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MERGERS AND ACQUISITIONS IN BANKING AND FINANCE This page intentionally left blank MERGERS AND ACQUISITIONS IN BANKING AND FINANCE What Works, What Fails, and Why Ingo Walter 1 2004 1 Oxford New York Auckland Bangkok Buenos Aires Cape Town Chennai Dar es Salaam Delhi Hong Kong Istanbul Karachi Kolkata Kuala Lumpur Madrid Melbourne Mexico City Mumbai Nairobi Sa˜o Paulo Shanghai Taipei Tokyo Toronto Copyright ᭧ 2004 by Oxford University Press, Inc. Published by Oxford University Press, Inc. 198 Madison Avenue, New York, New York 10016 www.oup.com Oxford is a registered trademark of Oxford University Press All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press. Library of Congress Cataloging-in-Publication Data Walter, Ingo. Mergers and acquisitions in banking and finance : what works, what fails, and why / by Ingo Walter. p. cm. ISBN 0-19-515900-4 1. Bank mergers. 2. Financial institutions—Mergers. I. Title. HG1722.W35 2004 332.1'068'1—dc22 2003015483 987654321 Printed in the United States of America on acid-free paper Preface On April 6, 1998, the creation of Citigroup through the combination of Citicorp and Travelers Inc. was announced to the general applause of analysts and financial pundits. The “merger of equals” created the world’s largest financial services firm—largest in market value, product range, and geographic scope. Management claimed that strict attention to the use of capital and rigorous control of costs (a Travelers specialty) could be combined with Citicorp’s uniquely global footprint and retail banking franchise to produce uncommonly good revenue and cost synergies. In the four years that followed, through the postmerger Sturm und Drang and a succession of further acquisitions, Citigroup seemed to outperform its rivals in both market share and shareholder value by a healthy margin. Like its home base, New York City, it seemed to show that the unman- ageable could indeed be effectively managed through what proved to be a rather turbulent financial environment. On September 13, 2000, another New York megamerger was an- nounced. Chase Manhattan’s acquisition of J.P. Morgan & Co. took effect at the end of the year. Commentators suggested that Morgan, once the most respected bank in the United States, had at last realized that it was not possible to go it alone. In an era of apparent ascendancy of “universal banking” and financial conglomerates, where greater size and scope would be critical, the firm sold out at 3.7 shares of the new J.P. Morgan Chase for each legacy Morgan share. Management of both banks claimed significant cost synergies and revenue gains attributable to complemen- tary strengths in the two firms’ respective capabilities and client bases. Within two years the new stock had lost some 44% of its value (compared to no value-loss for Citigroup over the same period), many important J.P. Morgan bankers had left, and the new firm had run into an unusual number of business setbacks, even as the board awarded top management some $40 million in 2002 for “getting the deal done.” vi Preface Even acknowledging that the jury remains out in terms of the long- term results, how is it that two major deals launched by people at the top of their professions, approved by boards presumably representing share- holder interests, could show such different interim outcomes? Is it in the structure of the deals themselves? The strategic profile of the competitive platform that resulted? The details of how the integration was accom- plished? The people involved and their ability to organize and motivate the troops? Or, in the light of both banks landing right in the middle of some of the worst corporate and financial market scandals in history, will the two deals end up looking much the same? These are some of the critical issues we attempt to address in this book. The financial services sector is about halfway through one of the most dramatic periods of restructuring ever undergone by a major industry— a reconfiguration whose impact has carried well beyond shareholders of the firms involved into the domain of regulation and public policy as well as global competitive performance and economic growth. Financial serv- ices have therefore been a center of gravity of global mergers and acqui- sitions activity. The industry comprises a surprisingly large share of the value of merger activity worldwide. In this book I have attempted to lay out, in a clear and intuitive but also comprehensive way, what we know—or