Mergers and Acquisition in Banking - Book Report/Review Example

Boom and Bust: The Role of Mergers and Acquisition in Banking during the recent financial crisis The present study is a review of literature related to merger and acquisition taken place during the recent financial crisis and its role or impact on various factors and stakeholders related to it. The secondary data has been collected from books, journals and online articles for the purpose of analytical review to present the scenario in detail and scientific manner. Though the present study is a literature review intended to focus only on the merger and acquisition in banking sector during the recent credit crisis, most of the information has been collected from previous works and an attempt has been made to link the same through data gathered from online sources. The recent financial crisis brought tsunami to banking industry globally resulting in the bankruptcy being filed by those who were considered as the leaders and looked upon by the world to make and formulate new banking strategies. The financial crisis also brought down the number of merger and acquisitions drastically from 15400 deals in 2007 to 9700 deals in the year 2009 amounting to approximately US $1800. Through review of various literatures, it has been found that merger and acquisitions has negative effect on deposit rates, net income rates, employment sector, top executives leaving their positions, economy, rate of growth, etc. Keywords: merger and acquisition, financial crisis, credit crisis, Introduction The recent financial crisis had tremendous effects on all forms of economies. Sunanda Sen (2008) states that current turmoil in the global financial market and its origin from the US financial markets from where it has spread to the whole world, has made it imperative to question the relevance and validity of the neo-liberal theory and policies relating to financial sector. The crisis which is also known as credit crisis and mortgage crisis was the result of deregulation and weak policies in the banking system. The impact of the economic crisis was such that international forum for discussions on the crisis had transformed from Group of Seven (G-7) to the Group of Twenty (G20) which included emerging market countries. (Dunaway, S. 2009) According to ILO Report (2009), the key contributor to the financial meltdown was the widespread use of leverage by financial institutions to pump up profits during the real estate boom. The leverage was considered to safe in rising markets and extremely profitable for the financial institutions as long as there were no problems underlying the MBS portfolios which started experiencing increasing delinquencies and foreclosures from early 2007. This resulted in decline of their values and prompted the banks that had leveraged earlier to ask their money back which gave rise to increasing losses, bankruptcy and were forced to merge with other institutions to survive. The financial crisis led to bankruptcy of those companies who were considered as market leaders in the industry like Lehmann Brothers, AIG, Merrill Lynch and also General Motors. Lamanda, C (2009) states that crisis has gripped the financial markets for two years exposing the inadequacy of the current regulatory and supervisory framework to deal with complex issues forcing many companies to merge with other companies in order to avoid bankruptcy whereas some companies that could not withhold the burden were taken over by the companies looking to enter in the market and expansion. Mody and Negishi (2000) stated that M&A activity is a market for corporate control which is motivated by private as well as regulatory incentives. Private incentives include imperfection and asymmetries in domestic products and capital markets, competitive environment of the market and differences in the tax system whereas regulatory incentives incluce variations in corporate governance and policy frameworks, towards foreign investment and ownership. The M&A's are further classified into two where the first type is mainly motivated by the past problems and attempts to create value through restructuring and second type is forward looking, seeking to create value through creative partnerships. The present paper aims at first type of M&A and to collect information regarding the mergers and acquisition in banking sector that took place during the financial crisis and what role did they play during the crisis through various literatures from books, journals, articles and other sources. Merger and Acquisition - Few Facts Jensen (1987) based on the economic analysis and evidence states that market for corporate control benefits the shareholders, society and the corporate form of organization. It is further mentioned that transactions ran at a record rate of $180 billion each year in 1985 and 1986 which was 47 percent above the 1981 record of $122 billion. Sharma (2010) states that acquiring; selling or merging of companies is big business throughout the world. In the year 2007, according the estimated figures by Mergermarkets, global M&A market was doing around US $ 3600 million worth of mergers in about 15700 deals and