Determinants Of Domestic And Cross-Border Merger And Acquisition Activities In Banking Sector
Global announced mergers and acquisitions (M&As) in banking sector rose to a new high record in 2007. Although now M&A activity has been hit notably because of the global financial crisis, it will have different performance in the time of post-crisis. Both China and UK will be the most active M&A areas in the future, especially in the financial service industry. To secure the success in future M&A wave, identifying the right potential targets is crucial.
The purpose of the study is to identify the determinants of bank’s domestic and cross-border acquisitions in China and UK over the two specific periods which are before global financial crisis (2005-2007) and during crisis (2008-August 2009). This study will help bank managers to identify the right targets for future acquisitions and also help policy makers to understand which factors can increase the likelihood of bank acquisitions. Three aspects are examined by employing Logit analysis for the likelihood of domestic bank acquisitions which include bank’s characteristics, market features and regulatory factors. Additional geographic factors will also be considered into cross-border bank acquisitions by using the same model.
The result of this study reveals the determinants of likelihood of being acquired for UK and Chinese banking industry respectively. It also shows the difference of determinants between domestic and cross-border acquisitions, and between the two specific time periods as well for two banking industries respectively. Detailed analysis is also provided for comparing the difference of determinants between China and UK, these two significantly different banking markets.
ABN AMRO, which created as of result of the 1991 merger between Amsterdam Rotterdam (AMRO) and ABN whose history dated back to 1824 and was one of the largest banks in Europe, was acquired by RFS Holdings B.V., a company jointly owned by RBS, Fortis N.V. and Banco Santander S.A. for a consequent amount of 71 billion Euros in October 2007 (Financial Times, 2007). This was the biggest banking takeover in history and together with other deals made global mergers and acquisitions (M&As) rose to a new high of US $ 4.8 trillion in 2007 (Francis and Hasan, 2008). However, the following global credit crunch has created a new international financing and banking network where M&As may be mainly involved as a survival solution for many entities.
This study will examine the determinants of bank’s domestic and cross-border acquisitions both in UK and China, the most active and representative country in developed financial market and emerging market respectively.
Therefore, this chapter will give the overview of UK and Chinese banking industry, then focus on M&A activities, and illustrate objectives and the value of this study.
Global Banking Industry Overview
The global banking industry experienced strong growth before the end of 2007. Assets of the largest 1,000 banks in the world grew 16.3% during 2007 to a record $74.2 trillion (Figure 1). This growth rate is 5.4% higher than the previous year.
Worldwide assets of banking industry
The Banker database)
EU banks held the largest share, 53% in 2006/2007, up from 43% in 1999/2000. And among this, the share of UK banks is always on the top of other EU countries. US banks’ share in term of assets remained relatively stable at the level around 14%. The left shares are from other Asian and European countries (IFSL, 2008a).
However, the global credit crunch which originated in the US sub-prime market impacted the whole financial system world widely. And it came close to collapse in the autumn of 2008, following the failure of Lehman Brothers and the ‘breaking the buck’ of a large US money market mutual fund (MMMF). The subsequent panic was then across global financial markets especially the western world. Although in recent months, market conditions have picked up which improves the outlook for banking systems, there has been a dramatic shift based on market capitalization in global banking industries (Bank of England, 2009). In 2007, the average level of world top 20 financial institutions’ market capitalization was peaked around $125bn, and banks from US and UK dominated the main financial market. However, in 2009, the market capitalization decreased by more than 50% for all financial institutions, and the top three largest ones are all Chinese banks. HSBS, which based on emerging markets at heart, is UK’s sole representative in the list (Figure 2) (Financial Times, 2009a). Banking industry in both UK and China experienced great change through the global financial crisis.
UK Banking Industry
The UK banking industry is a vital and essential part of the UK economy. It has experienced a deep level of restructure since the 1980s which includes regulatory change and banking system reform etc. Four major changes are associated with this restructure: increasing level of competition, both in market and out-of-market; deregulation; increased diversification and acquisitions (Drake, 2001). In 2007, UK banking industry reached a new high record for its assets and contribution percentage to UK economy comparing to other sectors. Assets of UK banking sector reached £6,964bn at the end of 2007, up 11% on 2007. And there were 331 banks authorized to conduct business in UK. The 254 foreign banks physically located in the UK which is more than in any other country (IFSL, 2008a). Banking industry accounted for 7.6% of UK GDP in 2007, increased from 5.7% in 1997 (IFSL, 2008b).
