain capital at or above the minimum level could be treated as an
unsafe or unsound practice and that substantially insufficient capital
was grounds for appointment of a conservator or receiver. 12 U.S.C. §§
1464(d)(2) and (s)(3) (1990).
[19] OTS, Capital Adequacy: Guidance on the Status of Capital and
Accounting Forbearances and Capital Instruments Held by a Deposit
Insurance Fund, Thrift Bulletin No. 38-2 (Jan. 9, 1990). This guidance
followed an OTS interim final rule establishing uniformly applicable
capital regulations for savings associations, as required by FIRREA. 54
Fed. Reg. 46,854 (Nov. 8,1989).
[20] 518 U.S. 839 (1996).
[21] Plaintiffs in Winstar-Related Cases v. United States, 37 Fed. Cl.
174 (1997).
[22] These agreements allegedly contained the promise of tax deductions
for losses incurred on the sale of certain thrift assets purchased by
plaintiffs from FSLIC, although FSLIC provided the plaintiffs with tax-
exempt reimbursement.
[23] Pub. L. No. 103-66 § 13224, 107 Stat. 312 (Aug. 10, 1993).
[24] The FRF pays the goodwill litigation expenses incurred by DOJ
based on a memorandum of understanding, dated October 2, 1998, between
FDIC and DOJ. DOJ returns any unused fiscal year funding to the FRF
unless special circumstances warrant that these funds be carried over
and applied against current fiscal year charges.
[25] The tax benefit agreements are described in Local America Bank of
Tulsa, v. United States, 52 Fed. Cl. 184, 185 (2002); First Nationwide
Bank v. United States, 49 Fed. Cl. 750, 751 (2001); and Centex Corp. v.
United States, 49 Fed Cl. 691, 693 (2001).
[26] In 1996, we determined that the known interest expense on bonds
issued to finance FSLIC's costs for savings and loans resolutions
totaled $111.8 billion ($138.2 billion in 2006 dollars). Specifically,
we determined that $76.2 billion of the $111.8 billion in total known
interest expense was paid by the taxpayers. We also estimated that
Treasury would incur $209 billion in interest expense associated with
appropriations resulting from legislation enacted to specifically
address the savings and loan industry crisis. This legislation was
enacted during a period in which the federal government was financing-
-via deficit spending--a sizable portion of its regular, ongoing
program activities and operations. We based our estimate of Treasury
interest expense on various simplifying assumptions, including (1) the
entire amount of appropriations used to pay direct costs was borrowed
and (2) appropriations for the FRF and RTC would be financed for 30
years at 7 percent interest, with no future refinancing. For further
information, refer to GAO/AIMD-96-123.
[27] FICO was established by the Federal Savings and Loan Insurance
Corporation Recapitalization Act of 1987, Pub. L. No. 100-86, tit. III,
§ 302, 101 Stat. 552 (Aug. 10, 1987). FICO is a mixed-ownership
government corporation whose main purpose is to function as a financing
vehicle for FSLIC. FICO provided funding for FSLIC-related costs by
issuing $8.2 billion of noncallable, 30-year bonds to the public. The
annual interest obligation on the FICO bonds will continue through the
maturity of the bonds in the years 2017 through 2019. We determined
that the total nominal interest expense over the life of the FICO bonds
will be $23.8 billion. FDIC acts as collection agent for FICO. The
Deposit Insurance Funds Act 1996 (DIFA), Pub. L. No. 104-208, div. A,
tit.II, subtit.G, 110 Stat. 3009-479 (Sept. 30, 1996), authorized FICO
to assess both Bank Insurance Fund (BIF)-and Savings Association
Insurance Fund (SAIF)-insured deposits, and require the BIF rate to
equal one-fifth the SAIF rate through year-end 1999, or until the
insurance funds are merged, whichever occurs first. Since the first
quarter of 2000, all FDIC-insured deposits have been assessed at the
same rate by FICO. Effective March 31, 2006, BIF and SAIF were merged
into the newly created Deposit Insurance Fund (DIF).
