U.S. banks face potential earnings hits as standard-setters debate whether to compel the industry to write off at least $259 billion in goodwill stemming from acquisitions.
All U.S. companies, including banks, will have to write off M&A premiums, known as goodwill, over perhaps 10 years under a proposal that is a 2022 priority for the Financial Accounting Standards Board. At present, companies can keep goodwill on their balance sheets indefinitely, unless there is an impairment caused by a deal going wrong.
The potential change would hurt U.S. banks because they have piled up goodwill through years of industry consolidation. Bank of America Corp. has the biggest exposure at $69.02 billion, followed by JP Morgan Chase & Co. with $50.32 billion and Truist Financial Corp. with $26.10 billion, according to 2021 year-end figures compiled by S&P Global Market Intelligence. They lead a group of 20 banks that together have goodwill worth $258.99 billion.
Companies with lots of goodwill will face "significant" amortization expenses if the change happens, said Peter Torrente, national sector lead, banking & capital markets at KPMG LLP. That is going to lead to "lower post-acquisition earnings," Torrente said in an email.
Advocates of the change say it will simplify accounting, as well as end companies' ability to retain goodwill on their balance sheets even after potential gains represented by the figure have been realized in higher profits. The new standard would also still include potential impairments so that goodwill is written down more quickly if a deal's expected gains fail to materialize.
Exact details on the proposal will be released in an exposure draft, according to a FASB spokesperson. The publication date is yet to be finalized. The International Accounting Standards Board, which sets standards outside of the U.S., is also looking at goodwill.
Bank of America and Wells Fargo did not respond to requests for comment on the proposal. Truist did not immediately respond, and JPMorgan declined to comment.
M&A considerations
Lenders have previously opposed the potential switch. Bank of America has said goodwill should not be amortized because the elements that go into it — such as the acquired company's reputation and cost savings from a combination — will provide benefits in perpetuity.
"We do not believe that goodwill is a wasting asset," Michael Tovey, then the lender's corporate controller, wrote in a letter to the FASB in 2019. The letter was a response to the standard-setter's request for comments on the proposal.
Wells Fargo said at the same time that the change was not necessary, partly because financial analysts already ignore goodwill when assessing banks' capital strength.
Still, lenders were not uniformly opposed. BOK Financial Corp. supported amortization because there is a "rather short" opportunity to create benefits from an acquisition. The switch would also lessen the need for impairment tests, which it described as costly exercises that produce few benefits.
Industry experts said a three-to-five-year amortization period could carry benefits.
"If the time frame for impairment testing is mid-term (3-5 years) this will provide acquiring banks to have enough runway to fully implement the cost savings and revenue synergies before those earnings have to cover the added non-cash expense of goodwill amortization," according to Rick Childs, a partner at financial services company Crowe LLP.
Childs noted that impairment itself represents significant work.
"Preparers in the banking industry don't find goodwill testing to be valuable in terms of strategy and performance, but instead as an added expense and added time," Childs said.
Looking more broadly, investment professionals favor retaining impairment testing over amortization by 58% to 31%, according to a survey last year by CFA Institute, an industry group. Still, that support was tempered by concerns about transparency and the timeliness of write-downs.
The biggest objections to amortization were distortions to financial metrics and concerns that the switch would make it harder to tell whether an acquisition was successful or not. By contrast, a write-down following an impairment test is a clear admission of failure.
If the FASB does ultimately decide to introduce amortization, companies could end up with less paperwork at the expense of reduced bottom lines.
"A change to amortization could, in some cases, simplify the monitoring of goodwill for impairment," Torrente said. The trade-off will be that companies "will always have the amortization expense," Torrente said.
Banks are closely watching the FASB project, which carries significant impacts for their acquisitions, according to Wes Bricker, vice chair and co-leader of US Trust Solutions at PricewaterhouseCoopers LLP.
"This is important to banks," Bricker said in an interview with Market Intelligence. "Whenever banks acquire a merger — the price that you pay in relation to the things that you bought, all of that goes into the balance sheet."
Bricker said the FASB project will determine, "Do we leave it on the balance sheet, or do we exclude it from the balance sheet?"