One casualty of the economy’s downturn has proven to be the goodwill held on banks’ balance sheets.
In the fourth quarter at least 16 publicly traded banking companies took significant impairment charges to reflect the declining value of goodwill, accumulated largely through acquisitions.
And that number is likely to grow as earnings reports continue to trickle in.
They included large companies such as Washington Mutual Inc., Sovereign Bancorp Inc., and National City Inc., as well as a slew of small ones.
This is the first time the industry has experienced such a flurry of goodwill impairment charges since new accounting standards relating to goodwill went into effect in 2002. As of Feb. 5 goodwill impairment charges for the fourth quarter totaled $4.2 billion — more than the amount taken by the industry in the previous 27 quarters combined, according to data from SNL Financial LC.
By comparison, banking and thrift companies wrote off just $12 million of goodwill in the fourth quarter of 2006, according to the investment banking firm Carson Medlin Co.
“I very rarely remember seeing a goodwill impairment charge prior to this,” said Andy Gibbs, a vice president with Mercer Capital Markets Inc., an appraisal and evaluation company in Memphis. “It really reflects how the conditions changed as 2007 progressed.”
Financial Accounting Standard 142 requires goodwill to be evaluated annually, and many companies choose to do so at yearend.
Goodwill, which is added to the balance sheet following an acquisition, represents how much the acquirer paid above the seller’s book value. Any goodwill kept on the balance sheet must be supported by the company’s market value —– support that in many cases eroded as stock prices fell below book value.
But that might only partly explain the fourth-quarter surge in impairment charges, according to Dan Bass, the managing director in Carson Medlin’s Houston office. Loan chargeoffs are also on the rise, Mr. Bass said, and it makes sense for bankers to move impaired assets off the balance sheet all at once.
It behooves them “to look at everything they can and get it off their books,” he said. “You want good news in the first quarter, and this is a way to help prepare you for that. You want a clean balance sheet going into 2008.”
Wamu, of Seattle, and Sovereign, of Philadelphia, took the largest impairment charges, a combined $3.4 billion.
Franklin Bank Corp. of Houston took a $65 million charge for the fourth quarter. Taylor Capital Group of Rosemont, Ill., reported a goodwill charge of $23.2 million. Centennial Bank Holdings of Denver reported a $142 million charge, and Park National Corp. of Newark, Ohio, took a $54 million charge.
The $2.3 billion-asset Centennial said its charge was the result of both souring investor sentiment toward its stock — which is trading at roughly 60% of book value — and previous acquisitions that had not performed as well as the company had hoped.
“In our case, we bought a bank in northern Colorado that had a tremendous amount of residential construction loans, and we have had a lot of difficulty with those loans, and that has helped drive the value to the bank down,” said Paul W. Taylor, Centennial’s chief financial officer and executive vice president. “What was happening in the general market and what we were experiencing with our acquisition were connected. It was all connected to the residential real estate market.”
Park National’s shares have dropped about 35% in the last year, though they are still trading above book value. The company has attributed its charge to the declining goodwill value of a Panama City, Fla., bank it acquired last year.
For the most part, Wall Street analysts tend to focus on tangible book value when valuing banking companies, because of the uncertainty surrounding the intangible assets. A charge against goodwill does not affect the cash flow or regulatory capital of a bank.
“It’s all an optics thing,” said Aaron James Deer, an analyst with Sandler O’Neill & Partners LP. “None of this is real dollars. It changes the optics of the balance sheet and returns, but it isn’t a fundamental performance thing.”
In fact, several observers said taking a charge against goodwill can be good for a company whose stock is trading well below its stated book value.
“Arguably, it could make the company look better in the sense that book value is now more closely aligned with tangible book value, and the company’s return on equity will improve,” Mr. Deer said.
Brent Christ, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, said companies like Centennial are revaluing themselves to reflect how the market values their previous acquisitions and, ultimately, what the companies would be worth to potential buyers.
“It boils down to the future value and cash flow of that business,” Mr. Christ said. “What comes into play is what could you get for the sale of the company. The earnings prospects weren’t what they once thought they were.”
