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IMPACT OF MERGERS & ACQUISITION ON BANKING INDUSTRY

EVALUATING IMPACT ON PROFTABILITY, FINANCIAL STRENGTH, BUSINESS KENDING & SHAREHOLDERS WEALTH

CONTENTS
CONTENTS.....................................................................................................................................2 .........................................................................................................................................................3 INTRODUCTION...........................................................................................................................4 PREVIOUS RESEARCH................................................................................................................4 PROPOSED METHOD...................................................................................................................6 Research Question 1: Profitability and Mergers & Acquisitions .........................................6

Research Question 2: Mergers And Financial Strength .............................................................7 Research Question 3: Effect of Mergers & Acquisitions on Small Business Lending...............8 Research Question 4: Impact of Mergers & Acquisitions on Shareholders wealth...................8 Data Collection............................................................................................................................8 Sample Size & Data Analysis......................................................................................................9 REFLECTION ................................................................................................................................9 CONCLUSION .............................................................................................................................10 RESEARCH TIMELINE...............................................................................................................11 REFERENCES..............................................................................................................................12 APPENDIX....................................................................................................................................15

CONTENTS.....................................................................................................................................2 .........................................................................................................................................................3 INTRODUCTION...........................................................................................................................4 PREVIOUS RESEARCH................................................................................................................4 PROPOSED METHOD...................................................................................................................6 Page 2 of 15

Research Question 1: Profitability and Mergers & Acquisitions

.........................................6

Research Question 2: Mergers And Financial Strength .............................................................7 Research Question 3: Effect of Mergers & Acquisitions on Small Business Lending...............8 Research Question 4: Impact of Mergers & Acquisitions on Shareholders wealth...................8 Data Collection............................................................................................................................8 Sample Size & Data Analysis......................................................................................................9 REFLECTION ................................................................................................................................9 CONCLUSION .............................................................................................................................10 RESEARCH TIMELINE...............................................................................................................11 REFERENCES..............................................................................................................................12 APPENDIX....................................................................................................................................15

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INTRODUCTION
Banks and financial institutions are linchpin of any economy. This research mainly focuses on the evaluation impact of merger on the profitability, financial strength, business lending and shareholders wealth of a financial institution. There has been a considerable research on the overall evaluation of mergers and acquisitions on a firm, but this research in context of financial institutions and banks is very limited. After recent financial turmoil, consolidation is that strongest force that has shaped the financial services industry. Analysts believe that from 2000 to 2010, one of the big bulge bracket bank has grown its assets from more than fourfold i.e. from $0.639 trillion to US $2.19 trillion, almost double the size of Indian GDP. It was mainly due to the technological innovations in the eighties and deregulation the financial services that prompted a wave of mergers, which eventually reached Europe in the nineties (Beitel, 2006). Financial crisis of 2008 has a profound effect on the financial performance of the banks and it was due to his reason that banks were doing whatever they can do in order to survive on of the deepest financial crisis of the history (Linder, 1991). Most financial institutions strive to gain from the synergies arising from the merger, these synergies can be in terms of increased efficient, economies of scale, cost savings, sharing risks and benefiting from technological sharing which all are the common motivations behind a merger (Ramaswamy, 1997). Another motivation that can be attributed to a successful merger was stricter regulation from the European and American authorities in terms of capital structure and minimum capital requirements that most financial institutions had to merge in order to the meet the capital requirements (Amaro, 2001). It will however also be beneficial to extend the research and study impact of mergers and acquisitions on the lending of the banks. All these factors discussed above will make the research even more interesting and an area yet unexplored.

