Analysts in the year 2000 are likely to look back on the 1995-99 period as one in which the consolidation movement fundamentally reshaped the structure of banking and greatly strengthened its competitive position vis- a-vis nonbanks.
According to "Bank Consolidation: Strategies for the Next Wave," a study written by First Manhattan Consulting Group and published by the Bank Administration Institute, banks are beginning to make consolidation work for the shareholder.
The six most active acquirers since 1987 not only increased assets and loan portfolios far more rapidly than the average top-100 bank, they also recorded higher total returns to shareholders . Bank consolidation is being fueled primarily by the challenge of the industry's lagging revenue growth. Deals will not only prove the primary way for buyers to lift unacceptable revenue growth rates, they will also enable many sellers to capture value above their potential as stand-alone entities.
The study answers five important questions about acquisitions:
*Under what circumstances can shareholder value be created through acquisition?
*What makes a successful buyer?
*Is remaining independent viable - and for whom?
*What deal structures should prospective sellers consider?
*What are the key factors influencing the timing of participation in the consolidation movement?
In general, success in creating shareholder value in acquisition requires not overpaying for the anticipated benefits of acquisition and achieving cost and revenue benefits in as timely a fashion as possible. From an economic perspective, the cost savings attainable in acquisitions can increase the net income of the selling bank between 20% and 75%, depending on the proximity of the buyer's and seller's operations. This can raise shareholder value by 50% to 120% of book value, enabling the buyer to pay a high merger premium.
The study finds that the most advantaged buyers are those that can: afford to pay prices that are attractive to prospective sellers; deliver on the synergies needed to earn back the premiums paid; pick and choose from a bigger list of sellers; and make themselves more appealing to prospective sellers in nonprice terms.
Also essential to becoming a successful acquirer is the capacity to identify suitable targets. The most successful buyers to date have focused on targets with a mainly retail and small-business/lower-middle-market orientation. In addition, most transactions have been either in-market or contiguous-market deals. In the future, successful buyers will have to rely more on extracting value from acquisitions in new territories and in specialty businesses.
We estimate that the excess capital likely to be generated by the banking industry through the year 2000 is so great that it will be more than enough to purchase every money management, regional brokerage, and mortgage firm that today is in nonbank hands. Consequently, deals such as the Mellon-Dreyfus merger could well foreshadow a major trend.
To remain independent, a bank will require the ability to buck the trend of slow growth and profitability pressure or a board and stockholder group that values other factors more than financial performance.
Perhaps the principal deal choice for potential sellers is whether to engage in a merger of equals. This involves consideration of how benefits will be split by the buyer's and seller's shareholders. The benefits of such a merger, in terms of cost savings, revenue improvement, and risk reduction, could be equal to those attainable in an outright sale, but can be compromised by the difficulty of shared or balanced decision-making.
The degree of urgency in joining the consolidation wave is a function of the relative change in the number of buyers and sellers and the effect of this and other factors on the outlook for deal pricing. For example, prompt buyer action increases the number of available deals, but those who wait may benefit from reduced deal prices, especially if the growing supply of sellers outstrips the capacity of capable buyers to digest new acquisitions.
The study estimates that by decade's end, the industry could be ready to begin a "final wave" of consolidation in which the business of banking in the 50 largest metropolitan markets will become dominated by 10 or fewer institutions. Mr. McCormick is president and Mr. Bowen is managing vice president of First Manhattan Consulting Group in New York.
