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Tax reform to add another wrinkle to bank M&A

Tax reform will boost U.S. bank earnings, but it could also make one aspect of bank acquisitions more expensive.

Lowering the U.S. corporate tax rate will offer a considerable shot in the arm to U.S. banks. Bank stocks have traded higher on that prospect, with the SNL Bank and Thrift Index trading at 2.05x tangible book value, compared to 1.87x when House Republicans first passed the tax reform bill in mid-November 2017.

The multiple expansion has increased the value of bank acquirers' currencies since they now can issue fewer shares and still offer sellers the same takeout price, making many transactions easier to ink. But the lower tax rate will drive up another cost in any bank deal, said Rick Childs, a partner in the financial advisory services practice at public accounting, consulting and technology firm Crowe Horwath LLP, in the latest Street Talk podcast.

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With a lower tax rate, an acquirer will now have more cost savings retained from the purchased deposits relative to other sources of funding, and therefore have to record higher amortized expenses for the so-called core deposit intangible asset. Childs said the asset effectively assesses the "cost avoidance" a buyer gains by having cheaper deposits over time, calculated using after-tax income earned or savings realized.

Childs applied the lower tax rate to two recently announced acquisitions and said the core deposit intangible would have been close to 13% higher than the amount that was originally recorded.

"It makes the deal more expensive," Childs said in the episode. "If it's already at the upper end of what you can pay, this might have an impact."

In a bank acquisition, buyers must account for the value that lower cost deposits like checking and savings accounts offer relative to more expensive and rate-sensitive forms of funding such as borrowings from Federal Home Loan Banks or brokered certificates of deposit.

"If I didn't have those accounts, I'd have to have an alternative source of funding that is at a higher rate," Childs said in the episode. "I would have to have wholesale funding. I would have to run rate specials. I would have to do something."

Acquirers recognize the relative value of those deposits by measuring the differences in interest rates and maintenance, net of fees, between funding sources. Buyers and their advisers also take into account how stable certain deposit accounts have proved over time. For instance, if a particular deposit remained with a given bank over a long period of time, it would receive a higher core deposit intangible value.

Buyers usually amortize those intangible assets over 10 years and record them as an expense. That expense has declined in recent years as interest rates fell to historical lows and the spread between cheap deposits and other forms of funding narrowed. As deposit costs have begun to increase, core deposit intangibles have risen in kind and are poised to increase even further with the recent tax cuts, Childs said.