MERGERS AND ACQUISITIONS IN THE SPANISH BANKING INDUSTRY: SOME EMPIRICAL EVIDENCE

Transcription

1 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE Ignaco Fuentes and Teresa Sastre Banco de España Banco de España Servco de Estudos ocumento de Trabajo n.º 9924

2 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE Ignaco Fuentes and Teresa Sastre (*) Ths paper was frst presented at the Autumn Meetng of Central Bank Economsts held at the Bank of Internatonal Settlements n October 1998.We wsh to thank Olmpa Bover, Jord Jaumandreu, Fernando Restoy and Jesús Saurna for ther heplful comments and suggestons. We also thank partcpants of semnars held at Banco de España, XV Jornadas de Economía Industral and European Central Bank for useful comments and Sofa Galmes for her research assstance. The vews expressed n ths paper are the authors and do not necessarly reflect those of the Banco de España.

3 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE ABSTRACT Snce the late eghtes, the Spansh bankng system has been undergong major changes that have affected both ts structure and the nature of strategc nteracton among bankng nsttutons. Varous dfferent strateges have been adopted to tackle the demands of ths new operatng envronment, one such strategy havng been consoldaton va mergers and acqustons. Ths paper attempts to provde some emprcal evdence on the mpact of the consoldaton process on the monetary transmsson mechansm, the degree of competton n bankng markets and the performance of bankng nsttutons. The mpact on the monetary transmsson mechansm s analysed n terms of the estmated mpact that mergers and acqustons may have had on nterest rates set by banks. To do ths, several equatons for bank nterest rates have been estmated usng panel data for Spansh banks from 1988 to These equatons also provde a test for the effects of ncreasng competton on bank's borrowng and lendng rates. The mpact on the performance of banks s assessed usng a case-study approach based on the changes n a set of fnancal ratos. Analyss of these ratos durng the pre- and post-merger perods provdes some nsghts on the effects of mergers and acqustons on the effcency, proftablty and strength of consoldated nsttutons. 2 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

4 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE CONTENTS I.- INTROUCTION II.- INFUENCE ON THE ETERMINATION OF BANK INTEREST RATES Theoretcal settng ata used Results of the estmatons III.- CASE BY CASE ANAYSIS OF BANK MERGERS IN SPAIN IN THE PERIO Methodology and ratos used n the analyss Summary of results IV.- CONCUSIONS APPENIX 1 APPENIX 2 REFERENCES TABES and GRAPHS BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

5 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE I.- INTROUCTION Snce the late eghtes, Spansh bank markets have been undergong major changes that have affected both ther structure and the nature of strategc nteracton among Spansh banks. These major changes have been a natural outcome of the heghtenng compettve pressure exerted on all countres' banks by processes such as deregulaton, globalsaton of fnancal and economc actvtes, the development of new technology and the prospect of the greater ntegraton of European fnancal markets. Varous dfferent strateges have been adopted by Spansh banks to tackle the demands of ths new operatng envronment wth much stffer competton both from other Spansh and foregn banks and from other fnancal nsttutons. One such strategy s consoldaton va merger and takeover. As a result of ths process the degree of concentraton of the Spansh bankng ndustry has ncreased and the share n the system's total assets of the ten bggest bankng groups grew from almost 50% n 1992 to over 70% n 1998 (see Table 1). Ths process has also changed the structure of the savngs bank and credt co-operatve sectors, wth sgnfcant reductons n the number of nsttutons -the number of savngs banks fell from around 80 n the eghtes to 51 n 1997 and the number of credt co-operatves from 150 to 97 n the same perod-. However, ths process of concentraton has not prevented a growng degree of competton n almost all the relevant segments of the bankng product markets. Ths ncrease n competton has gven rse to a progressve narrowng of the spread between lendng and depost operatons, whch has moved from levels close to nne ponts to below four ponts (see graph 1). The man purpose of ths paper s to provde emprcal evdence on the mplcatons of these two processes. It s worth addressng both ssues jontly n vew of the apparently countervalng effects that the ncrease n the degree of competton, on one hand, and the potental ncrease n banks' market power as a result of merger and takeover, on the other, could have on nterest rates and on bank proftablty. Mergers and other forms of consoldaton may nfluence bank nterest rates nsofar as the ncrease n sze and the opportuntes for reorgansaton nvolved ether may provde gans n effcency that bear on margnal costs or gve rse to ncreases n market power, or both together. Gans n effcency would be obtaned on movng onto a greater scale of actvty (f there are economes of scale 1 ) and/or owng to the possble reducton of X- 1 Accordng to some emprcal studes on the Spansh bankng system (Fanjul and Maravall (1985), elgado (1989) and Raymond and Replado (1991), economes of scale have been observed at branch level, but not at frm level. 4 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