the total value went down to US$ 1,800 billion in 9400 deals in the year 2009, which was mainly due the drastic effects of economic meltdown in the west which can be seen in the Figure 1 where the trend is decreasing year by year during the financial crisis. The fact is also supported by Associated Chambers of Commerce and Industry of India (ASSOCHAM) where the report mentions that companies have lost their valuation by 76% and only 72 M&A's worth $3.73 billion took place during the period from April - August 2008 as compared to $15.5 billion same period during 2007. Sharma, N. (2010) further states that the impact of recession was not uniform and the most of mergers took place in pharma industry with an increase of 103% which is mainly attributed to a mega deal between Pfizer and Wyeth of $63 billion which is also supported by the figures from ThaIndian News, that pharmaceutical sector topped the lists at $5.25 billion with 38.69 percent of total valuation of M&A deals. It is further reported by Lamanda (2009) that economic crisis of 1993 accelerated the phase of consolidation and restructuring and there were 566 merger and acquisitions of banks between the period 1990 and 2002 only in Italy, 654 merger and acquisition took place in Europe between 1995 and 2005 including 274 cross border transactions worth 158 billion and 158 mergers and acquisitions took place between European and Non European banks amounting to 134 billion The above data reveals that there had been number of M&A's before the financial crisis actually occurred and the transaction rapidly decreased after the crisis which can be understood from the Figure 1 above. Bruner (2004) states that cross border M&A transactions has increased rapidly to record levels and history of M&A in the United States offers sufficient evidence to prove that M&A waves are significantly driven by product market changes. Lambkin and Muzellec (2008) have stated that developments in the banking industry over the last two years has been dominated by the subprime crisis which has made the financial institutions to act cautiously about voluntary mergers and acquisitions and most of the world's major banks are looking towards consolidating and minimizing the impact of subprime crisis. The mergers and acquisition are not phenomena in the business environment, where business entity merge or sell their company to the well established company for various reasons which include avoiding bankruptcy too. Therefore it is necessary to understand the mergers and acquisitions in financial industry and how did it benefit the acquiring companies and stakeholders of the target company. Merger and Acquisitions - Causes Lambkin and Muzellec (2008) view the process of merger and acquisition as rebranding strategy as it can bring about changes and few additions to strengthen its equity that can be carried down through the hierarchy to the lowest level and smallest product. It is further explained that merger and acquisition between any two firms create four options of rebranding which includes the acquirer's brand, joint brand, flexible brand, and a new brand. Merger and Acquisitions are familiar in the banking sector with large number of international and domestic banks are engaged in such activities with an objective of reaping benefits of economies of scale. (Economy Watch) The most common reason why companies enter into M&A's is for restructuring their corporate strategy. Ivashina et al (2009) mentioned that huge amount of loans were used for corporate restructuring like leveraged buyouts, mergers and acquisitions, and stock repurchases and these loans accounted for 61% in the year 2007. Buono and Bowditch (2003) while assessing the different types of mergers and acquisitions states that there are various combinations raising number of different issues for firms employees posing problems and possibilities for pre-combination planning and post consolidation integration. Mergers and Acquisitions can be used to diversify markets, expand the company's present business, vertically integrate along industry lines or provide capital for the future leveraged buyouts. Claessens et al (2001) states that corporate restructuring is an ongoing process separating those firms that survives and prospers from those that are overwhelmed by new challenges and new founder. However governments have limited role to play in restructuring process but involves itself during the period of economic distress in order to provide assistance in paying their debts, fine tuning bankruptcy codes, formulate certain initiatives to increase labor mobility and facilitate mergers and acquisitions. In a survey conducted by the Boston Consulting Group (BCG) and UBS Investment Bank within the six weeks of the collapse of Lehmann Brothers, of the CEOs and senior managers of 164 publicly listed European Firms, it was found that most of the companies have not changed their M&A plans in the wake of crisis, one third of the companies expected to make an acquisition over the next 12 months and 43% believed that there would be large transformational deals in the coming year which could is visible in large acquisitions by Bank of America, National