February 6, 2025 • 24 mins
Bank mergers and acquisitions are on the rise, with institutions looking to expand, scale technology investments, and enhance profitability. But the accounting side of these deals—Day 1 valuation, CECL modeling, and income recognition—can introduce unexpected complexities that impact deal success.
In this episode, Abrigo Advisory’s Neekis Hammond and Derek Hipp bring their accounting expertise to discuss key accounting considerations for M&A transactions, such as common pitfalls and how leveraging data can streamline the transition. Join us to learn best practices for banks preparing for future acquisitions.
Helpful links:
Whitepaper: Valuation and purchase accounting in a dynamic macroenvironment
Webinar: Valuation and purchase accounting: Navigating the changing M&A landscape
Advisory services: Bank Valuation Services - Purchase Accounting Services
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Kate Randazzo (00:00):
This is Ahead of the Curve, a banker's podcast.
Bank mergers and acquisitionsare on the rise, with
institutions looking to expand,scale technology, and enhance
profitability.
But the accounting side ofthese deals– day one valuation,
CECL modeling, and incomerecognition– can introduce
(00:23):
unexpected complexities thatimpact deal success.
In today's episode, AbrigoAdvisors Neekis Hammond and
Derek Hipp bring theiraccounting expertise and break
down the key considerations forM&A transactions, like common
pitfalls and how leveraging datacan streamline the transition.
Join us to discuss bestpractices for banks preparing
for future acquisitions.
(00:43):
Thank you guys for joining ustoday.
We're going to start pretty bigpicture on this topic.
We are seeing a resurgence inmerger and acquisitions
interest.
We saw that 43% of bank leadersare saying they're likely to
(01:05):
buy another bank by 2025.
So could you guys tell uswhat's driving the increase in
activity right now?
Neekis Hammond (01:12):
Yeah, Kate, there's a few factors here that
kind of drive in that momentum.
I'll hit on a couple.
The first one being scale,just, you know, with...
with some fixed costs and maybesome regulatory costs.
These bigger banks, they canscale better.
So merging banks and findingsynergies is important.
(01:32):
Expanding into new markets.
M&A allows somebody to growinto a new market fast, much
faster than organically.
Another big one is just stockprices.
Just like your dollar can gofurther when it's worth more,
these banks' stock prices, whenthey're worth more, they may be
(01:55):
able to purchase more with theirstock compared to previous
years.
So stronger bank stock price isanother reason.
So I think acquisition interestis high, and banks are
comfortable paying a decenttangible book value.
I think the biggest thing iswhat we'll probably talk about
(02:15):
next, which is what'sconstraining M&A.
Derek Hipp (02:19):
Yeah, the other thing that I would mention is
there's a little bit of pent-updemand that I've heard and or
seen in the M&A market.
If you just look at the overalldeal activity from the past
couple of years, obviouslyliquidity and stock valuations
were a big problem in and aroundthe bank failures that
happened.
And there's just been somecontinuation of that, maybe some
(02:42):
regulatory burden that's maybemade people less susceptible to
really pursue meaningfulmergers.
And I think some of that, youknow, you expect to lessen.
So all those things, I agreewith what Neekis is saying
there.
I think there's also somecomponents of just the overall
environment that should be moreconducive to deals happening
(03:02):
into the future.
Neekis Hammond (03:03):
Yeah, pent-up demand's a big one.
That's a good call out there.
Kate Randazzo (03:08):
People have been waiting it out.
So with that in mind, let'stalk about the accounting side.
What are some of the biggestfinancial challenges that banks
face when they're integrating anew acquisition?
Neekis Hammond (03:19):
Yeah, I mean, there's a lot of challenges.
I think, you know, focusing in,like you said, on the
accounting is something we'reparticularly good at.
But the day one valuation,sometimes that just just kind of
go with who's helped them indue diligence or whatever but
that's a big one to get rightbecause it follows you forever
(03:39):
you know you've got some otheritems to consider on the
accounting side you've nowmerging two cecil or two banks
into one cecil model you don'twant to be using two models that
tell a different story soyou've got to integrate those
somehow end up with one thethird item is income recognition
these You'll have purchaseaccounting marks, marking these
(04:02):
loans and assets to fair value,and you've got to recognize
those over time.
And so having a model or havingan answer for how you're
recognizing the accretion or theamortization of those marks in
an auditable and transparent wayis not easy.
And so having an answer forthose three items is important.
(04:23):
Derek, what did I miss?
Derek Hipp (04:26):
Yeah, I mean, there's a lot of technicalities
to get into.
I think from a financialreport, I'll expand it from
accounting to say maybefinancial reporting around
business combinations.
And those three are kind of themajor classifications of where
we would see some process flowsaround them.
We've got a pretty good pieceof thought leadership content
(04:47):
that goes through all the stepson a detailed basis on our
website.
And we'll talk about, you know,on this, what are some of the
key things to think about to besuccessful in each one of them?
You know, the first there thatwe talked about was the day one
valuation or the mark to marketof the balance sheet of that
target.
So there's financialinstruments that have to be
(05:11):
maintained from a fair valueperspective moving forward.
And then there's some thatyou're just carving out
intangible separately fromgoodwill.
