By Dan Wilchins
(Reuters) - Over the past few years, Citigroup Inc has been grappling with an unusual problem - how to incur more U.S. taxes.
The third-largest U.S. bank tried to buy the foundering Wachovia Corp in the fall of 2008 in part because the deal would have brought it more taxable domestic income, a person familiar with the matter said.
In February this year, it agreed to buy a portfolio of about $7 billion in credit card loans to Best Buy Co Inc customers from Capital One Financial Corp - and taxes played a role in the bank's decision to do the deal, Chief Executive Michael Corbat said in March.
Citigroup is even reclassifying overseas profit as money that it might bring back to the United States, an odd move in an era in which many American companies try to keep much of their foreign income abroad to avoid paying higher U.S. taxes on the profits.
The bank is not feeling generous — it is just looking to use up $55 billion of tax credits and deductions, known as deferred tax assets, as of the end of March.
It had accumulated them from losses and foreign tax payments largely during and after the financial crisis. About 95 percent of these future tax benefits are in the United States.
Realizing these benefits over time could be worth some $27 billion to Citigroup today, or about $9 per share for a stock that trades at around $50 a share, according to John McDonald, a veteran bank analyst at Sanford C. Bernstein.
Using all these assets will free up more than $40 billion, about one-third, of the bank's capital. Citigroup could then return more capital to shareholders through stock-boosting moves like share buybacks.
Deferred tax assets arise because U.S. companies have to keep two sets of books - one for the financial markets, and a second for the Internal Revenue Service. The bank recognizes items including costs, such as expected losses on loans, at different times on the two books.
A cost that is on a bank's books for investors, but will not be recognized for tax purposes until later, generates a deferred tax asset. Regulators force banks to use more capital to support these assets, because there is often doubt over whether the assets will be fully realized.
Converting these expected future tax benefits into cash will not be easy for Citigroup. Doubts about the bank's ability to realize its deferred tax assets are baked into its share price, investors said.
Even as the bank in recent years has been consuming deferred tax assets (DTA), it has been creating new ones through expenses like mortgage litigation settlements. The bank's deferred tax assets actually grew by about $3.8 billion in 2012.
"One of my top priorities is to turn that trend around," said Citigroup CEO Corbat at the bank's annual meeting in April.
The bank estimates it needs to earn as much as $112 billion in U.S. taxable income to use all of its deferred tax assets. About $22 billion of the assets must be used within 10 years, but many of the other deferred tax assets will not expire.
Buying U.S. assets would be one way to boost its U.S. taxable income. Like any company, Citigroup primarily looks for deals that make strategic and economic sense, but within that framework it is also on the lookout for transactions that will help it use deferred tax assets.
"We are focused on executing our strategy and any allocation of resources must be in line with that strategy," Citigroup spokesman Mark Costiglio said in a statement. "If those actions also result in aiding the use of our DTA then that is an added benefit."
Other U.S. financial companies have big deferred tax assets as well because of the impact of the financial crisis. Bank of America Corp, for example, has $33 billion of the assets, net of its deferred tax liabilities. But Bank of America has much larger U.S. operations than Citigroup, which makes it easier for it to use these benefits.
For Citigroup, the two most important sources of U.S. taxable income are the credit card business and the investment banking business, in particular corporate bond underwriting and trading and interest-rate trading, said the person familiar with the matter who is not authorized to speak for attribution.
The recent selloff in bonds might help bond trading revenue, because market shifts often spur more trading volume. If the U.S. economic recovery continues, the bank's credit card revenue could grow, too. The improving housing market will also help the bank use or reverse deferred tax assets linked to mortgages.
Some critics who had argued in the past that the bank would have to write down some of the deferred tax assets, because of questions about its ability to earn enough taxable income, said that is less likely now.
"We're no longer in the throes of an economic crisis, and it would be shocking to me if they wrote them down at this stage," said Robert Willens, an accounting analyst who had previously worked for Lehman Brothers. In 2009, Willens said the bank would likely have to write down its deferred tax assets.
(Reporting by Dan Wilchins, additional reporting by David Henry; Editing by Paritosh Bansal, Martin Howell and Richard Chang)