Many acquirers remark, after the fact, they wish they had started the due diligence earlier in the process.
Merger Talk: Credit Unions
I keep hearing stories about credit unions that aren’t actively looking to merge — and then suddenly an opportunity presents itself. A scenario like this was complicated enough before January 1, 2009, but it has become even more so in the three and a half years since. January 2009 is when ASC 805 Business Combination rules were established, and merger accounting for credit unions took on a life of its own.
ASC 805 was the culmination of a Financial Accounting Standards Board (FASB) initiative to overhaul the accounting rules for business combinations and noncontrolling interests (formerly referred to as “minority interests”). It officially ended the “pooling of interest” method for credit unions, and replaced it with the purchase accounting process. Despite it being more than three years since the rules were implemented, we still get a lot of questions.
ASC 805 impact on the acquiring credit union
As mentioned, ASC 805 eliminated the pooling method of accounting for business combinations. In its place is an entirely different set of purchase accounting procedures. These procedures, referred to as the “acquisition method,” apply to the surviving credit union.
There are two steps in the acquisition method process:
- Determine the fair value of the equity in the credit union that is being merged-in. Generally speaking, the fair value can be estimated using valuation approaches to approximate a theoretical purchase price. This process must be performed since there is typically no measurable consideration in credit union transactions.
That leaves two options: a) Either fair value is equal to 100 percent of the targeted credit union or, b) fair value of an ownership interest in the buyer. It is likely easier and more reliable to determine the fair value of the targeted credit union. Thus, the determined fair value of a target credit union’s equity is equivalent to an estimated purchase price, if consideration had changed hands.
- Determine the fair value of the various assets and liabilities being acquired, including:
- Loan portfolio
- Time deposit portfolio
- Core deposit intangible
- Any other assets and liabilities identified
Positive or negative goodwill
Once the fair value of the equity is known and the fair value of the balance sheet components are known, goodwill can be determined to equalize the balance sheet. Goodwill can be positive or negative, but negative goodwill cannot be booked and implies a bargain purchase gain. Positive goodwill is booked and annually tested for impairment using valuation methodologies.
The concept of negative goodwill is a particularly hot topic right now when it comes to the acquisition process. Credit unions sometimes come to the conclusion that goodwill is negative (more assets than liabilities) after all of the fair value work is complete. This implies that the surviving credit union is getting a good deal (i.e., a bargain purchase).
Don’t let ASC 805 alone hinder an acquisition
ASC 805 affects the strategies, timing, and nature of merger transactions. The accounting requirements are significant, but they should not impede good business decisions. Proper due diligence can help credit unions determine if there is a “return on investment,” and allow them to move forward, even on the most complex merger transaction. In addition, credit unions should review due diligence procedures.
Good due diligence goes beyond assessing a potential target’s accounting and tax issues. An acquirer should get insight into a merger target’s business operations, and determine how the target would strategically fit into the acquirer’s organization. Due diligence can also include assessing the sustainability of the target’s key business drivers. By doing so, the acquiring credit union can gain an understanding of factors that might impact its investment model, and identify potential opportunities and contingencies of the credit union being acquired. Many acquirers remark, after the fact, they wish they had started the due diligence earlier in the process.
As presented, these rules are much more complex than the pooling of interest accounting that many credit unions are used to following. If your credit union is considering a merger it is very important that you research the rules to ensure the accounting aspect is understood.
Randie Dial, Credit Union Partner
email@example.com or 317-569-6212