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Special Advisor, Supervision, Regulation, and Credit
Federal Reserve Bank of Philadelphia
Pinchus D. Raice
- Bank Mergers: Overview
- Some basic statistics related to number of banks, sizes, and market shares – over the period 1989-2012
- Bank mergers trend – by asset size group – over the period 1990—2012
- Mergers of Large Banks
- Some banks became “too-big-to-fail” (TBTF) through M&A. Some already TBTF banks became even bigger and became even more systematically important during the recent financial crisis. When banks merge to become TBTF, who benefit from the merger transactions? How much of TBTF subsidy to be gained from crossing the TBTF size threshold?
- Eli Brewer and Julapa Jagtiani (2013) “How Much Did Banks Pay to Become Too-Big-To-Fail” and to Become Systemically Important?” Journal of Financial Services Research, Volume 43, Number 1, 1-35.
- The special treatment provided to TBTF institutions during the financial crisis that started in mid-2007 has raised concerns among analysts and legislators about the consequences for the overall stability and riskiness of the financial system. It was unclear after FDICIA and before the financial crisis whether some banking organizations were TBTF. It is now evident that being viewed by the market (and regulators) as being TBTF, being too interconnected, or being systemically important could add significant value to banking firms. The value of potential TBTF benefits is determined by the market’s perception.
- This paper estimates the value of the too-big-to-fail (TBTF) subsidy. Using data from the merger boom of 1991–2004, we find that banking organizations were willing to pay an added premium for mergers that would put them over the asset sizes that are commonly viewed as the thresholds for being TBTF. This added premium amounted to an estimated $15 billion to $23 billion extra that eight banking organizations in our data set were willing to pay for acquisitions that enabled them to become TBTF (crossing the threshold of $100 billion in book value of total assets).
- While these amounts are large, they are likely to underestimate the total value of the benefits that accrue to large banks. Reasons: Organizations seeking to obtain TBTF benefits are not likely to be forced by the marketplace to pass on anywhere near the full value of these benefits to the shareholders of their acquisition targets. In addition, these estimated benefits apply only to the organizations that became TBTF during our study period. Benefits already obtained by banking organizations that became TBTF prior to our sample period are not included in our calculations of TBTF benefits. As a result, the total subsidy value to TBTF banks could easily far exceed our estimates.
- In addition, both the stock and bond markets reacted positively to these TBTF merger deals.
- We examine whether the markets view each merger positively or negatively based on the TBTF category of the mergers, controlling for the risk characteristics of the target, the acquirer, and the merger deal. Our overall results, based on the cumulative abnormal stock market returns around the merger, indicate that there are significant benefits associated with being TBTF or being systemically important banking organizations.
- Our TBTF subsidy argument is supported not only by the CARs evidence from the stock markets but also by the bond market’s reactions through the changes in the acquirer’s funding cost (due to merger) in the bond market. The analysis of bond spreads before and after becoming TBTF supports our earlier findings that there are significant subsidies to TBTF banking organizations.
- Our estimated TBTF subsidy is large enough to create serious concern, particularly since the recently assisted mergers have effectively allowed for TBTF banking organizations to become even bigger. In addition, a few of the recent assisted mergers were between TBTF banks and nonbank financial institutions, allowing for some large nonbank institutions to become part of TBTF banking organizations – thus, extending the TBTF subsidy beyond banking. Ben Bernanke (2010) pointed out that “If the crisis has a single lesson, it is that the too-big-to-fail problem must be solved. Simple declarations that the government will not assist firms in the future, or restrictions that make providing assistance more difficult, will not be credible on their own…”
- SIFI Surcharge – This is an additional required common equity (as % of risk-weighted assets) to be applied to Systemically Important Financial Institutions (SIFIs). The surcharge is meant to offset the TBTF subsidies and to discourage TBTF mergers.
- For the first time, an official list of TBTF banking institutions was released on November 4, 2011.
