Colorado National Bankshares, Inc. v. Commissioner, Docket No. 3273-88.

CourtUnited States Tax Court
Citation60 T.C.M. 771
Docket NumberDocket No. 3273-88.
PartiesColorado National Bankshares, Inc. and Subsidiaries v. Commissioner.
Decision Date17 September 1990

James E. Bye, William S. Huff, Douglas A. Pluss, Norvell E. Brasch, and Garth B. Jensen, 1700 Lincoln, Denver, Colo., for the petitioner. William P. Boulet, Jr. and David J. Mungo, for the respondent.

Memorandum Findings of Fact and Opinion

COLVIN, Judge:

After concessions, the sole issue for decision is whether petitioner, Colorado National Bankshares, Inc. (CNB), is entitled to depreciate in taxable years 1982, 1983, and 1984 "core deposits intangible" acquired in the purchase of seven banks.

Petitioner is a bank holding company holding only the stock of commercial banks and bank-related subsidiaries.

Respondent determined the following deficiencies in petitioner's Federal income taxes:

                Year                          Deficiency
                1973 ........................   $   18,637
                1980 ........................   $3,130,835
                1981 ........................   $  289,202
                1982 ........................   $2,274,851
                1983 ........................   $  465,693
                1984 ........................   $  661,840

We hold that petitioner proved that its core deposits intangible had an ascertainable value separate and distinct from goodwill and going-concern value, and had a limited useful life, the duration of which could be ascertained with reasonable accuracy. Therefore, petitioner is entitled to depreciate core deposits intangible acquired in its purchase of seven banks.

Findings of Fact

Some of the facts have been stipulated and are so found.

1. Background

During the years at issue, petitioner was a Colorado corporation with its principal place of business in Denver, Colorado. Prior to the acquisitions at issue, petitioner owned substantially all of the stock of 13 commercial banks located in Colorado, primarily in the Front Range area. The Front Range is comprised of 10 Colorado counties located near the eastern edge of the Rocky Mountains, in which approximately 80 percent of the population of Colorado resided during the early 1980's.

During 1981 and 1982, petitioner acquired all of the outstanding stock of seven banks (the acquired banks), located in the Front Range area of Colorado. The acquired banks, their acquisition dates, purchase prices and adjustments thereto, are as follows:

                                                                                      Acquisition    Purchase
                   Acquired Bank                                                        Date           Price
                1. Aurora Mountain Bank (Aurora) ..................................    01/29/82     $ 3,494,143
                2. Boulder National Bank (Boulder) ................................    01/29/82     $11,993,077
                3. First National Bank of Pueblo (Pueblo) .........................    01/29/82     $22,008,235
                4. Ft. Collins National Bank (Park) ...............................    01/29/82     $ 3,218,425
                5. Park National Bank (Park) ......................................    01/29/82     $ 1,854,964
                6. Exchange National Bank of Colorado Springs (Exchange) ..........    10/19/82     $39,926,161
                7. Arvada State Bank (Arvada) .....................................    11/15/821    $ 6,894,7882

At the time of the bank acquisitions, all of the Colorado Front Range communities, except Pueblo, were experiencing an economic boom and significant population growth.

2. Definitions and Banking Industry Background

The term "core deposits" refers to funds on deposit with an acquired bank in the following types of accounts: (i) an interest-free checking account (demand deposit account); (ii) an interest-paying checking account (so-called NOW — negotiable order of withdrawal — account); and (iii) a savings account, with or without a passbook. Petitioner treated as core deposits only those funds on deposit in these three types of accounts.

The "core deposit mix" refers to the ratio of different types of core deposit accounts. Because each type of deposit account has different interest and operating costs to the bank, a change in the mix of core deposits affects the bank's net interest margin (the interest earned from all interest-earning assets less the interest paid to maintain the interest-earning assets), and therefore its profitability.

The term "core deposits intangible" refers to the intangible asset that represents the present value of the future stream of net income to be derived from utilizing the core deposits on account on the date a bank is purchased.

As used in this case, "conservative" means: (i) tending to understate rather than overstate value, (ii) tending to produce a slower rate of amortization, or (iii) tending to defer rather than accelerate amortization deductions.

