2.ACQUISITIONS

 

On January 1, 2014, the Company completed the acquisition of StellarOne, a bank holding company based in Charlottesville, Virginia, in an all stock transaction.  StellarOne’s common shareholders received 0.9739 shares of the Company’s common stock in exchange for each share of StellarOne’s common stock, resulting in the Company issuing 22,147,874 common shares at a fair value of $549.5 million.  As a result of the transaction, StellarOne’s former bank subsidiary, StellarOne Bank, became a wholly owned bank subsidiary of the Company.  The Company expects to operate StellarOne Bank as a separate wholly-owned bank subsidiary until May 2014, at which time StellarOne Bank is expected to be merged with and into the Bank.  As part of the acquisition plan and cost control efforts, the Company decided to consolidate 13 overlapping bank branches into nearby locations during 2014.  In all cases, customers can use branches within close proximity or continue to use the Bank’s other delivery channels including online and mobile banking as the Company works to retain and reassign employees affected by the branch closures.

 

 

The transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration exchanged were recorded at estimated fair values on the acquisition date.  Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition.  The following table provides a preliminary assessment of the assets purchased, liabilities assumed, and the consideration transferred (dollars in thousands, except share and per share data):

 

Statement of Net Assets Acquired (at fair value) and consideration transferred:

 

 

Fair values of the major categories of assets acquired and liabilities assumed were determined as follows: 

 

Loans

 

The acquired loans were recorded at fair value at the acquisition date without carryover of StellarOne’s previously established allowance for loan losses.  The fair value of the loans was determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then applying a market-based discount rate to those cash flows. In this regard, the acquired loans were segregated into pools based on loan type and credit risk. Loan type was determined based on collateral type, purpose, and lien position. Credit risk characteristics included risk rating groups (pass rated loans and adversely classified loans), updated loan-to-value ratios and past due status. For valuation purposes, these pools were further disaggregated by maturity, pricing characteristics (e.g., fixed-rate, adjustable-rate) and re-payment structure (e.g., interest only, fully amortizing, balloon). If new information is obtained about facts and circumstances about expected cash flows that existed as of the acquisition date, management will adjust in accordance with accounting for business combinations.

 

The acquired loans were divided into loans with evidence of credit quality deterioration which are accounted for under ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality, (acquired impaired) and loans that do not meet this criteria, which are accounted for under ASC 310-20, Receivables – Nonrefundable Fees and Other Costs, (acquired performing).The fair values of the acquired performing loans were $2.1 billion and the fair values of the acquired impaired loans were $145.5 million.  The gross contractually required principal and interest payments receivable for acquired performing loans was $2.5 billion.  The best estimate of contractual cash flows not expected to be collected related to the acquired performing loans is $35.4 million.

 

The following table presents the acquired impaired loans receivable at the acquisition date (dollars in thousands):

 

 

 

Bank Premises

 

The fair value of StellarOne’s premises, including land, buildings and improvements, was determined based upon independent third party appraisals performed by licensed appraisers in the market in which the premises is located.  These appraisals were based upon the highest and best use of the underlying asset(s) with final values determined based upon an analysis of the cost, sales comparison, and income capitalization approaches for each property appraised.  The Company also engaged independent appraisers to value the leasehold interests.  The fair value of the leasehold interest was not material to the consolidated financial statements.

Core Deposit Intangible

The fair value of the core deposit intangible was determined based on a blended market approach and discounted cash flow analysis using a discount rate based on the estimated cost of capital for a market participant. To calculate cash flows, deposit account servicing costs (net of deposit fee income) and interest expense on deposits were compared to the cost of alternative funding sources available through the Federal Home Loan Bank. The life of the deposit base and projected deposit attrition rates were determined using StellarOne's historical deposit data.

Time Deposits

The fair value adjustment of time deposits represents a premium over the value of the contractual repayments of fixed-maturity deposits using prevailing market interest rates for similar-term time deposits. The premium is being accreted into income using the sum-of-the-months digits method over the weighted average remaining life.

Long-term Borrowings

The Company assumed long-term borrowings in the form of FHLB advances and Trust Preferred Capital Notes.  The fair value of the Trust Preferred Capital Notes assumed was valued using an income approach with consideration of the market approach. The contractual cash flows were projected and discounted using a prevailing market rate. The market rate was developed using a third party broker opinion, implied market yields for recent subordinated debt sales, and new subordinated debt issuances for instruments with similar durations and pricing characteristics. The fair value of FHLB advances represents contractual repayments discounted using interest rates currently available on borrowings with similar characteristics and remaining maturities.

Deferred Tax Assets and Liabilities

Deferred tax assets and liabilities were established for purchase accounting fair value adjustments as the future amortization/accretion of these adjustments represent temporary differences between book income and taxable income.

The following table discloses the impact of the merger with StellarOne (excluding the impact of merger-related expenses) since the acquisition for the three months ended March 31, 2014.  The table also presents certain pro forma information as if StellarOne had been acquired on January, 1 2013.  These results combine the historical results of StellarOne in the Company's Consolidated Statement of Income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2014 or January 1, 2013.  In particular, no adjustments have been made to eliminate the amount of StellarOne’s provision for credit losses that would not have been necessary had the acquired loans been recorded at fair value as of January 1, 2013.  Merger-related costs of $13.2 million are included in the Company’s Consolidated Statements of Income for the three months ended March 31, 2014, and are not included in the pro forma information below.   The Company expects to achieve further operating cost savings and other business synergies, including branch closures, as a result of the acquisition which are not reflected in the pro forma amounts below (dollars in thousands):

 

 

 

 

 

 

 

Acquisition-related expenses associated with the acquisition of StellarOne were $13.2 million and $0 for the quarters ended March 31, 2014 and 2013, respectively.  Such costs include legal and accounting fees, lease and contract termination expenses, system conversion, integrating operations, and employee severances, which have been expensed as incurred. 

 

A summary of acquisition-related expenses associated with the StellarOne acquisition included in the Consolidated Statements of Income is as follows (dollars in thousands):