Bank of England and JP Morgan & Co. (Kronimus et al, 2008) Role of Merger and Acquisitions Walter (2008) states that merger and acquisitions in the financial sector is one of the major vehicles in transformation of a key set of economic activities standing at the center of the national and global capital allocation and payments system which has a disproportionate impact on the economy as a whole. Ron Brounes (2009) writes that banking sector was in midst of chaos because of recession that didn't seemed to be ending soon which can be recovered if not by the way of mergers and acquisition which is also in deep freeze. Claudia Vranceanu (2008) stated that global merger and acquisition fell by a third in 2008 after a continuous growth during five years. Barton et al (2003) states the companies are looking for new strategic opportunities to expand their business and horizons in the present global scenario. Financial crisis presents new and unique, regime shifting opportunities for companies to improve their market positions through M&A. During Asian Financial Crisis, deals amounting to $35 billion during August and December 1997 were undertaken which was an increase of 200 percent as compared to previous year. Unilever took advantage of cheap rupiah in Indonesia during the financial crisis, in order to acquire the four leading domestic brands and expand its business. And the M&A resulted in fivefold increase in the net profit to almost $90 million and returning sales to pre-crisis level. It is further stated the greater industry consolidation is the biggest impact of M&A activity during crisis. Morris (2004) using resource dependence theory, organizational ecology theory, niche theory has tried to find the reasons for the mergers among the banks. It was found that political economic environment is an important part of a historically social structure in which banks are embedded and the importance of conceiving an organization as social actors. It is suggested that bank's social behavior is embedded in political and economic structural arrangements and that this behavior responds to changes in social structure, specifically regulatory changes. As the effects of mergers and acquisitions will definitely affect the economy, stock prices, and employment sector, the study of Krug and Hegarty (2001) presents the probable effects it will have on top executives of the firm. The study focused on the perception of target company top managers to understand the reason for their decision to stay or leave the organization. It was found the executives' perceptions of the merger announcement, interactions with managers in the acquiring company after the merger, and long term effects of the merger, each had a significant effect on the executive's decision. This suggests that a sense of foreignness though working in the same company, has a negative effect on how the individuals view the outcomes of the acquisition of a firm whose headquarter is located in different country. It was found that merger announcement led to variety of dysfunctional outcomes such as dissatisfaction and intent to turnover among the target company's manufacturing employees and suggest that two third of the acquired company's executives leave for involuntary reasons. This finding is not supportive for any acquiring company as the employees are those assets whose experience cannot be replaced by any means. Further Craig and Dinger (2008) while examining the impact of mergers on deposit rates found that mergers have significant negative impact on checking account rates in in-market mergers that substantially increase the market share of the merging bank and result in substantial drop in checking account rates. According to the estimates of US Bureau of Labor Statistics, there were 847,900 in 2007 and the number would come down till the end of the year 2008 which was true with 142,00 employees laid off in the period of 11 months in the year 2008. The financial crisis of late 2008 however decreased the mergers and acquisitions dramatically throughout the world, but also brought above quick mergers and acquisitions of immense proportions which allowed the major giants to survive with the help of acquirers like Bank of America Corp, J.P. Morgan Chase & Co. and Citigroup. (Plunkett J.W, 2008a) During the year 2008, the biggest Mergers and Acquisitions in banking sector was Bank of America taking acquiring Merrill Lynch by paying $48.8 billion with US $29 per share. The other biggest was Royal Bank of Scotland Group which was nationalized by UK Government in return of US $ 26.1 billion financial aid and another was UK based Lloyds TSB which took over HBOS, the largest mortgage lender in Great Britain which was evaluated at $25.4 billion. (Claudiu, 2008) The merger of Chase Manhattan Corporation with J.P Morgan & Company, Firstar Corporation with US Bancorp, First Union Corporation with Wachovia Corporation, Fifth Third Bancorp with Old Kent Financial Corporation, Summit Bancorp with FleetBoston and the list goes on in the United States. The recent financial crisis was the product of such huge banking industries that were once considered as leaders in their industry