6 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE neffcences, derved from nadequate management and organsaton of resources that mght have placed a bank above ts cost curve. Mergers and acqustons may gve banks the opportunty to re-drect ther actvty towards busness areas that nvolve an ncrease n ncome greater than that n costs, thereby achevng an ncrease n proftablty. Some authors have also ponted to a potental effect on banks' captal adequacy nsofar as mergers and acqustons may allow for a greater dversfcaton of rsk wth the same captal base 2. Faced wth ths set of possble repercussons, t may well be asked whether the ncrease n prce competton between Spansh banks snce the start of the nnetes has been checked, to some extent, by the ncrease n concentraton and the potental rse n merged banks' market power. It s also worth evaluatng whether merged banks have actually obtaned gans n effcency and, should ths be so, whether these have translated nto mproved proftablty and hgher levels of soundness. To analyse these ssues two types of methodology wll be used n ths paper. The frst, of an econometrc nature, s used to seek the nfluence of the above-mentoned phenomena on the determnaton of bank nterest rates and s based on the estmaton of nterest rate equatons wth panel data. On one hand, ths allows prces of merged frms to be compared wth those of non-merged ones. On the other, the effect of competton on banks' nterest rates can be analysed by usng an ndcator of ther course over tme. There are few emprcal studes on the effects of competton on banks' nterest rates, probably due to the dffcultes of defnng adequate varables that could be used to measure the degree of competton. The most wdely used varable s concentraton. However, ths varable does not seem approprate accordng to recent developments n the Spansh bankng system. Instead, the cross-secton dsperson of bank nterest rates s the ndcator used n ths paper. The second methodology, used to assess the mpact of mergers on effcency, proftablty and soundness of merged nsttutons, conssts of a case-by-case analyss of most of the mergers and takeovers that have taken place n Span n the perod The paper s organsed as follows. Secton 2 analyses the effects of consoldaton and competton on bank nterest rates and the transmsson mechansm. Secton 3 analyses a wde range of varables n order to assess the mpact of merger processes on the levels of effcency, proftablty and solvency of merged nsttutons. Secton 4 concludes. 2 See Reboredo (1997). BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

7 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE II.- INFUENCE ON THE ETERMINATION OF BANK INTEREST RATES Theoretcal settng The estmaton of equatons that determne bank nterest rates s based on the frstorder condtons of a Klen-Mont type model, n whch ntermedares maxmse profts n the current perod and have the capacty to set the prce n both the credt and the depost markets. There s a thrd, compettve market n whch they are not able to nfluence the prce (the nterbank or government debt market) and to whch they resort to seek a return on surplus lqudty or borrow funds. Consequently the latter market s one of adjustment between the market for credt and that for deposts. Under these assumptons, the nterest rates on credt and on deposts are determned separately and ndependently. If, n addton, t s assumed that there s product dfferentaton and strategc nteracton between bank ntermedares, banks' decsons on prces wll depend on the actons of rvals or compettors, so that the elastcty perceved by each bank wll be the outcome of: the prce elastcty of the consumers whose demand t satsfes and the degree of rvalry among market partcpants. One of the features nherent to the credt market s the rsk arsng from the uncertanty about collectng loan prncpal and nterest. So as to take ths aspect nto account, the probablty of ncurrng past-due loans whch, along wth nterest rates, determnes the expected return on the loan portfolo, has been ntroduced nto the abovementoned model. The overall consderaton of all these aspects n a current proft maxmsaton model gves rse to two frst-order condtons 3: 1 p r = p + + M r = 1 + η η p + η M + η 1 [ r c ] ( r c ) (1) (2) where: r : lendng nterest rate extended by bank. r : depost nterest rate offered by. 3 See Appendx 1 for a more detaled presentaton of the model. 6 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

8 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE r: margnal fnancal cost - usually some type of representatve market rate. c : margnal operatonal cost of credt extended by. c : margnal operatonal cost of deposts rased by. p : probablty of the typcal clent of bank payng for the credt n due tme = 1 - average probablty of recordng past-due loans. η : elastcty of the demand for credt receved by f compettors do not react (related to consumer characterstcs). η : elastcty of the supply of deposts rased by f compettors do no react M η : degree of rvalry of frms n the credt market: M η : degree of rvalry of frms n the depost market. One of the features of ths model s that the credt market and the depost market are ndependent, that s, loan rates and depost rates are determned separately. However, ths s a farly controversal hypothess n bankng behavour models. In Span s case, the emprcal evdence avalable offers varous results. The papers by Hernández (1994), Sáez (1996a) and Sáez (1996b) confrm the exstence of separablty, whle Sastre (1991) and Camarero et al. (1995) reject ths hypothess. Nonetheless, the dfference n results here could stem from the dfferent sample perods analysed. These range from the eghtes -Sastre (1991) and Camarero et al. (1995)- to the nnetes -Sáez (1996a) and Sáez (1996b)-. Throughout ths perod the role played by the nterbank market n bank ntermedares decsons mght have been progressvely modfed. In the frst half of the eghtes, the notable volatlty of nterest rates on ths market mght have entaled an addtonal margnal cost of nterbank fnancng to that arsng from mantanng credt postons n the market. Thus, banks mght have encountered certan lqudty constrants, dependng on whether the gap between credt and deposts was postve or negatve. Aganst ths background, the margnal cost of obtanng new credt was not ndependent of the volume of credt and deposts but related to the magntude of the gap between them snce ths determned the lkelhood of havng to resort to obtanng nterbank BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

