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1CUNA Mutual Group Proprietary Reproduction, Adaptation or Distribution Prohibited © CUNA Mutual Group
Tax Lunch & LearnCapital Gains & Losses
April 29, 2010
2
DRAFT
Objectives
Financial Statement Impact
Strategies
Partnering
I
III
IV
V
Tax BackgroundII
3
DRAFTObjectivesI
Manage & Reduce Valuation Allowance Risk On Deferred Tax Assets1
Minimize Cash Taxes On 2010 Gains Taking Strategy2
Increase Surplus By Reducing Non-Admitted Deferred Tax Assets3
Utilize Capital Loss Carryovers 4
Goal: Maximize Financial Statement & Economic Returns To CUNA Mutual
4
DRAFT
General Rules
II Tax Capital Gains & Losses
Relevance
Need Sale Or Exchange To Trigger Tax Event – Exception For Certain Worthless Investments
Assets Are “Capital” Unless Explicitly Excluded– Most Investments Are Capital– Exceptions: Certain Tax “Hedges”, Partial Worthlessness, Foreign Exchange
Capital Gains Offset “Ordinary” Losses; Capital Losses Do Not Offset “Ordinary” Income– “Ordinary” Means Business Income– Net Capital Losses Need To Match Capital Gains In Other Periods
More Restrictive Carryover Rules For Capital Losses– Back 3, Forward 5 Years; Versus 3/15 For Ordinary Life Losses In Lifecos (2/20 For Nonlife)– Life / Nonlife Crossover Rules
Unused Losses (Including Unrealized) Are Carried On The Balance Sheet
5
DRAFTDeferred TaxesII
Book Basis > Tax Basis– Future Tax Losses > Book– Future Tax Gains < Book– Examples
• Accelerated Tax Depreciation In Leases
• Market Value > Tax Basis
Deferred Tax Liabilities (DTL)
Non-Interest Bearing– Increase
Condition
Implication
Tax Basis > Book Basis– Future Tax Losses > Book– Future Tax Gains < Book– Examples
• Impairments Not Currently Allowed For Tax
• Decreases In Market Value• Unused Capital Loss
Carryforwards
Deferred Tax Assets (DTA)
Non-Earning– Monetize– Sustain
6
DRAFT
As of 3/31/2010
GAAP
GAAP TAX GAAP-TAX DTA/(DTL)
Fixed Income 6,553 6,901 (348) 122Equities 198 215 (17) 6Derivatives 22 11 11 (4)Limited partnerships 360 435 (75) 26Mortgage loans 718 718 0 0Other 7 0 7 (2)Capital loss C/F 6 (6) 2
7,858 8,286 (428) 150
Asset Class
Total
Deferred Tax Position
III
Interest Rate Risk – Estimate $20-30 Change In Portfolio Value Per 10 bps– 1% Upward Shift Could Create $70-105 Additional DTA
Impairment Risk
$ Millions, Unless Noted
7
DRAFTValuation Allowance
Capital Gains Strategies Reduce Risks
Valuation Allowance Required Unless Utilization >50% Likely–Cannot Assume Credit Losses Will Recover
Valuation Allowance Risks–Additional Impairments–Planning Strategies–Rising Rates
III
Acceptable Proof For Recoverability–Recovery Via Holding To Maturity–Capital Loss Carryback, If Any–Future Capital Gains That Can Be Scheduled To Cover Losses–Technically Sound Strategies (“Prudent and Feasible”, Execution Not Necessary)
Recoverability Demonstrated At 4Q 2009 And 1Q 2010–Extension Losses Covered By Assertion That We Will Hold To Maturity
8
DRAFT“The Calculation”III
Step Action
GAAP View 4Q2010 1Q2010 4Q2009 4/1/2009 1Q2009
Aggregate Unrealized Tax Losses In Portfolio – If Losses < 0, Then Stop1
Unrealized Tax Losses (591) (649) (741) (1258) (1258)1
4Q 2010 Amounts Are Illustrative Only
– Could Be In Income Or Equity5 Record Valuation Allowance
Valuation Allowance (@35%) 0 0 0 29 445
Adjust (Self-Reversing Items, Ordinary, etc.) – If Gains > Losses, Then Stop2
Adjustments 340 340 382 778 734
Unrealized Capital Losses (251) (309) (359) (507) (551)2
Unrealized Capital Gains 226 226 198 98 98
Identify Existing Unrealized Capital Gains – If Gains > Losses, Then Stop3
Remaining Capital Losses (25) (83) (161) (409) (453)
3
Planning Strategies 220 220 220 326 326
Identify Planning Strategies – If Losses > Gains, Then Valuation Allowance4
Excess (Deficiency) 195 137 59 (83) (127)4
$ Millions
(428)
9
DRAFTKey ElementsIII
Restricted List
Partial Worthlessness On Eligible Investments
Unrealized Capital Gains
Planning Strategies
2
2
3
4
10
DRAFTPartial Worthlessness
Cumulative Ordinary Tax Deductions = ~385 (~135 Benefit To Capital DTA)
III
“Ordinary” Deduction Allowed For Certain Assets–Non-Corporate Issuers (e.g. Regular REMIC Interests)–High Certainty (Default Not Required)–To Extent Of Principal Loss (Extension Loss Not Deductible)
Other Considerations–IRS Industry Issue