PREVIOUS RESEARCH
Mergers in the banking sector are an unexplored area for research. While a rich literature exists on generic mergers in the international context, very few studies are conducted in particularly in the banking industry (Vives, 2000). In the post reform period, there has been a sharp increase in the merger activity across the globe. Berger (1996) analysed 36 mergers (1992-1995) using operating cash flow returns and do not found any increase in profitability. Cabral (2002) Page 4 of 15

analysed the motives of merger. In addition, he found no value addition due to merger. CyboOttone and Murgia (2007) identified the characteristics of merging firms based on 227 acquirer and 215 targets. Gande (2008) examined both domestic as well as foreign deals, and found that they are associated with positive announcement results and in long term is worse than pre-merger performance. Focarelli (2007) analysed the critical issues of consolidation in the western banking sector from the point view of shareholders and managers. They found that in forced merger, both bidders and targets share price has been reduced. In case of voluntary merger results are mixed. Pilloff and Santomero (2008) have studied the impact of merger announcement merger announcements on shareholders wealth. They took 5 private sector bank mergers globally and found positive gain for both bidders and target (Chatterjee, 1992). This report will make an attempt to analyse the implications of a merger on the overall financial performance of the banks and will specifically take into consideration the case of 16 different banks. Following research questions will be tried to prove: Research Question 1: There is direct relationship between the mergers and acquisition on the profitability of financial institution. Research Question 2: There is a significant impact of the mergers and acquisition upon the financial strength. Research Question 3: There is significant impact of mergers and acquisition on the lending behaviour of the banks. Research Question 4: Mergers and acquisition have significant effect on shareholders wealth. Cornett (2003), asserts that current regulatory and technological advancements will be not sufficient in disassemble the residual blockade for the assimilation of global retail banking markets. Gual (2005) argues that process of integration is remote from entire retail banking because of the existence of strategic (brand, branch network and reputation) and natural (distance and language) barriers as an exception to the tenet of regulations of the home country (Zajac, 1989). The Middle East and North Africa commonly known as MENA, is located strategically right in the middle of Asia and Western economies which were mostly colonised by the French or the British on the mid of the past century (Datta, 1992). Major financial institutions and the banks were formed according to the western principles, whose basic tenets were recently Page 5 of 15

challenged by the current financial crisis. Banks, which were based in the MENA region, came up with a unique idea of Islamic Finance which differs from the traditional banking (Shleifer, 2004). In the former banks were only providers of credit to the companies, finance government deficits and public investment projects.

PROPOSED METHOD
The main aim of this research will be focussed on analysing the impact of merger on the financial performance of selected financial institutions since the financial turmoil. It is very important to analyse the background information and the latest trends in the context of mergers and acquisition (Deng, 2005). Increase in the general level of economic integration has always been one of the motives of cross border merger and acquisitions of the financial institutions. Globalisation and recent augmented international has created demand for the international financial services (Hughes, 2003).

Research Question 1: Profitability and Mergers & Acquisitions


An underlying motive behind most mergers and acquisition is to seek synergies which are the enhanced economic value created by the resulting merger. Another perceived benefit of merger and acquisition is market penetration, market entry, vertical integration to control supply and demand and economies of scale (Houston, 2001). This question mainly mains at analysing impact of merger on the profitability and financial strength (DeYoung, 2003). The research will mainly entail both qualitative and quantitative analysis. Profitability, of a financial institution is mainly expressed in terms of financial ratios. These ratios must be carefully chosen, the main criteria. Total Mean
Profitability Return On Equity Return On Assets Gross Profit Margin Economic Value Added (EVA) Return On Capital Earnings Per Share Asset Turnover Return per Employee

PreMerger

PostMerger

Chan ge

Relative Change

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Table 1: Comparison of Profitability Pre and Post Merger Ratios (Mean) As shown in the Table 1 above shows the financial parameters of profitability and financial strength. These parameters are carefully selected in order to embrace a holistic approach to the research (Akhibe, 2003).
PR EME R GE RE QUIT YR AT IO- R OEGR APH P OS TME R GE RE QUIT YR AT IO- R OEGR AP H

R E O

EquityRatio (% )

E O R

EquityRatio (% )