So if we kind of go down thebalance sheet quickly, Generally
speaking, cash is cash.
You don't have to mark anythingon cash.
You then get into fixed assetsand maybe equipment and things
(05:37):
like that, ATMs, computers, allthat type of stuff.
Generally on the fixed assets,you're going to have a full
appraisal that's needed.
And there's obviously companiesthat our banks use to get real
estate appraisals.
On the equipment side, Prettystraightforward of that.
We generally see costs beingthe best estimate of fair value.
(05:57):
And those are all kind ofstraightforward.
And then you start getting intoloans, which is a big part of
the financial modeling.
And there's this concept inaccounting of different levels
of ways that you can approachfair value.
So most people know that, butI'll go back through it just at
a high level to explain that.
(06:18):
Level one is like Apple stock.
There is a very highly liquidmarket.
You know what the value ofthose assets are because it's
traded every day.
Level two is less liquid of amarket, and I'm just speaking in
general terms here to make iteasy to understand, where There
(06:39):
is a market that exists.
It may not be as quickly quotedor as accurately quoted.
And then there's level three,which there really isn't an
active market.
And that's what a lot of thisstuff falls into because there's
just not an active market ofcommercial loans that are not
securitized in the way thatthey're set up that you can just
(06:59):
go grab a QSIP on or somequoted price.
And so the valuation process isreally important to get
through.
And then you keep working downOutside of loans, right, we
talked about carving out thoseintangibles.
Generally speaking, a coredeposit intangible exists with a
bank M&A or a credit union M&Adeal because it's just obviously
(07:20):
a very valuable customer list.
And so it's an intangible thatcertainly gets carved out.
You have to mark time depositsto fair value, pretty
straightforward on that in termsof the interest rate marks.
The other thing to consider islong-term debt.
So if there's any outstandingtrust preferred from way back in
the day or subordinated debt,that needs to get marked to fair
(07:42):
value.
And the last one that wegenerally see is pretty relevant
is around leases.
And so when we think aboutleases, there is a concept of
favorable or unfavorablearrangements to consider.
So went into a lot of weedsthere, but the purpose is you
kind of work your way down thebalance sheet and just make sure
you've got a game plan aroundall of those.
(08:03):
And especially on the loanvaluation, getting into that
next step of how it interactswith CECL is really important
because CECL is not fair valueand fair value is not CECL, but
they're pretty close to oneanother conceptually.
And so because of that, there'sa lot of comparative analysis
(08:23):
that has to be done when you'reworking through that process.
And so if we kind of step intothat next step of these three
categories that we're goingthrough, day one valuation, CECL
transition and incomerecognition.
The CECL component is kind ofexactly what we see with what
Neekis said.
Generally, you're going to haveone surviving CECL process,
(08:43):
Kate.
We have not seen in the manytransactions that we've helped
out with at least any reason tocontinue on with the targets
CECL process and the buyer tohave their CECL process.
When there's a deal where thebuyer is significantly larger
than the target, Nine times outof 10, maybe more than that, 9.9
(09:04):
times out of 10, the buyer'sCECL framework is going to be
surviving.
Maybe there's some alterationsthat need to be made to that to
make that happen, but that'sgenerally going to be the case.
When you have a merger ofequals or even a buyer buying a
target that is significantlylarger, It may call into
(09:24):
question the framework that youhave.
Can it be used for the proforma combined company?
And there may be more work thatneeds to be done.
But there's things you got tothink about there.
Which methods are bothcompanies using?
It could be just something assimple as the buyer is using a
forecast regression componentfor probability default, loss
(09:45):
given default, and the target'susing kind of a warm model based
on historical charge-offactivity.
Will they even work together?
Or maybe the target, asresident auto loans of a
specialty that the buyer has nopools or framework set up.
So there's alterations thereand things you certainly need to
be thinking about as you lookat the combination of those
(10:06):
models and how ultimately theycan be used.
One major component thatprobably doesn't get enough
attention in that is thisconcept around PCD assets.
And generally during valuation,PCD assets are The term stands
for purchase creditdeteriorated.
And those are generally thosethat are more risky.
(10:29):
More than insignificant creditdeterioration is technically
what the accounting guidancesays.
But quite often, those loanswill carry very high marks or
heavy marks in the allowanceprocess and that mark-to-market
day one valuation.
And then when you get into yourCECL framework, you may not
really have a method as to getto those high marks, right?
(10:51):
If you just look at yourallowance components, it can be
quite a difference.
And we just talked aboutearlier where there's some type
of comparative analysis thatneeds to be done.
So quite often there is aprocess that there needs to be
some type of calibration to theCECL model to accept those PCD
assets.
It's one that probably doesn'tget enough attention on the
(11:14):
front end, and then it's quicklykind of observed.
as you're actually trying tocreate these CECL calculations.
And so all of those things wekind of talked about there were
more of the policy perspectiveto consider around CECL.
There's also just simpleoperational things, right?
Like if you're running a CECLsoftware, how are you going to
get the target's data into thatCECL software prior to the full
(11:37):
core merge happening?
So there's the policy stuffthat takes...
you know, a little bit moretime and documentation to work
through.
And then there's justprocedural steps mechanically to
create those.
