In the initial accounting for an acquisition, all assets and liabilities are marked to their fair values, with the most significant marks typically for the loan portfolio, followed by depositor customer relationship (core deposit) intangible assets. Fair value marks may also be appropriate on the liability side for time deposit portfolios and longer-term debt instruments such as FHLB advances, subordinated debt, or trust preferred securities.
At Mercer Capital, we work extensively with our clients to analyze loans and other acquired assets and liabilities both when assessing a target initially and when accounting for the transaction at the closing date. Our valuation analyses provide all the information you need to meet the complex financial reporting requirements for an acquisition.
Our loan valuation process begins with due diligence discussions focused on the target’s overall underwriting strategy as well as specific loans or areas of concern in the portfolio. We work with both the management of an acquirer and their loan review personnel (both internal and external) to obtain an in-depth understanding of the loans being acquired. Working with management, we then stratify the acquired loans based on characteristics such as loan type and interest rate, as well as credit characteristics, ensuring that both loans identified as purchased credit impaired and non-impaired loans are valued appropriately. We develop detailed monthly cash flow forecasts for the acquired loans that consider contractual loan terms as well as the outlook for future interest rates, estimates of prepayment speeds, credit loss estimates, and appropriate discount rates. We provide a detailed valuation model along with extensive documentation to support our analysis of the fair value of the subject loans, reflective of the contractual terms and the credit risk of the loan portfolio.
Core deposit intangible asset values are driven by both market factors, namely the interest rate environment, as well as bank-specific factors such as customer retention, deposit base characteristics, and a bank’s expense and fee structure. Mercer Capital assesses market data regarding the costs of alternative funding sources, the overall outlook for interest rates, and the sensitivity of the acquired deposit base to changes in market interest rates. Simultaneously, we analyze the cost of the acquired deposits relative to the market environment, looking at current interest rates paid on the deposits as well as other expenses required to service the accounts and fee income that may be generated by the accounts. We analyze historical retention characteristics of the acquired deposits and the outlook for future account retention to develop a detailed forecast of the future cost of the acquired deposits relative to an alternative cost of funds. We provide a detailed valuation model and supporting documentation for the intangible value of the acquired depositor customer base.
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