[28] Pub. L. No. 106-102 § 607(a), 113 Stat. 1338, (Nov. 12, 1999),
codified at 12 U.S.C. § 1441b(f)(2)(C). In past work, we noted that
this change minimized the financial obligation on the Federal Home Loan
Bank System during periods of relatively low profitability but
increased the total payment when profits increased. See Federal Home
Loan Bank System: An Overview of Changes and Current Issues Affecting
the System, GAO/05-489T (Washington, D.C.: April 13, 2005).
[29] According to REFCORP's December 31, 2006, Report of Independent
Auditors, interest on REFCORP's long-term obligations is funded in the
following order, to the maximum extent each is available: (1) interest
on earnings on REFCORP investments; (2) annually, 20 percent of the FHL
Banks' net earnings after the deduction for the Affordable Housing
Program; (3) FRF proceeds from the sale of assets transferred by RTC;
and (4) Treasury.
[30] First established in 1934, Ex-Im is the official export credit
agency of the United States under the authority of the Export-Import
Bank Act of 1945, as amended, and operates as an independent agency of
the U.S. government. Ch. 341, 59 Stat. 526 (July 31, 1945) (codified at
12 U.S.C. §§ 635, 635a, 635b, 635d to 635h, 635i-3, 635i-5 to 535i-9).
[31] Ex-Im defines a U.S.-domiciled bank or nonbank as one in which the
global parent is headquartered in the United States. According to Ex-
Im, in general, a nonbank lender is a financial institution that
provides banking services without meeting the legal definition of a
bank (i.e., one that does not hold a banking license). Ex-Im also
indicated that nonbank institutions frequently act as suppliers of
loans and credit facilities; however, they are typically not allowed to
take deposits from the general public and have to find other means of
funding their operations, such as issuing debt instruments (e.g., Sears
and American Express).
[32] Ex-Im officials said that the program includes an interface with a
commercial provider of business credit information that would help
resolve problems in identifying lenders that have merged or been
acquired and noted that in June 2006, Ex-Im had implemented the first
phase of the new online system for insurance products.
[33] According to Ex-Im, the agency reimburses after default, subject
to the insured's or guaranteed lender's compliance with terms and
conditions of the policy or guarantee (e.g., timely filing, proof of
export) that make the claim eligible for reimbursement.
[34] These recoveries do not necessarily relate to the claims paid in
the same year.
[35] The Country Exposure Report collects information on the
distribution, by country, of claims on foreigners held by U.S. banks
and bank holding companies. The Federal Reserve, FDIC, and OCC use the
data to determine the degree of risk in bank portfolios and the effect
of adverse developments in particular countries may have on banks or
the U.S. banking system.
[36] The Basel Capital Accord (Basel Accord) is an international
framework for risk-based capital. These risk-based capital
requirements, which were fully implemented by U.S. regulators by 1992,
focused on limiting credit risk by requiring certain firms to hold
capital equal to at least 8 percent of the total value of their risk-
weighted on-balance sheet assets and off-balance sheet items, after
adjusting the value of the assets according to certain rules intended
to reflect their relative risk.
[37] Repayment terms for Ex-Im's medium-term loan guarantees extend up
to 5 years and repayment terms for long-term loan guarantees extend
over 10 years.
[38] Treasury estimates the one tax expenditure available to credit
unions--tax exempt status--to cost $1.4 billion in revenue losses in
2007.
[39] 31 U.S.C. § 1105(a) (16) requires that a list of tax expenditures
be included in the budget.
[40] 26 U.S.C. §§ 585 and 593. Bad debt reserves are an account
maintained by financial institutions and used to offset losses from
foreclosed or uncollectible loans.
[41] Office of Management and Budget, Analytical Perspectives, Budget
of the United States Government, Fiscal Year 2008 (Washington, D.C.:
2007).
[42] See 26 U.S. C. § 1397E(d)(6). Treasury estimates that the 2007
revenue losses from the qualified zone academy bond tax credit are $140
million in aggregate; the share by industry is not available.
