Consolidation of the US Banking Industry and Small Businesses - Research Paper Example

Is the consolidation of the U.S. banking industry substantially reducing the supply of credit to small businesses? Merger and Acquisition is a linchpin activity in the recent banking reforms that brought about change beyond size and sophistication. Arguments whether the industry has taken a path of massive restructuring or has misconstrued value gains, does not conceal the fact that mere policy shift in capital structure drove up bank consolidation. Lifting country barriers in global scale deepened integration, mobilized private funds, and enhanced competition. Appropriateness of resource allocation and alterations in the degree of bank ownership are other outcomes. Nonetheless, its implications on small business lending recognize a behavior other than what is seen typical to non merger banks, positively associated to small business lending. This study attempts to examine the relation between Merger and Acquisition on Small Business Lending, specifically in the case of bank of America, before and after investing Merrill Lynch. Chapter 1 Bank Consolidation in the US banking industry 1. Background The age of industry consolidation in US Banking industry can be described as a period (1979-1994) consisting continued bank consolidation with extraordinary change in applied finance, information processing, technology, and derivative markets. Within this period the banking industry structure severely contracted in terms of the number of savings institutions and commercial banks or 48% of thrift banks (15,084 in 1984 to 7,842 in 2003). The same follows for what is characterized as the community bank sector that still accounts for 94% of banking organization. Critchfield et al (2004) detailed these declines across all four markets as proportionally similar (rural markets, small metropolitan markets, and suburban and urban parts of large metropolitan markets); largely due to M / A at about 7 in every year. Restraint on this downward trend is attributed to the number of de novo bank entrants that averaged 163 per year. In terms of industry concentration, assets increased from $3.3 trillion to $9.1 trillion, particularly to the nation’s largest financial institutions. In contrast, the share of industry assets held by community banks plummeted 28% and small banks shrank from 8% to 2%. A quarter of US deposits are controlled by just 3 organizations whereas that same proportion was held by 42 companies in 1984. Bank of America Corporation having the largest hold of domestic bank deposits with about $512 billion in domestic deposits and small banks account for 3 % of domestic deposits. As it is, the current concentration of market power is below the level where monopolistic behavior might manifest itself (Moore and Siems 1998 and Rhoades 2000). The consolidation phenomenon examined and discussed at considerable length by Berger, Kashyap, and Scalise (1995), Berger, Demsetz, and Strahan (1999), and Shull and Hanweck (2001). Although at macroeconomic level consolidation has been influenced by technology, deregulation, macroeconomic events, and other environmental factors; microeconomic factors that are largely responsible for the consolidation trend. That is a bank decides to consolidate charters, o merge with or acquire another firm reflects management’s chosen strategy in the preservation of company value. It can be part of a purely defensive strategy based on the self-serving motives of managers (Bliss and Rosen 2001 and Ryan 1999). Implied by Shull and Hanweck (2001), Penas and Unal (2004), is a desire to obtain “too-big-to-fail” status for competitive advantages and government support. 1.2 Static Effects of M / A Studies by Amel et al (2002) of 6,000 recent U.S. bank M / A describe the benefit of consolidation in the financial sector applies to a relatively small segment, and little evidence points out that mergers result economies of scale or that managerial efficiency is achieved. Discernment on mergers or acquisitions presumes increased efficiency on the average cost of transaction contracts and the advancement of managerial capacity as a result of an increased range of products and geographical reach. On the other hand and equally, the extent of exploitable scale and scope economics is raised while improvements seen of management in complex institutions could be illusive. The findings suggest that the gain in efficiency attributed to the exploitation of scale economies diminish once a certain size or scale above some threshold. Either managing large institutions prove difficult or the geographical coverage increases in tandem to the same amount of conflict. At the same time there also is indication that banks operating in concentrated markets are typically less efficient. Specifically to bank mergers, the lag in the company advancement reflect difficulty in the lengthy integration process which includes refocusing lending policies, rationalizing branches, streamlining systems and operations, and people reorientation of brands and culture adaptation. This is reinforced