think we know—about re- configuration of the financial services sector through mergers and acqui- sitions (M&A). This presumed understanding includes the underlying drivers of the mergers and acquisitions process itself, factual evidence as to whether the basic economic concepts and strategic precepts used to justify M&A deals are correct, and the efficacy of merger implementa- tion—notably the merger integration dynamic. Chapter 1 describes the activity-space occupied by the financial services industry, with a discussion of the four principal businesses comprising the financial services sector—commercial banking, investment banking, insurance, and asset management. This description includes profiles of subsectors such as retail brokerage, insurance brokerage, private banking, and wholesale banking, and how they are linked in terms of the functions performed. The objective of this introductory chapter is to provide a “helicopter” overview of the financial services businesses engaged in re- structuring through mergers. The chapter provides some background for readers not fully familiar with the industry or (as it often the case) familiar only with a relatively narrow segment of the industry. Chapter 2 positions financial services M&A deal-flow within the overall context of global mergers and acquisitions activity, assessing the structure of M&A volume in terms of in-market and cross-market dimensions (both functionally and geographically). It considers North American, European, and selected Asian financial services transactions in order to provide a context for discussing the underlying causes of structural changes in the industry, often under very different economic and regulatory conditions. Preface vii Chapter 3 provides a comprehensive review of the economic drivers of mergers and acquisitions in the financial services sector. Where does shareholder-value creation and destruction come from? How important are economies of scale, economies of scope, market power, conflicts of interest and managerial complexity, too-big-to-fail support by taxpayers, conglomerate discounts, and other factors—and how likely are they to influence market share and stock price performance of financial services firms engaged in M&A activity? It also suggests a framework for thinking about financial services M&A deals that integrates the economic and financial motivations raised in the preceding chapter into a consistent valuation framework. From a shareholder perspective, mergers are sup- posed to be accretive—they are supposed to add value in terms of total returns to investors. They almost always do that for the sellers. Often they do not succeed for the buyers, who sometimes find that the combined firm is actually worth less than the value of the acquiring firm before the merger. This chapter uses a “building block” approach to identify the possible sources of shareholder value gains and losses in merger situa- tions. Chapter 4 is the first of two that deal with merger integration. The underlying economics of an M&A transaction in the end determine whether the acquirer is “doing the right thing.” The managerial and be- havioral dimensions of the integration process determine whether the acquirer is “doing the thing right.” That is, failures and successes can involve either strategic targeting or strategic implementation. Best for firms and their shareholders is obviously “doing the right thing right.” Not so good is “doing the wrong thing” and “doing the right thing poorly.” The financial sector has probably had far more than its share of mergers and acquisitions that have failed or performed far below potential because of mistakes in integration. This chapter focuses on the key managerial issues, including the level of integration required and the historic development of integration capabilities on the part of the acquiring firm, disruptions in human resources and firm leadership, cultural issues, timeliness of decision making, and interface management. Chapter 5 continues the discussion on integration with specific regard to information and transactions-processing technology. It has often been argued that information is at the core of the financial services industry— information about products, markets, clients, economic sectors, and ge- ographies. At the same time, it is also one of the most transactions- intensive industries in the world. It stands at the heart of the payments system of economies and engages in all kinds of transactions, ranging from individual monetary transfers and