A few years ago, investors might have looked askance at H.F. Ahmanson's plan to use purchase accounting in its uninvited acquisition of Great Western Financial Corp.
Today, the method of accounting may be one of the least controversial aspects of the deal.
Although it is complex and creates an intangible asset-known as goodwill-that can drag down reported earnings, purchase accounting is now the favored method.
In the early 1990s, before multibillion-dollar deals became the order of the day, accounting for the transactions was simple. More than 90% of the time, acquiring banks simply combined, or "pooled," the assets of the target bank onto their balance sheets.
But in 1996, 59% of all completed mergers were accounted for as purchases, according to Goldman, Sachs & Co., up from only 9% in 1991.
"Poolings are on their way down and I'd expect to see that continue," said David Berry, director of research at Keefe, Bruyette & Woods Inc.
The main reason: Purchase accounting permits investors to have their merger and buy back stock too.
Last year the Securities and Exchange Commission ruled that banks must suspend buyback programs during pooling transactions.
Because repurchased shares are paid for in cash, the SEC reasoned that using them in a pooling could be seen as an indirect cash purchase, which would be subject to higher taxes. Because share repurchases commonly inflate stock prices, they could give an unfair advantage to the buyer, the SEC said.
According to Mr. Berry, 22 of the 25 largest banks have stock buyback programs. Because these banks want to consolidate and preserve their popular buybacks, pooling is no longer an option.
Another reason acquiring companies prefer purchase accounting, Mr. Berry said, is that it allows them to start disassembling their targets right away, rather than wait for a cooling-off period. This represents a helpful bit of freedom for acquirers under pressure to meet ambitious cost-cutting estimates.
Whereas pooling simply combines books, under purchase accounting whatever amount acquiring banks pay over the target bank's book value is put on their balance sheets as "goodwill" and amortized over time.
This can affect bank earnings for many years, Mr. Berry said, because unless the bank decides to pay off the goodwill all at once-and take a serious earnings hit-the goodwill's costs are subtracted from reported earnings.
Not only are more banks elbowing up to the goodwill bar nowadays, they are also trying to take bigger gulps.
Wells Fargo & Co., for example, took on $9.5 billion worth in its merger with First Interstate Bancorp. NationsBank Corp. took on $6.3 billion in its merger with Boatmen's Bancshares And Ahmanson's books will get $4.3 billion in goodwill if its merger with Great Western is completed.
For comparison's sake, Chase Manhattan Corp. had only $1.6 billion of goodwill on its books as of Sept. 30, and First Union Corp. had $2.4 billion.
Goodwill is a nonperforming asset, and Goldman Sachs partner Joseph H. Wender calls the huge amounts banks have started to take on "unhealthy." Mr. Wender wouldn't elaborate, but Michael S. Joseph, partner at Ernst & Young, said large amounts of goodwill put extra pressure on performing assets to boost bank earnings.
But for now, with bank earnings at record levels, the investor community couldn't care less about goodwill cluttering bank books. Smith Barney Inc. thrift analyst Thomas O'Donnell dismisses it as "an accounting convention" that "doesn't recognize the economic value" created in a merger.
Investment bankers and executives in the Wells Fargo deal pounded the tables to get investors to look at the economic value of a purchase transaction, rather than the drag of goodwill. The San Francisco bank urged investors to focus on "cash earnings"-earnings before goodwill is included- rather than reported earnings, when considering bank performance.
The crusade has won many followers: According to Goldman Sachs, Wells Fargo stock is trading 27% higher than it would if investors considered only its reported earnings,
So long as demand for bank stocks is strong, it appears investors will overlook such decades-long burdens as goodwill in favor of more transitory things, like the people running the bank and plotting its next merger.
After all, says Keefe's Mr. Berry, "goodwill will outlive all current management."
