If a company is currently carrying a 100% owned, non-consolidated, equity method subsidiary at 2.5x the subsidiary's book value, what happens to the parent's equity when the subsidiary is converted to consolidated treatment on the BS? Would parent's equity after the conversion be deducted by the amount the subsidiary is currently being marked up by? Or would some intangible asset like goodwill come into play to account for the 2.5 multiple?
USA Converting 100% owned subsidiary to Consolidated method
- Thread starter gwills242
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Thanks for answering. In fact, the subsidiary is 100% owned and has not been consolidated, though starting next quarter, the parent says it will be consolidating the subsidiary (my understanding is it was for regulatory reasons, they are changin their structure from BDC to closed end fund). The subsidiary Balance Sheet has assets of $100M, Liabilities of $80M, so equity of $20M. However, on the parent holding company balance sheet, the subsidiary is a single asset line item with a value of $50M. In the quareterly report, the parent says that they consciously carry the subsidiary at a 2.5x P/B multiple. Now that they will start consolidating, i am thinking that the assets and the liabilities of the parent will go up by 100M and 80M and they will lose the line item. Now what happens to that extra 30M of equity that only existed because of the internally generated multiple?
bklynboy
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My issue is I cant understand what accounting rule allowed them to record using a price/Book multiple that differs from the equity of the sub. Let me use an example. If I own a sub and use equity method and invest 100. Day 1 sub has assets and equity of 100. Assume I think its worth 200 on Day 2 using internal values (approved of course) then sub has an asset of 200 and unrealized of 100. This is what I pick up. I cant just make up a multiple and not record on the sub and consequently on the parent. There should be no breakage. Any insight how they were able to value differently than BV of sub - what accounting rule did they use to support?
Hi gwills242
I'd start with the folks who make the parent's acctg entry and ask them what method they are using.
If indeed they are booking parent equity income at 2.5 times sub's earnings then they need to correct that method first. That's going to be a reversal of income and you better get mgmt. review/approval on that before proceeding.
If it's legit for some reason, and as bklynboy says above it is hard to see how it is, then you've got parent with a $50MM investment to eliminate against sub equity of only $20 MM. So yeah that leaves a $30MM goodwill, unless someone revalues sub's assets to reduce that number. Maybe that process never got done at time of purchase and needs to get done now. Lots to look at here...
I'd start with the folks who make the parent's acctg entry and ask them what method they are using.
If indeed they are booking parent equity income at 2.5 times sub's earnings then they need to correct that method first. That's going to be a reversal of income and you better get mgmt. review/approval on that before proceeding.
If it's legit for some reason, and as bklynboy says above it is hard to see how it is, then you've got parent with a $50MM investment to eliminate against sub equity of only $20 MM. So yeah that leaves a $30MM goodwill, unless someone revalues sub's assets to reduce that number. Maybe that process never got done at time of purchase and needs to get done now. Lots to look at here...
Here is their explanation:
"The Company’s investment in Medallion Bank, as a wholly owned portfolio investment, is also subject to quarterly assessments of fair value. The Company conducts a thorough valuation analysis as described previously, and also receives an opinion regarding the valuation from an independent third party to assist the Board of Directors in its determination of the fair value of Medallion Bank on at least an annual basis. The Company’s analysis includes factors such as various regulatory restrictions that were established at Medallion Bank’s inception, by the FDIC and State of Utah, and also by additional regulatory restrictions, such as the prior moratorium imposed by the Dodd-Frank Act on the acquisition of control of an industrial bank by a “commercial firm” (a company whose gross revenues are primarily derived from non-financial activities) which expired in July 2013 and the lack of any new charter issuances since the moratorium’s expiration. Because of these restrictions and other factors, the Company’s Board of Directors had previously determined that Medallion Bank had little value beyond its recorded book value. As a result of this valuation process, the Company had previously used Medallion Bank’s actual results of operations as the best estimate of changes in fair value, and recorded the results as a component of unrealized appreciation (depreciation) on investments. In the 2015 second quarter, the Company first became aware of external interest in Medallion Bank and its portfolio assets at values in excess of their book value. Expression of interest in Medallion Bank from both investment bankers and interested parties has continued to the present time. The Company incorporated these new factors in the Medallion Bank’s fair value analysis and the Board of Directors determined that Medallion Bank had a fair value in excess of book value. In addition, in the 2016 third quarter there was a court ruling involving a marketplace lender that the Company believes heightens the interest of marketplace lenders to acquire or merge with Utah industrial banks. The Company also engaged a valuation specialist to assist the Board of Directors in their determination of Medallion Bank’s fair value, and this appreciation of $15,500,000 was thereby recorded in 2015, and additional appreciation of $128,918,000 was recorded in 2016, $7,849,000 was recorded in 2017, and $39,826,000 was recorded in 2018. See Note 4 for additional information about Medallion Bank."
And this is their explanation of the move to consolidate:
"In addition, we conduct business through a wholly-owned portfolio company, Medallion Bank, a bank regulated by the FDIC and the Utah Department of Financial Institutions which originates consumer loans, raises deposits, and conducts other banking activities. Medallion Bank generally provides us with our lowest cost of funds which it raises through bank certificates of deposit. To take advantage of this low cost of funds, historically we have referred a portion of our taxicab medallion loans to Medallion Bank, which then originated these loans, which then were serviced by MSC. As a non-investment company, as of March 31, 2018, Medallion Bank was not consolidated with the Company, which is an investment company under the 1940 Act. Following our withdrawal of our election to be treated as a BDC under the 1940 Act, as discussed below, we would be permitted to consolidate Medallion Bank with the Company"
Its because they claim that they have received external interest for the subsidiary and that interest is at a price higher than the subs BV. I agree, I think it should be a reversal of unrealized investment income as soon as they convert. But I could see it being some sort of intangible like goodwill too, i guess
bklynboy
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Your issue is that the underlying sub is not recording its assets at the same FV that the parent believes they are worth. Only way I think this is happening is that the sub does not record GAAP (not a public company and not required to file with the SEC) but likely some regulatory accounting basis, that does not allow all assets at FV and the parent is picking up the sub on a GAAP FV basis.
is this correct? If so, we can go from there but need to understand why the valuations are different (which they cannot be if both are GAAP)
is this correct? If so, we can go from there but need to understand why the valuations are different (which they cannot be if both are GAAP)
The value I gave earlier were simplified, th
Thanks for responding again. My understanding is that because the parent was a BDC, they were accounting for the sub under equity method, as a portfolio-owned company. My understanding is that the board of directors along with mgmt and input from an independent third party, are allowed to establish a FV based on an internal valuation method (per their SEC disclosures: 2.5x P/B, 25x P/E and 25% discount for DCF calcs). Up until 2015 they carried the sub at the Subs BV, as we all would expect, but then in 2015 they received interest in the sub from a hedge fund or PEquity group (though that's all the info they provided) and subsequently started valuing the company above BV based on internal valuation process. Have you ever seen anything like this before? Full disclosure: I am evaluating the company as a short selling idea and I think the conversion from BDC to non investment company status and thus the consolidation of results of the subsidiary will cause that unrealised equity gain in the sub to evaporate. Or turn into goodwill or something?