# Presentation: 183519

## M&A operations and performance in banking

- Elena Beccalli
*(London School of Economics and Università di Macerata)*
- Pascal Frantz
*(London School of Economics)*

- Conference on “Mergers and Acquisitions of Financial Institutions”
- Washington, 30th November 2007

## Aims

- Do M&A operations cause changes in the performance of banks?
- What are the sources of such changes, if any?
- Contributions to the literature:
- Enlarge the geographical coverage → 714 deals with EU acquirers and worldwide targets over 1991-2005
- Test of a wide set of performance measures → Accounting ratios (ROE and CFR), cost X-efficiency and profit X-efficiency
- Disentangle the total change in performance into the part due to the M&A operation itself and the part that would have occurred anyway

## Background

- Relevance of M&As in the banking industry:
- US: An intensive M&A process transformed the banking industry over the last decades (DeLong and DeYoung, 2007)
- EU: A further integration trough cross-border M&As in retail banking is one of the main objectives pursued by the ECB (Trichet, 2007)
- Nevertheless the evidence on the impact of M&As on performance is inconclusive

## Existing empirical evidence

- 	Surprisingly: mixed evidence, unclear impact of M&A on bank performance

## Existing empirical evidence

- Nevertheless all the above studies just refer to the overall change in performance by comparing in a dynamic analysis the post-M&A with the pre-M&A performance
- But some of the change could be due to a continuation of firm-specific performance before the merger or to economy-wide and industry factors → persistency (Healy *et al.,* 1992)
- Healy *et al. *(1992) however do not investigate the banking industry (i.e. impact on CFR of the 50 largest US mergers over the period 1979 and 1984)

## Methodology

- 1. ANOVA test - comparison of:
- Performance values for banks involved in M&A operations and banks not involved in any M&A operations → Industry-adjusted performance
- Performance values for target and acquirer in the pre-M&A period
- Performance for the combined bank resulting after the M&A deal and weighted average of the performance of the target and acquirer prior to the M&A deal → Change in industry-adjusted performance

## Methodology

- 2.  To split the overall change in performance into the change specifically due to the M&A and the change due to economy-wide factors, industry-factors, continuation of bank-specific performance (Healy et al. 1992):
-  = Impact of the M&A operation on performance
- β = Change in performance independent from the M&A (persistence in performance)
- AdjPer = Average annual industry-adjusted performance for each M&A (accounting values and X-efficiency estimation)
- 3.  To control for the determinants of the change in performance:
- CV (control variables): deal-specific, bank-specific and regulatory and institutional variables

## Accounting-based measures of performance

| ROE (Return on Equity) = 
Net Income/Book Value of equity | CFR (Cash-flow Return) = Operating Cash Flow/Equity Market Value |
| --- | --- |
| Accounting-based measure of shareholders profitability | Market-based measure of shareholders performance |
| Affected by:
 the method used to account for the M&A
 the method used to finance the M&A (cash vs shares)
 other discretionary accounting choices made by managers | Not affected by the method used to account for the M&A and by the method used to finance the M&A
 Less affected than ROE by the other discretionary accounting choices made by managers
 But may be distorted by changes in expectations |

## Operating efficiency as performance measure

- X-efficiency: measure of managerial best practice
- Methodological choices for the estimation:
- Parametric approach: SFA
- Cost efficiency and profit efficiency:
- Cost efficiency: how close a bank is to the cost sustained by the best practice bank to produce a given mix of outputs
- Alternative profit efficiency: how close a bank is to the realisation of the maximum level of profit given its mix of outputs → Ability to apply a price premium
- Functional form: Fourier flexible
- Definition of input and outputs: intermediation approach
- Cross-country panel

## Data set and sample

- Dataset:
- Data on the M&A deal: Thomson One Banker
- Prices of listed banks, benchmark and economic indexes: Datastream
- Bank financial statements: Bankscope
- M&A sample: M&A deals announced between 1/1/1991 and 31/12/2005 with a EU acquirer and a target located anywhere in the world:
- 714 deals (394 domestic and 320 cross-border transactions) → Unique sample
- Control sample: all banks that have not engaged in any M&A:
- Matching on the basis of: nationalities of acquirers and targets, year and type of activity
- 7963 observations over 1991-2005

## Adjusted efficiency of acquirers and targets (pre-deal)

- % of positive cases under the Wilcoxon test.
- °°°, °°, °
- Z-test respectively statistically significant at 1%, 5% and 10%.

## Adjusted ROE (BY) of acquirers and targets (pre deal)

**Notes:**
Acquirors outperformed their peers in each of the five years prior to the mergers and acquisitions. 
This result is furthermore robust to alternative measures of performance such as ROE(AVG).
There is some evidence of targets also outperforming their peers prior to the mergers and acquisitions.
This result is however not robust to alternative measures of performance such as ROE(AVG)

## Comparison of adjusted efficiency of acquirers and targets (pre-deal)

## Comparison of adjusted ROE and CFR of acquirers and targets (pre-deal) 

**Notes:**
Acquirors outperformed targets in some of the earlier years prior to the mergers and acquisitions. 
This result is furthermore robust to alternative measures of performance such as ROE(AVG).
With respect to net margin, acquirers outperform their peers pre-merger (but not by much) prior to the deals.
With respect to asset turnover, there is no evidence that acquirers outperform their peers prior to the deals.
With respect to net margin, there is some evidence suggesting that targets underperform their peers prior to the deals.
With respect to asset turnover, there is strong evidence suggesting that targets underperform their peers prior to the deals.
Compared with their peers, acquirers have both a lower personnel expense and a lower other administrative expense as a function of revenue in each of the five years prior to the mergers and acquisitions .
Compared with their peers, there is some evidence suggesting that targets have a lower personnel expense as a function of revenue in some of the earlier years prior to the mergers and acquisitions .
ROE(BY) = Net Income/Book Value of Equity (measured at the Beginning of the Year).
In order not to eliminate any data but to deal with outliers:
	the observations in the first three percentiles have been altered to the third percentile values;
	 the observations in the last three percentiles have been altered to the ninety seventh percentile values. 
3. ROE(AVG) = Net Income/Average Book Value of Equity.
4. Supporting evidence for the robustness claim can be found in Table A1 (Panel C). 