9 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE fnancng. Therefore, the rule for determnng the lendng nterest rate was not ndependent of the entty s volume of deposts 4. Bearng n mnd these consderatons and that the perod analysed n ths paper relates to a stuaton of scant nterbank market nterest rate volatlty, t has been opted to accept that the margnal cost of nterbank fnancng does not depend on the stock of loans and deposts. Thus separablty between the credt and depost markets s assumed and type-(1) and (2) nterest rate equatons are estmated 5. By makng approprate assumptons, these can be embedded n the followng emprcal equatons 6: r M = β + β r + β c + β p + β η + β η + ε (3) o r M = γ + γ r + γ c + γ η + γ η + ε (4) The estmaton of these equatons has been made wth a panel of Spansh bankng nsttutons -banks and savngs banks-. Ths allows to control for a seres of characterstcs proper to each bank whch gve rse to non-observable heterogenety and whch are ncluded n the ndvdual effects of both equatons ( ε,ε ). Thus, ncluded n these effects there would be a seres of aspects whch defne the management and organsatonal framework proper to each ntermedary and whch, bascally, determne the degree of X-neffcences. A decrease n the magntude of these X-neffcences n a bank would clearly reduce ts margnal cost, even though t were not necessarly reflected n ts accountng costs. As long as margnal cost s affected, the model predcts an mpact on bank lendng and depost rates. However, ths channel s not accounted for by any of the varables ncluded n equatons (3) and (4), except for the ndvdual effects ε and ε In ths study, t s assumed that the level of these neffcences holds stable over tme for each bank. Ths s a farly common assumpton n models used to estmate X-neffcences based on fronter functons wth panel data. However, some researchers have focused on relaxng ths assumpton at the cost of mposng some structure on the models (.e. some of them assume that effcency change s the same for all frms). In the current study the assumpton of frm-specfc and tme-nvarant techncal effcency s preferred snce the emprcal evdence avalable for the Spansh bankng ntermedares 4 Ths nterpretaton of the emprcal evdence n Span s case s based on the model by Tobn (1982) and the comments thereon by Kng (1986). 5 A theoretcal setup very smlar to ours s Jaumandreu and orences (1999). 6 See Appendx 1. 8 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

10 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE shows that changes over tme are ether scarcely sgnfcant 7 average 8. or non-sgnfcant, on To obtan emprcal equatons that may be estmated wth the nformaton avalable, some addtonal assumptons have been made. Frst, the prce elastcty of loan demand and of depost supply correspondng to each ntermedary ( η, η ) depends on the consumer characterstcs of each ntermedary market segment and on cyclcal macroeconomc factors. Consumer characterstcs n these market segments are assumed to hold stable over tme, so beng captured by ndvdual effects. On the other hand, the potental mpact on prce-elastcty of the economc cycle s captured by ncludng the GP growth rate as an addtonal explanatory varable n nterest rate equatons (3) and (4). Ths decson merts some further comments. If constant prce-elastcty functons are assumed away for loan demand and depost supply, then elastcty generally depends on the same varables as the orgnal functons (.e. f the supply of deposts rased by a bank s assumed to depend on ts customers' ncome, t s expected that the frst dervatve wll also depend on t). Therefore, one mportant factor determnng the tme-varyng average pattern of prce-elastcty mght be macroeconomc growth. The relatonshp between prce-elastcty and the economc cycle has been scarcely analysed n the lterature, although some nsghts can be ganed from the more wdely analysed ssue of prce mark-ups beng procyclcal or countercyclcal. Emprcal evdence can be found whch favours both alternatves and several explanatons have been provded for both results. Among them, that gven by Bls (1989) s closely related to ths paper's assumpton of a cyclcal pattern n prce-elastcty. Ths author bulds up a theoretcal model whch hnges on the result that hgher-wealth consumers have less prce elastc demands. The reason for t s that consumers wth more resources wll place a lower shadow utlty value on ncome. As a consequence, frms set hgher prce mark-ups on margnal costs n those markets. Ths cross-sectonal explanaton can be translated nto a smlar tme-varyng one n the followng way. In boom perods, when hgher average ncome s expected, average elastcty of consumer demand wll tend to be lower and prce mark-ups hgher, showng a procyclcal pattern. Secondly, t s assumed that the most relevant aspects of the multplcty of nteractons between the banks partcpatng n the market for credt and deposts (whch are M M ncluded n the terms η and η ) may be captured va an ndcator approxmatng to the 7 See Alvarez y Orea (1998). 8 See Maudos (1996) and Ros (1997). BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