And so working all the waythrough that, kind of the final
step is after you do things,there's a mark to market that
exists that has to be accretedinto earnings over time.
(11:58):
And, you know, that terminologytechnically is called income
recognition.
And what we quite often seethere is just different ways of
going about that.
Generally, you have threeoptions that we see, a software
product, a vendor softwareproduct, you have a spreadsheet
maybe you're keeping internallyor trying to do it on the core
processing system.
(12:18):
And one thing to really thinkabout there in that process is
these marks generally that arecoming onto the balance sheet,
especially in the currentinterest rate environment, can
be pretty material to theoverall earnings of these
companies, Kate.
And so they need to be reallycognizant of this process.
This is one that If it's asmaller deal, maybe people
(12:41):
haven't really thought about, oreven if it's a larger deal,
there's a process that theybelieve will work for them.
But when they start gettinginto the weeds, you have to
realize on mark-to-markets andthis concept of running it
through 31020 or FAS91, wheneveryou've got in your originated
portfolio, you're making newloans every day and loans are
(13:02):
paying off.
And so that number is neververy big.
But if I'm a $10 billion bankdoing an MOE with a $9 billion
bank, I'm now bringing $9billion, let's call it $7
billion of loans, onto thebalance sheet at one time.
So even if the fair valuemark's really, really low, I'm
still putting all those marks onat one time, right?
(13:24):
And it's material regardless ifthe mark is material or not.
And quite often in a lot ofscenarios we're seeing right
now, right, especially onresidential ones, the marks as a
percentage are very high.
And so that one probablydoesn't get as much attention as
the other two that we typicallysee, but it's very relevant and
just something to make surethere's a process to be handled
(13:45):
around.
Neekis Hammond (13:46):
And it's kind of, Kate, it's kind of newly
relevant also, you know,pre-CECL adoption, you know,
there was some more technicalaccounting behind how you should
account for these purchasemarks that kind of forced a lot
of folks to have a separateprocess for this.
Kate Randazzo (14:04):
Yeah.
Neekis Hammond (14:04):
But now there is a thinking that these can just
kind of be thrown onto your coresystem and accreted
accordingly, but these dollarsare big, as Derek described, and
there's not audit support to goalong with that core accretion
that's sufficient enough toreally dig into some of these
anomalies you may see orexplain, right?
outliers and so or even findthem for that matter and so it
(14:29):
becomes very important to beable to get the detail behind
that income recognition on thesemarks and it's really
challenging to get through acore provider so that's where
you know that's where it off wesee a lot of um that's often
overlooked when we when we talkto customers or experience in
m&a with some of our customers
Kate Randazzo (14:51):
yeah i can see how that'd be easy to do i mean
it sounds simple when you breakinto the three steps, day one
valuation, CECL transitioning,but then, you know, you break it
down and you end up with just alot of detail.
And I know a lot of banks haveturned to Yelp for help in the
past couple of years andAbrigo's had some really high
profile M&A deals recently.
Could you explain how yourteam's process works with really
(15:12):
streamlining all of thosetransitions?
Derek Hipp (15:16):
Yeah, we've got a big practice here, you know, and
it couples well with our CECLpractice as well.
But on any given day, year,we're probably working on 40 to
50 deals.
There's a press release thatwe've got out there we generally
put out annually.
But in 23 and 24, we worked onsix of the largest 10 MOEs, did
(15:39):
a ton of other activities aroundsmaller deals kind of all
across the country.
And so we certainly gotexposure to it.
And we'll go through some ofthose details of how we can be
involved.
But The reality of it is yougot to make sure that when
you're working through theseprocesses that you have a
(15:59):
provider or a partner that'sthinking through the entire
process with each of thesebecause there's a lot of work
that can be done out thereinternally or externally through
vendors where it's very much apoint solution.
And then you've got to fill inthe gaps.
And so that's definitelysomething to keep in mind when
(16:20):
you're going through these tomake sure It's all the way from
data ingestion.
It's policy documentationaround why you're making the
decisions you're making,actually doing it, and then
reporting off of it as well,because a lot of people can just
do it, and then all those otherthings are just kind of on you.
And there's a lot of auditsupport.
There's a lot of going back andforth with these things.
(16:43):
We talked about a lot of levelthree processes, a lot of
decisions to be made from apolicy perspective, not just
operationally.
And so because of that, justmake sure there's a partner we
would generally recommend thatis helping you through the
entire concept and really beingan extension of your team.
And that means being on a callwith auditors, being on a call
(17:06):
to present everything, right?
Not sending emails and thingslike that.
It's just not great because ofthe risk that's there in the
amount of detailed analysis.
But on that valuation side, howwe generally help is the
mark-to-markets of of all ofthose components.
And again, on the appraisalside, generally on real estate,
(17:29):
there's going to be specificsthere to work through.
And then the more burdensomevaluations that contain a lot of
assumptions are the loan inputsand then around CDI from there.
Some of the other things are alittle bit more straightforward.
Secondarily, as we move intothat second component of CECL,
(17:50):
we help all the way fromsomething as simple as just
manually getting data into thesystem for that target
portfolio, all the way toevaluating whether the current
CECL framework that the buyerhas is sufficient enough to be
used for the combined company,or if there's modifications that
(18:10):
need to be made.
