Mergers and Acquisitions in the European Banking Sector

Master's Thesis, 2005

95 Pages, Grade: 1


Table of Contents

1. Introduction
1.1. Executive Summary
1.2. Objectives of this study
1.3. Hypotheses
1.4. Data and Methodology
1.4.1. Data
1.4.2. Methodology

2. Theoretical background - Literature Review
2.1. Merger Terminology
2.2. Types of M&A transactions
2.2.1. Direction: Horizontal, Vertical and Conglomerate
2.2.2. Mode: friendly or hostile
2.2.3. Initiator: Vendor or Acquirer
2.2.4. Type of payment: unlevered or levered
2.2.5. Type of value transfer: share deal or asset deal
2.2.6. Functional criteria
2.3. Motivations for M&A - general and banking related
2.3.1. General Motivations for M&A
2.3.2. Motivations for M&A in the banking sector
2.4. How to define M&A success? - 4 Perspectives
2.4.1. Shareholder Perspective
2.4.2. Consumer Perspective
2.4.3. Employee Perspective
2.4.4. Society Perspective
2.5. Measuring success in bank related M&A transactions
2.5.1. Event Studies
2.5.2. Dynamical efficiency studies
2.5.3. Performance studies
2.6. Factors explaining M&A success in bank mergers
2.6.1. Geographical focus
2.6.2. Product / Activity focus
2.6.3. Size of the target
2.6.4. Growth focus of a transaction
2.6.5. Risk reduction potential
2.6.6. Profitability and cost efficiency of the target
2.6.7. Capital market performance of the target prior to a transaction
2.6.8. Experience of the acquiring bank
2.6.9. Method of payment
2.6.10. Post-merger Integration
2.7. Problems arising in different phases of a bank M&A transaction

3. European Banking sector
3.1. EU Banking Market Structure
3.1.1. Fragmentation
3.1.2. Performance
3.2. Spain: Banking sector overview
3.2.1. Current situation
3.2.2. Sector Performance
3.2.3. Legal framework
3.2.4. Fragmentation
3.2.5. M&A activity
3.2.6. Drivers and obstacles for further M&A activity in Spain
3.3. UK: Banking sector overview
3.3.1. Current situation
3.3.2. Sector Performance
3.3.3. Legal framework
3.3.4. Fragmentation
3.3.5. M&A activity
3.3.6. Drivers and obstacles for further M&A activity in the UK
3.4. France: Banking sector overview
3.4.1. Current situation
3.4.2. Sector Performance
3.4.3. Legal framework
3.4.4. Fragmentation
3.4.5. M&A activity
3.4.6. Drivers and obstacles for further M&A activity in France
3.5. Italy: Banking sector overview
3.5.1. Current situation
3.5.2. Sector Performance
3.5.3. Legal framework
3.5.4. Fragmentation
3.5.5. M&A activity
3.5.6. Drivers and obstacles for further M&A activity in Italy
3.6. Germany: Banking sector overview
3.6.1. Current situation
3.6.2. Sector Performance
3.6.3. Legal framework
3.6.4. Fragmentation
3.6.5. M&A activity
3.6.6. Drivers and obstacles for further M&A activity in Germany
3.7. Analysis of M&A transactions in the EU Banking sector
3.7.1. Domestic versus cross-border activity
3.7.2. Silence before the storm?
3.7.3. Four types of European M&A in the banking sector
3.7.4. Premium Analysis

4. Case study: Banco Sabadell’s acquisition of Banco Atlantico
4.1. Introduction
4.2. Banco Sabadell: Corporate profile
4.2.1. A history of successful acquisitions
4.2.2. Product and regional focus
4.2.3. Strategy
4.3. Banco Atlantico: Corporate profile
4.3.1. History
4.3.2. Strategy, Product and regional focus
4.3.3. Financial Analysis
4.4. Transaction details
4.4.1. Main acquisition facts
4.4.2. Time table
4.4.3. Integration process
4.5. Strategic motives for the transaction
4.5.1. Strategic fit
4.5.2. Synergies
4.5.3. Analysis of business units after the Atlantico acquisition
4.6. Performance measurement and comparison
4.6.1. Shareholder perspective: Abnormal return analysis
4.6.2. Financial Ratio analysis

5. Conclusion
5.1. Drivers and obstacles for a European Banking Consolidation
5.1.1. Drivers
5.1.2. Obstacles
5.1.3. Reasons for Banco Santander’s acquisition of Abbey National
5.1.4. Where synergies in cross-border Banking M&A can be found
5.1.5. Taking a look at the USA
5.2. Conclusions from the Case Study
5.3. Possible consolidation scenarios
5.3.1. Product driven consolidation scenario
5.3.2. Regional consolidation scenarios



1. Introduction

1.1. Executive Summary

The banking sector in Europe is bound to change its shape soon. In many countries the banking sector is still highly fragmented, especially in Germany and Italy. EU Banks need to grow in size if they want to be able to compete globally with financial titans such as Citigroup.