- More recently released TBTF list dropped 3 of the 29 previously TBTF banks and added 2 new TBTF banks on the G-SIFI list as of November 1, 2012.
- SIFI Surcharge will be applied beginning in 2016 and fully implemented in 2019, based on the G-SIFI list as of November 2014. As of now,
- 2.5% surcharge will be applied to Citigroup, Deutsche Bank, HSBC, and JPMC
- 2.0% surcharge for Barclays and BNP Paribas
- 1.5% surcharge for BAC, BNYM, Credit Suisse, GS, Mitsubishi, Morgan Stanley, Royal Bank of Scotland, and UBS
- 1% surcharge for State Street, Wells Fargo, etc.
- Mergers of Small Community Banks
- There has been a general perception that small community banks may have been acquired by large banks and that their disappearance would result in significant reduction in available funds for small (and local) businesses and destroy relationship lending. In contrast, some believe that despite significant reduction in number of small banks through mergers, the majority of small bank mergers may be joining successful small banks with less successful ones, thereby creating stronger, more efficient, and better managed banks. Who are the acquirers of community banks? Characteristics of the targets and the acquirers – e.g. returns, capital adequacy, efficiency, asset quality, in-state vs. out-of-state banks.
- Jagtiani, Julapa (2008) “Understanding the Effects of the Merger Boom on Community Banks,” Federal Reserve Bank of Kansas City: Economic Review, Second Quarter, 29-48.
- Looking at 3,900 mergers that involved publicly traded banking organizations during the period 1990-2006, I found that more than half of the acquiring banks that bought community bank were themselves community banks.
- Two competing hypotheses for value creation through mergers: increasing geographic diversification as opposed to focusing. Given that almost 90 percent of all mergers between community banks involved banks headquartered in the same state, the results suggest that community banks appear to have merged with the goal of concentrating their efforts on what they do best, which is to provide personal service to small businesses and other local customers.
- When viewed in terms of volume of assets, mergers of community banks with other community banks did not account for as big a fraction of community bank acquisitions. Community banks acquired by medium and large banks tended to be bigger than those other community banks acquired. About one-fourth of community banks were acquired by large banks. ICBA senior regulatory counsel agreed and pointed out that bigger banks cherry picked larger, well-positioned community institutions in growth markets.
- Finally, I found that small banks were willing to pay more to acquire other small banks. The average merger premium that medium-sized banks (large banks) were willing to pay for a community bank target was 17.7% (25.1%) percentage points less than the premium another community bank was willing to pay.
The Role of Corporate Governance in Bank Mergers
- Corporate governance and control mechanisms such as independent directors, independent blockholders, and managerial share ownership are usually important predictors of the size and distribution of the incremental wealth generated by M&A transactions.
- Eli Brewer, William Jackson, and Julapa Jagtiani (2010) “Corporate Governance Structure and Mergers,” Federal Reserve Bank of Philadelphia: Working Paper No. 10-26, August 19.
- We investigate the relationship between corporate governance structure and bank mergers, using a sample of banking organization M&A transactions over the period 1990-2004. Specifically, we examined the impact of independent directors, share ownership of the top five managers, and independent block holders on the merger purchase premiums.
- Our model controls for risk characteristics of the target banks, the deal characteristics, and the economic environment. As corporate boards increase the percentage of inside directors, merger prices negotiated for target shareholders tend to decrease. A possible explanation for this is that top-tier managers tend to trade potential takeover gains in return for their own personal benefits in terms of job security and other post-acquisition benefits with the bidding firm. Our results support the hypothesis that independent directors may provide an important internal governance mechanism for protecting shareholders’ interests, especially in large-scale transactions such as mergers and takeovers.
- We also find that independent blockholders as well as managerial share ownership play an important role in the market for corporate control.