[43] See Tax Policy: New Markets Tax Credit Appears to Increase
Investment by Investors in Low-Income Communities, but Opportunities
Exist to Better Monitor Compliance, GAO-07-296 (Washington, D.C.: Jan.
31, 2007) and Empowerment Zone and Enterprise Community Program:
Improvements Occurred in Communities, but the Effect of the Program Is
Unclear, GAO-06-727 (Washington D.C.: Sept. 22, 2006).
[44] Treasury estimates that 2007 tax revenue losses from the NMTC are
$210 million from corporate income taxes, with a total revenue loss of
$810 million (corporate and individual income taxes). The estimated
2007 revenue losses from the EZ/RC tax benefit are $340 million from
corporate income taxes, with a total revenue loss of $1.34 billion
(corporate and individual income taxes). The share by industry is not
available.
[45] Deductions for expenses incurred in earning income are considered
part of the normal tax structure and not tax expenditures.
[46] The general business credit consists of a combination of 27
individual credits for such things as research, low-income housing,
employer-provided child care, and community development. Of these, 26
are considered tax expenditures. The foreign tax credit provides credit
against U.S. income tax for income taxes paid to foreign countries or
U.S. possessions, and this credit is not a tax expenditure.
[47] Special tax rules for S-corporations are not considered tax
expenditures by the Joint Committee on Taxation or Treasury because
they are generally available to any entity that chooses to organize and
operate in the required manner.
[48] GAO, Banking Taxation: Implications of Proposed Revisions
Governing S-Corporations on Community Banks, GAO/GGD-00-159 (Washington
D.C.: June 23, 2000).
[49] The most recently available IRS data on the total number of U.S. S-
corporations is for 2003.
[50] Until 1997, financial institutions were not allowed to elect
Subchapter S status because of the special methods of accounting for
bad debts that were available to them for tax purposes.
[51] IRS issues formal guidance on certain potential tax avoidance
transactions that are referred to as listed transactions. See 26 U.S.C.
§ 6011, 26 C.F.R. § 1.6011-4(b)(2). Taxpayers are required to disclose
their participation in listed transactions. As of March 2007, 31 listed
transactions have been identified and addressed in formal guidance.
[52] GAO, Internal Revenue Service: Challenges Remain in Combating
Abusive Tax Shelters, GAO-04-104T (Washington, D.C.: Oct. 21, 2003).
[53] IRS describes LILO transactions in Revenue Ruling 2002-69, 2002-2
C.B. 760, and a related transaction, known as sale-in/lease-out (SILO),
in IRS Notice 2005-13, 2005-1 C.B. 630. SILO transactions are
structurally similar to LILO transactions, except that in SILO
transactions, the U.S. taxpayer purportedly buys the asset from the tax-
exempt entity. Also, in SILO transactions, the taxpayer claims
depreciation deductions rather than rent expense deductions. According
to IRS officials, many of the banks that participated in LILO tax
shelters also participated in SILO transactions.
[54] BB & T Corp. v. United States, 2007 WL 37798, slip opinion, No.
1:04CV00941 (M.D. N.C. Jan. 4, 2007).
[55] GAO, Credit Unions: Reforms for Ensuring Future Soundness, GAO/
GGD-91-85 (Washington, D.C.: July 10, 1991).
[56] FDIC-insured commercial banks, FDIC-supervised savings banks, and
OCC-supervised noninsured trust companies file consolidated Reports of
Condition and Income (call reports) as of the close of business on the
last day of each calendar quarter. Similarly, every federally insured
savings and loan institution regulated by OTS files a thrift financial
report on a quarterly basis. The specific reporting requirements depend
on the size of the institution and whether or not it has any foreign
offices. The information is extensively used by the banking regulatory
agencies in their daily offsite bank monitoring activities. Reports of
Condition and Income data are also used by the public, Congress, state
banking authorities, researchers, bank rating agencies, and the
academic community.