11 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE changes over tme n the degree of competton n the market for credt and n that for deposts. Nonetheless, t s dffcult to defne adequate varables to capture changes n market compettve pressure. Most studes use concentraton as a proxy of the degree of competton. However there are at least three reasons why ths s not a good choce n ths study. Frst, accordng to contestable market theory, concentraton s not a good ndcator of market competton. It s possble to observe hghly concentrated markets where competton s also very ntense because barrers to entry are not substantal and the potental competton from new entrants deters non-compettve behavour by ncumbent frms. Second, concentraton measures would only make sense n a well-defned market. Many features of bankng actvty suggest thet the relevant markets for deposts and loans are manly local. Therefore, the geographc areas for relevant bank markets should frst be defned n Span, calculatng thereafter concentraton measures on those markets so defned. However, these measures could not be related to nterest rates snce nformaton on nterest rates by geographc area s not avalable. Thrd, Spansh retal bank markets mght be consdered contestable to a certan extent, gven that there s a threat of new entrants although the cost of entry and ext can be consderable. In these crcumstances, the ncrease n market concentraton, whch has been observed as a consequence of mergers, could be hardly dentfed as a sgn of weaker competton. Takng nto account all these consderatons, a dfferent ndcator of prce competton has been used n ths study: the cross-secton dsperson of loan and depost nterest rates. The dea underlyng the use of dsperson n nterest rates as an ndcator of changes n the degree of competton among bank ntermedares s as follows: as the compettve pressure n a market wth a certan degree of product dfferentaton heghtens, the companes partcpatng n sad market wll have less ablty to set prces dfferentated from those set by the rest of the compettors, whereby prce set by each company wll tend to converge. Nonetheless, ths reducton n dsperson could lkewse be the outcome of a wde range of crcumstances. Hence, ths varable cannot be unvocally nterpreted as a competton ndcator. However, f the non-sample nformaton relatve to events n the Spansh bankng sector s taken nto account, the declnng tendency of dsperson (see Chart 2), should be nterpreted as evdence of greater compettve pressure 9. 9 An example of a smlar framework used to analyze prce dsperson can be found n Abbott (1994). 10 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

12 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE A thrd assumpton made n ths study s that average costs are a good approxmaton to margnal costs,.e. most ntermedares operate wth constant returns to scale 10. astly, t s assumed that banks do not have suffcent nformaton to dstngush between the operatng costs arsng from ther respectve actvtes n the credt and depost markets, and consequently tend to charge the aggregate of both, c. ata used The varables n equatons (3) and (4) have been approxmated va the followng nformaton: r :nterest rate on mortgage loans; r : nterest rate on tme deposts wth a maturty equal to or more than one year and less than two years; r :nternal rate of return on government bonds wth a maturty equal to or more than two years or, alternatvely, the three-month nterbank nterest rate along wth the dfferental between both nterest rates; c :operatng expenses per asset unt; ( 1 p ): rato of non-performng loans to total credt extended; M η, η M :cross-secton dsperson of bank nterest rates. In the estmatons, nterest rates on specfc bank operatons have been used rather than synthetc nterest rates ncludng those on the varous credt and depost-rasng operatons, so as to avod potental effects nduced on average rates by changes n the composton of bankng actvty. When consderng the market rate to be used as representatve of the margnal fnancal cost faced by banks, two requrements should be verfed: a) t should be the prce of operatons negotated n markets where banks behave as prce-takers and to whch they can resort n case they need funds or when they have surplus lqudty; b) the average term of operatons to whch ths prce s referred should be smlar to that of deposts or loans for 10 Ths assumpton does not run counter to emprcal evdence from the Spansh bankng system, gven that economes of scale have not been observed at frm level (see footnote 1). BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

13 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE whch they mght substtute. In the Spansh fnancal system ths role has been played both by the nterbank and government debt markets. Therefore, both nterest rates have been tred as ndcators of the margnal fnancal cost faced by banks. However, care has been taken to ntroduce the nterbank nterest rate together wth an ndcator of nterest rate expectatons over a longer term -.e. the dfferental between the nternal rate of return on government bonds and the three-month nterbank rate- to take nto account that the average term of bank lendng s longer than that of operatons n the nterbank market. Alternatvely, the government debt rate has also been used as a market rate representatve of banks' margnal fnancal cost 11. In prncple, all the varables are consdered to be exogenous except for the rato of non-performng loans to total credt whch s treated as an endogenous varable snce t depends on past values of loan nterest rates. Therefore, the mortgage loan rate equaton s estmated by usng an nstrumental varable method. In partcular the generalsed method of moments technque developed n Arellano and Bond (1988) s used to obtan vald nstruments. A dummy varable (FUS) has been added to capture the possble dfferental effect of merger processes on the nterest rates of the enttes resultng from such processes. Ths dummy takes a value equal to one n these enttes durng the three years followng the merger or takeover date 12, and a value equal to zero n the remanng observatons. Ths dummy has been ntroduced nto the equatons n two dfferent ways: ether drectly, so that t affects the ndvdual effects, or nteractng t wth the ndcator of market competton. In the frst case t would reflect the mpact on nterest rates of organsatonal changes that could have a bearng on the level of X-neffcences, whle n the second nstance t would reflect an effect of consoldaton processes on the compettve response of ntermedares. The analyss has not ncluded all the mergers that have taken place n the perod under consderaton, snce a seres of pror condtons was establshed whch had to be met by the merger for ts ncluson n the analyss. Frstly, only mergers between depost money nsttutons have been taken nto account, wth all mergers between specalsed fnancal credt establshments or between the latter and depost money nsttutons beng excluded from the analyss. The reason for ther excluson s that the motvaton for ths type of merger was the reorgansaton of fnancal groups further to legslatve changes and, therefore, they do not ft nto the habtual 11 The emprcal evdence n Sastre (1998) shows that both alternatves are farly equvalent for longer-term loans, ths not beng the case for short-term and varable rate lendng. 12 There are grounds for belevng that some of the possble effects of a merger on nterest rates may be of a more permanent nature. However, merger effects would be hardly dsentagled from those caused by other factors n the smple framework consdered n ths paper. Furthermore, a majorty of studes consder that most of the effects brought about by mergers cease to be felt after three or four years. See, for nstance, Perstan (1996) and Vander Vennet (1996). 12 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

