IMPACT OF MERGERS & ACQUISITION ON BANKING INDUSTRY

7/28/2019 IMPACT OF MERGERS & ACQUISITION ON BANKING INDUSTRY

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IMPACT OF MERGERS

& ACQUISITION ON

BANKING INDUSTRYEVALUATING IMPACT ON PROFTABILITY,

FINANCIAL STRENGTH, BUSINESS

KENDING & SHAREHOLDERS WEALTH


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CONTENTSCONTENTS.....................................................................................................................................2

.........................................................................................................................................................3

INTRODUCTION...........................................................................................................................4

PREVIOUS RESEARCH................................................................................................................4

PROPOSED METHOD...................................................................................................................6

Research Question 1: Profitability and Mergers & Acquisitions .........................................6

Research Question 2: Mergers And Financial Strength .............................................................7

Research Question 3: Effect of Mergers & Acquisitions on Small Business Lending...............8

Research Question 4: Impact of Mergers & Acquisitions on Shareholders wealth...................8

Data Collection............................................................................................................................8

Sample Size & Data Analysis......................................................................................................9

REFLECTION ................................................................................................................................9

CONCLUSION .............................................................................................................................10

RESEARCH TIMELINE...............................................................................................................11

REFERENCES..............................................................................................................................12

APPENDIX....................................................................................................................................15

CONTENTS.....................................................................................................................................2

.........................................................................................................................................................3

INTRODUCTION...........................................................................................................................4

PREVIOUS RESEARCH................................................................................................................4

PROPOSED METHOD...................................................................................................................6

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Research Question 1: Profitability and Mergers & Acquisitions .........................................6

Research Question 2: Mergers And Financial Strength .............................................................7

Research Question 3: Effect of Mergers & Acquisitions on Small Business Lending...............8

Research Question 4: Impact of Mergers & Acquisitions on Shareholders wealth...................8

Data Collection............................................................................................................................8

Sample Size & Data Analysis......................................................................................................9

REFLECTION ................................................................................................................................9

CONCLUSION .............................................................................................................................10

RESEARCH TIMELINE...............................................................................................................11

REFERENCES..............................................................................................................................12

APPENDIX....................................................................................................................................15

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INTRODUCTION

Banks and financial institutions are linchpin of any economy. This research mainly focuses on

the evaluation impact of merger on the profitability, financial strength, business lending and

shareholders wealth of a financial institution. There has been a considerable research on the

overall evaluation of mergers and acquisitions on a firm, but this research in context of financial

institutions and banks is very limited. After recent financial turmoil, consolidation is that

strongest force that has shaped the financial services industry. Analysts believe that from 2000 to

2010, one of the big bulge bracket bank has grown its assets from more than fourfold i.e. from

$0.639 trillion to US $2.19 trillion, almost double the size of Indian GDP. It was mainly due to

the technological innovations in the eighties and deregulation the financial services that

prompted a wave of mergers, which eventually reached Europe in the nineties (Beitel, 2006).

Financial crisis of 2008 has a profound effect on the financial performance of the banks and it

was due to his reason that banks were doing whatever they can do in order to survive on of the

deepest financial crisis of the history (Linder, 1991). Most financial institutions strive to gain

from the synergies arising from the merger, these synergies can be in terms of increased

efficient, economies of scale, cost savings, sharing risks and benefiting from technological

sharing which all are the common motivations behind a merger (Ramaswamy, 1997). Another

motivation that can be attributed to a successful merger was stricter regulation from theEuropean and American authorities in terms of capital structure and minimum capital

requirements that most financial institutions had to merge in order to the meet the capital

requirements (Amaro, 2001). It will however also be beneficial to extend the research and study

impact of mergers and acquisitions on the lending of the banks. All these factors discussed above

will make the research even more interesting and an area yet unexplored.

PREVIOUS RESEARCH

Mergers in the banking sector are an unexplored area for research. While a rich literature exists

on generic mergers in the international context, very few studies are conducted in particularly in

the banking industry (Vives, 2000). In the post reform period, there has been a sharp increase in

the merger activity across the globe. Berger (1996) analysed 36 mergers (1992-1995) using

operating cash flow returns and do not found any increase in profitability. Cabral (2002)

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analysed the motives of merger. In addition, he found no value addition due to merger. Cybo-

Ottone and Murgia (2007) identified the characteristics of merging firms based on 227 acquirer

and 215 targets. Gande (2008) examined both domestic as well as foreign deals, and found that

they are associated with positive announcement results and in long term is worse than pre-merger

performance. Focarelli (2007) analysed the critical issues of consolidation in the western banking

sector from the point view of shareholders and managers. They found that in forced merger, both

bidders and targets share price has been reduced. In case of voluntary merger results are mixed.

