First Interstate Scraps Plans for Bad Loans Spinoff

In a surprising switch, First Interstate Bancorp on Thursday canceled plans to spin off $400 million in troubled loans and real estate into a separate entity.

The spinoff had been planned for more than a year as a key part of the effort to restructure the Los Angeles banking company into a leaner, more profitable operation. The Internal Revenue Service issued a favorable tax ruling on the move in August, and the bank set aside $150 million in loan-loss reserves to support the deal.

The spinoff was expected to strip $400 million worth of its worst loans from First Interstate’s portfolio. The loans were to be transferred to a new company, which would have been given to First Interstate shareholders as a dividend with an estimated value of $3.25 a share.

Tax Breaks Reduced

Thomas P. Marrie, the company’s new chief financial officer, said in an interview that appraisals of the bank’s worst loans and real estate turned up only about $225 million that were appropriate for the spinoff.

As a result, he said, the economics behind the transaction no longer made sense because the tax benefits were reduced sharply.

He said First Interstate will now dispose of the troubled assets through its own internal process of negotiating with borrowers and selling some of the assets at a discount. Handling the loans internally will delay getting them off the books, but it will keep the company’s equity higher than putting them into a new entity, Marrie said.

Industry analysts, who had generally praised the spinoff, said they were surprised by Thursday’s reversal despite its apparent logic.

“It’s too bad,” said Thomas K. Brown, banking analyst at the New York investment firm of Smith Barney, Harris Upham. “It’s just another misstep.”

First Interstate, the nation’s eighth-largest banking company and parent of First Interstate of California and banks in 12 other states, suffered unexpected losses in its newly acquired Texas bank in the third quarter. Aspects of its restructuring, in addition to the spinoff, have also caused problems this year.

The result has been a drop in its stock price in recent weeks and uncertainty among some analysts and investors about its earnings prospects for the coming year. First Interstate stock closed on the New York Stock Exchange on Thursday at $45.50 a share, down 62.5 cents.

$225-Million Portfolio

The spinoff is known as the “good bank-bad bank” concept, and it has worked at several banks. The bad loans are transferred to a new entity, known as the bad bank, along with the money that has been reserved for potential losses on the loans.

The IRS approved a $250-million tax break on the deal, representing the difference between the expected $400 million value of the loans and the $150 million in reserves.

According to Marrie, an outside firm had been completing its appraisals of the property slated for the spinoff in recent weeks. The bank tried to combine those appraisals into a portfolio totaling $400 million.

But Marrie said the bank was able to come up with a portfolio totaling only about $225 million, which meant that the tax break for First Interstate would have been only $75 million. The reduction in the tax incentive, coupled with two other factors, made the deal less attractive.

One other factor was the bank’s third-quarter loss of $214 million, which reduced its need for tax deductions. In addition, the spinoff’s value was cut because the completion had been delayed from 1988 until sometime next year.

Marrie estimated that the bank will spend $40 million on expenses, mostly for staff, to get rid of the bad loans internally over the next two years. He said he expects half of the bad loans to be off the books by mid-1989.