This study aims at analysing the key drivers and success factors for external growth via Mergers and Acquisitions (M&A) in the European banking sector. After explaining the theoretical background of Mergers and Acquisitions (Chapter 2), the study examines the current condition of the EU banking sector followed by a more detailed view on the main markets and players (Germany, UK, France, Spain, Italy) focussing on their potential role in a future consolidation process (Chapter 3). It seems that important obstacles for consolidation have been removed and banks may indeed engage in domestic and even cross border M&A. A detailed comparison of Europe’s largest banks will complement this section. By analysing paid premiums in the five key European economies, we will draw conclusions on the influence of market structure on the potential for consolidation.

In Chapter 4, the Banco Sabadell - Banco Atlantico case is analysed and discussed as an example of a domestic bank merger. Emphasis is put on the logic behind the operation, performance measurement and its strategic impact. The question, if value has been created for shareholders as well as other stakeholders, will be addressed. This recent case (2004) only allows for a preliminary analysis of the success of the transaction, particularly in terms of achieved synergies versus expected synergies. The case evidences typical sources for higher synergies in domestic M&A but reveals also important sources of synergies that would apply in cross border operations.

In the final conclusion (Chapter 5), the market analysis is put into perspective to recent developments and briefly compares it with the US Banking market. Key observations from the case study are summarized and finally this section aims at developing different scenarios for a future consolidation within the European banking sector.

1.2. Objectives of this study

For the author this paper has been an incredible opportunity to learn about a very exciting and crucial industry for every economy.

The overall objective of this study is to give Managers valuable information about what have been the drivers and success factors in past transactions as well as what they could look like in the near future. Although every M&A transaction is unique, there may be common drivers, problems and solutions to them.

1.3. Hypotheses

If the target company lies in the same country than the acquirer (domestic merger), the merger has a higher possibility of being successful due to the lack of various obstacles that may arise in cross border transactions (culture, different legal or tax environment).

If the target company is smaller than the acquirer (in terms of assets) the merger has a higher possibility of being successful as the bidding company may be more likely to implement efficient management techniques introduced by the acquirer.

If synergies have been analysed and estimated correctly prior to the submission of an offer price, the merger has a higher possibility of being successful as the false estimation of synergies may lead to an overestimation of the target company value.

Fragmentation of the banking sector in many European countries is too high and leads to lower profitability of banks operating in the market.

With a harmonisation of regulations throughout European markets cross border M&A activity will increase.

EU Banks need to grow in size if they want to be able to compete globally with financial titans such as Citigroup.

1.4. Data and Methodology

1.4.1. Data

Extensive data gathering has been performed to analyse the European banking sector and the M&A activity in the industry over the last five years.

The sample of bank mergers has been selected from a dataset provided by Thomson Financial SDC (Securities Data Company - Mergers and Acquisitions Database), of originally 472 transactions in the EU financial services sector. To get to a manageable size of relevant transactions the dataset has been refined as follows:

- Only Banks (SIC code 6000)
- Mergers with a transaction value above $100m
- Transactions involving banks in EU15 Norway and Switzerland. In later analysis only transaction in France, Germany, Italy, Spain, and the UK have been taken into account.
- % of shares acquired above 25%, in order to reflect a significant shareholding and the take of control
- Transactions over the last 5 years (from 2000 to end 2004)
- Only completed mergers (exclusion of share repurchases and delisting as well as intended and pending deals)

The result was a data set of then 88 relevant transactions. Thomson SDC is regarded as a leading source among finance professionals. Nevertheless, to verify the data, additional press research via Factiva has been performed.

For the realisation of the Cumulative Abnormal Return analysis in the case study, the involved companies have to be quoted at a stock exchange for at least 252 trading days prior to the announcement, in order to receive the target’s closing prices and compare it to the relevant index. As a matter of fact the analysis was only useful for the acquirer as the target’s free float was too low. Further regarding the case study analysis all publicly available information such as annual reports, company presentations, web sites and news has been used.