And again, just kind of talkingabout a lot of the MOEs that
we've worked on in thosesituations, you're really
setting up to maybe wherethere's just some updates.
Maybe the full frameworkdoesn't have to be changed, but
if you're using a peer group,maybe the peer group's no longer
relevant.
If you're using a peer groupbased on a company that's 10
(18:30):
billion in one particulargeographic region, and now
you're 20 billion operating in amuch different geographic
region, the current CECLframework may not be relevant.
Or if your current CECLframework is using historical
losses from your entity only,right?
How are you going to bring awhole new portfolio into there
(18:51):
and say that those losses arerelevant for the combined
company?
And then finally, it's reallyjust, you know, working through
those simulations of whateverthat combined framework needs to
be, because again, that'sreally important.
So it's okay to think through,you know, considerably what
makes sense to use, but Untilyou actually do dry runs and
(19:12):
practices and see what theaccounting flow looks like with
some of these concepts aroundPCD, gross ups, et cetera, you
might not really know whatyou're getting into and the
decisions that you're making.
And then finally, we've got asoftware product to do income
recognition to work through.
Got deployed recently in theBrigo user interface.
(19:32):
Got a number of customers thatuse that.
It integrates from an allowanceperspective as well because the
allowance needs to considerthose for non-PCD assets.
And so we work with a lot ofcompanies and, you know, getting
that set up, getting thesoftware running, you know,
getting it flowing through CECLproperly.
Kate Randazzo (19:49):
That's great advice.
And for banks consideringacquisitions in the next few
years, what advice would yougive them to help them prepare?
Neekis Hammond (19:57):
Yeah, I mean, Derek's covered a lot of this,
but I think I'll try andsummarize.
But The valuation is important.
You have to live with thosedecisions.
It's not just a one and doneexercise.
And we see a lot of aggregatecalculations being pushed down
to the loan level.
That causes problems down theroad.
We see a lot of PCD credit lossestimates that are not thinking
(20:24):
about how you need torecalculate those into
perpetuity as part of a CECLmodel.
We see a lot of valuationproviders communicating to their
clients that a valuation creditmark is a CECL allowance, and
that's not correct.
And so the first thing would bevery careful about who you work
(20:46):
with your valuation.
As Derek described, there's alot of point solutions.
It's best to work with somebodythat can take you through the
entire process rather than justsolve one thing, because you're
going to have to bring thosegroups together, and that can be
a challenge.
The other idea here is just theCECL planning.
You need to start it early.
You can't wait till close.
(21:07):
You need to start buildingthese models early.
And the specific thing that I'dgive advice on here is you
can't just show up to an auditorand say, we threw these loans
into our existing allowancemodel because we have a similar
footprint, similar loan pool.
You need to prove it.
And so the specific thing I'dgive advice on there is, you
(21:28):
know, We prefer to run anindependent calculation for the
acquired bank using your model.
That way you can show here isfollowing our processes, our
procedures, our philosophy onthe newly acquired bank.
Here's the answer.
Here's the answer if you justplug them into our model.
What's the delta and why are wecomfortable with that delta?
(21:51):
In other words, be wittingabout that decision.
Document why.
with calculations, it'sappropriate for them to live in
a pool with your existing loansor why you need to create a new
segment for these loans thatyou've just acquired.
So that's a big part of theCECL planning process.
There's also setting uppurchase credit deteriorated,
(22:13):
these PCD segments, they need tobe calculated differently.
You need to set up thosesegments.
You've got to get yourdocumentation done.
Those are all big deals.
You need to figure out howthose new marks are gonna flow
into your CECL model at the endof every reporting period as
they change.
How are you accounting forthose marks in your CECL model
out of the valuation?
So those are the three keycomponents that Derek went
(22:37):
through, valuation, CECL andincome recognition, and you
can't do one without the other.
And so the advice is just talkto somebody that does all three
before you advance in yourdecision, because far too often
we're brought in too late.
The decision's been made and wecan't help.
And so just bring us in early.
Let's talk, you know?
Kate Randazzo (22:59):
Definitely.
And I did want to point outanother thing to our audience,
which is just that sometimesjust having a third party who
has heard from otherinstitutions can be so helpful.
And Abrigo has this database ofloan data from over, what,
2,000 financial institutions.
So you guys have theexperience, and I know that
you're happy to share thoseinsights and just have
(23:20):
exploratory conversations withpeople who are interested in
hearing about help.
Neekis Hammond (23:25):
Kate, you bring up a good point, which is a lot
of these organizations don'thave inputs and assumptions that
are beyond their own walls.
They have data that they have.
And so if they need to make anassumption for an institution
that's elsewhere in the countryor has a different kind of loan,
working with somebody that hasa strong database to draw
(23:47):
analogies from and to providesupportable inputs and
assumptions is a big dealbecause you don't You can't just
make up these numbers.
Everyone knows that.
It's listening.
But having strong supportbehind them is helpful.
Kate Randazzo (24:00):
Definitely.
So a lot of opportunity comingup in the M&A space, but got to
get the accounting right.
And Abrigo can help you dothat.