stock brokerage to institutional securities sales and trading. Transactions must be timely, accurate, and inexpensive in order for financial services firms to remain competitive, so the industry invests billions in information technology (IT) systems an- nually. Whether things go right or wrong in mergers of acquisitions de- pends heavily on how the firms handle technology. viii Preface Chapter 6 takes a look at the facts—what we know about whether financial sector mergers have “worked” or not. It considers all the evi- dence, attempting to do so in a careful and dispassionate way by avoiding the kinds of unsupported assertions that often accompany M&A deals in the financial services sector. The chapter considers the evidence based on well over 50 studies undertaken by central banks, financial regulators, management consultancies, and academics worldwide. Inevitably, there is disagreement on some of the findings—especially because meaningful international empirical work is extraordinarily difficult in this industry. But the basic conclusions seem clear and compelling. Whether mergers and acquisitions in the financial services sector have been successful tends to be difficult to assess in terms of shareholder value creation in the early 2000s. There is a need to separate between the company-related implica- tions and the effects of the market at large, as reflected by the evolution of the post-bubble stock market decline. In addition, one needs to be cognizant of the fact that unfavorable business conditions and other ad- verse circumstances can cast an economic shadow over even the best- conceived deals. Chapter 7 puts financial services M&A activity in the context of na- tional and global financial architecture. Restructuring in this industry matters a great deal to the shareholders, managers, and employees of the firms involved. But it also matters from the perspective of the safety and soundness, efficiency and creativity of the financial system. The industry is “special” in many ways. It deals with other people’s money. Its perfor- mance affects every other economic sector and the fate of whole econo- mies. Problems it encounters can easily become systemic and can trigger crises that are hard to contain and whose impact ranges far beyond the industry itself. Chapter 7 considers what kinds of financial structures seem to be emerging as a result of reconfiguration through M&A deals and what the financial structures mean in the broader economic and political context. This book is based on two decades of observing and teaching about the evolution of the financial services industry in a rapidly evolving global economic, regulatory, and technological environment. I have tried to take a dispassionate approach to an issue unusually replete with both scorn and hype. In this respect, a certain distance from the financial firms doing the restructuring has helped, as have discussions with academic col- leagues, senior executives, and regulators. So has a growing body of literature about what works and what doesn’t. A number of people assisted with various parts of this book. Gayle De Long was extremely helpful in compiling the evidence on financial sector M&A available so far in the literature—I join her in paying tribute to her father, George A. DeLong (1922–2002), a hero in every sense of the word. Shantanu Chakraboty and David L. Remmers helped with several of the case studies and issues related to merger integration, while Ralph Welpe was instrumental in surveying the evidence on IT integration con- Preface ix tained in Chapter 5. Harvey Poniachek provided helpful comments and corrections on the final manuscript. Particularly helpful in developing the ideas and assembling facts behind this book over the years were Allen Berger, Arnoud Boot, Lawrence Goldberg, Richard Herring, Christine Hir- sczowicz, Ernst Kilgus, Richard Levich, David Rogers, Anthony Santo- mero, Anthony Saunders, Roy Smith, Gregory Udell, and Maurizio Zollo. All are owed a debt of gratitude, although none can be held responsible for errors of fact or interpretation. Contents 1. Global Financial Services Reconfiguration 3 2. The Global Financial Services M&A Deal Flow 35 3. Why Financial Services Mergers? 60 4. Managing Financial Services Mergers and Acquisitions 99 5. The Special Problem of IT Integration 129 6. What Is the Evidence? 153 7. Mergers, Acquisitions, and the Financial Architecture 201 8. The Key Lessons 227 Appendix 1: Financial Service Sector Acquisitions 237 Appendix 2: Case Studies 263 References 281 Suggested Readings 289 Index 301 [...]