- The Role of Merger Advisors
- What are the key factors that determine whether mergers activities have achieved the stated goals of the merging firms? What roles do merger advisors play in helping their clients achieve the best merger outcomes? How does the merger advisory relationship affect the probability that an announced merger will actually be consummated, the speed with which an announced merger is consummated, and the size of the post-merger gains?
- William C. Hunter and Julapa Jagtiani (2003) “An Analysis of Advisor Choice, Fees, and Effort in Mergers and Acquisitions,” Review of Financial Economics, Volume 78, 1-17.
- This paper investigates the choice of financial advisors in mergers and acquisitions, the fees that the targets and the acquiring firms pay to these advisors, and the speed with which advisors complete transactions. The sample includes 5337 merger deals announced during the period January 1995 to June 2000, that involved publicly traded targets and acquirers.
- Speed -- In terms of the speed of completing a deal, tier-1 advisors were found to be more efficient in terms of the amount of time required to complete deals, other things equal. Top-tier advisors are more likely to complete deals and to complete them in less time than lower tier advisors. Surprisingly, we find that deals that are initiated by the advisors do not seem to take less time to complete.
- Ability to Complete M&A Deals -- The existence of a prior relationship between the acquirer and the advisor does not seem to have a significant impact on the advisor’s ability to complete the deal in less time.
- Number of Advisors Used -- Unlike the case of the probability of completing deals, increasing the number of advisors used by either the target or the acquirer adds complexity to the transaction requiring significantly more time for deals to be completed.
- Role of Contingent Fees -- A greater portion of advisory fees that are contingent upon completion of the deal (whether paid by the target or the acquirer) further shortens the time to deal completion. Contingent Fees play a significant role in expediting the deal completion.
- Realized Synergistic gains -- While tier-1 advisors tend to complete the deals with higher probability and complete them in less time, we find that the post-merger gains realized by the acquiring firms in these mergers actually decline when tier-1 advisors are employed. Post-merger gains realized by the acquirers declined when top advisors were used.
- Total Merger Advisory Fees -- Larger total advisory fees paid are associated with larger post-merger gains. While the payment of larger advisory fees does not play an important role in determining the likelihood of completing the deal, larger merger advisory fees are associated with greater acquisition gains realized by the acquirer.
- Switching Merger Advisors -- When acquirers switch their financial advisors within the same tier, the switching is associated with larger post-merger gains to the acquiring firms. Synergistic gains from mergers are correlated with the switching of financial advisors within the same tier.
Pryor Cashman LLP
- Change in Bank Control Act
- “Control” is the power, directly or indirectly, to direct the management or policies, or to vote 25 percent or more of any class of voting securities, of an insured bank.
- Rebuttable presumption (OCC): Ownership of, or the power to vote, ten percent or more of a class of voting securities of a national bank is an acquisition by a person of the power to direct the bank's management or policies if: (A) The securities to be acquired or voted are subject to the registration requirements of section 12 of the Securities Exchange Act of 1934, 15 U.S.C. 78l; or (B) Immediately after the transaction no other person will own or have the power to vote a greater proportion of that class of voting securities.
- Bank Holding Company Act
- Definition of “control.”
- Rebuttable presumption (FRB).
- Bank Merger Act
- No insured bank or other insured depositary institution may merge with, or acquire the assets or assume the liabilities of, another insured depositary institution without the prior written approval of the “responsible agency.”
- Where the acquiring or resulting bank is:
- National bank or federal savings association = OCC
- State member bank = FRB
- State non-member bank or state savings association = FDIC
- Letter of Intent
- GLB Act representation.
- Authority to contact regulators.
- Charter conversions are unavailable if formal or informal enforcement is in place.
- Exception if the primary federal regulator post-conversion assumes responsibility for resolving the “significant supervisory matters.”
- Informal OCC and FDIC policy is to decline to invoke the exception.
- Post-acquisition or post-merger capital standard raised from “adequately capitalized” to “well capitalized” and management must be “well managed” – UFIRS composite 1 or 2 and management component “satisfactory.”
