Coast Financial Inc.'s plan to spin off its anticipated windfall from a lawsuit against the government could gum up its potential merger with Washington Mutual Inc.
The spinoff could imperil the use of a favorable accounting method Washington Mutual wants to use in the combination, according to a source familiar with negotiations between the companies.
The glitch is not seen as a deal-killer but could make the negotiations more complex. Washington Mutual's chairman, Kerry Killinger, has a track record of sorting through complicated deals, most recently with Keystone Holding to buy American Savings Bank, Irvine, Calif. He has said he is determined to expand his presence in California with more purchases.
Like most acquirers, Washington Mutual would prefer to use the "pooling of interests" accounting method, which does not require the acquirer to write down the goodwill, or premium over book value, it pays in the deal.
But pooling of interests is allowed only if the combining companies meet several strictly defined conditions that ensure the two groups of shareholders are indeed pooling or combining all their interests.
A spinoff of substantial future legal damages, such as the one proposed by Coast, would appear to violate those conditions, accounting experts said.
"The notion of a pooling is like a marriage," said Mike Joseph, a partner at Ernst & Young in New York. "You take the good and the bad."
Thus, neither of the combining companies may sell assets, establish a new dividend, buy back more than 10% of its stock, or otherwise change the stockholders' equity for two years before the pooling. Spinning off a legal claim into a different share of common stock would change the stockholders' equity, Mr. Joseph said.
The damages in question stem from Coast's suit against the federal government over accounting for goodwill in the acquisition of troubled thrifts in the 1980s. By some estimates, Coast could win as much as $900 million, or about $45 a share.
Coast is among more than 125 thrifts suing the government. Last July, the Supreme Court sided with the thrifts, though damages are yet to be set.
Brian Yokley, a practice fellow at the Financial Accounting Standards Board, said the combining companies would likely try to persuade regulators that spinning off anticipated legal winnings is not the same as selling off other assets, because the potential winnings do not appear on the company's financial statement.
Washington Mutual's other prominent California target, Great Western Financial Corp., is among the few large thrifts without a goodwill claim. Industry sources said Washington Mutual is ready to step up talks with Great Western if the Coast deal falls through.