... services industry (commercial banking, insurance, securities, and asset management) in order to indicate the source of restructuring pressure and M&A deal flow The four pillars are depicted in a taxonomy of M&A transactions in Figure 2 -1 in the following chapter 14 Mergers and Acquisitions in Banking and Finance COMMERCIAL BANKING Commercial banking encompasses a variety of different businesses involving... Foreign Banking Offices in U.S Banking Holding Companies Savings Institutions Credit Unions Life Insurance Companies Government-Sponsored Enterprises Federally related mortgage pools ABS Issuers Finance Companies Mortgage Companies 2002 2047 .1 112 5.9 Ϫ5.6 11 31. 5 611 .8 253.3 15 6.8 7.5 10 2.2 Ϫ37.4 958.5 52.9 30.2 Ϫ0.9 23.6 7.4 1. 5 0.6 290.8 338.5 317 .6 Ϫ0.2 0.7 2308.6 13 63.7 257.5 11 06.2 756.9 62 .1 1 31. 8... (investing insurance reserves and the savings component of life insurance) and as pure asset managers (called third-party business in the insurance world) These four types of institutions may be combined in various ways Commercial and investment banking may be undertaken by the same firm, so may commercial banking and insurance (known as bancassurance Table 1- 1 Total Net U.S Borrowing and Lending in. .. finance These conduits involve alternative and competing modes 3 4 Mergers and Acquisitions in Banking and Finance of financial intermediation, or “contracting,” between counterparties in financial transactions both within and between national financial systems A guide to thinking about financial contracting and the role of financial institutions and markets is summarized in Figure 1- 1 The diagram depicts... cutting out the intermediary altogether by putting the issuer and the investor or fiduciary into direct electronic contact with each 10 Mergers and Acquisitions in Banking and Finance other The same is true in secondary markets, as shown in Table 1- 2, with an array of competitive bidding utilities in foreign exchange and other financial instruments, as well as inter-dealer brokerage, cross-matching, and. .. Mortgage Pools ABS Issuers Finance Companies Mortgage Companies REITs Brokers and Dealers Funding Corporations 2002 12 6.0 7 .1 0.0 309.0 338.5 2 91. 4 Ϫ5.7 1. 4 6.7 92.4 11 2.2 14 4.2 4.0 3.7 222.4 328 .1 2 41. 2 17 .5 1. 5 23.5 30.6 Ϫ40.3 Global Financial Services Reconfiguration 9 or Allfinanz in parts of Europe) A number of insurance companies have been active in the investment banking business And virtually all types... 17 44.6 39.9 205.2 19 1.6 Ϫ0.6 4.2 10 .0 42.8 41. 5 Ϫ28 .1 130.9 9.0 20.3 17 .7 246.0 2308.6 84.6 55.7 2.2 0.9 25.8 7.7 416 .9 17 99.5 77.7 410 .0 393.7 6.6 3 .1 6.6 35.5 44 .1 0.9 214 .9 30.5 31. 0 3.8 Ϫ25.3 Table 1- 1 (continued ) 20 01 24 REITs 25 Brokers and Dealers 26 Funding Corporations 8 Source: Federal Reserve Flow of Funds Accounts 2.5 1. 4 Ϫ55.2 18 .6 1. 8 1. 9 20 01 2002 50 51 52 53 54 55 56 57 58 59 60 Mutual... Figure 1- 2 shows developments in the United States 12 Mergers and Acquisitions in Banking and Finance Perc ent 40 Commercial Banks 30 20 Insurance Companies 10 Pension Funds Mutual Funds 0 19 70 19 80 19 90 2000 Figure 1- 2 U.S Financial Assets, 19 70–2000 Source: Board of Governors of the Federal Reserve System from 19 70 to 2000, highlighting the extent of commercial bank market share losses and institutional... corporate equities and mutual fund shares) 7 20 01 (continued) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Total Net Borrowing Domestic Nonfinancial Sectors Federal Government Nonfederal Sectors Household Sectors Nonfinancial Corporate Business Nonfarm Noncorporate Business Farm Business State and Local Governments Rest of the World Financial Sectors Commercial Banking U.S Chartered Commercial... Commercial Banking U.S Chartered Commercial Banks Foreign Banking Offers in U.S Banking Holding Companies Banks in U.S Affiliated Areas Savings Institutions Credit Unions Bank Personal Trusts and Estates Life Insurance Companies Other Insurance Companies Private Pension Funds State and Local Govt Retirement Funds Money Makers Mutual Funds 2002 2047 .1 Ϫ24 .1 Ϫ52.7 11 .5 2.0 38 .1 6.0 320.6 17 44.6 39.9 205.2 19 1.6 . MERGERS AND ACQUISITIONS IN BANKING AND FINANCE This page intentionally left blank MERGERS AND ACQUISITIONS IN BANKING AND FINANCE What Works,. 263 References 2 81 Suggested Readings 289 Index 3 01 MERGERS AND ACQUISITIONS IN BANKING AND FINANCE This page intentionally left blank 3 1 Global Financial Services Reconfiguration Few