14 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE pattern of mergers between ndependent enttes. For the same reason, other mergers between depost money nsttutons when ths was a consequence of nternal group reorgansaton have also been excluded, as have mergers of foregn banks' branches when ths was a consequence of mergers between ther parent banks. A sze crteron has also been establshed so as to consder a merger operaton, excludng from the analyss all those mergers where the entty merged or taken over does not exceed 15% of the total assets of the larger-szed entty. Ths s to avod the ncluson of operatons n whch t s hghly lkely that major changes wll not be detected n vew of the small sze of one entty n relaton to the other. Also excluded are those mergers n whch the resultng new entty lasted for less than one complete fnancal year, snce ths makes the type of analyss conducted n ths study mpossble owng to the lack of data. If the dsappearance of the new entty was as a result of a new merger, only the latter operaton wll be consdered. astly, t has also been decded to exclude one partcular operaton snce, although t met the establshed requrements, t showed anomalous values for the ratos consdered (such as negatve net ncome) and excessve volatlty n the ratos relatng to balance-sheet structure; accordngly, ts ncluson n the sample mght have dstorted the data. Applyng these crtera, 18 merger operatons have been ncluded n the analyss. Of these, two nvolve large prvate banks, two medum-szed subsdares and the remanng 14 varous savngs banks. Three of the mergers are between more than two enttes, the rest beng between two nsttutons. All the data are annual average values obtaned from the nformaton on nterest rates provded monthly to the Banco de España by banks and savngs banks and from the accountng nformaton ncluded n confdental statements. The sample of ntermedares ncluded n the panel data corresponds to those whch have reported nterest rates on an ongong bass. The nformaton covers the perod from 1988 to Results of the estmatons Tables 2 and 3 offer the results of the estmatons. These should be nterpreted wth some cauton n vew of the scant number of mergers and takeovers n the sample. The key aspects of these results are as follows: a) In general, the compettve response of Spansh ntermedares resultng from consoldaton processes s not lower, on average, than that shown by other enttes. There are even sgns that ths response may have ntensfed n the mortgage market f regard s BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

15 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE pad to the sgn and the t-rato value of the coeffcent of the varable resultng from nteractng the competton ndcator wth the merger dummy varable. b) The potental organsatonal changes related to X-neffcences and not reflected n accountng costs-, followng consoldaton processes do not appear to have affected the level of ether mortgage loan nterest rates or depost nterest rates. c) The varable used to approxmate to the changes n the degree of average competton n bank markets has a hgh explanatory power n the two nterest rate equatons, ndcatng the relevance ths factor has had n determnng Spansh bank rates n the nnetes. The results obtaned appear to confrm those from other, more qualtatve studes n whch sgnfcant dfferences are scarcely detected n the frms resultng from mergers compared wth certan control groups or wth the remanng market partcpants. Ths may be nterpreted n the sense that mergers and takeovers per se do not gve rse to generally dfferentated forms of behavour, and that are other types of factors whch determne whether potental effects of a merger arse or not. Consequently, t s approprate to supplement these results based n the use of statstcal nference wth a more detaled analyss of the effects of mergers on proftablty and effcency. The followng secton undertakes ths task, lookng nto the effects of each merger observed n the sample on the balance sheet of the enttes concerned. III.- CASE BY CASE ANAYSIS OF BANK MERGERS IN SPAIN IN THE PERIO The case-by-case analyss of mergers s made by comparng changes n the values of certan fnancal ratos of the nsttuton resultng from the merger process wth the same ratos calculated for a comparable group the selecton of whch wll depend, n each case, on the characterstcs of the enttes that have merged. Methodology and ratos used n the analyss To analyse the mpact of mergers on banks, several ndcators have been selected whch seek to measure the effects of the merger on varous aspects of bank actvty. Fve groups of ndcators are specfed. Frst are those whch attempt to measure proftgeneratng capacty; second, ndcators of the level of effcency and productvty; thrd, ndcators of changes n market share; fourth, ndcators of busness structure; and lastly, ndcators of captal adequacy. 14 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

16 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE The basc ndcators used are as follows: Group 1: Proft-generatng capacty * Total ncome: nterest ncome + commssons + result on fnancal operatons * Interest expenses * Gross ncome: total ncome - nterest expenses * Operatng expenses * Net ncome: total ncome - nterest expenses - operatng expenses All of these ndcators are expressed as a percentage of average total assets Although ROE s wdely used as a proft-generatng capacty rato, t has not been used n ths analyss because of the erratc behavour of some tems -manly net provsons and proft and losses from securtes and real estate sales- that are ncluded n the calculaton of fnal proft. Group 2: Effcency and productvty * Operatng expenses / average total assets * Operatng expenses / total ncome * Operatng expenses / gross ncome * Productvty per employee: average total assets / number of employees * Productvty per offce: average total assets / number of offces * Number of employees and offces followng merger In turn, to obtan supplementary nformaton, three addtonal types of ndcators are used, namely: Group 3: Indcators of market share and total assets growth * Growth rate of total assets * Market share (n terms of total assets). BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

