CHAPTER NINETEENMergers And Acquisitions:

Managing The Process

The purpose of this chapter is to understand why the financial services industry undertakes so many mergers each year and to determine what legal, regulatory and economic factors should be considered when the management of a financial services provider wants to pursue a merger.

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Motives Behind the Rapid Growth in Bank Mergers

Profit PotentialRisk ReductionRescue of Failing BanksTax and Market-Positioning MotivesCost-Savings or Efficiency MotiveMergers as a Device for Reducing CompetitionOther Motives

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Merger Motives Identified By Bank Executives

Quality of Management

Profitability (Return on Assets)

Efficiency of Operations

Maintenance of Market Share

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Most Important Goal of Any Merger

The Most Important Goal of Any Merger Should Be to Increase the Market Value of the Surviving Firm.

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Impact on Earnings Per Share

Generally Speaking Shareholders of Both the Acquired and Acquiring Firm Will Gain If:

1. Bank with Higher P/E Ratio Acquires Bank with

Lower P/E RatioAnd If:

2. Combined Earnings Do Not Fall After the Merger

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Merger Premium

A Merger Premium is Paid if the Acquiring Bank’s Shareholders Receive More Than the Current Market Price for Their Stock

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Exchange Ratio

The Number of Shares of Stock Offered By an Acquiring Bank for Each Share of Stock of the Acquired Bank

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Dilution of Ownership

Dilution of Ownership Occurs When the Acquiring Bank Offers an Excessive Number of Shares to the Acquired Bank Shareholders. Often the EPS Will Fall Below its Original Level for the Acquiring Bank When This Happens.

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Characteristics of Target Firm to Consider

The Bank’s History, Ownership and Management

The Condition of Its Balance Sheet

The Bank’s Track Record of Growth and Operating Performance

The Condition of Income Statement

The Condition and Prospects of the Local Economy

Competitive Structure of the Market Area

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Other Characteristics of the Target Firm to Examine

The Comparative Management Styles of the Merging OrganizationsThe Principal Customers the Targeted Bank ServesCurrent Personnel and Employee BenefitsCompatibility of Accounting and Management Information Systems of the Merging OrganizationsCondition of the Bank’s Physical AssetsOwnership and Earnings Dilution Before and After the Proposed Merger

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Purchase of Assets Method of Purchasing Another Bank

A Method of Carrying Out a Merger in Which the Buying Company Purchases All of the Assets of the Acquired Firm

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Purchase of Stock Method of Purchasing Another Bank

A Method of Consummating a Merger in Which the Acquired Firm Exchanges its Equity Shares for the Stock of the Acquirer

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Bank Merger Act

First Major U.S. Law to Bring Merging Banks Under Federal Supervision, Requiring Government Approval to Merge with or Acquire Other Banks

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Under the Bank Merger Act

Merger Must Be Approved By Principal RegulatorNational Banks – Comptroller of the CurrencyState Member Banks – Federal ReserveState Insured Banks – FDIC

Regulatory Agency Must Give Top Priority to Competitive EffectsMergers with Anti-Competitive Effects May Be Approved if it Can Be Shown That There Are Significant Public Benefits Such As Providing Convenient Services or Rescuing a Failing Bank

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Herfindahl-Hirschman Index

Measure of Market Concentration

It is the Sum of the Squared Market Share for All Banks in a Specific Market Area

Department of Justice GuidelinesPostmerger HHI of Less Than 1800

Change in HHI of Less Than 200

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Factors that Get In the Way of Merger Success

Poor or Ill-Prepared Management

Mismatch of Corporate Styles or Cultures

Excessive Prices Paid for Mergers

Failure to Take Into Account Customers’ Feelings and Concerns

Lack of Strategic Fit

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Keys to Merger Success

Acquirer Must Start By Evaluating Its Own Financial ConditionMust Have Detailed Analysis of Possible New MarketsMust Establish a Realistic Price for Target FirmAfterwards Combined Team Must Direct Progress Towards ConsolidationMust Establish Communication Between Senior Management and All EmployeesMust Create Communication Channels to Promote Understanding of Why Merger Took Place and Likely Consequences of MergerShould Create Customer Advisory Panels to Evaluate and Comment on Merged Bank’s Image and Products