Mergers and acquisitions in European banking: Overview, prospects and future research

Mergers and acquisitions in European banking: Overview, prospects and future research Presented at EUMOptFin3: The drivers of performance of large financial institutions Bergamo, 17-21 May, 2004 Rym AYADI, Paris Dauphine University / Centre for European Policy Studies (CEPS) Bergamo 17-21 May, 2004 1

Contents Main characteristics of the M&A wave on the 90s in the EU Key Drivers Overall assessment Prospects Research in progress Bergamo 17-21 May, 2004 2

Main characteristics of the recent wave of M&As in European banking (1) Sample and methodology elements 151 M&A transactions in banking in the EU 15 (120 domestic and 31 cross-border) Complete mergers or majority acquisitions exceeding the threshold of 49% of voting rights. Targets and acquirers are banking institutions as defined in the second banking directive Statistical analysis performed on the number, total value and average value of the transactions Bergamo 17-21 May, 2004 3

Main characteristics of the recent wave of M&As in European banking (2) 1 Acceleration of M&A activity since 1996 Upward trend of the number of the transactions A steady growth of the annual value of the transactions A global slowdown of M&A activity since 2001 following the overall downturn in the financial markets M&A Activity seems to peak up since the beginning of 2004 Bergamo 17-21 May, 2004 4

Main characteristics of the recent wave of M&As in European banking (2) 30 National vs. pan-european banking M&As, by number (1994-2000) 25 20 15 10 5 0 1994 1995 1996 1997 1998 1999 2000 National Pan-European Total Bergamo 17-21 May, 2004 5

Main characteristics of the recent wave of M&As in European banking (2) N a tio n a l v s. p a n - E u r o p e a n b a n k in g M & A s, b y v a lu e (1 9 9 4-2 0 0 0 ) 1 0 0 8 0 6 0 4 0 2 0 0 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 N a tio n a l P a n - E u r o p e a n T o ta l Bergamo 17-21 May, 2004 6

Main characteristics of the recent wave of M&As in European banking (3) 2 Emergence of mega-banks at national scale since 1999 ( BNP Paribas in France, SCH et BBVA in Spain, Intesa BCI et Unicredit in Italy, RBoS in the UK..) A continuing growth of the average value of the transactions reaching a peak in 2000 Bergamo 17-21 May, 2004 7

Main characteristics of the recent wave of M&As in European banking (3) 10 National vs. pan-european banking M&As by average value (1994-2000) 9 8 7 billions 6 5 4 3 2 1 0 1994 1995 1996 1997 1998 1999 2000 National Pan European Total Bergamo 17-21 May, 2004 8

Main characteristics of the recent wave of M&As in European banking (3) Two hypothesis could be mentioned to explain the significant increase in the average value of the transactions: Either this increase is due to a few large transactions, in that case, the concentration process is dominated by few large banking institutions; Or it is a consequence of a widespread concentration process affecting the whole banking industry. Bergamo 17-21 May, 2004 9

Main characteristics of the recent wave of M&As in European banking (3) The distribution per period indicates that the banking concentration process in the EU experienced two successive stages over the period 1994-2000. the first completed in 1998 was dominated by small and medium sized transactions suggesting the desire to reduce excess capacity. Over 1999-2000, a major change occurred where 85% of the transactions were medium to large sized. The distribution per year confirmed these results. The concentration process in European banking in the 90s was structural, profound and dynamic. Bergamo 17-21 May, 2004 10

Main characteristics of the recent wave of M&As in European banking (3) Changes in domestic M&A banking distribution per period 40% 35% 30% 25% 20% 15% 10% 5% 0% 100 500 1000 2000 5000 10000 10000 et + 1994-1998 1999-2000 1994-2000 Bergamo 17-21 May, 2004 11

Main characteristics of the recent wave of M&As in European banking (3) Changes in domestic M&A banking distribution per year 6 0 % 50 % 4 0 % 3 0 % 2 0 % 10 % 0 % 10 0 50 0 10 0 0 2 0 0 0 5 0 0 0 10 0 0 0 10 0 0 0 e t + 1994 1995 1996 1997 1998 1999 2000 Bergamo 17-21 May, 2004 12