17 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE Group 4: Indcators of busness structure * endng-depost actvty n pesetas, as a percentage of total assets Group 5: Indcators of captal adequacy * Captal / total assets In each merger these ndcators have been calculated annually for the four years pror to the operaton and the four years after, or for those years for whch data were avalable f the subsequent perod ran past The ndcators have been obtaned from the nformaton n the fnancal statements of the merged nsttuton durng the perod subsequent to the merger and by aggregatng the correspondng tems n the fnancal statements of the nsttutons ntervenng n the merger process for the prevous perod. The values of these ndcators are compared n each case, wth those that would be obtaned from a specfc control group for each type of entty 13. The control groups consdered n ths study are the followng ones: the group of four major banks, n the case of mergers between large banks, the group of subsdary banks of domestc banks for mergers of ths type, and the total sum of savngs banks for mergers between these nsttutons. The comparson s establshed between the average of the four years pror to the merger wth the average of the four years after. The values obtaned for each year, are also analysed. The analyss attempts to locate potental mprovements n the values of these ndcators for each entty vs-à-vs the values of the control group. The results are presented as the change observed n the dfference between the average values of the entty analysed and the control group before and after the merger. A sgnfcant mprovement n the compared values of a hgh number of ndcators n a specfc secton would be ndcatve of the fact that the merger has proven postve for the entty n that area of actvty. A "sgnfcant mprovement" n an ndcator s taken to be a postve change n ts average value hgher than one standard devaton of the dfference vs-à-vs the control group 14. A "sgnfcant worsenng" would be a negatve change hgher than one standard devaton, whle relatvely nsgnfcant changes would be those n the range of +1 standard devaton. Tables A.1 to A.3 ncluded n appendx 2 draw together the results of the analyss conducted, reflectng the changes that have come about n relaton to the control group n the ndcators consdered. Also, n charts 3 to 8 the man results are summarsed. Generally, 13 The control groups consdered also nclude the merged nsttutons. 14 Standard devatons have been calculated from the dfferences over the eght-year perod analy sed. 16 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

18 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE these changes are expressed n bass ponts, except n the case of market ndcators (where a dstncton s made only between a postve and a negatve change) and n the case of the number of employees and offces (where only an ncrease or a decrease n ths number s ndcated). Moreover, nformaton s gven on the ntal stuaton of the enttes takng part n the merger, showng whether these had hgher or lower effcency ratos than the control group consdered. Summary of results 15 The results of the analyss carred out do not dffer too much from those of other studes carred out on the effects of mergers n the Spansh bankng system. As an examnaton of graphs 3 to 8 shows, the effects of the mergers analysed on the proftgeneratng capacty and the level of effcency of the nsttutons are not very clear. In some cases sgns of mprovement are detected n comparson wth the control group, whle n other mergers these effects are not so clear and deteroratons are even observed after the merger. However t may be cautously ventured that the mergers analysed had a certan favourable effect on fnancal expenses (see table A.1 n appendx 2). Ths mght be related to the ncrease n market power of some of the analysed nsttutons followng the merger, owng to ther market share havng rsen n ther regonal area of operaton, but to confrm ths supposton, t would be necessary more n-depth analyss. Ths effect s counteracted by the negatve evoluton observed n total revenues, due to the change observed n the balance sheet structure wth a hgher proporton of operatons wth narrower margns (see Table A.3), so that the fnal effect on gross ncome and net ncome s uncertan -see graph 3 and 4.- In most of the cases analysed there does seem to be a slght mprovement n the rato of operatng costs to average total assets -see graph 5-. However, the changes seen are, n many cases, barely sgnfcant and f the analyss s lmted to those mergers n whch sgnfcant changes are observed, the results are much more ambguous. Sgnfcant ncreases n productvty per offce and productvty per employee have been detected n most of the cases analysed -see graphs 6 and 7-, due to the combned effect of balance-sheet growth and the reducton n the number of offces. Nonetheless, these ncreases n productvty have not been clearly reflected n the effcency rato (operatng costs/average balance sheet) due to the downward rgdty of staff costs and, to a lesser extent, of overheads. In the case of staff costs ths rgdty s explaned by the costs assocated wth makng staff cutbacks, snce the compensaton pad or the 15 A more detaled explanaton of the man fndngs of the rato analyss can be found n appendx 2. BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

