People Bancorporation and Subsidiaries v. Commissioner
| Decision Date | 18 May 1992 |
| Docket Number | Docket No. 29058-89. |
| Citation | 63 T.C.M. 3028 |
| Parties | Peoples Bancorporation and Subsidiaries v. Commissioner. |
| Court | U.S. Tax Court |
Philip C. Cook, Terence J. Greene, and Timothy James Peadon, 1201 W. Peachtree St., Atlanta, Ga., for the petitioners. Anne Hintermeister and William Stoddard, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in Federal income tax as follows:
Taxable Year Deficiency
1971 ............................ $ 20,898.16
1974 ............................ 186,549.00
1975 ............................ 6,119.48
1983 ............................ 292,818.58
1984 ............................ 6,264.57
1985 ............................ 286,275.01
The issues remaining for decision involve petitioners' entitlement under section 167 to depreciate the value of core deposit intangibles1 relating to two banks acquired by petitioners.2 The issues are: (1) Whether petitioners have established that the core deposit intangibles of two acquired banks have an ascertainable value separate and distinct from goodwill; (2) whether petitioners have proved that the core deposit intangibles have a limited useful life; (3) whether the values and amortization schedules used by petitioners in calculating the depreciation deductions for the core deposit intangibles are reasonable; and (4) whether petitioners may amortize the core deposit intangibles using an accelerated method.3
Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners, Peoples Bancorporation (Bancorporation) and its subsidiaries, including Peoples Bank and Trust Company (Peoples)4 are North Carolina corporations whose principal business is commercial banking. Petitioners' principal place of business was in Rocky Mount, North Carolina, at the time the petition was filed in this case.
Peoples was incorporated and chartered by the State of North Carolina in 1931. Bancorporation was incorporated as a bank holding company on July 22, 1982, and acquired the stock of Peoples on January 1, 1983.
During the 1982-84 time period, Peoples operated primarily in northeastern North Carolina, with about 50 branch offices and $350 million in total assets.
Petitioners have never acquired or sold, or offered to acquire or sell, accounts or deposit relationships independent from the sale or purchase of a bank or a branch of a bank.
Core deposits are a relatively low-cost source of funds, reasonably stable over time, and relatively insensitive to interest rate changes. The profitability of a bank depends on the difference between the cost of its funds and the interest earned on the loans and other investments into which the funds are invested, or the "spread". For example, before making a loan, Peoples computes the likely profit, and requires a profit or spread of about 5 percent in order to make the loan. As a lower cost source of funds, core deposits permit a larger spread, and thus higher profits, than other sources. There is attrition of core deposits for many reasons, for example, business closings or customer deaths.
For financial statement purposes, core deposits are considered liabilities, and goodwill is an amortizable asset. Before 1982, the Federal Deposit Insurance Corporation (FDIC) did not allow an acquiring bank to capitalize intangibles, including core deposits, in accounting for the purchase. In a letter dated March 5, 1982, the FDIC announced a change in this position to permit banks, on a case-by-case basis, to record as an asset and amortize acquired core deposit intangibles. In order to be permitted to do so, the bank had to submit with its merger application a detailed analysis to enable the FDIC to evaluate the account balances, the life thereof, the future net income stream therefrom, and the present value of the income stream.
In 1985, the FDIC issued regulations prohibiting banks from including core deposit intangibles in equity capital for purposes of assessing capital adequacy; this was not a change in position. The FDIC stated that: "Interest rate deregulation has been undermining the concept of the low cost core deposit base and assumptions about the average remaining lives of such deposits when acquired and the interest rate spreads projected over these lives have made the valuation of purchased core deposit intangibles increasingly subjective."
In an acquisition of a branch bank, the purchaser acquires assets, the customer base, established locations, and branch employees, and is able to avoid start-up costs.
Deposits are sometimes purchased separately from any other assets; the FDIC has done this in resolving insolvencies of troubled banks.
All deposits at commercial banks during the years in issue were insured up to $100,000 per account by the FDIC.
