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Goodwill Write-Downs Cause for Real Concern


Banks are de facto bringing down their future earnings estimates.


Editor's Note: The following was posted in real time on our premium Buzz & Banter (click for a free trial). It's being shared here for the benefit of the Minyanville community.

This morning's New York Times included an article on the significant amount of goodwill write-offs reported by banks (including Huntington (HBAN), SunTrust (STI) and Wells Fargo (WFC)) during the first quarter.

And while this should be old news to Minyans, I feel a need to comment on the following quote regarding goodwill by Rex S. Schuette, chief financial officer of United Community Banks (UCBI) from the article:

"It was just a paper entry sitting on your balance sheet,"

Mr. Shuette's quote got me thinking what if every investor were subject to goodwill accounting. In this scenario when you buy a stock, the part of the purchase price that is equal to book value would be reported as an investment and the the premium to book would be reported as goodwill.

So if, for example, you purchased 1,000 shares of Microsoft (MSFT), currently trading at $20.75, you would report $3.85 as your investment (Microsoft's book value per share) and the remaining amount, $16.90, as goodwill.

Now, let's say that Microsoft declines in value to $18.00 per share because the company says that future earnings don't look as good as they thought. Then, because of goodwill accounting, you would be required to write down your goodwill value to $14.15.

In this scenario, would you think that goodwill was "just a paper entry sitting on your balance sheet"?

As much as corporations and banks want you to ignore goodwill writedowns for any number of reasons ("They're non-cash." "They don't affect regulatory capital." "They're just a paper entry."), these writedowns reflect a real reduction in value.

Furthermore, and most important, these writedowns are due to forward-looking assessments - meaning that when a company writes down goodwill, they are de facto bringing down their future earnings estimates.

And to Todd's comment about state vs. federal domain over consumer-credit-protection laws, I would offer that there's a far more significant states-rights issue lurking in the wings: oversight of the insurance industry.

Today, insurance companies are regulated on a state-by-state basis, with large firms forming dozens of individual subsidiaries to operate in each state. Last year, before leaving office, Secretary Paulson suggested the creation of an "uber-regulator" (likely the Federal Reserve), which would pick up responsibility for all "systemically important" financial institutions, including the major insurers.

For state attorneys general, and for insurance commissioners, this would represent an enormous loss of power. So you can expect folks like Andrew Cuomo and Eric Danello to come out swinging. At the same time, due to the financial crisis, many states are now entirely beholden to the federal government for financial support.

With the federal government kicking 35% of every interest payment on states' taxable "Build America Bonds" (BABs), I keep wondering when Uncle Sam will say "enough is enough."

As this White House has already shown, people who need people aren't exactly the luckiest people in the world.
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