The Topsy-Turvy World of Banking: Cash Dominates Deals Amid Accounting Constraints

Strategic Insights -

Banks trying to complete deals in the cutthroat world of banking are often restricted by arcane accounting rules that can limit their flexibility and result in lower prices. The rules, known as purchase accounting, mean that banks must write off goodwill over 15 years, making it difficult for them to complete larger transactions on favorable terms. Despite this, some banks are turning to cash acquisitions to leverage excess capital across a broader asset base.

Key Takeaways:

  • Cash acquisitions have seen a small increase over the past 18 months, partly due to banks accumulating excess capital and wanting to avoid diluting earnings for existing shareholders.
  • Purchase accounting can limit the flexibility of banks in making deals, as they must write off goodwill over 15 years, making larger transactions more difficult to complete.
  • The lack of suitable buyers, particularly larger rivals, is affecting the sale of NatWest's New Jersey-based subsidiary, which has assets worth $31 billion.
  • The book value multiple in other New Jersey deals would lead to a price of at least $5 billion for NatWest, but it hopes to get around $4 billion due to limited competition from cash-rich buyers.
  • The main reason for the lower price is that companies have to write off goodwill, which reduces pretax earnings by at least $100 million per year.
  • Other factors depressing the price of NatWest include its extensive operations in New York City and on Long Island, making it unappealing to out-of-state banks.

Statistics:

  • The total assets of NatWest's New Jersey-based subsidiary: $31 billion
  • The book value of NatWest's US unit: $3 billion
  • The amount of goodwill: $1 billion
  • The reduction in pretax earnings per year: at least $100 million
  • The proposed price for NatWest's subsidiary: around $4 billion
  • The number of potential buyers: the Bank of New York Corporation, Fleet Financial, Keycorp, and Nationsbank

Sources:

  • The New York Times (1991)
  • Herbert A. Lurie, co-head of the bank mergers practice at Merrill Lynch
  • Republic New York Corporation
  • Brooks, R. (1991, September 30). In the Topsy-Turvy World of Banking, Cash Is King. The New York Times.