In the banking industry, core deposits are one of the most favorable sources of funds because they are relatively low-cost, reasonably stable over time, and relatively insensitive to interest rate changes. A bank can acquire core deposits through marketing efforts to attract depositors. A bank holding company can also acquire core deposits by purchasing an established bank. Banks can also purchase core deposits alone.

A bank typically invests the funds from deposits in loans and other income-producing assets, and receives fees for services performed for its depositors. A bank incurs expenses, e.g., payment of interest, and/or the costs associated with the provision of services to depositors, to attract and maintain core deposit accounts.

The costs of maintaining core deposit accounts include a portion of the costs of maintaining banking facilities, marketing and advertising expenses, and the costs of providing the variety of services which attract and keep deposit customers. For example, where a customer places a deposit with a bank that has extended credit to the customer, a portion of the costs associated with the extension of credit are also expenses of maintaining that deposit.

The excess of the income generated over the associated costs represents the profit attributable to core deposits. That is, the economic value of the core deposits rests upon the ability of the acquiring bank to generate a stream of net income over the useful life of the core deposits.

Core deposits are important to the profitability of a commercial bank. If a bank does not have sufficient core deposits, it must fund its investments through funds obtained at a higher interest rate and other sources of funding (known as the market alternative), thereby typically reducing net income.

The value to a bank of a core deposit account increases as its expected life increases, and decreases as its expected life decreases. Core deposits intangible would have no value whatsoever in the absence of the expectancy that deposit customers will continue to have deposits at the acquired banks.

Noncommercial deposit customers consider a bank's reputation, personnel, and location to be among the most important factors in deciding where to bank. Other factors that affect where an individual will open and maintain a core deposit account include personal relationships with the bank's personnel, the bank's physical facilities, advertising or public relations efforts by the bank, the bank's hours of operations, customer inertia, and the existence of a drive-up or walk-up facility. Among the most important factors enabling a bank to attract and maintain business depositors are the bank's reputation for good service and the quality of its personnel.

Although core deposits are liabilities on a commercial bank's balance sheet, core deposits intangible is an asset. That is, petitioner must pay depositors as they withdraw their funds, but until such time, petitioner will be able to invest the funds.

Depositors are customers of a bank who can generally withdraw their funds at any time. Deposit accounts do not necessarily remain with a bank indefinitely due to changes in depositor circumstances (such as movement from a bank's service area, dissatisfaction with bank service, or death, divorce, and marriage), bank services, bank reputation, bank condition, government regulation, economic conditions, or increased competition from other financial institutions, among other things.

Federal credit enhancements, e.g., the Federal Deposit Insurance Corporation, and the Federal Reserve Bank, enable banks to obtain insured core deposits at lower interest rates than they could through uninsured deposit financing.

3. Petitioner's Acquisitions of the Seven Banks

Petitioner reviewed and considered the level and mix of core deposits of the respective banks in its decision to acquire them. However, there were no specific discussions or negotiations between petitioner and Mountain Banks, Ltd. (MBL), or between petitioner and the owners of Arvada concerning the value of core deposits intangible or other assets at the acquired banks. Petitioner's primary emphasis in analyzing potential acquisition targets was on earnings history and trends at the target banks.

Petitioner paid a purchase premium (an amount paid in excess of book value) with respect to each of the acquired banks, as shown below:

                                            Purchase     Allocated
                Acquired Bank               Premium        to CDI
                Arvada ................   $ 3,879,821   $ 2,600,934
                Aurora ................     1,895,049     2,205,901
                Boulder ...............     6,907,675     6,326,609
                Exchange ..............    23,204,045    16,316,974
                Ft. Collins ...........     1,251,887     1,186,825
                Park ..................       477,945     1,027,219
                Pueblo ................    11,535,183    11,996,278

Petitioner's vice president and assistant treasurer, Charles Schley, projected earnings growth at each of the acquired banks by generally studying their growth rates for the previous five years.

During the period between the execution of the Five Banks3 and Exchange Purchase Agreements and the closing of the acquisitions, petitioner...

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