1.4.2. Methodology

First of all, the theoretical background and the market study have been prepared based on extensive literature review and the study of industry reports and company information. Here, the author took advantage of the excellent library of the HWWA (Hamburgischen Welt-Wirtschafts-Archiv) and used several online databases and archives (such as Genios, EBSCOS, Proquest, The Economist, McKinsey Quarterly, Reuters Business Insight, Multex, Lexisnexis and Factiva).

As for the methodology for the market analysis, a database consisting of Europe’s 27 largest banks with a market capitalisation of above €10 billion had to be created. Then a series of key ratios had to be calculated based on company’s financial information given in their annual reports or directly on their web sites. The resulting database helped to determine differences within European markets with respect to profitability and efficiency. For this, banks in one of Europe’s five largest nations (Germany, France, United Kingdom, Italy and Spain) were grouped together.

For the realisation of the case study analysis the relevant publicly available information has been reviewed in detail and was complemented by interviews with involved investment bankers. The performance analysis is based on the event study methodology. The event study methodology is used to measure the average daily abnormal returns associated with acquisition announcement. The event date, t0, is defined as the announcement date of the acquisition.

The event study methodology applied relies on the market model based approach introduced by Brown and Warner (1985):

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A linear regression model is applied to estimate the model parameters Įj and ȕj for each stock j. The parameters are estimated during a period of 252 trading days (one full year) prior to the event window and are referred to as [Abbildung in dieser Leseprobe nicht enthalten] und [Abbildung in dieser Leseprobe nicht enthalten] Expected returns calculated as follows:

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For market return RMt, the national industry index is employed (IBEX30).

Abnormal returns of a stock j in the event window are calculated by subtracting the expected stock return[Abbildung in dieser Leseprobe nicht enthalten] from the observed stock return Rjt in the event window:

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The event window T is 41 days: T = [-20;+20] days, where t={0} determines the announcement day of a transaction. Within the event windows particular periods are studied.

Cumulated abnormal returns (CAR) for any interval [-t1;t2] during the event window T are calculated as follows:

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Both, the effects on shareholders of the targets and of the bidders can be analysed separately and combined. To analyse the combined entity, this study follows Houston and Ryngaert (1994). To calculate the abnormal returns for the combined entity of the target and the bidder, they weigh the abnormal returns of the bidder ARtK and the abnormal returns of the target ARtG by their market values MV:

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The market capitalisation used for the entire event window, is the one observed at the day before the event window.

An additional performance analysis, based on accounting data, will be applied to see how financial ratios changed after the merger (see theoretical background section).

2. Theoretical background - Literature Review

2.1. Merger Terminology

Mergers comprise all combinations (acquisitions) in which the buyer absorbs all assets and liabilities of a target company.

We speak of Acquisitions when one company acquires a majority interest in another company. In a friendly acquisition the target firm agrees to be acquired. Also, the legal status of the acquired company may be kept.

A Takeover is a corporate action where an acquiring company makes a bid for a target company. If the target company is publicly traded, the acquiring company will make an offer for the outstanding shares. Takeovers can be friendly (amical) or hostile.

The terms, mergers and acquisitions, are used interchangeably throughout the paper even though some acquisitions are not mergers.

2.2. Types of M&A transactions

No clear-cut classification for types of M&A transaction exists. M&A transactions can be classified by their direction, the mode, the initiator, type of payment, type of value transfer and by functional criteria.1 Each classification will be explained in turn.

2.2.1. Direction: Horizontal, Vertical and Conglomerate

A horizontal merger defines a transaction where two companies, that have been competitors in the same sector, combine their assets. The aim is to create economies of scale or scope and to enhance market power. In the banking sector the combination of Credit Lyonnais and Credit Agricole is an example for a horizontal merger. Another popular example is the merger of Daimler Benz with Chrysler Corporation to create DaimlerChrysler.

In a vertical merger two companies that operate along one value chain of a product or service in the same industry combine. It is the combination of the vendor with a customer. The rationale behind such a transaction is to stabilize (1) the supply of raw materials, or (2) customer demand for the finished product of the firm that is farther up in the production process.2 The combination of a car producer with an automotive parts supplier would be an example for a vertical merger. However, vertical mergers go against the trend of outsourcing and focusing on core competencies (core business) and may therefore be hard to justify.