Research Question 2: Mergers And Financial Strength


Evidentially, the value of mergers and acquisitions in the Middle East rose by 42% in 2012 compared to the previous year. The net investment banking fees rose by 19% in 2012 reaching a total of $536.1 million. The U.S. financial after the financial crisis has burnt midnight oil to reform the whole banking sector with a radically new regulatory regime. Total Mean
Financial Strength Current Ratio Debt To Equity Ratio Debt To Assets Ratio Cash Flow Ratio Net Gearing Debt Ratio Capital Adequacy Ratio

PreMerger

PostMerger

Chan ge

Relative Change

Dodd Frank Act and Volker Rule were then framed to put a control to the irregularities in the financial services industry. Similar developments were observed not only throughout the world including United Kingdom, Middle East and Asia. Non depository industry has also shown an Page 7 of 15

uptrend throughout the globe in 2007-2010, these mergers however are driven mainly by domestic demand in a specific geographical location.

Research Question 3: Effect of Mergers & Acquisitions on Small Business Lending


It is often observed after merger banks and financial institutions are reluctant to lend money to small businesses. This is not because of risky nature of small businesses but due to organisational diseconomies arising due to the merger (Vander Vennet, 2002). Large banks face a trade off between their other business units including transaction based loans, derivatives etc.

Research Question 4: Impact of Mergers & Acquisitions on Shareholders wealth


Mergers and acquisitions have a significant impact on the shareholders wealth, allowing them to earn positive abnormal returns (Winton, 2004). Answering this question would mainly cover analysis of past research papers on mergers & acquisitions and the data around the announcement date of the merger and key ratios will be calculated. Further following ratios will be discussed in detail: Total Mean Investment Ratio Earnings per Share P/E Ratio Dividend Yield Price/Book Value Ratio Dividend Payout Ratio Return On Shareholders Fund PreMerger PostMerger Chan ge Relative Change

Data for this analysis will mainly be taken from Thomson Reuters and Bloomberg Terminals. SPSS will be used for data analysis and conclude results.

Data Collection
Primary data will be collected from surveys, online questionnaires, academic research papers and journals of the subject. Secondary data will be collected mainly from the online sources i.e. companys annual report, market research report and market opinions (i.e. Financial Times, BBC and Bloomberg). Page 8 of 15

Sample Size & Data Analysis


A sample size of 20 banks will be considered for the purpose of this research. The banks chosen for the analysis are carefully chosen and sample size contains banks from the U.S., Europe and Middle East. The financial data will be mainly accessed from the annual reports of the organisations (Rajan, 2001). In order to gain better understanding position of each bank is plotted against Equity-Ratio and ROE will be examined for pre and post M&A (DeLong, 2001). The purpose of analysing the Equity ratio and ROE is to predict the relation of profitability and bankruptcy risk. For banks with ROE and equity ratio can be inferred as lower risk of bankruptcy whilst having higher profitability. The whole data will be broken down in windows (-2,+2) as follows: Window (-2, +2): Evaluating performance and financial strength in the 2 year before the merger and 1 year after the merger. The rationale behind assuming 2 years is to avoid any anomalous behaviour of organisations (Morgan Stanley, 2003). ROE will be used as a dependent variable and following graph will be plotted against Equity ratio.

REFLECTION
This study will be carried out on 16 different financial institutions that have merged in the past 10 years. These firms are mainly financial institutions listed on various stock exchanges throughout the world. While these firms are listed on various stock exchanges and each have their own tenets of divulging information (McKinsey, 2002). I, have however, tried to analyse ratios and not financial numbers which I expect would give true and fair representation of the results. Another reflection of this research is the use of judgemental sampling and not considering the probabilistic method of sampling which would have been a much fairer perspective. This decision however can be defended with another limitation which is ease of availability of data. There are indeed numerous financial institutions that have either merged or acquired other financial institution but due to the nature of working and responsibility towards the shareholder, not all organisations publicise their financial performance. The sample size considered for this study is 20 which can be limited compared to vast number of mergers and acquisition in the past 10 years. Calculation of financial ratios and analysing these ratios from ones own perspective is Page 9 of 15