segment, which affected the whole world due its weakened regulation policy as Daft (2009) states that many organizational decisions turn out to be serious mistakes. It is further stated that Britain's RBS Banking Group which embarked on highly ambitious strategy through acquisitions and cost cutting strategy resulted in increased growth with high profit but also highly leveraged. The bank catapulted during the process of acquiring ABN AMRO for 46 billion in 2007 along with Fortis and Santander Bank bringing the RBS shares down from 7 to less than 50 pence. The acquisition of ABN AMRO led to the demise of Fortis and RBS was forced to accept massive capital injunction from the UK government, thus making government the controlling shareholder in the firm. The tradition followed by the Fortis where an injunction of nearly $15.2 billion in capital was provided by the government of The Netherlands, Luxemburg and Belgium in return of 49% interest in the firm. (Plunkett J.W., 2008a) Plunkett J.W. (2008a) stated that the Lehmann Brothers was the major bank which was not bailed out by the United States government that declared its bankruptcy in September 2008. There were few companies who came forward to buy Lehmann Brothers like U.K. banking giant Barclays showing interest in US capital markets divisions merely for $1.75 billion, Japans Nomura Holdings agreed to purchase Lehman's European, Middle Eastern and Asian assets and Private Equity companies Bain Capital and Hellman & Friedman planned to spend $2.15 billion on Lehman's money management concern. Further Plunkett J.W. (2008b) referring to the headlines in 2008, states that US had bailout the American International Group (AIG) to the tune of $120 billion in order to save the firm from bankruptcy. The above mentioned incidents of mergers and acquisitions as well as bailouts by the government with controlling shares were part of the policies adopted by the government for corporate restructuring. Sharma S.D. (2003) mentioned that governments formulate various policies for corporate restructuring of the banks which includes mergers and acquisitions. Mergers and acquisitions are part of the crisis management with stronger firms taking over weaker or failed high risk and previously under regulated investment banks. (OECD, 2009) Dr. K. Ravichandran mentioned that the wave o merger and acquisition which was built up since 2002 and during October 2008, the announced and cancelled deals hit record highs. Further rise of globalization has exponentially increased the market for cross border M&A where there were 2000 cross border transactions in 1996 which increased to $1,637 trillion 21% higher than the previous record in the year 2000. With regard to the effects of M&A, various studies have formulated and put together the benefits which are as follows (Jensen. M.C, 1987) The process benefits shareholder of the target company wherein premiums in hostile exceed by 30% on average and recently have gone up to 50%. Acquiring firm shareholders on average earn about 4% in hostile takeovers and zero in mergers. The acquiring firm do not waste credit or resources and generate a substantial gain which is averaged at 8% of the total value of both companies. The activities of takeover specialists do not harm or have negative effect on the shareholders. Kayafas N (2008) mentioned that major mergers and acquisitions force job losses mostly due to duplication of works and the opportunity to evaluate staff functions and the need for people. Banks merger and acquisition are no exception which is evident from the Bank of America merger with Fleet Boston Financial Corp that resulted in 12,500 jobs cut followed by Wachovia's acquisition of Golden West Financial Corp for $25.5 billion, which had 3159 offices in 16 states, was expected to close 55 branches and lay off 1100 employees. It is clearly understood that any merger and acquisition has definite impact on the employees in normal circumstances and their position during the times of financial crisis in unquestionable. The ILO report presents an overview regarding the effects of M&A activities on employment sector resulting in decline of the permanent employment, increasing the job instability and insecurity and rapid growth of various non standard forms of work, including part time work and temporary employment. The report also mentions the outcome of the study on the mergers of the major banks in the United States of America. The report consists of nine case studies of bank mergers which reveal that all the nine banks used cost cutting strategies in line with pre merger projections, whereas only four banks were able to successfully improve their financial reports. The cost reduction strategies include employee cut offs, payroll reductions accounting to 50%. According to Blaustein and Dressen, mergers aim at scaling economies through merging of services, retaining the best infrastructure and moving the staff as need and making others redundant. The report presents in detail that that the acquiring company adopted several cost cutting strategies to make for the loss through staff lay off and other cost reduction strategies. The report clearly