Bloomberg News

EU Banks Face $270 Billion Goodwill Hangover for Purchases

November 30, 2011

(Updates in 25th paragraph to add example of goodwill writedown.)

Nov. 18 (Bloomberg) -- European banks may have to write down some of the $270 billion of goodwill from their purchases in the run-up to the financial crisis before they can sell assets, or new stock, to bolster capital.

UniCredit SpA, Italy’s biggest lender, this week opted to take an 8.7 billion-euro ($10 billion) impairment charge following a series of acquisitions at home and in eastern Europe. Other European banks are yet to follow, analysts said. Credit Agricole SA, Banco Santander SA and Intesa Sanpaolo SA are among European banks with the most goodwill remaining on their balance sheets, according to data compiled by Bloomberg.

“Banks that paid a premium for businesses when the outlook was better will need to reassess the goodwill on their balance sheets,” said Andrew Spooner, an accounting partner at Deloitte LLP in London. “Previous acquisitions which are exposed to peripheral Europe are most vulnerable to impairments.”

European bank stocks are trading at an average 58 percent of their book value, according to Bloomberg data. While writing down goodwill won’t deplete banks’ capital for regulatory purposes, it’s a sign that executives overpaid for purchases.

“A big paper loss never looks good, but its often part and parcel of a change in strategic direction, or making disposals in the current environment,” said Kinner Lakhani, a bank analyst at Citigroup Inc. in London. “I expect to see more write downs, driven by a combination of the accounting rules and commercial necessity.”

IFRS Rules

Goodwill is an accounting convention that represents the amount paid for an acquisition over and above the fair value of its net assets. Under the accounting rules European banks use, the International Financial Reporting Standards, companies have to write down goodwill on their balance sheets if the underlying assets have permanently deteriorated in value.

Press officers for Credit Agricole and Santander declined to comment. Intesa Sanpaolo didn’t return calls seeking comment.

Houlihan Lokey, the Los Angeles-based investment bank, said in an October report that 40 percent of lenders in the region are vulnerable to goodwill impairments because of the large and growing gap between the book value they place on their assets and their value in the market.

UniCredit Writedown

UniCredit wrote down goodwill on assets in its home market, eastern Europe and former Soviet Union countries in its third- quarter earnings report this week, though it didn’t tie the charge to any specific deals among the $60 billion of acquisitions it made from 2005 to 2008.

The lender became the euro region’s sixth-largest by assets after buying Germany’s HVB Group and Rome-based Capitalia SpA. UniCredit’s writedown was announced along with a 7.5 billion- euro rights offer and the closing of its Western European equity brokerage and trading unit.

Austria’s Erste Group Bank AG took a charge of 939 million euros on its businesses in Hungary and Romania in October, citing the deterioration of market conditions in the region. Societe Generale SA, France’s second-largest bank, took a 200 million-euro charge on some consumer-finance businesses.

Companies are obliged to undertake a goodwill impairment test annually or, as with Erste Bank, in the event of an impairment-triggering event. An impairment is required if the carrying value of an asset is below both its value to the market and its value to its owner.

‘Embarrassing’ Impairments

Banks have historically justified not taking losses by saying that a business is worth more than market prices suggest, based on their own projections of future revenue.

“Current low market valuations increase the risk of goodwill impairments by year-end for banks, and that’s embarrassing for the reporting of earnings,” said Antonio Ramirez, a banking analyst at Keefe, Bruyette & Woods in London.

As an intangible asset, goodwill is stripped out of regulatory capital calculations, so any losses will not affect a firm’s solvency.

It can, however, reflect badly on a company’s management.

“By taking an impairment you are essentially saying that you did a bad deal,” said Justin Bisseker, who helps manage 205 billion pounds ($323 billion) as a bank analyst in London for Schroders Plc, Britain’s largest independent money manager.

That’s why impairments are often taken after a management change, Bisseker said. UniCredit’s writedowns were taken 14 months after Federico Ghizzoni replaced Alessandro Profumo as chief executive officer in the wake of a shareholder revolt.

Change of Direction

“Our decision to write down the goodwill of several brands and to raise capital will reinforce the bank from both a balance-sheet and capital point of view,” Ghizzoni said on Nov. 14.

Writing down goodwill can also be an indicator that a company is poised to undergo a change in strategic direction, according to Citigroup’s Lakhani.

“Taking an impairment is an acknowledgement that things aren’t working out,” Lakhani said. “If you seriously want to deleverage, then you may have to take the writedown.”

Credit Agricole, France’s third-largest bank, had 19 billion euros of goodwill on its balance sheet at the end of 2010, equal to 36 percent of total equity. It acquired Greece’s Emporiki Bank SA for 2.6 billion euros and Italy’s Cariparma for 7.5 billion euros in 2006.

Intesa had 19 billion euros of goodwill at the end of last year, which represents 35 percent of its total equity. The bank was formed when Banca Intesa SA acquired SanPaolo IMI SpA for 35 billion euros in 2006, and then bought Banca CR Firenze SpA for 3.3 billion euros in 2007.

Highest Impairment Risk

Spain’s Santander, the nation’s largest bank, had 24 billion euros of goodwill at the end of 2010, or 30 percent of total equity. It bought the U.K.’s Abbey National Plc for 12.5 billion euros in 2004 and ABN Amro Holding NV’s Brazilian arm for 11 billion euros in 2007.

Banco Bilbao Vizcaya Argentaria SA, Spain’s second-biggest bank, took a 1.05 billion-euro charge for the fourth quarter of 2009 to reflect one-off provisions and a charge for impaired goodwill at its U.S. business.

“From a theoretical view, looking at IFRS, everybody would expect a higher rate of impairment, but banks are not doing it,” said Marc Hayn, a Frankfurt-based managing director at Houlihan Lokey.

To be sure, Hayn said he expects some banks to put off taking impairments for another year.

“You’re not obliged to take the writedown if you can demonstrate you have a robust business plan, and many banks will keep doing that,” he said. “The question is whether your business plan is robust enough or too ambitious.”

Balance-Sheet Pressure

In Houlihan’s annual goodwill study, published last month, the firm tested the extent to which impairments were being recognized in the Stoxx Europe 600 Index, a pan-European benchmark, based on two ratios: companies’ market capitalization to book value of equity, and purchase price to market capitalization.

Among 18 industry groups in the index, banks were the least likely to take impairments, and therefore are most at risk of further losses, Houlihan Lokey said.

“No industry shows a higher risk of impairments, and the longer that goes on the more difficult it is for banks to defend,” said Hayn.

Mark Byatt, a spokesman for the International Accounting Standards Board in London, said it was up to national regulators to enforce IFRS rules. Reemt Seibel, a spokesman for the European Securities and Markets Authority, an umbrella group for the region’s financial regulators, said the issue would be discussed at the next meeting of representatives from the 27 member states later this year.

Banks that are under the most pressure to sell assets or sell shares will also be those most driven to write down goodwill, Hayn said.

“It is not easy to go to the market and ask for an investment or go to potential bidders for a disposal if you are trading at 50 percent to book value,” he said. “In that situation, you want to get pressure out of your balance sheet.”

--Editors: Keith Campbell, Steve Bailey.

To contact the reporters on this story: Liam Vaughan in London at lvaughan6@bloomberg.net; Charles Penty in Madrid at cpenty@bloomberg.net.

To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net; Edward Evans at eevans3@bloomberg.net


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