Secrets of the Bargain Basement

Why do some companies hawk their assets at less than fair value?

What a difference a quarter makes. Had JPMorgan Chase bought Washington Mutual on or after January 1, 2009, it would have faced reporting requirements that would have cast the deal in a different light. The earnings outlook would likely have looked weaker over the long term, for one thing, taking away some of the luster that the deal enjoyed at the time.

Indeed, JPMorgan’s September 25, 2008, purchase of failing Washington Mutual’s banking operations from the Federal Deposit Insurance Corp. looked like a steal: for the $1.9 billion it shelled out that day, it acquired an operation with a fair value amounting to a cool $10 billion. Under the Financial Accounting Standards Board’s business-combinations rule then in effect, the $8.1 billion difference between the fair value of the assets and the purchase price constituted the bulk of what was then called “negative goodwill.”

For JPMorgan, the ability to account for goodwill under the old regime was anything but negative. Instead of having to book the $10 billion as an extraordinary gain on its income statement, the bank used that $8.1 billion to reduce the fair value of the WaMu assets it acquired. The company reported the remaining $1.9 billion gain as negative goodwill on its income statement. (That figure was only coincidentally the amount of the purchase price.)

Now in the process of parceling out the $8.1 billion gain as income in the years following the acquisition, the bank appears to be slowly but surely boosting its income by decreasing the depreciation and amortization of its assets. “As a result, $8.1 billion of nonrecurring gain takes on the appearance of a more recurring quality,” contend the authors of a report by the Georgia Tech Financial Analysis Lab on the changes in accounting for negative goodwill.

The Future Is Now

As of 2009, FASB began to regard “negative goodwill” as a contradiction in terms, and now calls the product of such sweet deals “bargain purchase” amounts. As a result, acquirers can no longer set those amounts off against the fair value of acquired assets and report increased income over future years. Now the acquirer must recognize the entire fair value of the bargain-purchase gain as soon as the deal is done.

Further, the new reporting standard asks companies a fundamental question: Why would a target want to sell its assets to you at less than their fair value?

Spilling the Beans

A look at JPMorgan’s 2008 10-K at the time it was issued would have provided hardly a clue as to what could have driven WaMu to provide the acquirer with such a bargain. For more, you would have had to consult the news media — and learned that the purchase was merely the biggest of the distressed sales of banks the FDIC was engineering in the wake of the biggest economic downturn since the Great Depression.

Under FASB’s revised 141(R) standard, though, JPMorgan would have had to spill the beans. Besides reporting the amount of the gain recognized in a bargain purchase, and the line item in the income statement in which the gain is recognized, acquirers must supply a “description of the reasons why the transaction resulted in a gain.”

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