- Golden Parachutes
- Restrictions on “golden parachute” payments apply to banks in “troubled condition.”
- A bank is in “troubled condition” if:
- Its composite UFIRS rating is 4 or 5;
- It is subject to a cease-and-desist order or written agreement with a regulator to improve its financial condition;
- It Is informed in writing by the FDIC based on its most recent report of examination, or other information available to the FDIC;
- The FDIC is pursuing termination or suspension of deposit insurance.
- A golden parachute payment made as a result of a change-in-control requires the consent of the primary federal regulator.
- Non-Controlling Investments
- Non-voting preferred
- Passivity commitments
- Formal Enforcement Actions
- Whether formal enforcement actions survive a change-in-control depends on the advocacy of the acquiror.
- Business Plans
- By eliminating the need for the target’s regulators to consider the feasibility and safety and soundness of a new plan, the approval process is limited almost entirely to a review of the biographical backgrounds of the investors.
- An acquisition motivated by the perceived benefits of integration with an existing business will necessitate submission of a revised business plan.
- To the extent that your existing business targets a specific geographic market, you are best served by acquiring a community bank in that region to avoid a deposit-lending area mismatch.
- Change-in-control application will meet with resistance if your business plan is likely to create an excessive concentration of loans in a particular industry.
- An acquirer can avoid the changing-the-business-plan obstacle that tends to impede approval because a roll-up does not require a change in the business plans of the subsequent targets.
- The focus of the change-in-control approval process therefore shifts away from the safety and soundness of the business plan and focuses more on effectively managing risk during the expansion.
- To the extent an acquirer is able to present for approval a management team with a depth of experience in managing the mergers of financial institutions and a high-resolution, comprehensive plan for doing so, the regulatory approval process is likely to be less complicated than if it were matched with a new business plan.
- Organic Change-in-Control
- Avoids a change in control by changing management and conducting an offering.
- Board of directors elects new officers.
- New officers conduct a securities offering on behalf of the bank.
- No investor acquires more than 10 percent of outstanding securities.
- Investors represent that they are not acting in concert.
- At the next annual meeting, board of directors nominates new slate of directors.
- Continuing Regulator
- Holding Company Regulation
- In general, the responsible Reserve Bank (“RRB”) for a banking organization has been the Reserve Bank in the District where the banking operations of the organization are principally conducted. For domestic banking organizations, the RRB typically will be the Reserve Bank District where the head office of the top-tier organization is located and where its overall strategic direction is established and overseen (BHC Supervision Manual).
- With regard to changing the RRB, that is a decision made by the Federal Reserve Board. The Board’s Division of Banking Supervision and Regulation, in consultation with the Division of Consumer and Community Affairs, may designate an RRB when the location-based principle set forth above could impede the ability of the Federal Reserve to perform its functions under law, does not result in an efficient allocation of supervisory resources or is otherwise not appropriate. In other words, a bank holding company is not entitled to apply to change its RRB, but the RRB may be changed in the discretion of the FRB.
Stinson Morrison Hecker LLP
- "Zombie BHCs": Transactions involving solvent banks owned by insolvent holding companies
- Bank stock loans (in default or foreclosure)
- Trust Preferred Securities (in deferral status)
- TARP Preferred
- Shareholder voting control (with little economic interest)
- Sales of bank assets and deposits
- Chapter 11 Section 363 Sales of Banks
- Sale of bank stock in bankruptcy of a BHC
- Foreclosure by bank stock lender
- Buyer's goals (stalking horse or otherwise)
- Seller's goals (Bankruptcy Trustee)
- Branch Sales by Troubled Banks
- Raising equity with deposit premiums
- Shrinking balance sheet
- Regulatory approval issues
- TARP Banks
- Sale of TARP by U.S. Treasury to private investors
- Redemption v. repurchase limitations
- What regulatory approvals are required?