19 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE costs arsng from early-retrement plans curb the reducton n staff costs. In the case of overheads the reason could have been an ncrease n some costs assocated wth the process of nternal reorgansaton. When analysng the other effcency ratos used, whch relate operatng costs to gross and total ncome, the results are less clear because, n certan cases, productvty gans have had a negatve mpact on the level of ncome generaton f they occurred as a consequence of a growth n busness areas wth lower margns. When comparng the changes n the number of employees and offces wth the growth of total assets after the merger (see Tables A.2 and A.3), t s clear that n most cases n whch after the merger there s an ncrease n market share, nether the number of employees nor the number of offces decreases. Conversely, n all those cases n whch there s a reducton n the number of employees and offces, except n one n whch the result s uncertan, there s also a slowdown n the growth of total assets and losses of market share. Ths suggests the exstence of two types of mergers, those n whch busness expanson crtera predomnate and others n whch crtera of cost cuttng and productvty ncreases predomnate. However, the dfferences between these two groups are not clear, snce as commented above, the reductons n staff and offces are not always reflected n changes n operatng costs, so that the dfferences between the two groups are not very evdent when comparng ther effcency ratos. The clearest effect n the mergers analysed, as can be seen n graph 8, s the ncrease n the captal-adequacy rato of the merged nsttutons, due largely to the dsclosure n books of reserves upon the revaluaton of assets recorded at cost prce durng merger processes. Although ths effect s a purely accountng phenomenon, t s of economc relevance for some nsttutons, partcularly savngs banks, snce t allows them to ncrease ther avalable captal 16 and thereby have a larger margn for makng new nvestments. It also contrbutes to mprovng ther fnancal ratos, whch could be reflected n a smaller rsk premum, reducng ther fnancng costs, and thus mprovng ther proft generatng capacty. IV.- CONCUSIONS In ths study a short to medum term perspectve has been adopted as a three or four year horzon has been chosen to be analyzed after each merger. Although most studes tend to focus on ths perod, the mpact of merger operatons on long run bank profltablty may take more tme to develop. Therefore t should be borne n mnd that the 16 The applcaton of accountancy methods based on the prncple of hstorc cost are the orgn of these hdden reserves whch appear when the asset s valued at current prces. 18 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

20 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE results of the study do not rule out ths potental long run effects, whch have not been analyzed here. An overall evaluaton of the results of the varous sectons of ths paper leads to two types of concluson. Frst, the consoldaton of the bankng ndustry does not appear to have lessened the growng degree of competton whch has been seen n the sector n recent years. A bgger sze offers, n prncple, greater capacty to set prces out of lne wth the market, but n an envronment charactersed by a ferce competton, t s probably very costly -n terms of market share- to take advantage of ths fact. In prncple, t could be argued that ths capacty s the man reason for the sgnfcant reducton n nterest expenses whch has been observed n some takeovers. However, t s not clear f ths should be nterpreted ether as the result of an ncrease n market power or as an strategc decson taken by most bankng nsttutons whch have ruled out competng strongly n the depost market and have shfted a good deal of compettve pressure to the mutual fund market. Wthn a process marked by the general shft of savngs from bank deposts to mutual funds, ths decson seems to be a sensble way to redstrbute compettve pressure among dfferent markets whle mnmsng ts negatve mpact on proftablty. The basc effect of any merger or takeover s to wden the range of strategc alternatves avalable to a bank, by enablng t to attan a sze whch, n the absence of ths process, t could probably not have acheved and by requrng a reassessment of exstng organsatonal arrangements. It seems that n the case of mergers and takeovers n Span one can speak of two types: those whch have sought to expand busness and those whch have opted for ncreases n productvty and mprovements n the level of effcency. The ambguty of the results obtaned n terms of proftablty per unt of assets would suggest that t s practcally mpossble to acheve both thngs at the same tme;.e. the growth n the gross ncome of certan merged nsttutons as a result of a strategy of busness expanson s usually accompaned by an ncrease n operatng costs whch tend to compensate the hgher ncome. On the other hand, those nsttutons whch opt for a sgnfcant reorgansaton, wth elmnaton of duplcatons n ther offce networks, seem to suffer a loss of ncome-generatng capacty, so that the productvty and effcency gans are not transformed nto mprovements n proftablty, at least wthn a four-year perod. In short, t may be sad, n general, that although the mergers analysed n ths study gve no clear results as regards mprovements n the proft-generatng capacty or effcency levels of the merged nsttutons, from the vewpont of the bankng sector they can be mostly consdered satsfactory, snce they have been an nstrument for achevng some postve objectves: a) certan reductons n costs, although these have been small; b) mplementaton of ratonalsaton plans whch, although they have not been mmedately BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

21 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE reflected n banks' proft and loss account due to the dffcultes and hgh costs of staff cutbacks n Span, have certanly served to mprove the compettveness of some nsttutons; and c) mprovements n captal-adequacy ratos, whch have helped to facltate nvestment growth. These effects observed n the mergers analysed, have most lkely helped put the merged nsttutons n a better poston to confront the growng competton n the fnancal sector, specally n those cases where merged nsttutons were of a relatvely small sze and compettors n the same regonal market. 20 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

22 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE APPENIX 1 The group of models that seem most satsfactory for analysng bank nterest rate determnaton are those that consder banks as frms operatng n mperfectly compettve markets. Wthn ths group, the "Klen-Mont model" s relatvely standard n studes of the settng of nterest rates by banks, beng frequently used as a reference paradgm to ntroduce elements of greater complexty 17. The Klen-Mont model assumes the exstence of two markets -loans and depostsn whch the banks have access to dfferentated segments -ther customers. In ths way they are able to mantan a certan amount of market power n those market segments. There s a thrd market n whch the banks operate as prce-takers. In most models ths s usually a publc or prvate securtes market; however, n the verson presented n ths paper, banks obtan fnance or nvest funds on the nterbank market at an nterest rate controlled ndrectly by the Bank of Span. Accordng to ths verson, the balance-sheet constrant of a bank s gven by: q + = FI + where: q: reserve rato : deposts : loans FI: nterbank fnancng Each bank maxmzes current profts gven by: π = r q + r rfi r R C where: r : rate of return of reserves R r : nterest rate on loans 17 See Klen (1971) and Mont (1973). BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

