Impacts of financial decisions
Add Fair Value Estimates Into Your Financial Institution’s Due Diligence Process
Your financial institution has found an acquisition opportunity. You’ve written a letter of intent, completed the acquisition due diligence, and negotiated the purchase price. The last thing you want at this stage is a surprise. But too often, this is when you’ll discover that the assets and liabilities of the institution you’re acquiring must be recorded at fair value — not the historical cost basis. And the surprises only grow when you find out that the allowance for loan and lease losses disappears. After the initial shock dissipates, you are left scrambling to figure out these fair values.
Incorporating fair value estimations into your due diligence process can help mitigate the chances of accounting surprises complicating your acquisition. When you know these estimates up front, you can even uncover information that can economically benefit your institution later in the process.
Know which assets and liabilities experience the most adjustment
While all assets and liabilities are subject to fair value adjustment, the following assets and liabilities are impacted the most:
- Land, buildings, and leasehold improvements
- Other real estate owned
- Favorable or unfavorable leases
- Mortgage servicing rights
- Core deposit intangibles
- Certificates of deposits (specifically the advantage associated with below market rates or the obligation to continue paying above market interest rates)
- Trust preferred securities (the value of borrowing money on an unsecured basis for an extended period of time at favorable interest rates)
Fair value estimations bring holistic benefits
Although fair value estimations add time to your due diligence process up front, having these numbers early in the process can benefit your institution by:
- Helping you consider items that are easily overlooked, such as mortgage servicing rights, favorable and unfavorable leases, and the value of below market trust preferred securities
- Requiring you to think about the value and usefulness of the target institution’s office furniture, computers, networks, and telephone equipment, and how these will integrate into your existing systems.
- Reminding you, as the buyer, that the fair value adjustments will either increase or decrease goodwill, and therefore has a direct impact on your regulatory capital
- Initiating discussions and planning related to post-closing accounting for the loan portfolio
- Estimating the impact to capital when considering the potential write-up of the target institution’s land and building
- Bringing valuation professionals, such as real estate appraisers or brokers, into the process earlier. This tends to trigger planning related to the need for, and cost of, remodeling, and initiates the process of rebranding the purchased building to match your institution’s image.
When working with fair value accounts, you may be pleasantly surprised to find that the target’s holding company has outstanding long-term trust preferred securities. This debt is unsecured, long-term in nature, and payments can be deferred in case of financial difficulty. Best of all, these rates are often very attractive. Putting a value on these advantages reduces the amount of recorded goodwill. By adding fair value estimations to your process, you may find yourself changing your deal structure in order to assume this debt, and therefore reduce the amount of your bank stock loan.
Create action plans for your team
Everything your team considers when marking the balance sheet to fair value for purchase accounting and fair value accounting processes should align with the requirements under the generally accepted accounting principles.
Keep in mind that unexpected items may pop up during this transition. For example, deferred loan fees and costs will likely disappear, as these items now are part of the fair value of the loans and won’t be separately tracked after closing. Because of this change, you may also discover that your book basis and tax basis are different, and you will need to make a plan for tracking these differences. Using information gleaned from your due diligence, you may also want to revise your pro forma balance sheet and projections and incorporate the changes into your funding needs and plans.
How we can help
You don’t have to do the work alone. Our professionals work with institutions of all sizes every day and are well-versed in acquisition requirements. We can help you complete your due diligence, including fair value assessments of investments, loans, core deposit intangibles, trust preferred securities, favorable and unfavorable leases, and deposit interest rate adjustments. And, if needed, we can help you prepare the financial projections and pro forma financial statements needed for regulatory applications.