yet another limitation that cannot be avoided. Of all the financial ratios, average of those ratios is taken, one can also argue to consider mean instead, which is yet another constraint that must be considered. This research can be even more comprehensive if time is not a limitation. And, with respect of conceptual and theoretical analysis length of time can be one of the hurdles that a researcher might face. It cannot also be however excluded, to devote more time and rework on parts of the research that needs more attention (Demsetz, 2006).

CONCLUSION
This research will enable to understand the long term implications of merger on a firms financial performance. This research can also be extended to analyse whether mergers tend to create or destroy the value of a financial institution and what impact it has on the consumers. If mergers destroy the value then for how long this period remains and when it start creating value. Profitability and financial strength will be mainly indicated through the financial ratios, and the results of this research will prove whether mergers are a profitable or not for a financial institution and does mergers with other financial institution helps in meeting capital adequacy ratio according to Basel III norms.

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RESEARCH TIMELINE
TASK MILESTONE 1
PROPOSAL SUBMISSION LITERATURE REVIEW DATA GATHERING

FEBRUARY

MARCH

APRIL

MAY

WEEK 1 WEEK 2 WEEK 3 WEEK 4 WEEK 1 WEEK 2 WEEK 3 WEEK 4 WEEK 1 WEEK 2 WEEK 3 WEEK 4 WEEK 1 WEEK 2 WEEK 3 WEEK 4

MILESTONE 2
STATISTICAL ANALYSIS (MAINLY THOUGH EXCEL AND SPSS) AMENDMENTS ACCORDING TO SUPERVISOR'S REMARKS ANALYSIS OF RESULTS

MILESTONE 3
WRITING UP DISSERTATION CONCLUSION PROOF READ SUBMISSION OF FIRST DRAFT FINAL EDITING

MILESTONE 4
DISSERTATION SUBMISSION

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REFERENCES
Akhibe, A., & Whyte, A. M. (2003). Changes in market assessment of bank risk following the Riegle-Neal Act of 19/94. Journal of Banking and Finance, 27, 87102. Altunbas, Y., Molyneux, P., & Thornton, J. (1997). Big-bank mergers in Europe: An analysis of the cost implications. Economica, 64, 317329. Amaro de Matos, J. (2001). Theoretical Foundations of Corporate Finance. Princeton University Press Beitel, P., & Schiereck, D. (2006). Value creation of domestic and cross-border M&A in the European Banking market. ICFAI Journal of Mergers & Acquisitions, 3, 729. Berger, A. N., Herring, R. J., & Szego, G. P. (1996). The role of capital in nancial institutions. Journal of Banking and Finance, 19, 393430. Cabral, I., Dierick, F., & Vesala, J. (2002). Banking integration in the euro area. European Central Bank Occasional Paper, 6. Chatterjee, S., Lubatkin, M., Schweiger, D. M., & Weber, Y. (1992). Cultural differences and shareholder value in related mergers: linking equity and human capital. Strategic Management Journal, 7, 119139. Cornett, M. M., Hovakimian, G., Palia, D., & Tehranian, H. (2003). The impact of the managershareholder conict on acquiring bank returns. Journal of Banking and Finance, 27, 103131. Cybo-Ottone, A., & Murgia, M. (2000). Mergers and shareholder wealth in European banking. Journal of Banking and Finance, 24, 831859. Datta, D. K., Grant, J. H., & Rajagopalan, N. (1991). Management incompatibility and postacquisition autonomy: Effects on acquisition performance. Advance in Strategic Management, 7, 157182. DeLong, G. (2001). Stockholder gains from focusing versus diversifying bank mergers. Journal of Financial Economics, 59, 221252.