with the study by Cybo-Ottone and Murgia (2000) which concludes that in domestic bank mergers, a significant increase in shareholder value occur but is not the same for cross-border transactions. Policy changes on interstate transactions brought on M / A to banks with severely concentrated portfolios. Quoting Akhavein et al (1997), a clear benefit of M / A is risk diversification, typically to larger banks with low equity-asset ratios and diversified loan portfolios. In sum, the principle of economy of scale is not realized through M / A because the risk before and after a merger is not held at a constant. Considering that large banks assume a cost-minimizing level of capital, the tendency to exploit government subsidies to banks “too big to fail” is implied (Hughes, et al 2001). Results of a study analyzing the operating performance of forty seven bank intrastate mergers through 1982 and 187 indicate that mergers had not raised operating income, substantiated by net interest income plus net non-interest income to assets (Linder and Crane 1992). Related reviews describe that more complex banking institutions of M / A origin are less predisposed to fund informal organizations which are in fact extremely dependent on bank credit. Considering small business lending entails fetching intimate information of the borrower, the business detail and the local market which larger banks are distant about. Large institutions work within an entirely different credit culture prepped for transaction driven loans to large transparent borrowers, and find it burdensome to sift through relevant information associated with small business lending (Berger et al 1998). What is more is that a size of a bank is associated with small credit lending reversely. In contrast to an average bank, large institutions fund a fewer number of creditors and lend lesser proportion of per naira of asset to small businesses (Cole et al 1996). Similar conclusions surfaced in the study of Strahan and Weston (1996) where banks categorized either small or medium, tend to invest a chunk of assets in small business loans. Small business is the backbone of economic advancement in many developing countries, if not the path to industrialization in a number of regions, that its importance cannot be overemphasized (Berger and Udell 1996). What was perceived in older days of home-based businesses comprising merely hobbies that add a bit to an overall income has completely changed. A study on home based Small Business Success Index (SBSI) show that technological advances in productivity and connectivity as well as societal acceptance of working out of home. This aspect makes up a majority of the small business landscape of financially successful companies. Small businesses employ more than 13 million people in the United States alone. And among these home-based companies, half of which have been in operation for over 15 years and generating an average income of US$75,000. 1.2.2 Dynamic effects of M&A In an environment of relaxed regulatory restriction coupled by borderless technologies, a new market evolved as a result of policy change. Merger and Acquisition was a natural response, although in unimagined considerable volume. The first of issues presents in the social cost of small businesses availing financial products, where indications of less accessibility for more cost and risk are threshed. Comparative studies show that large banks charges about 1% point less on small businesses loans than average and require collateral about 25% below small banks (Berger and Udell 1996). However, these formidable institutions issue credit on the basis of banking relation or prior borrowing records, and rely less on soft information which can not be captured in the formal information drawn from balance sheets. As such, small business lending is passed up as restrictive. One review confirmed that larger banks allocate smaller proportions of assets to small business lending. SBL/GTA ratios for the following size groupings: small banks 0.0849 / somewhat large banks 0.0840 / fairly large banks 0.0494 / very large banks 0.0295. Another is that the age of the bank has a strong effect on small business lending. Berger et al (1998) explains the reduction in the supply of small business lending brings to bear the impact from combining the financial condition of the two smaller institutions into a single balance sheet for competitive positioning. It is also reasoned that this new lending behavior is attributable to the need to refocus attention following organization realignment. The dynamic effect is in a forward looking manner that the reactions of other lenders in the same local market that might pick up any profitable loans that are no longer supplied by the consolidated institutions, or may react with their own dynamic changes in behaviour that either increase or decrease their supply of small business loans (Berger and Udell 1996). Goldberg and White (1998) consistent with this possibility found that de novo banks tend to lend more to small businesses as a percentage of assets than other small banks of