If you are considering the acquisition of a depository institution, preliminary valuations are more important than ever. The yield curve not only impacts the pricing of most loan and deposit products, but it also impacts the valuation of the existing investment, loan, and deposit portfolios. These valuation marks will have an impact on the opening balance sheet and future earnings.
In today’s interest rate environment, there are substantial interest rate marks on all three of these portfolios. Investment portfolios held to maturity have substantial discounts when marked to fair value. So too, do the loan portfolios, especially those with substantial fixed-rate loans. On the liability side, the core deposit portfolio provides a below-market rate funding source that has greater value in higher interest rate environments.
These financial reporting marks can impact acquisition planning significantly:
- How much capital will you need?
- How much goodwill will be created and booked on the balance sheet?
- How much earnings accretion will be generated by the discounts on the loan portfolio?
- How much amortization expense will be created by the core deposit intangible mark?
Complicating matters even further is the time that will elapse from the pricing and announcement of the deal until regulatory approval and closing. During this period market rate swings and changes in the yield curve can significantly affect the interest rate marks.
Performing a preliminary valuation and anticipating the potential shift in rates will provide a better indicator of the marks as of closing. This provides better visibility around the capital that will be needed at close and the accretion/amortization in proforma earnings. With the Federal Reserve expected to begin lowering rates in the latter half of this year and throughout 2025, these market changes can have a material impact on the interest rate marks. As the Fed lowers interest rates, the discounts on the investment and loan portfolios will decrease and the value of the core deposit intangible and related amortization expense will also decrease.
Performing these valuations and sensitivities early in the transaction lifecycle will be very beneficial in transaction planning and execution as rates decline.
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