Pilloff and Santomero (2008) have studied the impact of merger announcement merger

announcements on shareholders wealth. They took 5 private sector bank mergers globally and

found positive gain for both bidders and target (Chatterjee, 1992). This report will make an

attempt to analyse the implications of a merger on the overall financial performance of the banks

and will specifically take into consideration the case of 16 different banks.

Following research questions will be tried to prove:

Research Question 1: There is direct relationship between the mergers and acquisition on the

profitability of financial institution.

Research Question 2: There is a significant impact of the mergers and acquisition upon the

financial strength.

Research Question 3: There is significant impact of mergers and acquisition on the lending

behaviour of the banks.

Research Question 4: Mergers and acquisition have significant effect on shareholders wealth.

Cornett (2003), asserts that current regulatory and technological advancements will be not

sufficient in disassemble the residual blockade for the assimilation of global retail banking

markets. Gual (2005) argues that process of integration is remote from entire retail banking

because of the existence of strategic (brand, branch network and reputation) and natural (distance

and language) barriers as an exception to the tenet of regulations of the home country (Zajac,

1989). The Middle East and North Africa commonly known as MENA, is located strategically

right in the middle of Asia and Western economies which were mostly colonised by the French

or the British on the mid of the past century (Datta, 1992). Major financial institutions and the

banks were formed according to the western principles, whose basic tenets were recently

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challenged by the current financial crisis. Banks, which were based in the MENA region, came

up with a unique idea of Islamic Finance which differs from the traditional banking (Shleifer,

2004). In the former banks were only providers of credit to the companies, finance government

deficits and public investment projects.

PROPOSED METHOD

The main aim of this research will be focussed on analysing the impact of merger on the

financial performance of selected financial institutions since the financial turmoil. It is very

important to analyse the background information and the latest trends in the context of mergers

and acquisition (Deng, 2005). Increase in the general level of economic integration has always

been one of the motives of cross border merger and acquisitions of the financial institutions.

Globalisation and recent augmented international has created demand for the internationalfinancial services (Hughes, 2003).

Research Question 1: Profitability and Mergers & Acquisitions

An underlying motive behind most mergers and acquisition is to seek synergies which are the

enhanced economic value created by the resulting merger. Another perceived benefit of merger

and acquisition is market penetration, market entry, vertical integration to control supply and

demand and economies of scale (Houston, 2001). This question mainly mains at analysing

impact of merger on the profitability and financial strength (DeYoung, 2003). The research will

mainly entail both qualitative and quantitative analysis. Profitability, of a financial institution is

mainly expressed in terms of financial ratios. These ratios must be carefully chosen, the main

criteria.

Total MeanPre-

MergerPost-

MergerChan

geRelativeChange

Profitability

Return On Equity

Return On Assets

Gross Profit MarginEconomic Value Added(EVA)

Return On Capital

Earnings Per Share

Asset Turnover

Return per Employee

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Table 1: Comparison of Profitability Pre and Post Merger Ratios (Mean)

As shown in the Table 1 above shows the financial parameters of profitability and financial

strength. These parameters are carefully selected in order to embrace a holistic approach to the

research (Akhibe, 2003).

PRE MERGER EQUITY RATIO - ROE GRAPH POST MERGER EQUITY RATIO - ROE GRAPH

Equity Ratio (%)

ROE

Equity Ratio (%)

ROE

Research Question 2: Mergers And Financial Strength

Evidentially, the value of mergers and acquisitions in the Middle East rose by 42% in 2012

compared to the previous year. The net investment banking fees rose by 19% in 2012 reaching a

total of $536.1 million. The U.S. financial after the financial crisis has burnt midnight oil to

reform the whole banking sector with a radically new regulatory regime.

Total MeanPre-

MergerPost-

MergerChan

geRelativeChange

Financial Strength

Current Ratio

Debt To Equity Ratio

Debt To Assets Ratio

Cash Flow Ratio

Net Gearing

Debt RatioCapital Adequacy Ratio

Dodd Frank Act and Volker Rule were then framed to put a control to the irregularities in the

financial services industry. Similar developments were observed not only throughout the world

including United Kingdom, Middle East and Asia. Non depository industry has also shown an

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uptrend throughout the globe in 2007-2010, these mergers however are driven mainly by

domestic demand in a specific geographical location.

Research Question 3: Effect of Mergers & Acquisitions on Small Business Lending

It is often observed after merger banks and financial institutions are reluctant to lend money to

small businesses. This is not because of risky nature of small businesses but due to organisational

diseconomies arising due to the merger (Vander Vennet, 2002). Large banks face a trade off

between their other business units including transaction based loans, derivatives etc.

