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GOODWILL AND OTHER INTANGIBLE ASSETS

9 Months Ended

Sep. 30, 2020

GOODWILL AND OTHER INTANGIBLE ASSETS

8. GOODWILL AND OTHER INTANGIBLE ASSETS

Information related to core deposit intangibles, net are as follows:


(In Thousands)	September 30,		December 31,
	2020		2019
Gross amount	$	6,639	$	3,495
Accumulated amortization		(2,580)		(2,248)
Net	$	4,059	$	1,247

Amortization expense related to core deposit intangibles is included in other noninterest expense in the consolidated statements of income, as follows:


(In Thousands)	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
	2020		2019		2020		2019
Amortization expense	$	208	$	74	$	332	$	149

Amortization expense of $208,000 in the third quarter 2020 and $332,000 in the nine-month period ended September 30, 2020 included $146,000 related to the Covenant acquisition as described in Note 2.

Goodwill represents the excess of the cost of acquisitions over the fair value of the net assets acquired. Changes in the carrying amount of goodwill are summarized in the following table:


(In Thousands)	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
	2020		2019		2020		2019
Balance, beginning of period	$	28,388	$	28,618	$	28,388	$	11,942
Goodwill arising in business combination		24,138		0		24,138		16,676
Balance, end of period	$	52,526	$	28,618	$	52,526	$	28,618

Goodwill is tested at least annually at December 31 for impairment, or more often if events or circumstances indicate there may be impairment. In 2020, the COVID-19 pandemic led to government-imposed emergency restrictions that have had significant adverse effects on macroeconomic conditions. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects.

Broader US stock market valuations decreased significantly in the latter part of the first quarter and early second quarter 2020 but have bounced back to levels consistent with, or higher than, pre-COVID-19 levels. Bank stock valuations have lagged, reflecting market concerns about potential credit losses and the effects of a substantial drop in interest rates. The closing price (last trade) of the Corporation’s common stock on September 30, 2020 was $16.24 per share. The average closing price for the last 10 trading days of the third quarter 2020 (September 17 through September 30, 2020) was $15.96 per share. In comparison, the average closing price of the Corporation’s common stock in the fourth quarter 2019 was $26.05 per share and the book value of the Corporation’s common stock at September 30, 2020 was $18.65 per share.

In light of the decline in the Corporation’s stock price triggered by the adverse circumstances resulting from COVID-19, management determined it necessary to evaluate goodwill for impairment at September 30, 2020.

In evaluating goodwill for impairment, the Corporation performed a quantitative assessment and determined that the fair value of its reporting unit, its community banking operation, exceeded its carrying amount, including goodwill, at September 30, 2020. In reaching this conclusion, management estimated the fair value of the reporting unit to be $352.7 million, which exceeded the Corporation’s stockholders’ equity (book value) of $296.3 million by 19%.

Management calculated the estimated fair value of the reporting unit based on the weighted average of values determined using the following valuation approaches:

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Income approach - This approach was given a weighting of 60%, and resulted in a value of $375.3 million, which was the mid-point of a range of $340.0 million to $410.7 million. This approach is based on estimated cash flows to an acquirer based on anticipated future results assuming a change of control transaction. This approach assumes an acquirer will achieve an expected base level of earnings, achieve integration cost savings and incur certain transaction costs. The analysis then calculates the present value of all excess cash flows generated (above a minimum tangible capital ratio), plus the present value of a terminal value, to determine the fair value.

●

Change of control premium to the Corporation’s September 30, 2020 market price – This approach was given a weighting of 20%, and resulted in a valuation of $329.0 million, which was the mid-point of a range of $322.6 million to $335.5 million. The premium to market approach calculates the change of control price a market participant would pay for a firm by adding a change of control premium to the Corporation’s recent trading value. Management used a subjectively determined range of control premiums from 25% to 30%. This range of control premiums was in line with data for publicly traded banks and thrifts comparing control premiums paid, as compared to target valuations one-month and three-months prior to deal announcements, for the annual periods 2017 through 2019 and the nine months ended September 30, 2020.

●

Change of control premium to the Corporation’s volume-weighted average market price – Similar to the approach described immediately above, management applied a subjectively determined 25% to 30% range of control premiums to the 5-day average volume-weighted average trading price for the period September 23, 2020 through September 29, 2020. This approach was given a weighting of 20%, and resulted in a valuation of $319.2 million, which was the mid-point of a range of $312.7 million to $325.7 million.

Key assumptions used in the calculation of estimated fair value include:

●

The valuation techniques utilized. Management used the valuation techniques identified above, which represent a range of techniques commonly used to estimate the value of a company using either an income-based or a market-based approach.

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The weighting assigned to each of the valuation approaches considered. Management believes a market participant would apply a significant weighting to the income approach (60%) since it incorporates specific expected operating cash flows and merger synergies to be generated by the reporting unit. Management assigned equal (20%) weightings to the comparison of change of control premiums from comparable transactions to the Corporation’s recent trading price. Management believes market participants would typically consider current trading values, and recent pricing of comparable transactions, in considering an acquisition price, but that the weighting should be lower than the income approach because it does not incorporate company-specific cash flow projections or merger synergies. Management considered use of a guideline market-based approach based on recent, selected sale transactions with consideration of relevant price-to-tangible book value and price-to-earnings multiples; however, given the general lack of bank merger and acquisition transactions since the COVID-19 epidemic started, and in particular, lack of transactions in which the seller’s total assets exceeded $2 billion, management did not believe this method would produce a relevant indication of value for the goodwill impairment analysis at September 30, 2020.

●

In applying the income approach, key assumptions included: estimated earnings for each of the next 5 years, which reflected the effects of assumptions related to deposit and loan growth, loan losses, changes in noninterest revenues and expenses and other cash flows; reduction in operating expenses to be realized by an acquirer (integration synergies) of 20%; the level of post-acquisition capital the acquirer would be required to maintain, of 9% of tangible assets; the discount rates applied to projected cash flows, which ranged from 12% to 14% with a midpoint of 13% used in determining the midpoint valuation; and the capitalization rates applied to terminal cash flows, which ranged from 9% to 11% with a midpoint of 10% used in determining the midpoint valuation.

All of the key assumptions identified above are significant and subjective, and changes in those assumptions would result in a different calculation of estimated fair value of the reporting unit.

Based on the results of its impairment analysis, the Corporation determined that the fair value of its only reporting unit, its community banking operation, exceeded its book value, and there was no goodwill impairment as of September 30, 2020.