CUNA Comment Letter

Combinations of Non-stock Depository Institutions

October 24, 2001

Financial Accounting Standards Board
401 Merritt 7
Norwalk, Connecticut 06856

Members of the Board:

After discussion with FASB staff, this letter and its attachments have been prepared to help inform the Board’s decision finalizing guidance on the vital issue of the accounting treatment for combinations of non-stock (or “mutual--) depository institutions. We are pleased to be able to offer comments that will help FASB better fashion accounting guidance that is representationally faithful to the economic realities of combinations of mutual depositories.

This document is the product of discussions among participants in a Joint Working Group on Combinations of Non-stock Depository Institutions (“JWG--). Participants in the JWG are affiliated with various trade associations for and regulatory agencies of thrifts, banks, and credit unions. The working group was established to promote discussions of the participants’ views on the accounting for combinations between two or more mutual institutions following the FASB’s decision to separately consider issues related to such combinations. This document reflects discussions among participants of the JWG. However, the views expressed in this document do not necessarily reflect the official views of each of the organizations involved in the discussions of the working group. These organizations include America’s Community Bankers (“ACB--), the Credit Union National Association (“CUNA--), Credit Union Central of Canada (“CUCC--), the Federal Deposit Insurance Corporation (“FDIC--), the National Credit Union Administration (“NCUA--), National Association of Federal Credit Unions (“NAFCU--), National Association of State Credit Union Supervisors (“NASCUS--), the Office of Thrift Supervision (“OTS--), and the World Council of Credit Unions (“WOCCU--).

While participants in the working group have previously submitted their views to FASB and may again do so independently of this letter, our purpose here is to present information to the Board about our industries and some of the common views we have about the nature of non- stock depositories. Thus, the appendices to this letter – including charts – serve as an integral part of our efforts.

While the business models of mutual depository institutions are varied, and in some cases different than those of stockholder-owned institutions, a common element in business combinations between mutuals is that explicit consideration is not paid to the acquired institution to effect a merger. Thus, for example, cash or securities are not given to the depositors (referred to as “members-- in credit unions) and other customers, or to management. This lack of an explicit acquisition cost is perhaps the most distinguishing element of a merger of non-stock institutions.

The following broadly drawn principles underlie any approach developed by the Board governing combinations of non-stock entities.

(1) With respect to mergers of mutual institutions, the fact that the net asset amount of an acquired institution exceeds the consideration paid does not create a presumption of “measurement errors-- in accounting for the combination (see paragraphs B187 – B193 of SFAS 141). Consequently, the excess net asset amount should not be allocated to reduce all acquired assets. Statement 141 paragraph 44 proposes reductions in the value of all net assets except: financial assets other than investments accounted for by the equity method, assets to be disposed of by sale, deferred tax assets, prepaid assets relating to pension or other post retirement benefit plans, and any other current assets. Reducing valuable assets such as fixed assets, noncurrent assets, and many other classes of assets would grossly misstate the asset values of the combined (mutual) institution.

(2) Non-stock depository institutions may not be good candidates for application of a NFP accounting model . Although non-stock depositories are run for the benefit of their customers (e.g., depositors, borrowers, and members) they have an obligation to generate earnings and maintain adequate capital. As regulated and insured depositories, earnings are a critical component of financial performance. While non-stock institutions may face less pressure to maximize income than do similar stock institutions, earning a return on assets and return on capital are imperative. Since mutual institutions typically do not issue capital or debt instruments, earnings are the primary means for non-stock institutions to grow their capital base and thus support new lending and investment activity.

In some of its previous Statements (Statement 116, for example), the Board has clearly indicated that a NFP institution is defined as, among other things, an organization that receives “contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return.-- Clearly, the customers and members of non-stock depository organizations expect commensurate benefits from their institutions, such as: higher interest (or “dividend--) rates on deposits, lower interest rates on loans, lower fees and service charges, higher levels of service and similar economic benefits.

Combinations of mutual – or similar – institutions are effected for a variety of reasons, including for supervisory reasons or because an economically weaker institution seeks to partner with a stronger institution. Combinations of healthy institutions are effected for a variety of business motivations that may frequently include obligations undertaken by the acquiring institution to the acquired and resulting institution. Some of the motivations to combine may be to achieve economies of scale or economies of scope.