Research Question 4: Impact of Mergers & Acquisitions on Shareholders wealth

Mergers and acquisitions have a significant impact on the shareholders wealth, allowing them to

earn positive abnormal returns (Winton, 2004). Answering this question would mainly cover

analysis of past research papers on mergers & acquisitions and the data around the

announcement date of the merger and key ratios will be calculated. Further following ratios will

be discussed in detail:

Total MeanPre-

MergerPost-

MergerChan

geRelativeChange

Investment Ratio

Earnings per Share

P/E Ratio

Dividend Yield

Price/Book ValueRatioDividend PayoutRatioReturn OnShareholders Fund

Data for this analysis will mainly be taken from Thomson Reuters and Bloomberg Terminals.

SPSS will be used for data analysis and conclude results.

Data Collection

Primary data will be collected from surveys, online questionnaires, academic research papers and

journals of the subject. Secondary data will be collected mainly from the online sources i.e.

companys annual report, market research report and market opinions (i.e. Financial Times, BBC

and Bloomberg).

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Sample Size & Data Analysis

A sample size of 20 banks will be considered for the purpose of this research. The banks chosen

for the analysis are carefully chosen and sample size contains banks from the U.S., Europe and

Middle East. The financial data will be mainly accessed from the annual reports of the

organisations (Rajan, 2001). In order to gain better understanding position of each bank is plotted

against Equity-Ratio and ROE will be examined for pre and post M&A (DeLong, 2001). The

purpose of analysing the Equity ratio and ROE is to predict the relation of profitability and

bankruptcy risk. For banks with ROE and equity ratio can be inferred as lower risk of bankruptcy

whilst having higher profitability. The whole data will be broken down in windows (-2,+2) as

follows:

Window (-2, +2): Evaluating performance and financial strength in the 2 year before the merger

and 1 year after the merger. The rationale behind assuming 2 years is to avoid any anomalous

behaviour of organisations (Morgan Stanley, 2003). ROE will be used as a dependent variable

and following graph will be plotted against Equity ratio.

REFLECTION

This study will be carried out on 16 different financial institutions that have merged in the past

10 years. These firms are mainly financial institutions listed on various stock exchanges

throughout the world. While these firms are listed on various stock exchanges and each have

their own tenets of divulging information (McKinsey, 2002). I, have however, tried to analyse

ratios and not financial numbers which I expect would give true and fair representation of the

results.

Another reflection of this research is the use of judgemental sampling and not considering the

probabilistic method of sampling which would have been a much fairer perspective. This

decision however can be defended with another limitation which is ease of availability of data.

There are indeed numerous financial institutions that have either merged or acquired other

financial institution but due to the nature of working and responsibility towards the shareholder,

not all organisations publicise their financial performance. The sample size considered for this

study is 20 which can be limited compared to vast number of mergers and acquisition in the past

10 years. Calculation of financial ratios and analysing these ratios from ones own perspective is

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yet another limitation that cannot be avoided. Of all the financial ratios, average of those ratios is

taken, one can also argue to consider mean instead, which is yet another constraint that must be

considered.

This research can be even more comprehensive if time is not a limitation. And, with respect of

conceptual and theoretical analysis length of time can be one of the hurdles that a researcher

might face. It cannot also be however excluded, to devote more time and rework on parts of the

research that needs more attention (Demsetz, 2006).

CONCLUSION

This research will enable to understand the long term implications of merger on a firms

financial performance. This research can also be extended to analyse whether mergers tend tocreate or destroy the value of a financial institution and what impact it has on the consumers. If

mergers destroy the value then for how long this period remains and when it start creating value.

Profitability and financial strength will be mainly indicated through the financial ratios, and the

results of this research will prove whether mergers are a profitable or not for a financial

institution and does mergers with other financial institution helps in meeting capital adequacy

ratio according to Basel III norms.

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RESEARCH TIMELINE

TASK

WEEK 1 WEEK 2 WEEK 3 WEEK 4 WEEK 1 WEEK 2 WEEK 3 WEEK 4 WEEK 1 WEEK 2 WEEK 3 WEEK 4 WEEK 1 WEEK 2 WEEK 3 WEEK 4

MILESTONE 1PROPOSAL SUBMISSION

LITERATURE REVIEW

DATA GATHERING

MILESTONE 2

AMENDMENTS ACCORDING TO

SUPERVISOR'S REMARKS

ANALYSIS OF RESULTS

MILESTONE 3

WRITING UP DISSERTATIONCONCLUSION

PROOF READ

SUBMISSION OF FIRST DRAFT

FINAL EDITING

MILESTONE 4DISSERTATION SUBMISSION

FEBRUARY MARCH APRIL MAY

STATISTICAL ANALYSIS (MAINLY

THOUGH EXCEL AND SPSS)

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REFERENCES

Akhibe, A., & Whyte, A. M. (2003). Changes in market assessment of bank risk following the

Riegle-Neal Act of 19/94. Journal of Banking and Finance, 27, 87102.