comparable size. Clearly, mergers and acquisitions render containment of financial disturbance, while the transformation repositions institutions in global trade, presenting a new order of abundant opportunities for small business lending for others to assert. Berger et al (2001) wrote: Large institutions tend to cede market shares of small business lending to new entrants, rather than being stimulated to compete against them. Chapter 2 Bank of America 2.1 Background Bank of America –the behemoth global holding bank company, largest in terms of assets and total revenue as of 2009. Bank of America ranks third in revenue and second among the big US banks in terms of assets as of 2009. Bank of America assets 2,300 US$, 113 US$ in revenue / JP Morgan Chase assets 2,000 US$, 101 US$ in revenue / Citigroup assets 1,800 US$, 106 US$ in revenue / Wells Fargo assets 1,200 US$, 151.7 US$ in revenue. The bank has a complete line of services in financial and non-financial areas, rendered through a six segment operating prong: Global Card Services (24% revenue / -87% of net income), Global Banking (19% of revenue / 49% of net income), Global Markets (17% of Revenue / 114% of Net Income), Global Wealth & Investment Management (15% of revenue / 43% of net income) Home Loans & Insurance (14% of revenue / -60% of net income), and Deposits (11% of revenue / 41% of net income). A bank capture over 55 million consumer and small business clients and in 44 nations. It began a small operation in 1904 to cater to immigrants other banks do not serve by Amadeo Giannini and took on mergers and acquisitions to become formidable as it is today. Through the acquisition of Banca de llItalia Meridionale in 1922, Bank of America was established. Then on, a series of consolidations and acquisitions occurred. In 1927, Liberty Bank of America was formed with 175 branches with a capital base of $30,000,000 and resources of $115,000,000. In 1928, a merger was carried out with Bank of America Los Angeles. The consolidation formed the largest banking institution in the country. The firm was renamed Bank of Italy in 1930, calling it Bank of America. These days it is a financial services company, if not by assets the largest bank holding company in the United States and by market capitalization is the second largest bank by market capitalization. Bank of America serves in more than 150 countries, has depositor relationships with many formidable firms, a member of the Federal Deposit Insurance Corporation (FDIC) and a component of both the S&P 500 Index and the Dow Jones Industrial Average. A pivotal point occurred in 2008, Bank of America capitalized in Merrill Lynch, thus becoming the worlds largest wealth manager with 12.2% of all U.S. deposits. Its main competitors as of August 2009 are Citigroup, JP Morgan Chase and Wells Fargo. The purchase of Merrill Lynch & Co., Inc. was carried out in an all-stock deal in the amount of $50 billion, with Merrill Lynch within days of collapse. It was around the same time that dialogues with Lehman Brothers tool place. Lehman Brothers filed for bankruptcy the same day the acquisition announcements of Merrill Lynch came through. The merger makes up more than 16,000 financial advisors with about 20,000 brokers and 2.5 trillion dollars in assets under management. The merger is designed such that the bank would also be able to cross sell stocks, bonds and other investments It is thought that the merger would be especially useful in a faltering economy with its valuable revenue stream from abroad Cruelly, in 2009, a release confirmed that sales and trading churned out an operating loss of $21.5 billion in the quarter, necessitating funds infusion previously negotiated with government. Bank stock plunged to $1.07, or 5.5 percent, to $18.41 similar to the broader market where stocks were hurt. Bank of America set aside less money for overall loan losses than in previous quarters it increased the amount set aside for home mortgage loans, to $3.6 billion, as mortgage losses widened. Net revenue in the unit fell 31 percent, as the bank saw lower mortgage production volume and a drop-off in refinance activity. A total of US $20 billion in federal bailout through the Troubled Asset Relief Program (TARP) was received by bank of America in January 2009, with guarantee of US $118 billion in potential losses at the company. The amount is in addition to the $25 billion received in the fall of 2008. Because of which, members of the US Congress expressed concern about how this money has been spent, especially since a number of the recipients are accused of misusing the bailout money. Several management problems came after the federal bailout, to include the risk of having to face up harsher penalties by federal regulators in the near future. In 2009, the bank announced it had completed the repayment on December 9. The merger, which is said to be forced upon by the U.S. government sank stock price to $7.18, its lowest level in 17 years. Congress proceedings unveiled the misgivings of the acquisition of Merrill Lynch and exposed federal pressure put upon the bank. On August 3, 2009, a $33 million fine was agreed to by bank of America without admission or denial of charges. Investigations continue on the issue in the United States House Committee on Oversight and Government Reform under chairman Edolphus Towns and in its investigative Domestic Policy Subcommittee under Kucinich. On a positive note, the acquisition made Bank of America the foremost underwriter of global high-yield debt and adviser on global mergers and acquisitions. 