states that any merger and acquisition activity processed during the crisis has drastic effects on employments of the target company. (ILO, 2001) The ILO (2009) reported the concerns of employment sector stating that the sector has been at the epicentre of the financial and economic crisis as there were 325,00 announced layoffs between August 2007 and February 2009 on in financial sector. The employment expansion in the financial service sector has been reportedly slow at a growth rate of 0.5% between 1996 and 2006 while in other sectors the growth rate was 3% during the same period because of extensive mergers and acquisitions leading to consolidation and restructuring of the financial services sector as the world has witnessed large number of M&A during this period. More jobs were in the lay-off zone, like information technology that was exempted previously from major redundancy waves. Due to the process of restructuring led by merger activity, investment banking industry is set to cut off the jobs by 50,000 in the IT sector by the end of 2009. Dr. K. Ravichandran in his study of merger and acquisition in GCC countries stated that M&A activity in the region increased as compared to global M&A rate which was mainly driven by economic reform and foreign investment liberalization in the region, market leaders in the region like Dubai Holdings, Abu Dhabi Investment Authority and Saudi Public Investment Fund acquired stakes of global companies to diversify government income, ample liquidity in the record oil prices, investors turning smarter, global buoyancy in the private equity market. The trend of M&A increased the value to $101 billion in 2007 as compared to $4.17 billion which the author says is two thousand percent jump. It is further mentioned that the mergers and acquisitions would promote interrelation among GCC market and integrate these markets with international markets thus providing an opportunity to extend its business in wider context. The author is optimistic about the growth of GCC in the coming years in view of big investment choices. But in another study by Correa (2008), it is found that banks are more likely to get acquired in the cross border deal if they are large, bad performers, in countries with less financial intermediation and when the banking sector concentration is high. It is also stated that post acquisition, the performance of the banks does not improve in first two years which is caused by Net Interest Margins, and an increase in Overhead costs. Elena and Pascal (n.d.) during their study of 714 deals involving EU acquirers and target located throughout the world analysed whether M&A are reflected in improved performance. It was found that despite the extensive and ongoing consolidation process in the banking industry, the operations are associated to a slight deterioration in profit efficiency and contemporaneously to a pronounced improvement in cost efficiency in the 6 years after the deal, thus transferring the cost efficiency to the bank clients rather than to bank shareholders. This study clearly states that the M&A operations will be back to profit related services only after six years till then the banks have to consolidate according to the financial situation of the economy. Lou and Phillips (2009) of PricewaterhouseCoopers in a survey carried out in the Asian financial markets during 2008 found that despite sharp fall in the number of M&A transactions, the Asian financial institutions are actively exploring opportunities in contrast to the companies in the west, where they have shifted from strategic expansion to rapid contraction. This indicates that M&A activity has dramatic and drastic impact on the economy of the nation as whole during the financial crisis. Conclusion The review of various literature documented in this paper reveals very interesting findings pertaining to M&A activity during the recent financial crisis. There are numerous studies in the fields of merger and activities but very few are based on the recent credit crisis of 2008. Through this review of literature, it is found that the major sector that will be affected by merger and acquisitions is the employment sector irrespective of the fact whether the process takes place during crisis or in normal circumstances. But during the financial crisis, the impact is worldwide. Mergers and Acquisitions are major restructuring activity during the times of crisis allowing the banks in distress to recapitalize on their mistakes and its shareholders are benefited. Moreover merger and acquisitions is an expansion strategy for most of the companies those who are looking to enter the new market, credit crisis allow them the required market like in case of Lehman Brothers who were approached by foreign banks to buy the stakes giving an indication of cross border merger and acquisition process. Coming back to employees in context with cross border mergers and acquisitions, it was found in one of the study that most of the senior executives and managers tend to leave their jobs due to sense of foreignness that arise because of the merger or acquisition with the company that has its branches in another country. Further it