Main characteristics of the recent wave of M&As in European banking (4) A timid development of cross-border transactions at AU level Predominance of domestic M&As in European banking throughout the period, but a marked increase can be observed in cross-border transactions starting in 1999. Increase of the acquisitions in emerging areas offering high potential growth and new opportunities for development such as in Eastern Europe, Latin America and in the US. Bergamo 17-21 May, 2004 13

Main characteristics of the recent wave of M&As in European banking (4) C o m p a r i s o n o f n a t io n a l v s. p a n - E u r o p e a n b a n k i n g M & A s, b y n u m b e r ( 1 9 9 4-2 0 0 0 ) 1 0 0 % 8 0 % 6 0 % 4 0 % 2 0 % 0 % 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 N a t i o n a l P a n - E u r o p e a n Bergamo 17-21 May, 2004 14

Main characteristics of the recent wave of M&As in European banking (4) C o m p a r i s o n o f n a t io n a l v s. p a n - E u r o p e a n b a n k i n g M & A s b y to t a l v a l u e ( 1 9 9 4-2 0 0 0 ) 1 2 0 % 1 0 0 % 8 0 % 6 0 % 4 0 % 2 0 % 0 % 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 N a t i o n a l P a n - E u r o p e a n Bergamo 17-21 May, 2004 15

Main characteristics of the recent wave of M&As in European banking (5) Towards the constitution of European financial conglomerates 4 A relative importance of cross-industry transactions (insurance and investment firms) The distribution of targets and acquirers industries in 1999 (in Billions $) Target Insurance Banks Securities Acquirer companies Total Banks 89 9 20 118 36,03% 3,64% 8,10% 47,77% Securities 23 19 24 66 9,31% 7,69% 9,72% 26,72% Insurance companies 11 6 46 63 4,45% 2,43% 18,62% 25,51% Total 123 34 90 247 49,80% 13,77% 36,44% 100% Source : DeLong, Smith & Walter Securities Data Company (2000). Bergamo 17-21 May, 2004 16

Key drivers of banking M&As (1) The leading role of the environment Value-maximising motives Enhanced market power Greater efficiency Other motives Managerial motives Mimicry effect Defensive reaction Bergamo 17-21 May, 2004 17

Key drivers of banking M&As (2) M a i n c h a r a c t e r i s t i c s o f a t y p o l o g y o f i n d u s t r i a l s t r a t e g i e s t h r o u g h M & A i n E U b a n k i n g N a t i o n a l M & A C r o s s - b o r d e r M & A G e o g r a p h i P a n - E u r o p e a n I n t e r n a t i o n a l N a t i o n a l c o n s o l i d a t i o n c a l d i v e r s i f i c a t i o n d i v e r s i f i c a t i o n d i m e n s i o n N a t i o n a l M & A P a n - E u r o p e a n M & A I n t e r n a t i o n a l M & A N a t i o n a l c o n s o l i d a t i o n N a t i o n a l d i v e r s i f i c a t i o n C r o s s - b o r d e r d i v e r s i f i c a t i o n A c t i v i t y s e g m e n t o r b u s i n e s s S a m e a c t i v i t y, s a m e b u s i n e s s S a m e a c t i v i t y, d i f f e r e n t b u s i n e s s e s D i f f e r e n t a c t i v i t i e s S a m e a c t i v i t y, s a m e b u s i n e s s S a m e a c t i v i t y, d i f f e r e n t b u s i n e s s e s T y p e s o f i n d u s t r i a l s t r a t e g y S a m e a c t i v i t y D i f f e r e n t a c t i v i t i e s I n d u s t r i a l s t r a t e g i e s M o t i v a t i o n s r e s u l t i n g f r o m M & A o p e r a t i o n s N a t i o n a l c o n s o l i d a t i o n ( b u s i n e s s ) I n c r e a s e o f t h e m a r k e t p o w e r i n a g i v e n m a r k e t N a t i o n a l d i v e r s i f i c a t i o n ( b u s i n e s s ) R e d u c e d r i s k d u e t o t h e d i v e r s i f i c a t i o n o f a c t i v i t i e s ( o f t h e i n c o m e ), a n d t h e e x t e n s i o n o f t h e a c t i v i t y i n t o a n o t h e r g e o g r a p h i c a l a r e a N a t i o n a l a n d c o n g l o m e r a t e d i v e r s i f i c a t i o n B u s i n e s s c o n s o l i d a t i o n a n d c r o s s - b o r d e r d i v e r s i f i c a t i o n B u s i n e s s d i v e r s i f i c a t i o n a n d c r o s s - b o r d e r d i v e r s i f i c a t i o n M o t i v a t i o n s r e l a t e d t o t h e s t r a t e g i e s a d o p t e d S c o p e e c o n o m i e s t h r o u g h d i v e r s i f i c a t i o n o f t h e h e l d p o r t f o l i o A t t a i n i n g a n i m p o r t a n t s i z e i n a c r o s s - b o r d e r m a r k e t D i v e r s i f i c a t i o n o f r i s k s a n d i n c o m e s A c t i v i t y c o n s o l i d a t i o n a n d i n t e r n a t i o n a l d i v e r s i f i c a t i o n A t t a i n i n g a l a r g e r s i z e i n a c r o s s - b o r d e r m a r k e t Bergamo 17-21 May, 2004 18 C o n g l o m e r a t e a n d i n t e r n a t i o n a l d i v e r s i f i c a t i o n S c o p e e c o n o m i e s a n d d i v e r s i f i c a t i o n o f r i s k s

