For One Broken Deal, Blame the Accounting

Key Bank dropped plans to acquire other banks this year because of fair value's entry into rules for business combinations.
Sarah JohnsonOctober 30, 2008

Fair-value accounting drove Key Bank’s decision earlier this year to abandon all its acquisition plans. And the explanation of why may be instructive, fair value’s critics suggest.

New business-combination rules require companies to apply fair value to financial assets and liabilities — the factor that killed Key Bank’s plan to buy another financial institution, according to Chuck Maimbourg, director of accounting policy. He joined other bank representatives yesterday during a Securities and Exchange Commission roundtable in explaining the implications FAS 157, the two-year-old fair-value measurement standard, has had on his sector.

Key Bank decided not to acquire the other bank after applying fair value to that bank’s loans. FAS 141(R), Business Combinations calls on acquiring companies to value target companies’ financial assets and liabilities under FAS 157 as of the acquisition date, when traditionally they were measured at historical cost. For Key Bank, during a down market, the combination of this change with the problems in the credit crisis ended the deal.

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“The capital ratio and other transaction ramifications of this accounting conclusion caused Key Bank to not pursue this particular acquisition as well as others throughout the balance of the year,” said Maimbourg, who formerly held the CFO positions at Zaxis International and Trion Technologies.

“I believe our experience with 141(R) and 157 highlight the fact that there are more consequences of 157 that have not been felt by the financial markets at this time,” he added.

The target bank’s loans — which were considered held to maturity — appeared to be worth less when marked to current sales in the market as FAS 157 requires. “Those marks could be as seep as 20 or 30 cents on the dollar than they were worth,” Maimbourg said. “That’s a huge amount to make up when you’re trying to buy a company and you’re have to fund that sort of capital to get into that business. We just couldn’t make it work.”

The SEC held the talk on Wednesday as part of its congressional mandate to study by January the issue of fair-value accounting and its effect on the financial crisis, particularly its impact on the banks. One participant went so far as to pin FAS 157 as the sole culprit for the turmoil. The rule effectively “destroyed hundreds of billions of dollars of capital,” according to former FDIC chairman William Isaac.

Outside the banking sector, fair-value accounting has staunch supporters in accountants and investors. Patrick Finnegan, director of the CFA Institute, told the SEC that “fair-value reporting provides the single best measurement for economic reality at any given reporting date.”