Even harder to justify are conglomerate mergers or lateral3 mergers where two companies of unrelated sectors combine. Managers often use the diversification motive as the justification for conglomerate mergers. However, some of the biggest companies in the world are conglomerates such as General Electric. Nevertheless in the 1980s and 1990s many conglomerates proved unwieldy and inefficient and were unwound (for example ITT).

2.2.2. Mode: friendly or hostile

M&A transactions can be either friendly or hostile depending on the attitude of the target towards the transaction. In a friendly transaction, constructive negotiations between acquirer and target with a common goal are held. If the target management disagrees with the acquirer and rejects an acquisition offer, the acquirer can go the way of a hostile takeover via a public offer to the shareholders. A popular example was the acquisition of Mannesmann by Vodafone. Hostile transactions may lead to costly defensive measures of the target company that may change the financial attractiveness of the transaction for the acquirer.

In the banking sector hostile takeovers are rare. However, the acquisitions of National Westminster by Royal Bank of Scotland in 2000 and Paribas by BNP in 1999 were hostile takeovers.

2.2.3. Initiator: Vendor or Acquirer

This classification, introduced by Berger (1998) differentiates M&A transactions by the initiator of the process. The main difference lies in the impact on the transaction process. For example a seller may determine the structure of the sales process (public or controlled auction or exclusive negotiations). This process may lead to either acquirers overpaying for the target as they overestimate the value or underpaying as the target is regarded as weak because of his willingness to sell.

2.2.4. Type of payment: unlevered or levered

In unlevered M&A transactions the acquirer pays either in cash or with shares for the target but does not use debt. Various forms of levered transactions exist, such as Management Buy-outs (MBOs), Management Buy-ins (MBIs) or Leveraged Buy-outs (LBOs). LBOs are irrelevant in transactions with banks due to their size. However, the type of payment used in M&A transactions may be seen as a signal to capital markets and as a factor explaining the success or a Merger (see below).

2.2.5. Type of value transfer: share deal or asset deal

The company or parts of it will be transferred to the acquirer via a share deal, where a considerable shareholding is transferred, or asset deal, in which particular assets or rights are transferred.

2.2.6. Functional criteria

With functional criteria transactions are divided into capital investment oriented transactions and marketing or product-oriented transactions. The latter can be explained with strategic motives.

Not part of this study are other forms of combinations of companies such as joint ventures or strategic alliances although in the chosen case study joint ventures play an important role and will be discussed briefly within that chapter.

2.3. Motivations for M&A - general and banking related

Before analysing the motivations for M&A in the banking sector, general reasons for M&A are examined. External (market driven) drivers for increased M&A activity in the European banking sector will be analysed in section 3.

2.3.1. General Motivations for M&A

Economic literature states various reasons for mergers. The overall predominant motivation is synergies. Academics divide them into operating synergies and financial synergies4. Operating synergies comprise improvements in any business function such as management, labour costs, production or distribution, resource acquisition and allocation or market power.

Financial synergies are obtained when the combined market value is greater than the sum of the individual market values due to the “financial configuration of the merged firm”. However, in an ideal capital market, financial synergies would be impossible because of the irrelevance of an individual firm’s capital structure (Modigliani and Miller, 1958).

Brealey and Myers5 give more sensible motives for mergers:

1. Economies of Scale and Scope (Synergies) largely depend on the direction of the transaction (see above).Economies of scalearise when activities of the merged company can be combined and streamlined. Possible sources of scale economies include a leaner workforce, a smaller and more efficient distribution, one single headquarter and reduction or complete exclusion of duplicate activities in all business areas (e.g. R&D, back-office). Economies of scope are realized when costs are spread over an increased range of output of different products or services.6

2. Economies of vertical integration may to a certain extent lead to considerable advantages as it facilitates coordination and administration. But as explained above it is against the principle of core business.

3. Complementary resources are gained if two companies who each possess complementary resources such as a unique technology or human resources, which in combination increase the value of the firm. In addition, the combined firm may open up business opportunities that otherwise would not have existed. 4. Myers and Majluf’s Pecking order theory (1984) may also provide a motive for mergers in that cash poor companies may want to acquire cash rich companies in order to be able to pursue all profitable investments. Vice versa, companies with excess cash but few profitable investment opportunities may turn to mergers financed by cash.

