An accounting quirk that greased a $1.5 billion deal in California this month could be bad news for the go-it-alone prospects of Synovus Financial Corp.
The problem revolves around a large deferred tax asset on the Columbus, Ga., bank's books, analysts at Sanford C. Bernstein & Co. wrote in a recent research note. A DTA is a pool of money on a balance sheet that represents tax writeoffs on loan or securities losses. It is in essence a coupon that lets a bank use accumulated losses to offset future tax bills.
When Pacific Capital Bancorp in Santa Barbara, Calif., announced March 12 that it had agreed to sell itself to UnionBanCal Corp. of San Francisco, it demonstrated how deferred tax assets can help a buyer strike a deal that might otherwise be too pricey, the Sanford Bernstein analysts wrote.
A bank needs to have sustainable profits before it is allowed to draw down its deferred tax asset. Until then it is basically shadow equity.
Synovus reported a loss of $119 million for 2011. Like Pacific Capital, it has a fairly large deferred tax asset: Synovus' was $813 million at Dec. 31. That is a substantial amount of hidden equity for a bank with just $1.9 billion of common shareholder equity and another $947 million worth of preferred equity outstanding to the Treasury Department.
A buyer of Synovus could benefit from its deferred tax asset by immediately recognizing it as equity, thus marking up its book value by about 45%, the Sanford Bernstein report said.
A lot of banks built DTA allowances during the downturn. But the allowances have been disappearing among large players that have returned to profitability. Four large community banks activated them in the fourth quarter, and at least another four banks — including Synovus and Citizens Republic Bancorp in Flint, Mich. — are expected to do so within the next year, Keefe, Bruyette & Woods said in a January report. But Synovus is larger than most of these other banks and a hot subject of takeover speculation.
The $27 billion-asset Synovus, still holding some $968 million in federal aid, has long been seen by Wall Street as vulnerable to takeover by BB&T Corp., Toronto-Dominion Bank, PNC Financial Services Group Inc. or other players eager to expand in the Southeast.
Synovus closed Friday slightly above $2 per share. Sanford's price target on the company is $3 per share, which it pegs as a likely sale price. A buyer could justify paying $3 per share, or roughly $2.4 billion, for Synovus because recognizing its deferred tax asset would add another 90 cents to its tangible book value.
In other words: Its adjusted tangible book value would be around $2.90 per share. The current tangible book value is roughly $2.03 per share.
A buyer at $3 per share would be paying roughly par relative to its adjusted tangible book value — a reasonable price — compared with about 150% its current tangible book value, a relatively hefty price.
UnionBanCal, a subsidiary of Mitsubishi UFJ Financial Group Inc., intends to mark up the value of Pacific Capital's tangible book (assets minus goodwill and other intangibles) by about 40%, largely by recognizing as equity its $248 million deferred tax asset.
UnionBanCal would be paying a fairly robust 222% tangible book for Pacific Capital without the recovery of its deferred tax asset. Instead it is paying a reasonable 160% tangible book.
Kessel Stelling, Synovus' chairman and chief executive, predicted in an interview Friday that Synovus would realize its deferred tax asset in late 2012 or early next year.
"The deferred tax asset is very important to our company," he said when asked if it would make it harder to fend off suitors. "It just further strengthens our balance sheet and our franchise and allows us to continue to do the things we are doing."
There is "no direct correlation" between the DTA and Synovus' flexibility to stay independent or sell itself. "The deferred tax asset makes us stronger," Stelling said. "Our focus right now is on getting stronger."
He said he expects the company to repay the Troubled Asset Relief Program "soon" and that its prospects of remaining independent "are very strong." A spokesman clarified later that Synovus expects to its repay Tarp next year or in 2014.