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DeYoung, R. (2003). Bank mergers, X-Efciency, and the market for corporate control. Managerial Finance, 23, 3247. Demsetz, R., & Strahan, R. (2006). Diversication, size and risk at bank holding companies. Journal of Money Credit and Banking, 29, 300313. Deng, E., & Elyasiani, E. (2005). Geographic diversication and BHC return and risk performance. Temple University Working Paper, 135. Focarelli, D., & Panetta, F. (2007). Are mergers benecial to consumers? Evidence from the market for bank deposits. The American Economic Review, 93, 11521172. Gande, A., Puri, M., & Saunders, A. (2008). Bank underwriting of debt securities: Modern evidence. The Review of Financial Studies, 10(4), 11751202. Harrison, J. S., Hall, E. H., & Nargundkar, R. (1991). Resource allocation as an outcropping of strategic consistency: performance implications. Academy of Management Journal, 36, 1026 1051 Houston, J. H., James, C., & Ryngaert, M. (2001). Where do merger gains come from? Bank mergers from the perspective of insiders and outsiders. Journal of Financial Economics, 60, 285 331. Hughes, J. P., Lang, W. W., Mester, L. J., & Moon, C. G. (2003). The dollars and sense of bank consolidation. Journal of Banking and Finance, 23, 291324. Linder, J. C., & Crane, D. B. (1993). Bank mergers, integration and protability. Journal of Financial Services Research, 7, 274282. McKinsey (2002). Europes banks: Verging on merging. McKinsey Quarterly, 3. Morgan Stanley (2003). Consolidation: The prospects examined, equity research. European Banks Industry Review. Rajan, R. G., Servaes, H., & Zingales, L. (2001). The costs of diversity: The diversication discount and inefcient investment. Journal of Finance, 55, 3580.

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Ramaswamy, K. (1997). The performance impact of strategic similarity in horizontal mergers: evidence from the U.S. banking industry. Academy of Management Journal, 40, 697715. Shleifer, A., & Vishny, R. W. (2004). Stock market driven acquisitions. Journal of Financial Economics, 70(3), 295489. Vander Vennet, R. (2002). Cross-border mergers in European banking and bank efciency. In H. Herrmann & R. Lipsey (Eds.), Foreign direct investment in the real and nancial sector of industrial countries(pp. 295315). Vives, X. (2000). Lessons from European banking liberalization and integration. In S. Claessensy & M. Jansen (Eds.), The Internationalization of Financial Services (pp. 177198). Kluwer Law International. Winton, A. (2004). Dont put all your eggs in one basket? Diversication and specialization in lending. Wharton School Center for Financial Institutions Working Paper, 0016, September. Zajac, E. J., & Shortell, S. M. (1989). Changing generic strategies: Likelihood, direction and performance implications. Strategic Management Journal, 5, 413430.

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APPENDIX
1.) List Of Banks To Be considered:
S .NO 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Acquirer

Acquired Entity

Nam e Of Merg ed Entity Y ear Of Merg er


2011 2008 2008 2008 2008 2002 2010 2007 2008 2008 2012 2008 2008 2006 2005 2005

Capital One ING Direct USA Capital One JP Morgan Chase Washington Manual JP Morgan Chase Wells Fargo Wachovis Wells Fargo Bank Of America Meryll Lynch Bank Of America Bank Of New York Mellon Financial Bank Of New York Citigroup Golden State Bancorp Citigroup Abu Dhabi Commercial Bank Royal Bank of Scotland Abu Dhabi Commercial Bank Emirates Bank National Bank Of Dubai Emirates NBD Royal Bank of Scotland ABN AMRO Royal Bank of Scotland Barclays Plc Lehman Brothers Barclays HSBC Oman International Bank HSBC Lloyds TSB Halifax Halifax Malayan Bank Bank Internasional Indonesia Malayan Bank OCBC Great Eastern Holding OCBC UOB Bank Of Asia UOB Toronto Dominion Bank Banknorth NA TDBanknorth

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