Overall assessment of M&As in European banking: What economic effectiveness? Value creation : still not conclusive results Event studies (effects of M&As on stock market values) mixed results Efficiency remains contested and controversial topic Economies of scale (size-efficiency) seems to be exhausted at relatively small output levels, in Europe research yielded mixed findings Economies of scope (product-mix efficiency) little consensus, but apparently also exhausted at very low levels of output X-efficiency (operational-efficiency) generally much larger than scale efficiencies and scope-efficiencies, or banks can improve their overall cost efficiency to a greater extent if they emulate the banking industry s best practice than by increasing size (scale) or diversifying (scope) (Berger 1999) Bergamo 17-21 May, 2004 19

Overall assessment of M&As in European banking: What economic effectiveness? Empirical findings to be manipulated with caution: Most empirical research undertaken in US banking market, not necessarily transposed in the EU (different regulation and structure) Time period insufficiently long after an M&A to obtain reliable results Striking differences between domestic and cross-border M&As, and the intrinsic characteristics of the operation (hostile, friendly..) Data conformity and limitations of econometric tools difficulties in the post integration process Managerial hubris : is it a relevant piece of explanation? Bergamo 17-21 May, 2004 20

Overall assessment of M&As in European banking: What economic effectiveness? Improvement of collective welfare: little consensus Domestic (increase of market power?) / cross border (increase in competition?) Market power (a simple profit redistribution in favour of shareholders) / efficiency (a possible pass-on to consumers) Impact on the quality of banking services: geographical availability, financial access and technology integrated into the service: major role of new technologies Bergamo 17-21 May, 2004 21

Overall assessment of M&As in European banking: banking M&As and growth? M&As may strengthen the soundness and the stability of the banking sector: The threat of a possible takeover by a competitor urges banks to be more competitive Reduction of excess capacity has a positive impact on profitability M&As constitute a natural selection mechanism through the rationalisation of banking supply structure Bergamo 17-21 May, 2004 22

Overall assessment of M&As in European banking: banking M&As and growth? But the emergence of mega-banks may create a new source of fragility: The extension of application of too big to fail rule and the exacerbation of the moral hazard phenomenon May jeopardise financial stability and cause competitive disruption Bergamo 17-21 May, 2004 23

Overall assessment of M&As in European banking : impact on market structure? Overall increase in concentration levels in almost all EU15 banking markets. Significant differences continue to exist, however, across countries: In some countries, concentration raises anti-competitive concerns In others, a highly fragmented banking market Concentration indicators to be manipulated with caution, What relevant market? The degree of contestability of the market Bergamo 17-21 May, 2004 24

Overall assessment of M&As in European banking : impact on capacity? M&As may perform disciplining function against cost inefficiencies and excess capacity through (job-cuts and branch closure) But, other factors may also explain the capacity reduction Emergence of call centres and e-banking leading to the rationalisation of banking branch network (Scandinavian countries) In southern Europe, the trend is different owing to the local characteristics of these countries (dual structure of their banking sectors) Bergamo 17-21 May, 2004 25

