RPT-DEALTALK-U.S. accounting rules could prolong pain for banks

(Repeats article first issued on Tuesday afternoon)

By Dan Wilchins

NEW YORK, May 20 (Reuters) - Stronger U.S. banks are increasingly reluctant to buy weaker ones because accounting rules make these deals unpalatable, a trend that could slow consolidation in the sector and prolong the banking downturn.

The accounting rules, combined with the unusually deep pockets of some investors, have spurred banks, including National City Corp NCC.N to issue shares and convertible securities instead of selling themselves at fire-sale prices.

But allowing weaker banks to limp along is not a positive for the broader banking system.

"It keeps the system from recovering as fast as it should," said James Ellman, president of hedge fund Seacliff Capital, which invests in financial stocks.

Under U.S. accounting rules, if a company acquires another, it must record the value of the target's assets and liabilities at their market value at the time of purchase. Any gap between the net value of the company and the purchase price is recorded as "goodwill" -- an intangible asset -- on the acquirer's balance sheet.

For banks acquiring banks, that is a problem -- the net value of the assets might be low or even negative. That would translate into high goodwill, which cuts a bank's regulatory capital. That is particularly problematic because many would-be buyers do not have much regulatory capital to spare these days.

"Banks are severely limited in their ability to do M&A -- ability in terms of buying other banks -- because of the purchase accounting impact that an acquisition has," said Neil Carragher, a managing director at Credit Suisse.

It was not always thus. During the last major banking downturn between 1989 and 1991, pooling of interests accounting was still allowed, which meant banks that merged did not have to record their assets at fair value.

But effective mid-2001, rule makers at the Financial Accounting Standards Board did away with pooling of interests accounting, leaving only the current method. Purchase accounting was seen as allowing investors to better evaluate the subsequent performance of the acquisition.

That may generally be true, but in this case purchase accounting creates problems. In the last economic downturn, weaker banks were bought by stronger institutions. The purchasers reduced competition and could also cut costs across both banks. Lower competition and costs leave stronger banks in a position to turn in better growth.

ACQUIRERS REAP BIG BENEFITS

A report from Sandler O'Neill last week found the banks that acquired the most during the 1989-1991 downturn -- such as Valley National Bancorp (VLY.N) and M&T Bank Corp (MTB.N) -- were some of best performing stocks in the three and five year periods after the sector's low point.

But bankers say this cycle may be different because weaker banks are having trouble finding acquirers. Meanwhile, private equity firms have billions of dollars to invest and few other obvious opportunities for investment.

National City needed capital earlier this year and talked to potential acquirers for weeks. Several banks were interested, but declined in part because of the potential accounting hit. National City instead raised $7 billion from private equity firms and other investors.