23 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE r : depost nterest rate r : nterbank market rate C : operatng costs, whch s a separable functon of the volume of loans and deposts, C = C (,). In ths model the decson varables for each ntermedary are the nterest rate on loans and on deposts, r and r. Once the values of these nterest rates are set, credt demand determnes the amount of credt and depost supply determnes the volume of depost. Ths n turn requres the mantenance of a volume of bank reserves whch, n conjuncton wth the volume of credt granted, gves the sze of the balance sheet. In these crcumstances, t s precsely nterbank borrowng whch adjusts the funds rased on the depost market to the nvestment requrements on the lendng sde. The decson-makng rules that determne the nterest rate for loans and deposts are gven by the followng frst-order condtons: 1 η r = ( r c ) (A.1) r = η 1 ( r c ) (A.2) where the superscrpt has been added n order to shft away from the representatve agent framework and explctly ntroduce the dfferentated product nature of bankng markets. In addton, the varables relatng to the reserve requrement rato, whch would nfluence the depost nterest rate, have been omtted. The reasons for ths omsson are the small magntude of the changes n ths rato n the sample perod used n the estmatons of ths paper and the fact that t was not sgnfcant n earler perods of tme 18, when these changes were larger. The meanng of the symbols s as follows: η, η :elastctes of credt demand and depost supply, respectvely, for each ntermedary ; c, c :margnal operatng costs of loans and deposts. 18 See Sastre (1991). 22 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924

24 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE Accordng to equaton (A.1), the bankng frm sets the lendng rate r n such a way as to make the margnal ncome and margnal cost of loans equal. The margnal cost s a functon of the opportunty cost as reflected by a market rate, such as the nterbank rate, and the ncrease n operatng costs derved from rasng the volume of loans nstead of borrowng on the nterbank market. Smlarly, equaton (A.2) ndcates that a bankng ntermedary establshes the nterest rate on deposts r n such a way that there s no dfference between rasng addtonal funds n the nterbank market or n the deposts market. In the latter case, the margnal cost s the sum of two components: the ncrease n costs due to the fact that the supply of deposts s not perfectly elastc and the ncrease n operatng expenses produced by ncreasng the level of deposts. Wth both loans and deposts, the response of nterest rates to varatons n the margnal -fnancal and operatng- cost s a functon of the prce elastcty for each of those markets, whch, n prncple, may vary at any pont on the credt demand and depost supply curves. The Klen-Mont model assumes that bankng ntermedares have market power n both the lendng and depost markets, but t does not envsage the possblty of a strategc nteracton between them. Thus, market structure s not fully reflected n ths model. To ncorporate the possblty that an nsttuton's decsons on prces and volumes depend on actons undertaken by compettors, plus the exstence of product dfferentaton (derved n the case of bankng from the fact that the market each entty serves dffers from others), two further varables are added to the model: j j e, e : substtuton elastctes between products of ntermedares and j n loan and depost markets; j j e, e :changes n the prces of compettor j when decdes to change ts prces. In other words, conjectural varatons between (,j) n loan and depost markets. In an mperfect competton model wth product dfferentaton n the loan and depost markets, the factors condtonng the nterest rates fxed by bankng ntermedares are the followng: j ( r c ) r = j j η + 1 ε e 1 (A.3) BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº

25 MERGERS AN ACQUISITIONS IN THE SPANISH BANKING INUSTRY: SOME EMPIRICA EVIENCE r = 1 + η + 1 j 1 ε j e j 1 ( r c ) (A.4) These equatons ndcate that the senstvty of bank nterest rates no longer depends solely on the prce elastcty of each bankng nsttuton's own market as n (A.1) and (A.2) but also on the type of strategc nteracton among partcpants n the same market and the degree to whch ther products -or dfferent clent segments-can be substtuted for one another. Nevertheless, ths framework s stll nsuffcent to explan how banks behave, because t fals to take nto account the rsk nherent n grantng a loan because of uncertanty as to whether the nterest wll be pad and the prncpal repad 19. If ths s borne n mnd, equaton (A.3) allows us to calculate the expected return on the loan portfolo R : R = g, [ r p ( ) ] where: r : nterest rate vector of (k 1) dmenson establshed by the -th bank for k types of credt n ts market; p ( ) : average non-performng loan probablty functon of bank, whch depends, n turn, on the nterest rate on loans ( r (k)) of the economy (y) for the class k customer and on the overall state Under the assumpton that the rsk groups nto whch the customers of a bank can be classfed may be represented n the form of an average prototype customer wth a bnomal probablty functon that corresponds to the event: payment/non-payment of the loan n due tme, the expresson (A.3) may be rewrtten as: 19 The fndngs of Slovn and Sushka (1984) ndcate that the most approprate theoretcal framework for presentng emprcal evdence on bankng frms' performance should combne portfolo theory and prce-settng n an mperfect competton market. 24 BANCO E ESPAÑA / OCUMENTO E TRABAJO Nº 9924