The Facts You Need About Merger Accounting Before Executing a Voluntary Merger (part 1)

As of Dec. 15, 2008, all credit unions undergoing a merger are required to use the Acquisition Method of accounting. This article addresses the most common questions regarding the Acquisition method and provides appropriate perspective to the senior management team who might not be well grounded in accounting for business combinations under SFAS 141-R.

 
 

As I began my career in 1977, there were approximately 20,000 federally insured credit unions in the United States. Fast forward to 2009, and the numbers are down to less than 8,000 credit unions. Wow! The number of institutions continues to decline rapidly today as credit unions recognize the competitive & strategic advantages that are created by improved economies of scale.

Prior to 2009, accounting for credit union mergers was easy—“the whole equaled the sum of the parts.” That is to say, you added the two balance sheets of both credit unions together, and the balance sheet of the new entity was born. This accounting method, also known as the Pooling of Interest method, was permitted for mutual organizations even though most business entities were required to use the Purchase (or Acquisition) method. The Pooling method was simple, didn’t require any fair value adjustments and therefore didn’t require the retention of fair value consultants.

Unfortunately, SFAS 141 was revised in 2008 (SFAS 141-R) to eliminate the use of the Pooling method for mutual organizations (including credit unions). The new method, referred to as the Acquisition Method, will be required for all credit union business combinations for fiscal years (of the Acquirer) beginning after December 15, 2008. The purpose of this article is to address the most common questions regarding the Acquisition method, and provide appropriate perspective to the senior management team who might not be well grounded in accounting for business combinations under SFAS 141-R.

The most common questions regarding acquisition method accounting are:

  1. How does the Acquisition method differ from the Pooling method?
  2. What parts of the Acquiree will have to be recorded at fair value?
  3. How is fair value defined, and how is fair value determined?
  4. What are the most common intangible assets that will be identified in a credit union business combination?
  5. What are the impacts to total capital?
  6. What are the impacts to Regulatory Net Worth?
  7. What are the impacts to future reported earnings and retained earnings?
  8. What level of documentation will be required by my CPA?
  9. What are the most important practical considerations that we should consider as we pursue merger opportunities?

Note: Questions 5-9 will be addressed in Part II of this article.

How does the Acquisition method differ from the Pooling method?

The Acquisition method, previously referred to as the Purchase method, requires the acquirer to record the acquisition of the acquiree at fair value, as that term is defined in SFAS 157. The fair value of the entire entity and the fair value of all individual assets and liabilities of the acquiree must be determined, including both tangible and intangible assets. The difference between the fair value of the entity, less the fair value of the tangible & intangible net assets (assets less liabilities) will be recorded as goodwill. Goodwill must be evaluated for impairment each reporting period. As noted earlier, the Pooling method didn’t require any fair value adjustment, and simply required the combining of both balance sheets to determine the book value of the new entity.

What parts of the Acquiree will have to be recorded at fair value?

All assets and liabilities, tangible and intangible, those already recorded and those not recorded but having value will have to be determined. For example, even though not recorded in the past, the acquiree will most likely have a “core deposit intangible (CDI)” that will be recorded as part of the fair value process. Other assets and liabilities that will likely have significant fair value gains/losses include loans, buildings, investments and shares. Consideration will also have to be given to recording certain contingencies that might not have been required of the acquiree under SFAS 5.

How is fair value defined, and how is fair value determined?

Fair value is defined in SFAS 157. Simply stated, fair value is the price that would be received to sell an asset (or paid to transfer a liability) in an orderly transaction between marketplace participants at the measurement date.” Fair value is based on an exit price (for an asset, the price at which it would be sold) rather than an entry price (the price at which it would be bought). Many assets (and liabilities) can be valued based on actively traded markets for exact or similar items. If no active market exists, SFAS 157 provides for fair value to be estimated by other means, such as discounted cash flow (DCF) models.

As noted earlier, SFAS 141-R will require a valuation of the entire entity. Since credit unions don’t trade in an active market, the fair value will either be derived based on recent sales of similar size financial institutions (difficult in today’s environment), or using a DCF model meeting the stringent requirements of SFAS 157.

What are the most common intangible assets that will be identified in a credit union business combination?

As previously discussed, the CDI will be common in most credit union business combinations. What is the CDI? The CDI represents the benefit derived by a retail banking institution for having access to a constant source of low-cost deposits and access to a customer base that represents “additional wallet share” for the future sale of additional products and services. Other intangibles might include carry-over items from prior CUSO acquisitions (insurance agency goodwill, customer lists, non-compete agreements, etc.). And most of the time, goodwill will result from a credit union business combination, and will be recorded and then tested for impairment in future periods. Goodwill will not be amortized, which is a significant difference from how goodwill was accounted for in the past.

Part II

About Mike Sacher:
As a CPA with over 30 years experience providing services to credit unions, Mike Sacher has earned a national reputation for his expertise in areas such as accounting & finance, internal control, ALM and governance issues of importance to credit unions. Mike stands ready to assist your credit union with practical and effective solutions to the complex merger accounting requirements imposed by GAAP.

 

 

 

April 27, 2009


Comments

 
 
 
  • As usual, Mike has taken a complex issue and presented it in a straightforward and understandable format.
    Anonymous