By 1982, deregulation of the banking industry was almost completed, which resulted in rising interest costs, increased competition, elimination of interest ceilings on certificates of deposit, and the creation of new types of accounts, such as money market and "super NOW"5 accounts. As a result of deregulation, there was a shift to higher cost types of deposit accounts (i.e., a shift from demand deposits to certificates of deposit). During 1983 and 1984, the increased competition from deregulation was beginning to create pressure towards higher costs on transactional accounts.
In general, most bank deposits are held in a small number of high balance accounts, which tend to have longer lives than lower balance accounts.
National Bank of North Carolina (NCNB)6 entered into a plan of reorganization and merger agreement with the Bank of North Carolina (BNC) on March 26, 1982. As a condition to approval of the merger, NCNB was required by the regulatory authorities to divest two NCNB branches in Jacksonville, North Carolina, and six BNC branches in Wilmington, North Carolina (collectively sometimes referred to as the NCNB branches). The NCNB branches were full-service banks which offered the normal types of banking services, and were historically profitable.
NCNB's first step in this divestiture was to identify potential bidders, which the regulatory authorities required be banks not then operating in the Jacksonville or Wilmington markets. NCNB identified about 11 potential bidders, and prepared a package of information to forward to them.
NCNB estimated a selling price for the branches by using methodologies based on a multiple of book value and a multiple of earnings, and on computing a premium on certain deposits7 of the branches and appraised values for fixed assets. By August 1982, NCNB had estimated a price of about $7 million, including estimated premiums of $544,850 and $4,802,600 for the core deposits at the Jacksonville and Wilmington branches, respectively. The greater value estimated for the deposits of the Wilmington branches was in part based on the strong market position of these branches. In September of 1982, NCNB estimated that the premium on the deposits at the branches would be $2.6 million.
In November of 1982, NCNB delivered its information package soliciting bids to a number of potential bidders, including petitioners. The information package invited potential bidders to bid on either the Jacksonville or Wilmington branches or both. All offers were to state the total amount of cash to be paid. The information package stressed that the locations of the branches were in desirable areas with high growth, high median income, low unemployment, and other favorable economic characteristics. The package included income statements and balance sheets for the NCNB branches for 1978 through October of 1982, and a schedule of types of deposits as of October 31, 1982.
Petitioners retained Grant L. Hamrick (Hamrick), a managing partner in the Charlotte, North Carolina, office of Price Waterhouse, to assist in formulating a bid for the NCNB branches. Hamrick worked with petitioners' employees to analyze the impact of different bid prices on earnings and capital. His projections, which were presented at petitioners' December 3, 1982, executive committee meeting, assumed premiums for bidding ranging from $3 million to $6 million. In analyzing the impact on cash flow of acquiring the NCNB branches at a $4 million premium, Hamrick allocated $2.125 million to deposits and $1.875 million to goodwill.
By November 30, 1982, letter, NCNB furnished Peoples a draft purchase agreement for the NCNB branches, which neither provided for an allocation of the purchase price to, nor defined bank assets as including a category identified as, core deposits. The draft purchase agreement provided for a price adjustment based on the actual amount of deposits existing not later than 15 days after closing as compared with the amount shortly before closing.
By December 6, 1982, letter, Peoples made a bid of $6,175,000 for the NCNB branches (which was subject to regulatory authority and board of directors' approval, but preapproved by the executive committee). On December 8, 1982, NCNB accepted Peoples' bid subject to certain conditions, including regulatory and board approval.
By December 9, 1982, letter Hamrick forwarded a schedule of deposits as of October 31, 1982 for the NCNB branches for review by Dr. Bruce Morgan (Morgan) of Golembe Associates, Inc. (Golembe), an economist and consultant specializing in banking. Morgan had no input in determining the price Peoples offered in the bid. The schedule included demand deposits (including NOW and related deposits), savings accounts, and certificates of deposit. In a December 12, 1982, letter, Morgan provided the following preliminary estimates of the value of all deposits of the NCNB...
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