So if you enjoyed thisconversation and you want to
learn more, I will link in theshow notes to some of the
resources that Derek mentionedand to our advisory pages if you
would like to talk to someone.
But Derek Neekis, thank you somuch for sharing your expertise
(24:21):
today.
Yeah,
Derek Hipp (24:21):
thank you, Kate.
Absolutely.
Kate Randazzo (24:22):
Appreciate it, guys.
This is Ahead of the Curve, a banker's podcast.
Bank mergers and acquisitionsare on the rise, with
institutions looking to expand,scale technology, and enhance
profitability.
But the accounting side ofthese deals– day one valuation,
CECL modeling, and incomerecognition– can introduce
(00:23):
unexpected complexities thatimpact deal success.
In today's episode, AbrigoAdvisors Neekis Hammond and
Derek Hipp bring theiraccounting expertise and break
down the key considerations forM&A transactions, like common
pitfalls and how leveraging datacan streamline the transition.
Join us to discuss bestpractices for banks preparing
for future acquisitions.
(00:43):
Thank you guys for joining ustoday.
We're going to start pretty bigpicture on this topic.
We are seeing a resurgence inmerger and acquisitions
interest.
We saw that 43% of bank leadersare saying they're likely to
(01:05):
buy another bank by 2025.
So could you guys tell uswhat's driving the increase in
activity right now?
Neekis Hammond (01:12):
Yeah, Kate, there's a few factors here that
kind of drive in that momentum.
I'll hit on a couple.
The first one being scale,just, you know, with...
with some fixed costs and maybesome regulatory costs.
These bigger banks, they canscale better.
So merging banks and findingsynergies is important.
(01:32):
Expanding into new markets.
M&A allows somebody to growinto a new market fast, much
faster than organically.
Another big one is just stockprices.
Just like your dollar can gofurther when it's worth more,
these banks' stock prices, whenthey're worth more, they may be
(01:55):
able to purchase more with theirstock compared to previous
years.
So stronger bank stock price isanother reason.
So I think acquisition interestis high, and banks are
comfortable paying a decenttangible book value.
I think the biggest thing iswhat we'll probably talk about
(02:15):
next, which is what'sconstraining M&A.
Derek Hipp (02:19):
Yeah, the other thing that I would mention is
there's a little bit of pent-updemand that I've heard and or
seen in the M&A market.
If you just look at the overalldeal activity from the past
couple of years, obviouslyliquidity and stock valuations
were a big problem in and aroundthe bank failures that
happened.
And there's just been somecontinuation of that, maybe some
(02:42):
regulatory burden that's maybemade people less susceptible to
really pursue meaningfulmergers.
And I think some of that, youknow, you expect to lessen.
So all those things, I agreewith what Neekis is saying
there.
I think there's also somecomponents of just the overall
environment that should be moreconducive to deals happening
(03:02):
into the future.
Neekis Hammond (03:03):
Yeah, pent-up demand's a big one.
That's a good call out there.
Kate Randazzo (03:08):
People have been waiting it out.
So with that in mind, let'stalk about the accounting side.
What are some of the biggestfinancial challenges that banks
face when they're integrating anew acquisition?
Neekis Hammond (03:19):
Yeah, I mean, there's a lot of challenges.
I think, you know, focusing in,like you said, on the
accounting is something we'reparticularly good at.
But the day one valuation,sometimes that just just kind of
go with who's helped them indue diligence or whatever but
that's a big one to get rightbecause it follows you forever
(03:39):
you know you've got some otheritems to consider on the
accounting side you've nowmerging two cecil or two banks
into one cecil model you don'twant to be using two models that
tell a different story soyou've got to integrate those
somehow end up with one thethird item is income recognition
these You'll have purchaseaccounting marks, marking these
(04:02):
loans and assets to fair value,and you've got to recognize
those over time.
And so having a model or havingan answer for how you're
recognizing the accretion or theamortization of those marks in
an auditable and transparent wayis not easy.
And so having an answer forthose three items is important.
(04:23):
Derek, what did I miss?
Derek Hipp (04:26):
Yeah, I mean, there's a lot of technicalities
to get into.
I think from a financialreport, I'll expand it from
accounting to say maybefinancial reporting around
business combinations.
And those three are kind of themajor classifications of where
we would see some process flowsaround them.
We've got a pretty good pieceof thought leadership content
(04:47):
that goes through all the stepson a detailed basis on our
website.
And we'll talk about, you know,on this, what are some of the
key things to think about to besuccessful in each one of them?
You know, the first there thatwe talked about was the day one
valuation or the mark to marketof the balance sheet of that
target.
So there's financialinstruments that have to be
(05:11):
maintained from a fair valueperspective moving forward.
And then there's some thatyou're just carving out
intangible separately fromgoodwill.
So if we kind of go down thebalance sheet quickly, Generally
speaking, cash is cash.
You don't have to mark anythingon cash.
You then get into fixed assetsand maybe equipment and things
(05:37):
like that, ATMs, computers, allthat type of stuff.
Generally on the fixed assets,you're going to have a full
appraisal that's needed.
And there's obviously companiesthat our banks use to get real
estate appraisals.