5. Eliminating inefficiencies through better management is one of the principal motives for Private Equity firms who are increasingly involved in today’s M&A activity. This motive is particularly interesting when acquiring poor managed companies with unexploited opportunities to cut costs.

Problematic explanations for M&A include the Hubris Hypothesis (Roll, 1986) where the bidder’s management overvalues the target because they overestimate their ability to create value after gaining control. Finally, and related to the prior explanation, Managements self interest may explain mergers where managers pursue personal objectives instead of shareholder value maximization when entering the transaction. The transaction may have offensive as well as defensive motivations. The first relates to “empire building” and in the second the manager tries to secure his job or wants to avert potential acquirers.

2.3.2. Motivations for M&A in the banking sector

The motivations for M&A in the banking sector can mainly be classified into valuemaximising motives and non-value-maximising motives.7 Additionally there may be specific strategic motivations resulting from the current market situation or from the inside of the company. One frequently stated motive is growth, however, the primary motive is shareholder value maximisation although managers may enter M&A transactions for other reasons too as we have seen.

- Value-maximising motives:

Not all but the most significant value-maximising motives in banking M&A transactions are analysed below.

If we define value as the discounted value of expected future cash-flows, mergers lead to increased cash-flows if either expected costs can be reduced or expected revenues increased.

Possible sources of cost reductions in banking M&A:

- Economies of scale
- Economies of scope
- Economies of skill
- Implementation of improved management skills and techniques
- Reduced tax obligations
- Increased market power leading to reduced prices of suppliers
- If a bank needs to enter into a new market, M&A may be a cheaper means than de novo entry

Economies of scale in the banking sector result predominantly from combining particular back-office activities, for example customer services or the handling of securities and money transfer.8

Economies of scope in the banking sector may have three sources: provisioning, production and distribution.9 Economies of Scope from the production side exist for example when services or products can be used at many places without limitation. A good example for Economies of Scope from the distribution side is the possibility of “cross-selling” existing products through existing distribution channels of the target company.

Economies of Skill is certainly not as important as economies of scale as a rationale for mergers but may contribute positively to the value of the merged entity. For example, gaining access to specialist knowledge is very important especially in Investment Banking. Also, in areas such as information technology and risk management value enhancing knowledge can be gained through M&A.10

Through the introduction of new managers who bring important management skills and techniques into the acquired company further cost reductions may be realized. In addition, these managers are more likely to take more drastic decisions, which may be needed in order to achieve the expected cost reduction.

Reduced tax obligation may be achievable depending on local tax regimes. In Spain, for example, the goodwill of the acquired company is tax deductible, which was relevant in the Santander - Abbey acquisition.

By increasing the market power, a company is able to put pressure on suppliers to grant more favourable conditions, i.e. lower prices, bulk discounts etc..

Entering a new geographical or product market through M&A provides cost advantages compared to building a presence from scratch (see q-Ratio below). Costly and time-consuming administrative work has already been completed and an existing network of branches can provide a starting point for the merged company, as do already established client contacts and a functioning network of suppliers.

Interestingly, empirical studies in the US showed that that economies of scale and economies of scope in the banking sector are limited.11

Possible sources of increased revenues in banking M&A:

- Gaining critical size enabling banks to access new customer groups (for example large customers or customers in different geographic regions)
- Offering “one-stop-shopping” to customers through an increased product range
- Attract new customers thanks to increased visibility and reputation
- Increased market power in order to raise prices

After presenting this non-exhaustive list of sources that may lead to an increase in expected future earnings (and hence value), other important value maximizing motives have to be mentioned.

The information hypothesis, introduced by Seidel (1995), says that acquiring an undervalued company that has been identified through information that is publicly not available, is a value-maximizing motive. This kind of “insider” information may be the result of intense business relations.

Weston and Chung (1990) introduced the q-Ratio motive, where the q-Ratio stands for the ratio of equity market value of a firm and the replacement value of its assets. It is also called Tobin’s Q. The q-Ratio motive means that, with the aim of capacity expansion, the acquisition of a company may be the more efficient (cheaper) way compared with own capacity creation. This is true in the case when the own company has a q-Ratio greater than one and the target a q-Ratio multiplied with the %-acquisition premium of below one. Buying that company is cheaper than purchasing all the necessary goods to replicate its activity.