2.2 The small business lending data on Bank of America before and after the bank’s acquisition of Merrill Lynch Commitment to small business lending is a tabled objective of Bank of America with a legacy as top lender to Small Business Administration (SBA) interstate for ten consecutive years in 2007, critiques assert that there is more to that (a) The banks churn out in terms of number of SBA loans for several years, this completes a significantly smaller amount than the amount of money lent out by its top competitors. (b) Since the acceptance of bailout funds last fall, SBA lending slowed and the value contracted at both the state and federal levels. (c) Bank of America has refused to participate in Government led SBA programs designed to survive the recession. (d) Express loans and credit card loans became a particular concern of the bank. These are smaller amount loans through supervised banks and require no collateral for loans under $25,000. These smaller dollar amount loans have been found more likely to default, sometimes due to less due diligence in the initial processing problems that mirror those encountered with subprime mortgage loans. One report specified that “over the past two years, Bank of America’s small business lending has plummeted. The decline has been most stark since the bank received bailout funds last October, presumably so that it could start lending again. In FY 2007, the bank made 10,878 loans through the SBA 7(a) program, worth $336 million. In FY 2008 only 3,296 SBA loans, worth only $102 million—a third of what it had lent out the previous year. In the twelve months between May 2008 and April 2009, this number further dropped to 484 loans worth a total of $20 million.” In earlier discussions, the way and manner bank M / A affect the availability of small business lending is categorized before and after the acquisition of Merrill Lynch. The method uses the association of ratios of the bank revenues against the value of small business lending and total assets against the value of small business lending. The findings confirm a regression of small business lending after the investing activity but no association can be established relative to revenue and assets size. No direct proportions is determined to mean that for every N1 revenue or asset received the bank gave out N2 as loans to small business lending. Although the volume and value in small business lending definitely shrank, there is no evidence or indication of a constant value proportionate to increases or decreases of bank revenue or total asset. Conclusion Merging and Acquisition of banks are more likely to reduce small business lending. Related reviews assert that these reductions are offset by increases in small business lending by the average commercial banks and other micro-financing institutions. The relationship associated with the acquisition activity of Merrill Lynch and Small Business Lending indicates that the consolidation activity affected upon a regression on Small Business Credit growth. No trend line can be established or value ratios determined as a constant. Bibliography Amel D., Barnes C., Panetta F., Saleo C. Consolidation and Efficiency in the Financial Sector: A Review of the International Evidence. 2001: Print Amin, Samar. Emerging from capitalism in crisis? 2010: European Alternatives Berger A., Saunders A. Scalise and Udell G., The effects of bank mergers and acquisitions on small business lending, Journal of Financial Economics, vol. 50, n. 2, pp. 187-229.1998 Berger A., Goldberg L. and White L. The Effects of Dynamic Changes in Bank Competition on the Supply of Small Business Credit, European Finance Review, vol. 5, n. 1-2, pp. 115-139. 2001 Berger A., Miller N, Petersen M., Rajan R and Stein, J, Does function follow organization form? Evidence from the lending practices of large and small banks, Journal of Financial Economics, vol. 76, n. 2, pp. 237-269. 2005 Berger A., Demsetz R and Strahan P. The consolidation of the financial services industry: Causes, consequences, and implications for the future, Journal of Banking and Finance, vol. 23, n. 2. (1999) Black S. and Strahan P. Entrepreneurship and Bank Credit Availability, The Journal of Finance, vol. 57, n. 6, pp. 2807-2833. 2002: Gower G. Lending and Securities, 2nd Institute of Financial Services. 2003 http://en.wikipedia.org/wiki/List_of_bank_mergers_in_the_United_States http://en.wikipedia.org/wiki/Bank_of_America http://smallbusinessonlinecommunity.bankofamerica.com Small Business Memo 06-25-09 – Legalized Elumilade, D. (2010) Mergers & Acquisitions and Efficiency of Financial Intermediation. Nigeria Read More