trending Market Intelligence /marketintelligence/en/news-insights/trending/1kp8e7mboFX-OoBgYbJ2hQ2 content esgSubNav
In This List

Ohio bank merger models how to describe CECL's impact

Podcast

Street Talk Episode 87

Blog

A New Dawn for European Bank M&A Top 5 Trends

Blog

Insight Weekly: US banks' loan growth; record share buybacks; utility M&A outlook

Blog

Banking Essentials Newsletter 2021: December Edition


Ohio bank merger models how to describe CECL's impact

A $473 million Ohio bank merger is one of the first to show how the current expected credit loss model will affect banks accounting for acquisitions.

Defiance, Ohio-based First Defiance Financial Corp. had to account for CECL when disclosing the expected impact of its plans to acquire Youngstown, Ohio-based United Community Financial Corp. The deal is expected to close in the first quarter of 2020, after large public companies will adopt the new accounting standard. CECL will change the way banks reserve for losses, requiring institutions to set aside expected lifetime losses at origination.

Working CECL into the acquisition will create a "double dip" in recording loan allowances that roughly doubles the merger's earnback period to just under two years, First Defiance's management said on a conference call to discuss the purchase of United Community.

When acquiring another institution, banks must apply a fair value and interest rate mark on the target's balance sheet. When accounting for loan marks for the deal, First Defiance started by dividing the loan portfolio into two parts: a purchase credit deteriorated, or PCD, segment and a non-purchase credit deteriorated segment.

The bank is expecting a pretax mark of approximately $4 million on the PCD loans, recorded as allowance for loan and lease losses; a $25 million pretax mark on the non-PCD loans, recorded as a contra-loan balance that will be accreted through income; and another $25 million in allowance for loan and lease losses established Day 1 on United Community's loans. This second mark of $25 million will be recorded through provision expense on the income statement, according to an investor presentation.

"We now have to also record an allowance on the bulk of the portfolio, the non-PCD pool, which essentially doubles that dilution for that transaction," First Defiance CFO Paul Nungester said on the call. This "double dip" will add 500 basis points of accretion annually, said Nungester.

According to the presentation, tangible book value dilution will be approximately 4%, and the deal will have about a 1.8 year earnback period. If it were not for the extra provisioning to account for CECL, dilution would be "closer to 1%," said Nungester, and earnback would be cut about in half to less than one year.

Analysts praised First Defiance for the deal as well as for the openness about including CECL in its estimates.

"We have to sort of rip the Band-Aid off and understand how this process is going to work with CECL," Christopher Marinac, a bank analyst with Janney Montgomery Scott LLC, said in an interview.

Marinac said the bank did a "nice job" disclosing the costs of CECL and how management described those costs in the presentation and on the deal call.

"They were very open about the fact that there's a CECL charge in these numbers," he said.

For banks considering closing deals after CECL is implemented, the First Defiance merger could be an important guide, according to Marinac. "Now that you have a leader doing a transaction and showing you the example, I think over time, you see more people follow."

The banks also highlighted their similar cultures on the deal call, which Marinac called another positive aspect of the deal.

"The transaction, like any other deal, is a function of executing and making the cultures work," he said. "What they've outlined is reasonable."

Damon DelMonte, an analyst with Keefe Bruyette & Woods, was also positive about the deal. "We view this announcement favorably," DelMonte wrote in a note. He wrote that the deal makes sense "strategically and financially," pointing to the high performance of the two banks and their "complementary geographic footprints." Keefe Bruyette & Woods was First Defiance's financial adviser for the transaction.

The market reacted positively to the deal's announcement. First Defiance's stock rose 3.46% from market open Sept. 9 to $27.23 per share at market close, while United Community closed the day up 5.10%.

"We've seen many transactions be less than warmly received in the marketplace," said Marinac. "As initial reactions go, it's certainly positive."