1. Chapter Nineteen Acquisitions and Mergers in Financial-Services Management Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

2. Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Key Topics Merger Trends in the United States and Abroad Motives for Merger Selecting a Suitable Merger Partner U.S. and European Merger Rules Making a Merger Successful Research on Merger Motives and Outcomes 19-2

3. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Motives Behind the Rapid Growth in Bank Mergers Profit Potential Risk Reduction Rescue of Failing Banks Tax and Market- Positioning Motives Cost-Savings or Efficiency Motive Mergers as a Device for Reducing Mergers as a Device for Maximizing Competition Management’s Welfare Other Motives Forces of Consolidation and Convergence: Since 1980 more than 10,000 mergers among US-insured depository institutions. Why? 19-3

4. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Some Recent Acquisitions in the Credit Crisis of 2007 19-4

5. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Merger Motives Identified By Bank Executives and Employees Quality of Management Profitability (Return on Assets) Efficiency of Operations Maintenance of Market Share 19-5

6. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz What is consolidation? Convergence? Why are there so many mergers each year in the financial-services industries? What factors seem to motivate most mergers? 19-6

7. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Selecting a Suitable Merger Partner The Most Important Goal of Any Merger Should Be to Increase the Market Value of the Surviving Firm. Where annual expected dividends per share are represented by E(D t ) and c is the opportunity cost of capital 19-7

8. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. How Can The Maximization Goal be Achieved? Improve Operating Efficiency (reduce operating cost per unit of output) ▫ Consolidate Operations and Eliminate Duplication Geographic Diversification Product Line Diversification 19-8

9. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Impact on Earnings Per Share Generally Speaking Shareholders of Both the Acquired and Acquiring Firm Will Gain If: 1. Bank with Higher P/E Ratio Acquires Bank with Lower P/E Ratio And If: 2. Combined Earnings Do Not Fall After the Merger 19-9

10. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Merger Premium As Long as the Acquiring Institution’s P-E Ratio is Larger Than the Acquired Firm’s P-E Ratio, There is Room for Paying Merger Premium. A Merger Premium is Paid if the Acquiring Bank’s Shareholders Receive More Than the Current Market Price for Their Stock 19-10

11. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Exchange Ratio The Number of Shares of Stock Offered By an Acquiring Bank for Each Share of Stock of the Acquired Bank 19-11

12. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Dilution of Ownership Dilution of Ownership Occurs When the Acquiring Bank Offers an Excessive Number of Shares to the Acquired Bank Shareholders. The EPS Will Fall Below its Original Level for the Acquiring Bank When This Happens. 19-12

13. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Principal Factors of Target Firm to Consider The Bank’s History, Ownership and Management The Condition of Its Balance Sheet The Firm’s Track Record of Growth and Operating Performance The Condition of Income Statement The Condition and Prospects of the Local Economy Competitive Structure of the Market Area 19-13

14. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Other Characteristics of the Target Firm to Examine The Comparative Management Styles of the Merging Organizations The Principal Customers the Targeted Bank Serves Current Personnel and Employee Benefits Compatibility of Accounting and Management Information Systems of the Merging Organizations Condition of the Bank’s Physical Assets Ownership and Earnings Dilution Before and After the Proposed Merger 19-14

15. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Purchase of Assets Method of Purchasing Another Bank A Method of Carrying Out a Merger in Which the Buying Company Purchases All of the Assets of the Acquired Firm Using Either Cash or its Own Stock 19-15

16. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Purchase of Stock Method of Purchasing Another Bank A Method of Consummating a Merger in Which the Acquired Firm Ceases to Exist; The Acquiring Firm Assumes all of its assets and Liabilities; Exchanges its Equity Shares for the Stock of the Acquirer 19-16

17. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Regulatory Rules for Bank Mergers in the US: Bank Merger Act, 1960 First Major U.S. Law to Bring Merging Banks Under Federal Supervision, Requiring Government Approval to Merge with or Acquire Other Banks 19-17

18. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Under the Bank Merger Act Merger Must Be Approved By Principal Regulator ▫ National Banks – Comptroller of the Currency ▫ State Member Banks – Federal Reserve ▫ State Insured Banks – FDIC Regulatory Agency Must Give Top Priority to Competitive Effects Mergers with Anti-Competitive Effects May Be Approved if it Can Be Shown That There Are Significant Public Benefits Such As Providing Convenient Services or Rescuing a Failing Bank 19-18

19. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Herfindahl-Hirschman Index (HHI) Measure of Market Concentration It is the Sum of the Squared Market Share for All Banks in a Specific Market Area Department of Justice (DOJ) Guidelines ▫ Postmerger HHI Below 1000, then the market is unconcentrated, no further action; ▫ Moderately Concentrated Market (HHI between 1000-1800) and change in HHI<100, no further action ▫ Possible challenges if HHI increases by more than 200 points to a level of 1800 or more See the St. Louis Fed Cassidi website: http://cassidi.stlouisfed.org 19-19

20. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Keys to Merger Success Acquirer Must Start By Evaluating Its Own Financial Condition Must Have Detailed Analysis of Possible New Markets Must Establish a Realistic Price for Target Firm Afterwards Combined Team Must Direct Progress Towards Consolidation Must Establish Communication Between Senior Management and All Employees Must Create Communication Channels for Customers and Employees to Understand Why Merger Took Place Should Create Customer Advisory Panels to Evaluate and Comment on Merged Bank’s Image and Products 19-20

21. McGraw-Hill/Irwin Bank Management and Financial Services, 7/e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. Quick Quiz What factors should a financial firm consider when choosing a good merger partner? What factors must the regulatory authorities consider when deciding whether to approve or deny a merger? When is a market too concentrated to allow a merger to proceed? Does it appear that most mergers serve the public interest? 19-21