On the equipment side, Prettystraightforward of that.
We generally see costs beingthe best estimate of fair value.
(05:57):
And those are all kind ofstraightforward.
And then you start getting intoloans, which is a big part of
the financial modeling.
And there's this concept inaccounting of different levels
of ways that you can approachfair value.
So most people know that, butI'll go back through it just at
a high level to explain that.
(06:18):
Level one is like Apple stock.
There is a very highly liquidmarket.
You know what the value ofthose assets are because it's
traded every day.
Level two is less liquid of amarket, and I'm just speaking in
general terms here to make iteasy to understand, where There
(06:39):
is a market that exists.
It may not be as quickly quotedor as accurately quoted.
And then there's level three,which there really isn't an
active market.
And that's what a lot of thisstuff falls into because there's
just not an active market ofcommercial loans that are not
securitized in the way thatthey're set up that you can just
(06:59):
go grab a QSIP on or somequoted price.
And so the valuation process isreally important to get
through.
And then you keep working downOutside of loans, right, we
talked about carving out thoseintangibles.
Generally speaking, a coredeposit intangible exists with a
bank M&A or a credit union M&Adeal because it's just obviously
(07:20):
a very valuable customer list.
And so it's an intangible thatcertainly gets carved out.
You have to mark time depositsto fair value, pretty
straightforward on that in termsof the interest rate marks.
The other thing to consider islong-term debt.
So if there's any outstandingtrust preferred from way back in
the day or subordinated debt,that needs to get marked to fair
(07:42):
value.
And the last one that wegenerally see is pretty relevant
is around leases.
And so when we think aboutleases, there is a concept of
favorable or unfavorablearrangements to consider.
So went into a lot of weedsthere, but the purpose is you
kind of work your way down thebalance sheet and just make sure
you've got a game plan aroundall of those.
(08:03):
And especially on the loanvaluation, getting into that
next step of how it interactswith CECL is really important
because CECL is not fair valueand fair value is not CECL, but
they're pretty close to oneanother conceptually.
And so because of that, there'sa lot of comparative analysis
(08:23):
that has to be done when you'reworking through that process.
And so if we kind of step intothat next step of these three
categories that we're goingthrough, day one valuation, CECL
transition and incomerecognition.
The CECL component is kind ofexactly what we see with what
Neekis said.
Generally, you're going to haveone surviving CECL process,
(08:43):
Kate.
We have not seen in the manytransactions that we've helped
out with at least any reason tocontinue on with the targets
CECL process and the buyer tohave their CECL process.
When there's a deal where thebuyer is significantly larger
than the target, Nine times outof 10, maybe more than that, 9.9
(09:04):
times out of 10, the buyer'sCECL framework is going to be
surviving.
Maybe there's some alterationsthat need to be made to that to
make that happen, but that'sgenerally going to be the case.
When you have a merger ofequals or even a buyer buying a
target that is significantlylarger, It may call into
(09:24):
question the framework that youhave.
Can it be used for the proforma combined company?
And there may be more work thatneeds to be done.
But there's things you got tothink about there.
Which methods are bothcompanies using?
It could be just something assimple as the buyer is using a
forecast regression componentfor probability default, loss
(09:45):
given default, and the target'susing kind of a warm model based
on historical charge-offactivity.
Will they even work together?
Or maybe the target, asresident auto loans of a
specialty that the buyer has nopools or framework set up.
So there's alterations thereand things you certainly need to
be thinking about as you lookat the combination of those
(10:06):
models and how ultimately theycan be used.
One major component thatprobably doesn't get enough
attention in that is thisconcept around PCD assets.
And generally during valuation,PCD assets are The term stands
for purchase creditdeteriorated.
And those are generally thosethat are more risky.
(10:29):
More than insignificant creditdeterioration is technically
what the accounting guidancesays.
But quite often, those loanswill carry very high marks or
heavy marks in the allowanceprocess and that mark-to-market
day one valuation.
And then when you get into yourCECL framework, you may not
really have a method as to getto those high marks, right?
(10:51):
If you just look at yourallowance components, it can be
quite a difference.
And we just talked aboutearlier where there's some type
of comparative analysis thatneeds to be done.
So quite often there is aprocess that there needs to be
some type of calibration to theCECL model to accept those PCD
assets.
It's one that probably doesn'tget enough attention on the
(11:14):
front end, and then it's quicklykind of observed.
as you're actually trying tocreate these CECL calculations.
And so all of those things wekind of talked about there were
more of the policy perspectiveto consider around CECL.
There's also just simpleoperational things, right?
Like if you're running a CECLsoftware, how are you going to
get the target's data into thatCECL software prior to the full
(11:37):
core merge happening?
So there's the policy stuffthat takes...
you know, a little bit moretime and documentation to work
through.
And then there's justprocedural steps mechanically to
create those.
And so working all the waythrough that, kind of the final
step is after you do things,there's a mark to market that
exists that has to be accretedinto earnings over time.
(11:58):
And, you know, that terminologytechnically is called income
recognition.
And what we quite often seethere is just different ways of
going about that.
Generally, you have threeoptions that we see, a software
product, a vendor softwareproduct, you have a spreadsheet
maybe you're keeping internallyor trying to do it on the core
processing system.