Altunbas, Y., Molyneux, P., & Thornton, J. (1997). Big-bank mergers in Europe: An analysis of

the cost implications. Economica, 64, 317329.

Amaro de Matos, J. (2001). Theoretical Foundations of Corporate Finance. Princeton University

Press

Beitel, P., & Schiereck, D. (2006). Value creation of domestic and cross-border M&A in the

European Banking market. ICFAI Journal of Mergers & Acquisitions, 3, 729.

Berger, A. N., Herring, R. J., & Szego, G. P. (1996). The role of capital in financial institutions.

Journal of Banking and Finance, 19, 393430.

Cabral, I., Dierick, F., & Vesala, J. (2002). Banking integration in the euro area. European

Central Bank Occasional Paper, 6.

Chatterjee, S., Lubatkin, M., Schweiger, D. M., & Weber, Y. (1992). Cultural differences and

shareholder value in related mergers: linking equity and human capital. Strategic Management

Journal, 7, 119139.

Cornett, M. M., Hovakimian, G., Palia, D., & Tehranian, H. (2003). The impact of the manager-

shareholder conflict on acquiring bank returns. Journal of Banking and Finance, 27, 103131.

Cybo-Ottone, A., & Murgia, M. (2000). Mergers and shareholder wealth in European banking.

Journal of Banking and Finance, 24, 831859.

Datta, D. K., Grant, J. H., & Rajagopalan, N. (1991). Management incompatibility and post-

acquisition autonomy: Effects on acquisition performance. Advance in Strategic Management, 7,

157182.

DeLong, G. (2001). Stockholder gains from focusing versus diversifying bank mergers. Journal

of Financial Economics, 59, 221252.

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DeYoung, R. (2003). Bank mergers, X-Efficiency, and the market for corporate control.

Managerial Finance, 23, 3247.

Demsetz, R., & Strahan, R. (2006). Diversification, size and risk at bank holding companies.

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Deng, E., & Elyasiani, E. (2005). Geographic diversification and BHC return and risk

performance. Temple University Working Paper, 135.

Focarelli, D., & Panetta, F. (2007). Are mergers beneficial to consumers? Evidence from the

market for bank deposits. The American Economic Review, 93, 11521172.

Gande, A., Puri, M., & Saunders, A. (2008). Bank underwriting of debt securities: Modern

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Harrison, J. S., Hall, E. H., & Nargundkar, R. (1991). Resource allocation as an outcropping of

strategic consistency: performance implications. Academy of Management Journal, 36, 1026

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Houston, J. H., James, C., & Ryngaert, M. (2001). Where do merger gains come from? Bank

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Hughes, J. P., Lang, W. W., Mester, L. J., & Moon, C. G. (2003). The dollars and sense of bank

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McKinsey (2002). Europes banks: Verging on merging. McKinsey Quarterly, 3.

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Ramaswamy, K. (1997). The performance impact of strategic similarity in horizontal mergers:

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Shleifer, A., & Vishny, R. W. (2004). Stock market driven acquisitions. Journal of Financial

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Vander Vennet, R. (2002). Cross-border mergers in European banking and bank efficiency. In H.

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APPENDIX

1.) List Of Banks To Be considered:

S.NO Acquirer Acquired Entity Name Of Merged Entity Year Of Merger

1 Capital One ING Direct USA Capital One 20112 JP Morgan Chase Washington Manual JP Morgan Chase 2008

3 Wells Fargo Wachovis Wells Fargo 2008

4 Bank Of America Meryll Lynch Bank Of America 2008

5 Bank Of New York Mellon Financial Bank Of New York 2008

6 Citigroup Golden State Bancorp Citigroup 2002

7 Abu Dhabi Commercial Bank Royal Bank of Scotland bu Dhabi Commercial Ban 2010

8 Emirates Bank National Bank Of Dubai Emirates NBD 2007

9 Royal Bank of Scotland ABN AMRO Royal Bank of Scotland 2008

10 Barclays Plc Lehman Brothers Barclays 2008

11 HSBC Oman International Bank HSBC 2012

12 Lloyds TSB Halifax Halifax 2008

13 Malayan Bank Bank Internasional Indonesia Malayan Bank 2008

14 OCBC Great Eastern Holding OCBC 2006

15 UOB Bank Of Asia UOB 2005

16 Toronto Dominion Bank Banknorth NA TD Banknorth 2005

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IMPACT OF MERGERS & ACQUISITION ON BANKING INDUSTRY