Merger Lessons Learned from a Year of Change

Given today’s economic challenges and stringent regulatory environment, it’s no wonder many credit unions are considering mergers. Whether it’s mergers of necessity or mergers of choice to better serve members, the process to combine credit unions has undergone substantial changes.


Given today's economic challenges and stringent regulatory environment, it's no wonder many credit unions are considering mergers. Whether it's mergers of necessity or mergers of choice to better serve members, the process to combine credit unions has undergone substantial changes. Revisions to the Statement of Financial Accounting Standards (SFAS) 141 have made accounting for mergers more challenging.

What's different?
For mutual organizations, including credit unions, whose acquirers' fiscal year began after Dec. 15, 2008, SFAS 141-R now requires switching from the Pooling Method of accounting to the Acquisition Method. The new SFAS 141-R has several provisions that have added to the complexity of financial reporting.

To make it easier for credit unions to comply, ALM First Financial Advisors put together a team of valuation and accounting experts, RP Financial and Sacher Consulting, who began helping clients fulfill the revised SFAS 141-R requirements. In the process, our combined Merger Valuation Services team learned several lessons that can help your credit union better manage its merger process.

Engage auditor early on.

Auditors cannot complete the valuation analysis because of their requirement to maintain independence over the audit process. However, they must satisfy themselves that the valuation techniques meet the standards set forth by the relevant accounting standards, most notably SFAS 141-R and SFAS 157. Because auditing firms have different documentation standards and methodology expectations, it can save considerable time to involve them early in the process.

Negative goodwill is not unusual.

Negative goodwill occurs when the fair value of the assets and liabilities is greater than the entity valuation. This could result from positive valuation adjustments to net assets, a low entity value, or a combination of both. Subsequently, an accounting gain is realized by acquiring an institution at a lesser price than what the net assets are worth. Negative goodwill is reflected by the acquirer as an immediate gain to net income.

Entity Value Observations

In late 2008 and early 2009, merger prices dropped below book value. But as the economy has shown signs of recovery, the merger pricing has been firming, albeit at levels well below the recent historical averages.

Separate credit and interest-rate impairments.

When valuing loans, it is imperative to separate the projected losses that are based on credit impairments from market rates. Then, the loans can be monitored for actual versus projected credit losses, and adjustments to the credit portion of the valuation adjustment can be evaluated.

Obtain amortization schedules from valuation consultant.

Amortization schedules should be developed for each loan type and for the core deposit intangibles (non-maturing deposits). For example, the ALM First team amortizes the yield adjustment on a proportional basis to interest paid (approximation of level-yield method) and the credit adjustment on a proportional basis to projected gross losses. For core deposit intangibles, our team uses the sum-of-the-years digit as the amortization method.

Expect lower valuations with high numbers of home equity loans.

Loss-severity assumptions for home-equity loans approximating 100 percent are commonplace, particularly in Arizona, California, Florida and Nevada. If considering a merger partner that has many home-equity loans, especially lines of credit, the valuation of these loans may be discounted by as much as 50 percent of their book value.

Know the level of analysis needed.

If the merger is considered "immaterial," a more broad-based analysis might be warranted, as in-depth, loan-level detailed analyses and amortization schedules may not be needed. Also, if the credit union has participated in a "bid" process, an entity valuation might not be needed. Ask the auditor for guidance on these issues.

Think about conducting two valuations.

Prior to a merger, credit unions must receive approval from NCUA and/or state regulators. In addition, management often wants an assessment of the target credit union’s value. In both situations, an initial broad-based analysis can be helpful. Then, once the merger is finalized, a comprehensive and detailed analysis can be completed, if appropriate.

To learn more, contact ALM First Financial Advisors, (800) 752-4628, or visit

About ALM First Financial Advisors
ALM First is a leading, trusted strategic partner for financial advisory services. Since 1995, credit unions have relied on our outstanding industry expertise to help them manage their balance sheets and optimize their investment portfolios. With over $11 billion in funds under management and over 120 clients, ALM First acts as an unbiased third party, formulating strategies to manage risk and enhance return, uncovering opportunities for greater efficiencies, and helping credit unions avoid non-compliance.



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Jan. 4, 2010


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    Larry Day