For once, banks may be ahead of the curve.
Earlier this week the Financial Accounting Standards Board alarmed merger-happy Wall Street by saying it would consider abolishing pooling-of- interests, the most popular method of merger accounting.
But banks, in the midst of their own consolidation wave, have been moving away from poolings for the past two years and see the alternative method, known as purchase accounting, as the modus operandi for the foreseeable future.
"Most people in banking believe poolings are a thing of the past," said William M. Parent, director of mergers and acquisitions at Bank of Boston Corp.
Accounting board spokeswoman Deborah Harrington said the board would revisit rules on pooling to align them with practices in other countries. "Most other countries prohibit pooling except in rare circumstances," she said.
In a pooling-of-interests, the balance sheets of the acquiring company and the target company are combined and treated as if they were always together. The chief drawback is that the Securities and Exchange Commission forbids companies from buying back shares from investors while completing the merger. And aggressive share buyback programs are a major reason bank stocks are so popular with investors nowadays.
Not wanting to alienate shareholders, banking companies started switching en masse to purchase accounting in 1995. These transactions present their own problem: Any price the acquiring bank pays over the target's book value must be accounted for as "goodwill" and written off over time. The price of this goodwill must be subtracted from earnings reported to investors.
When bank earnings were weak, banks overwhelmingly preferred poolings. According to Goldman, Sachs & Co., 91% of all mergers in 1991 were poolings.
But poolings dropped as earnings and share prices improved. They accounted for 41% of all mergers in 1996. The strong performance of banks in recent years has given investors confidence to look past goodwill and focus on the revenue-generating potential of today's megamergers.
Purchase accounting got a huge boost last year when Wells Fargo & Co. and NationsBank Corp. persuaded investors to overlook goodwill's drag on earnings and focus on "cash earnings"-earnings before goodwill is accounted for.
"This analysis has been accepted because it's intelligent," said Michael T. Mayes, head of the financial institutions group at Advest Inc. "It also revolves around enhancing earnings per share."
Investment bankers are more interested in another rule the accounting board plans to revisit: how much time companies should have to amortize goodwill.
Currently, banks may amortize goodwill over 40 years, Ms. Harrington said. But in Europe, banks can write it all off at once when they merge. American banking companies have long lobbied for similar treatment.
Although shortening goodwill amortization periods would force banks to wolf down enormous amounts in this era of the blockbuster deal, Richard J. Barrett, managing director of the financial institutions group at UBS Securities, doesn't think increases in goodwill would necessarily be a bad thing.
"It's true you'll get dramatically different cash earnings over reported earnings," he said. "But where people get screwed up is when there is so little goodwill they don't take the time or energy to adjust for it." u