What prospects (1) Banking consolidation in the medium-term Different patterns of consolidation in European banking: In countries where concentration threshold admitted by the competition authorities is reached, cross-border consolidation could be the alternative to external development (Scandinavian Countries, and Benelux) In countries where concentration levels are intermediate, some specific scaled M&As are expected at domestic level and growing interest to cross-border acquisitions (France, Spain, and UK) In countries where concentration level are relatively low, further domestic consolidation is expected at a first stage (Germany, and Italy) Bergamo 17-21 May, 2004 26

What prospects (1) Banking consolidation in the medium-term Cross-border consolidation in the medium term leading to the emergence of cross-border European financial groups Until now the majority of cross-border M&As were confined to geographical areas with strong historical and cultural links Nordea, HVB-Bank Austria, RBoS-Natwest, Dexia Bergamo 17-21 May, 2004 27

What prospects (1) Banking consolidation in the medium-term Remaining cross-border consolidation barriers in Europe: Still high level of public ownership of banks Non-economic motives ( national flagships ) Remaining large number of co-operative savings banks Present labour rigidities and problem of staff reduction Regulatory barriers (national regulations on mergers can act to protect domestic interests from foreign competition... Bergamo 17-21 May, 2004 28

What prospects (1) Banking consolidation in the medium-term Initiatives to promote the the full integration of banking and capital markets in Europe: FSAP is a step forward to ensure the full integration of banking and capital markets Extension of Lamfalussy procedure to banking The progress made in the New Basel Capital Accord Reform of the European Community Merger regulation Reducing the regulatory burden and hence facilitate crossborder growth opportunities Bergamo 17-21 May, 2004 29

What prospects (2) Towards which banking model in Europe? The recent consolidation wave together with the regulatory developments have blurred the boundaries between financial activities and contributed to the enlargement of the range of activities proposed by the major European banks Whereas universal banking model has prevailed as a reference in the past, two trends have emerged following the recent consolidation wave Bergamo 17-21 May, 2004 30

What prospects (2) Towards which banking model in Europe? On one hand, emergence of global investment banking, highly concentrated (following few targeted acquisitions) on a worldwide scale and specialised in few activities (Deutsche Bank, Crédit Suisse Group,UBS, ) On the other hand, the multi-specialised banking institutions or universal retail banking, heavily involved in retail businesses and considered to be a dominant model in Europe. Bergamo 17-21 May, 2004 31

What prospects (2) Towards which banking model in Europe? Bergamo 17-21 May, 2004 32

What prospects (2) Towards which banking model in Europe? The development of universal banking is justified by the benefits of diversification, but it is not the only possible business model, specialised banking model is also beneficial. This specialisation can take two dimension: It can be functional when covering an individual activity or customer segment Or geographical through the knowledge of a specific geographical area Bergamo 17-21 May, 2004 33

What prospects (2) Towards which banking model in Europe? It is difficult to choose between the alternatives of diversification and specialisation. Universal and specialised banking institutions will continue to co-exist, each one having its characteristics and responding to individual needs. One of the objectives of banking consolidation is to reconcile the advantages of diversification specific to universal banks with a search of a better specialisation Bergamo 17-21 May, 2004 34

What prospects (2) Towards which banking model in Europe? Optimum size : a controversial question Empirical research concluded that a larger size is not synonym of a higher profitability. A larger scale may increase the risks of bureaucratisation, and inefficiencies In the future, although many banking activities will be increasingly dependent on a larger size, it more the product mix and the targeted customer that will determine the optimum bank size Bergamo 17-21 May, 2004 35

Research in progress (1) Assessment of M&As in European banking in the 90s Based on the sample of 151 M&As in banking Typology of M&As according to the business strategy involved the day of the announcement Dynamic efficiency analysis on sub-samples having the same characteristics Application of DEA methodology Produce efficiency scores Compare efficiency score before and after a merger Additional Regression analysis (Logit model) to explain changes in efficiency scores after the merger Bergamo 17-21 May, 2004 36