- Non-value-maximising motivations:

Based on the Principal-Agent-Theory12 founded by Ross in 1973 two problematic motives for M&A in the banking sector have been identified. The first motive relates to the Free-Cashflow-Hypthesis13, meaning that managers disposing of significant free cash flow tend to pursue non-value-maximizing M&A transactions. In doing this, they are trying to maintain or even increase their power. Related to this motive is the “manager- utility-maximization”-Hypothesis, which has been verified in empirical studies about bank mergers in the US.14 Managers are increasing their utility function through components like compensation, power and reputation, which normally increases with firm size.

- Strategic motivations:

Other strategic motivations may indirectly also have impacts on valuation. These strategic motivations explaining M&A activity are a result of the company strategy.15 The two main strategic motivations for M&A with particular meaning for EU banks today are

- New strategic positioning
- Establishing a presence in a new market

A new strategic repositioning where a company changes his focus on clients, products or markets may be the response to margins drops in the existing business, competition increases or technological change. A good example for a new strategic positioning with a change in the product focus of a company is the acquisition of Dresdner Bank by Allianz in Germany.

Due to exogenous factors such as globalisation and deregulation, establishing a presence in a new market is becoming more and more important.16 In the market section main exogenous factors driving consolidation in the EU banking sector will be discussed.

2.4. How to define M&A success? - 4 Perspectives

A general definition of M&A success seems to be problematic as it does not hold for the various parties affected by the M&A transaction. Therefore Berger, Demsetz et al (1999) differentiated between shareholders, managers and the government regarding the success of a merger17. Looking at different stakeholders involved in such transactions, its success should also be regarded from the perspective of clients, employees and society. Studies analysing M&A transaction generally focus on the impact on shareholders but considering the impact on the above mentioned other stakeholders is also important.

Figure 1: Overview of merger success from 4 different perspectives

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Source: Adapted from Beitel (2002)

2.4.1. Shareholder Perspective

The paramount economical goal of an M&A transaction has to be the increase in shareholder value. The shareholder value approach was first introduced by Rappaport in 1986 and regarding the responsibility of companies he states: “In a market-based economy that recognizes the rights of private property, the only social responsibility of business is to create shareholder value (…).”18 Principal factors impacting shareholder value include variations of the share price, dividend payments and possible share repurchases.

The value creation model19

Value from a transaction is generated if the value of the combined company (PVAB) exceeds the stand-alone value of the merging companies A (PVA) and B (PVB), where value is determined by the present value (PV).

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PVAB includes the stand-alone value of companies A and B plus the present value of synergies (PVS) minus existing restructuring costs (PVC)

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As a consequence value is only created when the present value of synergies exceeds the present value of restructuring costs plus the present value of the transaction premium paid (PVP).

(3) PVS > PVC + PVP

We now define the value creation for shareholders of the acquiring company versus shareholders of the selling company. For the acquirer the maximum acquisition price [Abbildung in dieser Leseprobe nicht enthalten] is determined as follows:

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For shareholders of the acquiring company value is created if the actual price paid for the target [Abbildung in dieser Leseprobe nicht enthalten] is below the maximum acquisition price.

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For shareholders of the acquired target company added value stems from the transaction premium paid by the acquirer.

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Both shareholder groups benefit from the transaction when actual price paid is below the maximum acquistion price but above the present value of B.

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From this model it becomes evident that the success of an M&A transaction from the shareholder point of view is very much dependent on the ability of the involved managers to correctly assess future synergies and restructuring costs associated with the transaction.

2.4.2. Consumer Perspective

Generally we have to distinguish two classes of consumers: large consumers and small/private consumers. Large consumers (corporations) have more market power and information than small businesses (SMEs) or private consumers and may therefore be able to pass around negative impacts of mergers (such as price increases or lower interest rates). Broaddus (1998) identifies 4 criteria that make bank mergers successful for consumers20:

- No reduction in the product and service portfolio
- Same or improved level of attention through personal bank clerks
- Price reductions
- No change in accessibility to bank services and products

One recent empirical study21 demonstrates that in the short run, in-market mergers increase market power, resulting in unfavourable deposit rate changes for consumers. Not enough attention has been paid to this field of study to date. Managers should however pay attention to this issue as a loss of clients due to unfavourable conditions after a merger may result in significant decrease in value.