## Change in efficiency (pre- vs. post- deal)

- Base year are weighted averages of the performance measure in the years prior to the M&A of the target and acquiring banks.

## Change in ROE and CFR (pre- vs. post- deal)

**Notes:**
There is some evidence that firms engaging in M&A experience a decrease in their performance post-merger.
This result is furthermore robust to alternative measures of performance such as ROE(AVG).  In the latter case, the empirical evidence is however weaker.
There is no evidence of any significant increase in either net margin or asset turnover post-merger.
Both the ratio of personnel expense over revenue and the ratio of other administrative expenses over revenue are increasing post-merger. 
ROE(BY) = Net Income/Book Value of Equity (measured at the Beginning of the Year).
In order not to eliminate any data but to deal with outliers:
	the observations in the first three percentiles have been altered to the third percentile values;
	 the observations in the last three percentiles have been altered to the ninety seventh percentile values. 

## Change in efficiency pre vs. post (domestic deals)

## Change in efficiency pre vs. post (cross-border deals)

## Change in ROE(BY) pre vs. post(domestic vs. cross-border deals)

**Notes:**
There is little evidence suggesting that firms engaging in domestic mergers and acquisitions experience a decrease in their performance post-merger from the second to the fifth year following the mergers and acquisitions.
There is strong evidence suggesting that firms engaging in cross-borders mergers and acquisitions experience a decrease in their performance from the second to the fifth year following the mergers and acquisitions.

## Cost efficiency: M&A vs. persistency (post- vs. pre- deal average)

## Profit efficiency: M&A vs. persistency (post- vs. pre- deal average)

## ROE and CFR: M&A vs. persistency (post- vs. pre- deal average)

**Notes:**
Evidence from regressions based on industry-adjusted ROE (BY) suggests that M&A lead to decreases in performance. 
There is no evidence of any gains from M&A from regressions based on industry-adjusted ROE (AVG). 

## Cost efficiency: M&A vs. persistency (post- vs. pre- deal average) Domestic vs. cross-border deals

## Profit efficiency: M&A vs. persistency (post- vs. pre- deal average) Domestic vs. cross-border deals

## Determinants of changes in efficiency pre- vs. post- deal

- Freedom from government (_[http://www.heritage.org/research/features/index/](http://www.heritage.org/research/features/index/)_) = Government expenditures and state-owned enterprises. Regulatory quality (_[www.worldbank.org](http://www.worldbank.org/)_) = Ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development. Traditional banking = Loans/Total assets; Riskiness = Stand. Dev ROE; Big,  Medium, Small = 33°, 66°, 99° percentile (ln (Total assets)).

## Conclusions

- Slight decrease in ROE, CFR and profit efficiency after the M&A, but pronounced improvement in cost efficiency → Cost efficiency benefits transferred to clients rather than to shareholders
- Changes in performance are directly determined by the M&A and would have not otherwise occurred
- Changes in performance exhibit a particularly negative trend for cross-border deals → Importance of geographical relatedness
- Before the M&A operation, banks involved in M&A operations (both acquirers and targets) are more efficient and profitable than their peers not involved in M&A operations

## Conclusions

- Before the M&A operation, target banks exhibit weaker performance than acquirers in terms of profit efficiency, CFR, ROE, personnel expenses and operating costs
- Acquirers should tend to direct investments to those countries with a better regulatory quality and a higher freedom from government
- To achieve positive changes in efficiency in the medium-term, transactions should be domestic, paid in equity (not in cash), and result in a combined bank with a higher focus on traditional banking activities

## Support slides

## Unadjusted performance of acquirer and target banks (pre-deal)

- Return on Equity (ROE) = Net income / Total Equity (end of the year); Non Traditional Banking (NTB) = OBS/Total assets; Net margin (NM) = Net income /Revenues (= Interest income+ Commission income + Trading income); Total Operating Expense Ratio (TOER) = Total non-interest operating expense /Total assets; Personnel expense ratio (PER) = Personnel costs / Total assets. ***, **, * T-test respectively statistically significant at 1%, 5% and 10%.

## Unadjusted performance  Comparison of acquirers and targets (pre-deal)

- Return on Equity (ROE) = Net income/Total Equity (end of the year); Non Traditional Banking (NTB) = OBS/Total assets; Net margin (NM) = Net income/Revenues (= Interest income+ Commission income + Trading income); Total Operating Expense Ratio (TOER) = Total non-interest operating expense/Total assets; Personnel expense ratio (PER) = Personnel costs/Total assets.
- ***, **, * T-test respectively statistically significant at 1%, 5% and 10%.

## Adjusted efficiency M&A banks vs. non-M&A banks (by year)

## Adjusted efficiency: M&A banks vs. non-M&A banks (by country)

## Change in ROE (AVG)(pre- vs. post- deal)

**Notes:**
There is no evidence of any gains from M&A from regressions based on industry-adjusted ROE (AVG). 
There is no evidence of any gains from M&A from regressions based on industry-adjusted ROE (AVG). 

## Change in CFR (premia adjusted)(pre- vs. post- deal)

## Descriptive statistics of determinants

- Freedom from government: http://www.heritage.org/research/features/index/; Regulatory quality: _[www.worldbank.org](http://www.worldbank.org/)_