- Recapitalization of Troubled Banks
- Push Down Accounting Issues
- Tax Issues
- Regulatory Capital Issues
- Sales of Perpetual Preferred Stock
- Strategies for Dealing with Troubled Assets
- Who gets stuck with problem loans and OREO?
- Bulk sales to troubled asset buyers
- Liquidating trust
- Buyers perspective v. Sellers perspective
- In the first few weeks in each of the past several years, innumerable predictions have been made about the coming “wave’’ in banks mergers and acquisitions (M&A). The consensus of opinion has been that, at 7,200, the number of Federal Deposit Insurance Corporation (FDIC)-insured banks in the United States (in the fourth quarter of 2012) is too many, and that the number will drop precipitously in the very near future. There is precedent for the prediction: The number of FDIC-insured banks in the U.S. has declined roughly 30 percent in the past 15 years, from 10,400. But in the past few years the much-heralded wave has been - at best - a ripple. And, again, this year there is no shortage of prognosticators making the same forecast.
- Looking back, there were 236 deals announced in 2012, compared to 178 transactions announced in 2011, although the total deal value was lower in 2012 than in 2011, an estimated $13.7 billion, compared to $17.1 billion. The median price to tangible book value was about 120 percent in 2012, compared to about 106 percent in 2011. While book values are creeping upward, they have much ground to gain before approaching pre-crisis levels.  At that time, price-to-book was often 2.5X, and sometimes 3X-plus. Those days are long, long gone.
- The reasons for the slow pace these past few years are well-documented: Potential sellers look back just a short time ago and see much-higher multiples, and they expect that their banks are worth better than 1.1 or 1.2 – about what we are seeing now – sometimes even lower than 1X. If not compelled to sell by regulatory or financial pressures, many sellers are having difficulty accepting that their institutions can no longer – at least in this market – demand historical averages when it comes time to sell. Buyers, for their part, are requiring a better perceived deal to make the transaction. The asset risks and continued slim margins are compelling acquirers to pay less than past multiples or find a “perfect fit” in order to display an accretive deal.
- Bank acquirers have explored a number of transaction structures and risk profiles in the current environment. Recent transactions have predominantly been acquisitions of distressed banks by healthy institutions, however, other structuring options - such as pre-packaged bankruptcies – may be evident in the coming months.
- Going forward, we expect strategic acquisitions to be characterized by a bank’s ongoing geographic expansion, for the enhancement of product capabilities, and cost-reduction opportunities. But, we also expect that the existing large bid/ask spread will continue through 2013, and could keep activity relatively low.
- Smaller institutions will continue to face profitability challenges and shareholder activism to sell - putting more pressure on them to merge, although we expect buyers to remain concerned about current price levels, as well as issues associated with capital preservation and potential surprises.
- The issue of whether to use stock or cash will hinge on the perception of marketplace improvement, which remains difficult to predict.
- Regardless, we expect very limited market permission for high-premium transactions, given ongoing and wide concerns about the strength of sellers’ balance sheets. Such concerns will put a high premium on due diligence – proof of “health” and validation of strategic fit, as well as on the integration and value-realization plan. Investors will demand credible evidence of such health and they will seek a well-defined value creation/synergy plan.
- Post merger, acquiring banks will need to ensure that a) they address the myriad compliance and regulatory requirements regulators are placing on bank mergers, b) the merged organization addresses the promised financial metrics that formed the basis for the deal and that was advertised to investors, and c) the merged organization represents in aggregate a better overall value to investors than the pre-merger separate bank values.
- In order to achieve this bank mergers have to be predicated on more than a cost/ capacity creation play. The value associated with that alone will usually not be significant enough to warrant a deal with consequent premiums. Any deal will need to create the capacity to grow the merged organization, provide greater value to its customers and generally establish a platform for growth that the separate organizations could not create as independent organizations.
- Why Strategic Mergers make sense financially but are difficult to achieve
- Resurgence of Community Bank M&A, Fact or Fiction
- Factors Impacting the M&A Market and Bank Valuation