2.4.3. Employee Perspective

The employee perspective may be crucial for shareholders as the loss of key employees (brain-drain) due to unfavourable changes post-merger, is a frequent phenomenon that negatively affects the value creating potential of the merged company. This is particularly true for Investment Banks and has negatively impacted the Allianz - Dresdner deal as key Investment Bankers of Dresdner Kleinwort Wasserstein (DrKW), the investment banking division, left the company due to a lack of strategic commitment by the new Allianz management.

For employees of a merging bank the transaction is successful if (1) there is no risk of redundancy, if (2) equal or better career-paths exist and finally if (3) the salary stays stable or increases. For managers, as a particular class of employees, success is achieved when compensation, reputation and power increases.

2.4.4. Society Perspective

For the society (mainly government and inhabitants in the affected region) a merger is successful when enough competitors remain in the market in order to guarantee competition (no monopolies), the company does not leave the region, no workplaces are lost and the overall economic stability is untouched. Regulation has as its primary concern, to ensure that the society perspective is taken into account and will be respected in M&A processes.

2.5. Measuring success in bank related M&A transactions

Which methodologies can be used to measure success in M&A transactions of banks?

M&A success is to be seen from different angles. These angles consist, as we have seen, of various stakeholders of the involved companies. However, the focus nowadays rests on shareholder value. As a result, M&A success depends highly on whether or not shareholders are better off after the deal or not. How to determine if they are better off or not?

Academic literature has developed various approaches to measure M&A performance in the banking sector.

Beitel22 differentiates three main methodological approaches:

1. Event Studies
2. Dynamical efficiency studies
3. Performance studies

2.5.1. Event Studies

First used by Fama and Fischer et al in 196923, this approach analyses the impact of a specific event (Merger) on the value (share price) of a company. In fact, all company specific events could be analysed in this way. Event, in this study, is defined as the public announcement of the merger. Event studies are the most frequently used methodology and the only one oriented towards capital markets. This methodology is explained in detail in the methodology section (1.4.2.).

Further advantages of this methodology:

- Changes in value can be calculated separately for the acquirer, target and combined entity
- Based on market data this methodology better reflects the value of the companies (as opposed to annual report data)
- It is a forward looking approach that automatically takes into account future expectations about the combined entity

The last point inherits one of the disadvantages of this methodology:

- Assumption of efficient capital markets implies that all publicly available information and future expectations are correctly factored into the share price
- No set rules for the length of the event window exist and it may be difficult to exactly determine the time of the event (information leakage)
- No information gains about changes in efficiency of the merged companies are gained from this analysis

2.5.2. Dynamical efficiency studies

Since the early 1990s this methodology is used in the empirical research of M&A transactions. It relies on publicly available company data such as balance sheet and Profit and Loss account. For this reason, these kind of studies can only measure indirect transaction success and only at a later stage the impact on shareholder value can be analysed.

As compared to event studies, dynamical efficiency studies allow for the identification of changes in efficiency (changes in prices, market power). In general, this approach is more complex than others but follows a more company focused path and hence is an important means of analysing M&A success. Results are obtained using frontier methodology and the relative industry rankings of banks participating in mergers. Frontier methodology involves econometrically estimating an efficient cost frontier for a cross-section of banks. For a given institution, the deviation between its actual costs and the minimum cost point on the frontier corresponding to an institution similar to the bank in question measures X-efficiency.24 This measure shows the maximum possible gain in efficiency of a bank to the best practice bank.

2.5.3. Performance studies

Dynamical efficiency studies and performance studies are accounting based methodologies, which differentiate them from the event study approach.

The financial performance of an M&A transaction is influenced from two directions: market power gains (companies can change prices to their advantage) and efficiency gains (change in input and output quantities which lead to reduced costs, increased revenues and/or reduce risk to increase value for a given set of prices)25. In other words performance gains may come from either the cost side, the revenue side or from both sides. At the heart of performance studies lies the comparison of financial ratios over a specific period (one year). Important ratios include Return on Asset (ROA), Return on Equity (ROE), Net interest Margin or the Cost-Income-Ratio. The major drawback of these indicators, apart from their static view, is the fact that they are not risk adjusted and do not take into account any value creation for the shareholder. The solution to this shortcoming can be found in metrics like Tobin’s Q, see above, the risk adjusted return on equity (RAROE) and the concept of economic value added (EVA).