Character and Timing Benefits–Ordinary Versus Capital–Carryovers–No Need To Be Completely Worthless To Take Tax Writeoff
Cumulative GAAP Impairment: $835M
11
DRAFTStrategiesIV
Potential Transactions–RE-REMIC–Coupon Stripping–Lend Zero Coupon Bonds–Selling Assets In Gain Position–Other
Idea Generation
12
DRAFTMCA/Finance Success
- 2009 CDO SalesV
Conditions
Held 1851 In Impaired CDOs – Tax Benefit For Losses Not In SAP Surplus– Pre-Tax Loss (185) Had Reduced Surplus– Tax Benefit (65) Did Not Increase Surplus Due To Surplus Limit
Appetite To Recognize Capital Gains
1 Cumulative Impairment2 Gain Amount
3 Prior Impairment, Illustration Only - Actual Sale Was 83
Transactions
Results
Sold 703 In Impaired CDOs
Sold 702 In Securities
Cash: No Tax Payment (Gains Offset Losses)
GAAP: 45 After –Tax Gain
SAP: 25 Surplus Increase
Amounts Are Illustrative Only
Accounting Sign Format Sec CDO TotalIncome Statement
Realized Gain 70 0 70Tax (Exp) Benefit (25) 25 0Net Loss Before IMR 45 25 70Transfer To IMR (45) 0 (45)Net Income To 2009 A/S 0 25 25
Balance SheetNet Assets (Cash - Investment) 70 70Increase to IMR Liability
Gain (70) (70)Tax 25 25
Current Tax Payable (25) (25)Tax Receivable 25 25Change To Surplus At 12/31/09 0 25 25
SAP Impact - 2009 CDO/Securities Trade
$ Millions
13
DRAFT2010 PartneringV
Target 2010 Capital Gain/Loss Plan (For Illustration Only)Tax
GAAP Capital Ordinary
Through 1QTrading Gains 20 20 0Derivative Gains 9 0 9Impairments (14) 0 0Subtotal 15 20 9
Forecast 2Q - 4QTrading Gains 20 20 0Derivative Gains 0 0 9Impairments (141) 0 0Subtotal (121) 20 9
OpportunitiesCDO Sales 0 (13) 0
Total (106) 27 18Capital Loss C/F Absorbed (27)Total After C/F 0
$ Millions
Maximize Outcomes– Evaluate & Quantify Potential Strategies– Measured Gains Taking – CDO Dispositions
Better Data
Align Measurement Systems
14
DRAFT
Appendix
15
DRAFTRE-REMIC
Issue Debt (Regular And Residual Interests) Backed By MBS Collateral
Sell Senior Tranche To External Party
Follow Ups–Surplus/Required Capital Impact –Regulatory View–Rating Agency View
IV
Example–Pool MBS
– Worth $100, Book Basis $120, Tax Basis $250 And Par $500
–Issue Debt– Senior $10 2 Year Tranche And Other Tranches– Sell Senior Tranche To 3rd Party
–Tax Impact– Capital Loss – Based On Proportion Of Debt Sold = (100 – 250) * 10% = (15)– Ordinary Deduction – Recognized Proportionately To Retained Debt = (150) – (15) = (135)– Other Considerations
16
DRAFTRE-REMICIV
Assumptions Results - RE-REMIC Results - Sell Assets
Collateral Book Book
Tax Basis 250 Realized Loss -20Book Basis 120Market Value 100
Transaction Near-Term Tax Results Tax
% Financed 10% Realized Capital Loss (Immed.) -15 Realized Capital Loss -150
$ Borrowed 10Ordinary Deductions (Over life of debt) -135
Interest Rate TBDTransaction Costs TBD Future Tax Results
If Retained & Held to MaturityOrdinary Income 150
Depends On Whether Financing Treatment Is Available
17
DRAFTCoupon Stripping
Example–Assume 15 Year Bond, $100 Principal, 3% Semi-Annual Coupon
– Could Create $3 Capital Gain Per $100 Face Amount
–Strip 6-Month Coupon And Sell For $3– Remaining Tax Basis Is $97 (Equals Value)
–In 6 Months The Bond’s Value Accretes to $100–Tax Basis Remains $97 Provided Stripped Coupon Is De Minimis
– De Minimis If Stripped Coupon Is Less Than ¼% Times Years To Maturity
Strip Upcoming Coupon From Long Duration Bonds
Amount Stripped Creates Potential Capital Gains
Follow Ups–Capacity To Strip Bonds–Impact On Ability To Pledge Stripped Bonds As Collateral
Accelerates Cash Recognition
IV
18
DRAFTLend Zero Coupon Bonds
Example–Purchase $100 Zero Coupon Bond For $70–Loan The Bond–Basis Remains $70 During Term Of Security Loan
– No OID To Securities Lender– Purchaser From Securities Lender Accrues The OID
–Accretion Creates Capital Gain Upon Closing The Loan– Capital Gain = Principal * Interest Rate
Acquire And Lend Zero Coupon Bonds
Potential Capital Gains = Accretion While On Loan
Follow Ups–Market Availability Of High-Yielding Zeros–Asset/Liability Matching–Lending Appetite (Internal And External)
IV
19
DRAFTOther Strategies
Sell Appreciated Securities And Repurchase Similar Securities
IV
Partnerships
Sell Other Assets (Mortgage Loans, Subsidiaries, Etc.)
Follow Ups–Identify Appreciated Assets–Determine & Optimize GAAP & SAP Impact (NII, DAC Recoverability, Cash Flow Testing, etc.)–Drill Down On Partnerships–Quantify Other Opportunities
New Rules