BANKTHINK
Do Bank Mergers Work?
CLEAR ANSWER: Shareholder patience with "underperforming banks" is running thin, especially when they could sell themselves for "more than they are even worth," says Philip Timyan, a longtime bank investor and blogger about community banking.
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Why Bank M&A Is Good for Buyers, Sellers and the Economy

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Second of a two-part BankThink series debating whether bank mergers are worthwhile. Previously: former investment banker Harvard Winters argued that there are lots of risks and little financial reward in bank mergers.

Bank mergers are an economic necessity because there are currently more banks than the nation can support, leaving many of them struggling to earn a decent return.

In Chicago alone there are more than 200 banks. Harrison Steans, a legendary Chicago banker turned bank investor, predicts that half of them will be merged away.

Considering bank failures in 2010 cost the Deposit Insurance Fund $24.18 billion, consolidation is a good alternative to another wave of closures!

Banks that are producing inadequate returns are squandering shareholder capital that could be invested more productively elsewhere, and they are increasingly at risk of government seizure. Moreover, because they typically offer poorer products and services than stronger players, these banks are not even doing right by their own customers.

High-performing banks, on the other hand, are by definition generating strong returns for shareholders, supplying the capital our nation's businesses and communities need to prosper, and offering top-notch products and services for consumers. Given increasingly stiff competition for loans and talent, it makes perfect strategic sense for these banks to buy underperforming institutions they know that they can turn around, rather than compound the problem by building more branches.

Consider the case of the underperforming Heartland Community Bank in Franklin, Ind., acquired by Horizon Bancorp (HBNC) in Michigan City, Ind., in 2012 — a deal that was good for all parties. (I was one of them, having owned about 8% of Heartland's shares.)

Horizon paid off the $246 million-asset Heartland's Troubled Asset Relief Program obligations the day the deal was completed. That benefited taxpayers, and it spared shareholders the risk of a dilutive capital raise to repay Tarp followed by anemic returns. It may have even prevented a failure that could have cost the federal insurance fund millions of dollars.

Heartland's customers also benefited, because Horizon was able to offer them larger loans, stronger cash management programs, a greater range of trust and wealth management offerings, and even better rates on certificates of deposits.

Heartland's stock rose 30% the day the merger was announced. Horizon's shares held steady that day and since then have doubled in value. Considering the progress the combined companies have made, shareholders can expect to see even greater gains.

Specifically, in 2011, Horizon reported the largest profit in its 138-year history, including an average return on equity of 11% and return on assets of 0.9%. By mid-2013, almost a year after consummating the deal, Horizon could boast of a stellar 14.7% ROE and 1.3% ROA. And there's still plenty of room for it to grow in Heartland's home base in and around Indianapolis.

This is why the market has rewarded smart buyers, like Wells Fargo (WFC) and U.S. Bancorp (USB) — two of the country's most profitable banks. Since 1990, Wells Fargo has purchased a whopping 127 banks and . U.S. Bancorp has purchased 18 banks. Each of these acquirers now trades above its precrisis high, while earning more than 1.5% on assets and more than 13% on shareholder equity. Given the inherent operational efficiencies of combining enterprises, it's almost a given these days that an acquirer's earnings per share and market value will go up upon announcement of a bank M&A deal.

This is also why poor performance is becoming less and less acceptable to investors. I have to agree with activist shareholder groups such as Stilwell Partners and PL Capital on this score — there's really no excuse for continuing to tolerate underperforming banks, when there are plenty of opportunities for them to obtain more than they are even worth in a sale.

Philip Timyan, who ran the former Riggs Partners investment fund, writes a blog on community banking and sits on the board of two Chicago-area banks.

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Comments (3)
Missing from this debate is how the transaction affects the value of the combined franchise. There are several other aspects where M&A adds value. For example, the branch network: if a south metro bank acquires a north metro bank, the combined franchise is clearly more valuable combined than separate. Having coverage for an entire metropolitan area creates value for customers and results in a more valuable franchise for investors. Additionally, size does matter in bank valuations. Larger banks are more valuable in terms of valuation metrics than smaller institutions. As two banks merge, the valuation of the combined entity is often enhanced simply through size. There are a number of these other factors that need to be taken in consideration when examining the value of M&A.
Posted by Adam | Friday, August 09 2013 at 5:13PM ET
The author blithely asks us to ignore a LOT.

If there weren't a market for 200 banks in Chicago, there wouldn't be 200 banks. Nothing will protect the banking industry from a macro 'black swan' event, but a multiplicity of institutions should tend protect the economy from the bad decisions made by a few - and bad decisions happen all the time. (This mechanism is imperfect - only capital fleeing overseas moves faster than the spread of a bad business model.) Every business model has an activity/profitability ceiling. I know because I've seen this happen myself more than a few times), after which the costs of management become prohibitive - you NEVER mess with the law of diminishing returns - EVER. I've personally witnessed productivity rise after capacity has been shed, and I've been with one company which went under because of the cost-burden of trying to manage processed which were already mastered, just not on a bigger scale.

Hardly any managers, in my experience, aren't savvy enough to grasp the work it takes or the costs involved with making a merger succeed. Nor are they willing to work that hard. If they were, they'd go out and start their own bank.
Posted by papicek | Saturday, August 10 2013 at 11:23AM ET
Interesting article , there's a whitepaper on Post Merger Integration that readers may also find very interesting "Strategic growth and the impact of an effective integration infrastructure " @ http://bit.ly/UvpjVz
Posted by Aditya Guru | Monday, August 12 2013 at 5:26AM ET
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