Key Considerations Related to the Valuation of Net Assets Obtained in a FDIC-Facilitated Transaction
Many banks have been seizing the opportunity to be active with FDIC-facilitated transactions. These strategic transactions generally involve the acquisition of certain assets and liabilities through a purchase and assumption arrangement
In addition, the FDIC generally provides a guarantee on certain assets pursuant to a loss-sharing arrangement (LSA), acting like an insurance plan for the acquiring institution. Many of these transactions have resulted in an accounting gain (bargain purchase gain) for the winning bidders.
Accounting Standards Codification (ASC) Topic 805, Business Combinations, (previously FAS 141R), requires that all acquired assets and liabilities are recorded at fair value. Determining the fair value of the loans and deposits acquired, the related indemnification asset if there is a LSA and a core deposit intangible includes various complexities and challenges that are not common with normal bank mergers and acquisitions. The proper use of current market interest rates and credit related factors have a significant impact on the value of the loans, the indemnification asset, the potential bargain purchase gain and regulatory capital. The following provides an overview of some key considerations when valuing net assets obtained in a FDIC-facilitated transaction.
Complications in dealing with a failed institution
The LSA between the FDIC and the acquiring institution is accounted for as an indemnification asset pursuant to ASC Topic 805. There is a correlation between the fair value of the loans and the LSA, as the expected credit loss assumed in valuing the loans, as well as the timing of the loss, is taken in account in determining the fair value of this indemnification asset.
Core deposit intangible
CDI values are significantly lower than they were a few years ago due to the current interest rate market. With a failed institution, the premium is usually even lower due to higher expected attrition. A discounted cash flow method is also typically used to value a CDI, which reflects the cost savings the core deposits provide to the bank. Key assumptions include expected initial account run-off, annual attrition rate, current market interest rates, non-interest income, operating expenses attributable to core deposits and the alternative cost of borrowing, such as FHLB advance rates or brokered CD rates. In determining expected attrition rates, historical performance is considered, as well as the impact if it is assumed that interest rates will be reset. CDs are not typically included as core deposits for purposes of calculating the CDI due to their rate sensitivity.
There are always many factors to consider when valuing the net assets in a bank merger or acquisition. However, when acquiring the net assets of a failed institution, there are often more complications and less time to manage them. Having a thorough knowledge of common issues at the outset of your transaction could eliminate difficulties and allow your purchase accounting efforts to progress more smoothly.
For more information on issues pertaining to troubled institution transactions, please read Tax Consequences of Amounts Received by the Acquiring Bank in an FDIC Assisted Transaction as well as The Effect of FAS 141R on Bargain Purchases.
Suzanne Marra, ASA, is a director at McGladrey. She can be contacted at 847.413.6965 or at email@example.com.
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