[57] ACB Compensation and Benefits Survey, America's Community Bankers
(2006). For information on executive compensation issues in the credit
union industry, including results from an industry survey on staff
salaries and a pilot program from NCUA that, among other things,
collected data on credit union executive compensation, see our recent
report, Credit Unions: Greater Transparency Needed on Who Credit Unions
Serve and on Senior Executive Compensation Arrangements, GAO-07-29
(Washington, D.C.: Nov. 30, 2006).
[58] Our review cites a number of professional studies that date back
to the1990s.
[59] Kose John and Yiming Qian, "Incentive Features in CEO Compensation
in the Banking Industry," FRBNY Economic Policy Review, vol. 9, no. 1
(2003). The authors measured direct compensation as the sum of salary,
bonuses, other cash compensation, option grants, and grants of
restricted stock. Overall findings and conclusions included lower pay-
performance sensitivity in the banking industry than in the
manufacturing industry and pay-performance sensitivity of top-
management compensation in banks might be useful input in pricing FDIC
insurance premiums and establishing regulatory procedures in the
banking industry.
[60] Pub. L. No. 103-328, 108 Stat. 2338 (Sept. 29, 1994) (amended the
Bank Holding Company Act of 1956, Revised Statues of the United States,
and the Federal Deposit Insurance Act to permit interstate banking and
branching).
[61] Elijah Brewer III, William Curt Hunter and William Jackson III,
"Deregulation and the Relationship Between Bank CEO Compensation and
Risk-Taking," Federal Reserve Bank of Chicago Working Paper, WP 2003-
32, (2003).
[62] Rebecca S. Demsetz and Marc R. Saidenberg, "Looking Beyond the
CEO: Executive Compensation at Banks," Federal Reserve Bank of New York
Staff Report , no. 68, (1999).
[63] John E. Core, Wayne R. Guay, and David F. Larcker, "Executive
Equity Compensation And Incentives: A Survey," FRBNY Policy Review,
vol. 9, no. 1 ( 2003).
[64] Joel F. Houston and Christopher James, "CEO Compensation and Bank
Risk: Is Compensation in Banking Structured to Promote Risk Taking?,"
Journal of Monetary Economics vol. 36, no. 2 (1995).
[65] John and Qian, "Incentive Features."
[66] Riegle-Neal authorized interstate mergers between affiliated banks
beginning June 1, 1997, generally without regard to state law unless
both states had opted out before that date.
[67] R. Glenn Hubbard and Darius Palia, "Executive Pay and Performance:
Evidence from the U.S. Banking Industry," Working Paper Number 4704,
National Bureau of Economic Research, (1994).
[68] The Internal Revenue Code also establishes limitations on the
deductibility of executives' compensation at publicly held companies,
including banking organizations. 26 U.S.C. § 162(m). In addition,
section 403 of the Sarbanes-Oxley Act of 2002 (Pub. L. No. 107-204, 116
Stat. 745 (July 30, 2002)) requires insiders (defined as officers,
directors, and 10 percent shareholders) to file with SEC reports of
their trades before the end of the second business day on which the
trade occurred. This provision applies to grants of stock options, a
key form of executive compensation. Before the enactment of Sarbanes-
Oxley, disclosure of option grants was not required until 45 days after
the end of the fiscal year. SEC rulemaking and a Financial Accounting
Standards Board directive contain certain disclosure and accounting
requirements for executive compensation.
[69] Pub. L. No. 101-647, tit. XXV, § 2523, 104 Stat. 4859, 4868-4870
(Nov. 29, 1990), 12 U.S.C. § 1828(k).
[70] Pub. L. No. 102-242 § 132(a), 105 Stat. 2236, 2267-2270 (Dec. 19,
1991), 12 U.S.C. § 1831p-1(c). Among other things, Prompt Corrective
Action (PCA) requires regulators to prescribe safety and soundness
standards related to noncapital criteria. According to OCC officials,
PCA directives are not formal enforcement actions, and most include a
provision regarding restrictions on future salaries, fees, and
dividends to prevent a future drain on capital.
[71] 12 U.S.C. § 1831o.
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