As it is a commonly used metric in the financial industry a further explanation of the risk adjusted return on capital (RAROE) seems appropriate. We will start out with the formula and discuss all items in turn.

illustration not visible in this excerpt

The ROE is Net Income after tax divided by the Shareholder’s Equity of the firm. One has to take into account that exceptional items should be excluded from net income and that shareholder’s equity is book value and hence does not reflect the market based return of the equity.

A major shortage of a simple ROE is that it does not account for the change in risk of a company. By applying the Capital Asset Pricing Method (CAPM), we are able to calculate the cost of capital, which takes into account the business risk of the company and will have to be deducted from the simple ROE. This cost of capital can be computed by using the CAPM model which shows that the market compensates only for the systematic risk and not for the total risk of the company. The Security Market Line (SLM) effectively gives us the expected returnRiby the following equation:

illustration not visible in this excerpt


illustration not visible in this excerpt

Concerning beta [Abbildung in dieser Leseprobe nicht enthalten], it is calculated using regression analysis, and it is the tendency of an asset’s or security's returns to respond to swings in the market. A beta of 1 indicates that the security's price will move with the market. Betas may vary significantly among banks and are determined by the complete range of business activities they pursue. As a consequence, betas of a merged bank may be different from the individual beta before the merger. Therefore, the beta used in analysing a bank merger would be the beta of the acquiring company. We may have found a good model to assess the success of a bank merger but have to keep in mind that RAROE is still founded on accounting data and betas which are problematic to rely on.

In addition to the above mentioned methodologies,Surveys of executivesandClinicalStudiescan be seen as possible means to examine M&A performance26. Both can deliver valuable information about value creation not known by the market. This kind of inductive research reveals more detail and factual background. As a result, new patterns and behaviours can be discovered.

2.6. Factors explaining M&A success in bank mergers

Based on a considerable amount of empirical research of past M&A transactions in the banking sector, some key factors for their success can be derived27:

2.6.1. Geographical focus

Almost all studies that cover geographic focus of a transaction conclude that more shareholder value is created when target and bidder operate in a related geographical region.

2.6.2. Product / Activity focus

The ratio of net interest income of a target to its total operating income can be used to quantify and determine the product/activity focus of a transaction. Many US studies find evidence that high product/activity focus has a positive effect on the success of bank mergers.28

2.6.3. Size of the target

The relative size of the target compared to the bidder may also affect M&A-success. Hawawini and Swary (1990) find that M&A-transactions are more favourable for bidders if the targets are small relative to the bidders.29


1 Beitel. P., (2002)

2 Ogden, J.P., Jen, F.C., O’Connor, P.F. (2003)

3 Achleitner, P.M., (2000)

4 See Ogden, J.P. et al (2003)

5 Brealey, Myers (2003)

6 Sudarsanam, S. (2003)

7 See BIS (2001) or Berger, A.N., Demsetz, R.S. and Strahan, P.E. (1999)

8 Beitel. P. (2002)

9 Dermine, J. (1999)

10 Schuster, L and Wagner, A. (2000)

11 Hawawini, G.; Swary, I. (1990)

12 Ross, S. (1973)

13 Jensen, M.C. (1986)

14 Bliss, R.T. and Rosen, R.J. (2001)

15 Achleitner (1999)

16 Berger, A.N., DeYoung, R., Genay, H. and Udell, G.F. (2000)

17 Berger, A.N., Demsetz, R.S. and Strahan, P.E. (1999)

18 Rappaport, A. : Creating shareholder value : a guide for managers and investors. Rev. and updated. New York, Free Press, 1998

19 Adapted from Brealey and Myers, p.938

20 Broaddus Jr, J. A. (1998)

21 Focarelli, D. and Panetta, F. (2002)

22 Beitel, P. (2002)

23 Fama, E.F., Fischer, L., Jensen, M.C. and Roll, R. (1969)

24 Pilloff, S.J. and Santomero, A.M. (1998)

25 Berger, A.N., Demsetz, R.S. and Strahan, P.E. (1999)

26 Bruner, F.A. (2004)

27 Beitel, P., Schiereck, D., Wahrenburg, M. (2003)

28 See for example DeLong (2001)

29 Hawawini, G.A. and Swary, I. (1990)

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Mergers and Acquisitions in the European Banking Sector
ESCP Europe  (Department Finance)
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Mergers, Acquisitions, European, Banking, Sector
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Daniel Wülbern (Author), 2005, Mergers and Acquisitions in the European Banking Sector, Munich, GRIN Verlag,


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