(12:18):
And one thing to really thinkabout there in that process is
these marks generally that arecoming onto the balance sheet,
especially in the currentinterest rate environment, can
be pretty material to theoverall earnings of these
companies, Kate.
And so they need to be reallycognizant of this process.
This is one that If it's asmaller deal, maybe people
(12:41):
haven't really thought about, oreven if it's a larger deal,
there's a process that theybelieve will work for them.
But when they start gettinginto the weeds, you have to
realize on mark-to-markets andthis concept of running it
through 31020 or FAS91, wheneveryou've got in your originated
portfolio, you're making newloans every day and loans are
(13:02):
paying off.
And so that number is neververy big.
But if I'm a $10 billion bankdoing an MOE with a $9 billion
bank, I'm now bringing $9billion, let's call it $7
billion of loans, onto thebalance sheet at one time.
So even if the fair valuemark's really, really low, I'm
still putting all those marks onat one time, right?
(13:24):
And it's material regardless ifthe mark is material or not.
And quite often in a lot ofscenarios we're seeing right
now, right, especially onresidential ones, the marks as a
percentage are very high.
And so that one probablydoesn't get as much attention as
the other two that we typicallysee, but it's very relevant and
just something to make surethere's a process to be handled
(13:45):
around.
Neekis Hammond (13:46):
And it's kind of, Kate, it's kind of newly
relevant also, you know,pre-CECL adoption, you know,
there was some more technicalaccounting behind how you should
account for these purchasemarks that kind of forced a lot
of folks to have a separateprocess for this.
Kate Randazzo (14:04):
Yeah.
Neekis Hammond (14:04):
But now there is a thinking that these can just
kind of be thrown onto your coresystem and accreted
accordingly, but these dollarsare big, as Derek described, and
there's not audit support to goalong with that core accretion
that's sufficient enough toreally dig into some of these
anomalies you may see orexplain, right?
outliers and so or even findthem for that matter and so it
(14:29):
becomes very important to beable to get the detail behind
that income recognition on thesemarks and it's really
challenging to get through acore provider so that's where
you know that's where it off wesee a lot of um that's often
overlooked when we when we talkto customers or experience in
m&a with some of our customers
Kate Randazzo (14:51):
yeah i can see how that'd be easy to do i mean
it sounds simple when you breakinto the three steps, day one
valuation, CECL transitioning,but then, you know, you break it
down and you end up with just alot of detail.
And I know a lot of banks haveturned to Yelp for help in the
past couple of years andAbrigo's had some really high
profile M&A deals recently.
Could you explain how yourteam's process works with really
(15:12):
streamlining all of thosetransitions?
Derek Hipp (15:16):
Yeah, we've got a big practice here, you know, and
it couples well with our CECLpractice as well.
But on any given day, year,we're probably working on 40 to
50 deals.
There's a press release thatwe've got out there we generally
put out annually.
But in 23 and 24, we worked onsix of the largest 10 MOEs, did
(15:39):
a ton of other activities aroundsmaller deals kind of all
across the country.
And so we certainly gotexposure to it.
And we'll go through some ofthose details of how we can be
involved.
But The reality of it is yougot to make sure that when
you're working through theseprocesses that you have a
(15:59):
provider or a partner that'sthinking through the entire
process with each of thesebecause there's a lot of work
that can be done out thereinternally or externally through
vendors where it's very much apoint solution.
And then you've got to fill inthe gaps.
And so that's definitelysomething to keep in mind when
(16:20):
you're going through these tomake sure It's all the way from
data ingestion.
It's policy documentationaround why you're making the
decisions you're making,actually doing it, and then
reporting off of it as well,because a lot of people can just
do it, and then all those otherthings are just kind of on you.
And there's a lot of auditsupport.
There's a lot of going back andforth with these things.
(16:43):
We talked about a lot of levelthree processes, a lot of
decisions to be made from apolicy perspective, not just
operationally.
And so because of that, justmake sure there's a partner we
would generally recommend thatis helping you through the
entire concept and really beingan extension of your team.
And that means being on a callwith auditors, being on a call
(17:06):
to present everything, right?
Not sending emails and thingslike that.
It's just not great because ofthe risk that's there in the
amount of detailed analysis.
But on that valuation side, howwe generally help is the
mark-to-markets of of all ofthose components.
And again, on the appraisalside, generally on real estate,
(17:29):
there's going to be specificsthere to work through.
And then the more burdensomevaluations that contain a lot of
assumptions are the loan inputsand then around CDI from there.
Some of the other things are alittle bit more straightforward.
Secondarily, as we move intothat second component of CECL,
(17:50):
we help all the way fromsomething as simple as just
manually getting data into thesystem for that target
portfolio, all the way toevaluating whether the current
CECL framework that the buyerhas is sufficient enough to be
used for the combined company,or if there's modifications that
(18:10):
need to be made.
And again, just kind of talkingabout a lot of the MOEs that
we've worked on in thosesituations, you're really
setting up to maybe wherethere's just some updates.
Maybe the full frameworkdoesn't have to be changed, but
if you're using a peer group,maybe the peer group's no longer
relevant.
