1. AN EXAMINATION OF BANK MERGER ACTIVITY: A STRATEGIC FRAMEWORK CONTENT ANALYSIS Cheryl Frohlich, University of North Florida –Cfrohlic@unf.edu C. Bruce Kavan, University of North Florida –Bkavan@unf.edu

2. Agenda for the Day AN EXAMINATION OF BANK MERGER ACTIVITY: A STRATEGIC FRAMEWORK CONTENT ANALYSIS 1960-1979 1980-1989 1990-1998 Purpose of Study Perceived Motivation Drivers Stewart’s Motivating Forces Stewart’s Merger Motivation Theory of Increasing Financial Performance Cost Savings Financial Performance Performance Due to IBBF Act and Geographic Diversification IBBF Act and Geographic Diversification Consolidated Debt Capacity TBTF Methodology Fishbone Analysis Coders and Referee Tabulations Results-Four Main Paths Cost Reduction Increasing Gross Revenue Geographic Expansion Increasing Gross Revenue Larger Asset Base Increasing Gross Revenue Market Power Support For Stewart Merger Motivations Where Do We Go From Here?

3. AN EXAMINATION OF BANK MERGER ACTIVITY: Over the last decade, bank mergers and acquisitions have been occurring at an unprecedented rate.

4. 1960-1979 1960-1979 170 mergers per year –Prior to 1980’s Prohibition against interstate banking and state-level restrictions on branch banking and multiple bank ownership –DIDMCA (1980) and Garn St. Germaine (1982)

5. 1980-1989 1980-1989 498 mergers per year In 1980’s mergers and acquisitions were means for banks to penetrate new markets.

6. 1990-1998514 mergers per year The Riegle-Neal Interstate Banking and Branching (IBBF) Act of 1994 allowed bank holding companies to acquire banks in any state after September 29, 1995 and allowed mergers between banks located in different states after June 1, 1997. After Riegggle-Neale Act, banks have the full freedom to acquire another out-of-state bank in order to expand geographically across state lines and to diversify geographically and by product. 1990-1998

7. Purpose of Study Determine the underlying and driving forces and/or causations of bank mergers

8. Perceived Motivation Drivers The acquiring banks' desire to increase its return by expanding geographically. This perception is similar to Stewart’s premises of merger motivation.

9. Stewart’s Motivating Forces The actual motivating forces behind mergers –(1) increase financial performance (net operating profits) – (2) financial benefits through borrowing against the seller’s unused debt capacity or against an increase in the consolidated debt capacity (lending capacity for banks) –(3) tax benefits derived from expensing the stepped-up basis of assets acquired or from the use of otherwise forfeited tax deductions or credits.

10. Stewart’s Merger Motivation Theory of Increasing Financial Performance Largely accepted as being a merger motivator within the banking industry Increases in net operating profits result from: cost savings and/or increase in revenue (financial performance)

11. Cost Savings Downsizing (Craig, 1997) Technological efficiencies (Investor’s Chronicle, 1997)

12. Financial Performance Research---conflicting conclusions on combined banks –Financial performance-Not Improving (Baradwaj, Dubofsky, and Fraser, 1992; Palia, 1993; Hawawine & Swary, 1990; Toyne & Tripp, 1998; Madura and Wiant, 1994) –Financial performance-Improving (Cornett & De, 1991; Chong, 1991; Cornett and Tehranian, 1992; Subrahmannyam, Rangan, & Rosenstein, 1997).

13. Performance Due to Geographic Diversification Increase the bank’s market share Decrease risk Increase long-term profits

14. IBBF Act and Geographic Diversification Prior to the Riegle-Neal Interstate Banking and Branching (IBBF) Act of 1994 Banks were not allowed to expand across state line (with some exceptions).

15. IBBF Act and Geographic Diversification After Riegle-Neale Act –Diversify geographically across the nation Result –Unassisted merger rate has increased

16. Consolidated Debt Capacity As the banks merge and their capital base enlarges – Combined lending ability increases – Ability to offer larger loans without another bank partner increases Net Results – Increase in market share and revenue –Decrease in competition.

17. TBTF Continental Illinois National Bank and Trust Company in May 1984 was taken over by the FDIC. The subsequent resolution by its regulatory bodies, resulted in the government policy of “Too Big to Fail”(TBTF).

18. TBTF ( Continued ) Federal Deposit Insurance Corporation Act of 1991 the “TBTF” motivation should have decreased in importance some researchers still found that the “TBTF” was an important motivator in the larger mergers of the 1990’s (Benston, Hunter, and Wall, 1995; Hunter and Wall, 1989; Boyd and Graham, 1991).

19. Methodology A content analysis was performed utilizing the FDIC Applications for Merger/ Acquisitions for 1996 and 1997. Unit of analysis consisted of each independent merger/acquisition application. Sample-- FDIC provided a random sample of the merger/acquisition applications from 1996 and 1997.

20. Methodology (Continued) The coding scheme adopted for this content analysis was conceptualized in the Porter strategic model (Porter, 1980) as operationalized in a “fishbone” analysis framework (Nolan, Norton & Company, 1986).

21. Fishbone Analysis The coding scheme adopted –Benefits: ease high reliability –Disadvantages: may be more limited over surveys in terms of content validity to the extent that the applications closely reflect the underlying stated merger decision rationale

22. Coders and Referee Multiple coders and a referee insure a high degree of reliability in coding effort. For each application, two coders independently coded each paragraph Results entered into a spreadsheet for data management purposes. Results of the two coders were then compared, and, if there were any disagreement, the referee discussed the differences with each of the coders and made a final determination.

23. Tabulations For each application: – a resultant tabulation was created for stated and implied merger rationale within the merger application –tabulations were overlaid on the fishbone for visual inspection

25. Results-Four Main Paths These four paths are related to –(1) creating economies of scales –(2) expanding geographically –(3) increasing the combined capital base (size) and product offering –(4) gaining market power.

26. Cost Reduction Cost Reduction Rationales appear at a Higher level in Porter’s “fishbone” framework than increasing gross revenue. – Stated Cost reduction rationale: Combined institution would create economies of scales. Utilizing the synergies between the merging partners would create cost reducing operating efficiencies.

27. Increasing Gross Revenue The remaining three paths are related to increasing gross revenue but at a much lower level on the fishbone framework.

28. Increasing Gross Revenue Geographic Expansion decrease total risk increase product sales increase overall gross revenue.

29. Increasing Gross Revenue Larger Asset Base Make loans to companies that the individual institutions could not have previously serviced due to capital base lending regulatory restrictions. Offer a greater product array increasing their sales and, thereby, increasing gross revenue.

30. Increasing Gross Revenue Market Power Better able to compete with institutions within their market Increasing their product sales Increase gross revenue

31. Support For Stewart Merger Motivations Content analysis supports Stewart’s first two motivation theories: (1) Mergers increase financial performance (net operating profits) (2) Mergers produce financial benefits through increasing the consolidated debt capacity (lending capacity for banks)

32. Where Do We Go From Here? Categorical Discriminate Analysis Possible Problems--- With the number of observations per cell on the fishbone