The accounting for any combination of mutual financial institutions should reflect the economic realities of the transaction and the motivations that led the acquired institution to contribute its net assets to the surviving (combined) institution. In some combinations of healthy mutual depositories, significant obligations may be created that reflect costs that would not otherwise be expenses in future periods had not the business combination transpired. These obligations can include, among other things: agreements to maintain certain branch offices; make certain lending commitments; fund an underfunded pension plan of the acquired entity; offer expanded benefits to the employees of the combined entity; make charitable or economic development contributions; and a variety of similar obligations.

One area in which the participants in this working group have had divergent opinions is regarding the extent to which such obligations should be recognized as liabilities relating to the business combination. Some participants in the working group generally believe that liabilities should be recognized only when these liabilities represent a legal or contractual obligation of the financial institution and are readily determinable in value and that the accretion period should be based on the nature and term of the obligation.

Other participants in the working group favor a more expansive view of the liabilities and economic impacts of the business combination, similar to the definition recently noted in FASB’s Exposure Draft No. 213-C, Proposed Amendment to FASB Concepts Statement No. 6 to Revise the Definition of Liabilities, with respect to defining the nature of liabilities:

“Obligations in the definition is broader than legal obligations. It is used with its general meaning to refer to duties imposed legally or socially; to that which one is bound to do by contract, promise, moral responsibility, and so forth (Webster’s New World Dictionary, p. 981). It includes equitable and constructive obligations as well as legal obligations.-- (italics from FASB).

This view of obligations broadly describes the nature of obligations that may be undertaken to effect a combination between two healthy non-stock financial institutions. The obligations are not necessarily a purchase price. Some mergers may create no obligations to the surviving institution: supervisory or regulatory-assisted mergers may be examples of these types of mergers.

FASB has previously required the recognition of liabilities in business combinations accounted for under the purchase method. For example, EITF Issue 95-3 offers guidance as to what types of direct, integration, or exit costs should be accrued as liabilities. The 95-3 guidance specifically discusses incremental costs that have no future economic benefit to the combined company. The guidance in 95-3 and 94-3 is conceptually very similar to the identification of obligations and costs that the Working Group has discussed. Since FASB is still deliberating the exact differentiation between what is a liability and what is equity, it may not be within the scope of the Working Group’s efforts to define exactly what specific obligations give rise to liabilities, but it is clear that if such liabilities exist related to a business combination a conservative application of GAAP would require recognition of a liability rather than an incrementally larger extraordinary gain that creates capital.

Given the views expressed regarding the nature of a combination of non-stock depositories, we would suggest that the following sequence of events underlie the establishment of accounting entries to reflect a business combination using purchase accounting:

With respect to existing “negative goodwill-- that arose from applying purchase accounting to mutual combinations, only a few institutions (less than 10) have such negative goodwill, which is currently being accreted to income under existing GAAP. Based on discussions with institutions where this negative goodwill exists, the accretion is over a 5 to 10 year period and actually offsets certain incremental expenses from commitments and obligations made to the acquired institutions that were not separately recorded as liabilities at the date of acquisition. The accretion amount is clearly disclosed in the financial statements. To the extent that negative goodwill accretion exceeds the related expenses, income is recognized for the period. If this negative goodwill is recorded as extraordinary income upon adoption of the new accounting standard, current income and capital would be overstated and future income would be understated as planned expenses related to the combination are incurred. Therefore, we believe that any FASB interpretive guidance regarding negative goodwill should not apply to existing negative goodwill created by previous mutual combinations under previous GAAP. The views expressed related to existing negative goodwill are not an endorsement of the idea that negative goodwill should continue to be recognized for acquisitions after the date that SFAS 141 and 142 take effect for combinations of mutual institutions.

The Working Group appreciates this opportunity to provide the Board with information on our respective industries and our views on the nature of non-stock depositories.

Respectfully Submitted,

Joseph Blalock
Chairman, Drafting Group

cc: Timothy S. Lucas, FASB
John J. O’Leary, FASB
Charlotte Bahin, ACB
Mary Dunn, CUNA
Catherine Orr, CUNA
Mary Martha Fortney, NASCUS
George Reynolds, NASCUS
Jonathan Lindley, NASCUS
Gwen Baker, NAFCU
Bill Hall, NAFCU
Karen Kelbly, NCUA
Timothy Stier, OTS
Robert Storch, FDIC
Gary Rogers, CUCC
David Grace, WOCCU