If you're using a peer groupbased on a company that's 10
(18:30):
billion in one particulargeographic region, and now
you're 20 billion operating in amuch different geographic
region, the current CECLframework may not be relevant.
Or if your current CECLframework is using historical
losses from your entity only,right?
How are you going to bring awhole new portfolio into there
(18:51):
and say that those losses arerelevant for the combined
company?
And then finally, it's reallyjust, you know, working through
those simulations of whateverthat combined framework needs to
be, because again, that'sreally important.
So it's okay to think through,you know, considerably what
makes sense to use, but Untilyou actually do dry runs and
(19:12):
practices and see what theaccounting flow looks like with
some of these concepts aroundPCD, gross ups, et cetera, you
might not really know whatyou're getting into and the
decisions that you're making.
And then finally, we've got asoftware product to do income
recognition to work through.
Got deployed recently in theBrigo user interface.
(19:32):
Got a number of customers thatuse that.
It integrates from an allowanceperspective as well because the
allowance needs to considerthose for non-PCD assets.
And so we work with a lot ofcompanies and, you know, getting
that set up, getting thesoftware running, you know,
getting it flowing through CECLproperly.
Kate Randazzo (19:49):
That's great advice.
And for banks consideringacquisitions in the next few
years, what advice would yougive them to help them prepare?
Neekis Hammond (19:57):
Yeah, I mean, Derek's covered a lot of this,
but I think I'll try andsummarize.
But The valuation is important.
You have to live with thosedecisions.
It's not just a one and doneexercise.
And we see a lot of aggregatecalculations being pushed down
to the loan level.
That causes problems down theroad.
We see a lot of PCD credit lossestimates that are not thinking
(20:24):
about how you need torecalculate those into
perpetuity as part of a CECLmodel.
We see a lot of valuationproviders communicating to their
clients that a valuation creditmark is a CECL allowance, and
that's not correct.
And so the first thing would bevery careful about who you work
(20:46):
with your valuation.
As Derek described, there's alot of point solutions.
It's best to work with somebodythat can take you through the
entire process rather than justsolve one thing, because you're
going to have to bring thosegroups together, and that can be
a challenge.
The other idea here is just theCECL planning.
You need to start it early.
You can't wait till close.
(21:07):
You need to start buildingthese models early.
And the specific thing that I'dgive advice on here is you
can't just show up to an auditorand say, we threw these loans
into our existing allowancemodel because we have a similar
footprint, similar loan pool.
You need to prove it.
And so the specific thing I'dgive advice on there is, you
(21:28):
know, We prefer to run anindependent calculation for the
acquired bank using your model.
That way you can show here isfollowing our processes, our
procedures, our philosophy onthe newly acquired bank.
Here's the answer.
Here's the answer if you justplug them into our model.
What's the delta and why are wecomfortable with that delta?
(21:51):
In other words, be wittingabout that decision.
Document why.
with calculations, it'sappropriate for them to live in
a pool with your existing loansor why you need to create a new
segment for these loans thatyou've just acquired.
So that's a big part of theCECL planning process.
There's also setting uppurchase credit deteriorated,
(22:13):
these PCD segments, they need tobe calculated differently.
You need to set up thosesegments.
You've got to get yourdocumentation done.
Those are all big deals.
You need to figure out howthose new marks are gonna flow
into your CECL model at the endof every reporting period as
they change.
How are you accounting forthose marks in your CECL model
out of the valuation?
So those are the three keycomponents that Derek went
(22:37):
through, valuation, CECL andincome recognition, and you
can't do one without the other.
And so the advice is just talkto somebody that does all three
before you advance in yourdecision, because far too often
we're brought in too late.
The decision's been made and wecan't help.
And so just bring us in early.
Let's talk, you know?
Kate Randazzo (22:59):
Definitely.
And I did want to point outanother thing to our audience,
which is just that sometimesjust having a third party who
has heard from otherinstitutions can be so helpful.
And Abrigo has this database ofloan data from over, what,
2,000 financial institutions.
So you guys have theexperience, and I know that
you're happy to share thoseinsights and just have
(23:20):
exploratory conversations withpeople who are interested in
hearing about help.
Neekis Hammond (23:25):
Kate, you bring up a good point, which is a lot
of these organizations don'thave inputs and assumptions that
are beyond their own walls.
They have data that they have.
And so if they need to make anassumption for an institution
that's elsewhere in the countryor has a different kind of loan,
working with somebody that hasa strong database to draw
(23:47):
analogies from and to providesupportable inputs and
assumptions is a big dealbecause you don't You can't just
make up these numbers.
Everyone knows that.
It's listening.
But having strong supportbehind them is helpful.
Kate Randazzo (24:00):
Definitely.
So a lot of opportunity comingup in the M&A space, but got to
get the accounting right.
And Abrigo can help you dothat.
So if you enjoyed thisconversation and you want to
learn more, I will link in theshow notes to some of the
resources that Derek mentionedand to our advisory pages if you
would like to talk to someone.
But Derek Neekis, thank you somuch for sharing your expertise
(24:21):
today.
Yeah,
Derek Hipp (24:21):
thank you, Kate.
Absolutely.
Kate Randazzo (24:22):
Appreciate it, guys.
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