Consolidation could help the banking sector recover, but an accounting rule adopted in 2001 is stalling consolidation efforts. After a 2001 rule change eliminated “pooling of interest” accounting, buyers are required to record the net value of purchased assets at current market rates, and then record the gap between this value and the purchase price as goodwill. In most industries, this is irrelevant. In the banking industry, however, purchase accounting affects regulatory capital requirements and therefore makes acquisitions more difficult. Reuters:
In [the banking industry] purchase accounting creates problems…Under U.S. accounting rules, if a company acquires another, it must record the value of the target’s assets and liabilities at their market value at the time of purchase. Any gap between the net value of the company and the purchase price is recorded as “goodwill” — an intangible asset — on the acquirer’s balance sheet.
For banks acquiring banks, that is a problem — the net value of the assets might be low or even negative. That would translate into high goodwill, which cuts a bank’s regulatory capital. That is particularly problematic because many would-be buyers do not have much regulatory capital to spare these days.
“Banks are severely limited in their ability to do M&A — ability in terms of buying other banks — because of the purchase accounting impact that an acquisition has,” said Neil Carragher, a managing director at Credit Suisse.
So there’s an opportunity for legislators to do something smart for a change. Rollback an arbitrary accounting rule that is preventing the banking sector from recovering as quickly as it should.