is also found that the M&A has negative impact on the deposit rates and will not garner profits until two years. The main reason to undertake the process of merger and activity is for corporate restructuring through various strategies which also includes rebranding strategy providing both the companies, acquirer as well as target companies to rebrand their products and services, individually or jointly into the market with a new vision and goal. References 1. Barton, Dominic, Roberto Newell and Greg Wilson (2003) Dangerous markets: managing in financial crises, John Wiley and Sons. United States 2. Bruner, R.F (2004) Applied Mergers and Acquisitions, John Wiley and Sons, United States 3. Buono, A.F and Bowditch, J.L. (2003) The human side of mergers and acquisitions: managing collisions between people, cultures, and organizations, Beard Books, United States 4. Claessens, Stijn, Simeon Djankov and Ashoka Mody (2001) Resolution of financial distress: an international perspective on the design of bankruptcy laws, World Bank Publications 5. Claudiu Vranceanu (2008) Biggest Mergers and Acquisitions in 2008, WallStreet www.wall-street.ro 6. Correa, Ricardo (2008) Cross Border Bank Acquisitions - Is there a performance effect, International Finance Discussion Papers, Board of Governors of the Federal Reserve System, No. 922, www.ssrn.com 7. Craig R.B and Dinger V (2008) Bank Mergers and the Dynamics of Deposit Interest Rates, Working Paper 08/06, Federal Reserve Bank of Cleveland. 8. Daft (2009) Organizational theory and Design, Cengage Learning, United States. 9. Dr. K. Ravichandran, Effect of Financial Crisis over Mergers and Acquisitions in GCC countries, King Saud University. 10. Dunaway, S. (2009) Global Imbalances and the Financial Crisis, Volume 2009,Part 2, Council on Foreign Relations, United States. 11. Elena Beccalli and Pascal Frantz (n.d) M&A Operations and Performance in Banking, FDIC, www.fdic.gov 12. Financial Crisis hits global merger and acquisition deals, Oct 26th, 2008, ThaIndian News. www.thaindian.com ILO (2001) The employment impact of merger and acquisition in the banking and financial services sector, Report for discussion at the Tripartite Meeting on the Employment Impact of Mergers and Acquisitions in the Banking and Financial Services Sector, Geneve 5 -9, ILO Office,Geneva. 13. ILO Report (2009) Impact of the financial crisis on finance sector workers, Issues paper for discussion at the Global Dialogue forum on the impact of financial crisis on finance sector workers, Geneva 24 - 25, February 2009. ILO Office. Geneva. 14. Ivashina, V. and Scharfstein, D (2009) Bank Lending during financial crisis of 2008, Harvard Business School and NBER, 15. Jensen, M.C (1987) The Free Cash Flow Theory of Takeovers: A Financial Perspective on Mergers and Acquisition and the Economy, SSRN Library. 16. Kayafas N. (2008) Welcome to the Poverty Class: The Growing Unemployment and Underemployment Problem, Dorrance Publishing, United States., 17. Kronimus, Andre, Roos, Alexander and Stelter, Daniel (2008) M&A; Down but Not out, A Survey of European Companies' Merger and Acquisition Plans for 2009, The Boston Consulting Group, www.bcg.com 18. Krug J.A and Hegarty, W.H (2001) Predicting Who Stays and Leaves after an Acquisition: A Study of Top Managers in Multinational Firms, Strategic Management Journal, Vol. 22, No. 2 John Wiley & Sons 19. Lamanda, Caramine (2009) The Financial Crisis: Less Internationalization or better supervision, UNICREDIT SPA, Review of Economic Conditions in Italy, Rome. 20. Lambkin, Mary and Muzellec, L. (2008) Rebranding in the banking industry following mergers and acquisitions, International Journal of Bank Marketing, Vol. 26, No. 5, Emerald Group Publishing Ltd. 21. Lou Nelson and Phillips Mathew (2009) Report and Survey Results: The Outlook for FS M&A in Asia, A New Playing Field, PriceWatehouseCoopers, China. 22. Mody, A and Negishi,S (2000) The Role of Cross Border Mergers and Acquisitions in Asian Restructuring, FIAS/PREM 23. Morris, Theresa (2004) Bank Mergers under a Changing Regulatory Environment, Sociological Forum, Vol. 19, No. 3 (Sep., 2004),Springer pp. 435-463, 24. OECD (2009) OECD Strategic Response to the Financial and Economic Crisis. OECD. 25. Plunkett J.W. (2008b) Plunkett's Insurance Industry Almanac 2009: Insurance Industry Market Research, Statistics, Trends & Leading Companies, Plunkett Research, Ltd. 26. Plunkett, J.W (2008) Plunkett's Investment and Securities Industry Almanac 2009 (E-Book): Investment and Securities Industry Market Research, Statistics, Trends and Leading Companies, Plunkett Research, Ltd 27. Ron Brounes (2009) The US Market for Deals Remains in a Deep Freeze, Money Morning, www.moneymorning.com 28. Sharma S.D. (2003) The Asian financial crisis: crisis, reform and recovery, Manchester University Press 29. Sharma, Nimesh (2010) Mergers and Acquisitions in times of financial crisis, DARE, www.dare.co.in 30. Sunanda Sen (2008) Global Financial Crisis, A Classic Ponzi Affair, Working Paper, No 2008/12. ISID. 31. Walter, Ingo (2008) Mergers and acquisitions in banking and finance: what works, what fails, and why, Oxford University Press US. Read More