However, the following global financial crisis impacted the UK banking industry materially. During 2008, the return on the major UK banks’ total assets turned negative and the impact of this on return on equity was amplified by banks’ high level of gearing (Figure 3). Meanwhile, the mark-to-market losses of major UK banks’ book assets roughly doubled between October 2008 and January 2009, exceeding fresh capital raising over that period which partly reflected increase in expected losses (Figure 4) (Bank of England, 2009). But in recent months, market conditions have been improved, and it can be expected that UK banking industry which experienced restructuring and changed policies on bank regulations during the crisis will seek substantial domestic and cross-border business opportunities afterwards to strength its position in global financial market which gives great potential for M&A activities (Economics Outlook, 2009).
Bank Of England, Bloomberg)
Chinese Banking Industry
China’s economy has been growing about 8% per year in real terms over the last decade. Even during the financial crisis, the Chinese economy continued to grow in a steady way (People’s Bank of China, 2008). This rapid growth may be largely linked to the globalization of trade, but China has yet to ‘globalize’ its banking sector.
The Chinese banking industry was dominated by four large state-owned banks with about 80% of industry assets, and very few foreign banks before WTO entry in December 2001. After 2001, the existing regulations and laws such as the Central Bank Law and Commercial Bank Law were revised to be aligned with the WTO agreement. There will be more liberalization of interest rates, more fair treatment of tax rates, less restrictions on ownership of takeovers and M&As, and great freedom of operational and geographical scope in the Chinese banking industry (Berger et al., 2009). In 2003, China Banking Regulatory Commission (CBRC) updated guidelines to encourage foreign share purchases. Foreigners then can own up to 25% of any domestic bank, with the ownership from any one investor allowed between 5% and 20%. This led to a historical high level of cross-border M&A activities in Chinese banking industry later on (CBRC, 2005). At the end of 2007, total assets of banking institutions increased by 19.68% to RMB 52.6 trillion than 2006. And the reform and opening up of Chinese banking industry continued to advance, the assets share of large state-owned commercial banks decreased from around 80% in 2001 into 53.25% while others includes foreign banks increased into 15.98% (Figure 5). This indicated that Chinese banking industry encouraged foreign investors more than before which gave big potential for further cross-border M&As in China.
People’s Bank Of China)
Even in 2008’s special context, Chinese banking industry followed the reform strategy and promoted the reform and opening up policy of banking industry, and its total bank assets amounted to RMB 62.4 trillion, 18.7% higher than in 2007 while most banks in western world decreased their bank assets by more than 50%. The Chinese banking industry took the financial crisis as an opportunity for further reforms, development and finally achieving globalization in banking sector (CBRC, 2009). This growth trend also provides great potential for both domestic and cross-border M&As in China which can help strength the market position and substantial development for Chinese banks.
The Merger And Acquisition Market
There are two primary mechanisms by which ownership and control of a public corporation can change: merger and acquisition. In both cases, the acquiring entity must purchase the stock or existing assets of the target either for cash or for something equivalent value (such as shares in the acquiring or newly merged corporation). Mergers and acquisitions (M&As) are part of what is often referred to as ‘the market for corporate control’ (Berk and DeMarzo, 2007).
The global merger and acquisition market is highly active, averaging more than $1 trillion per year in transaction value. Global announced mergers and acquisitions (M&As) rose to a new high of US $4.8 trillion in 2007, up 23% from US $3.9 trillion in 2006. Since the increasingly fierce competitions in banking sector during this time, banks conducted large-scaled M&A within and across the border in aim to expand operation and enhance competitiveness. In 2007, M&As in banking increased 32.5% from US $543 billion in 2006, was again the most active sector for M&As (Francis and Hasan, 2008). But M&A activities correlate with bull markets and are often greater during economic expansions than during contractions.
During the past year when global banking industry was suffered by the credit crunch which originated in the US sub-prime market, M&A activities were hit notably in financial service sector. The worldwide M&A volume decreased significantly during the end of 2007 and the beginning of 2008. But, against all the negative factors, the trend of selective M&A still exists as ‘acquirers take advantage of the lower market valuations to strengthen their business with synergistic deals’ and ‘the ongoing strength of emerging market’ (Financial Times, 2009b). From August 2008 by monthly comparison, the M&A volume increased again increased gradually and kept vibrating. On average, the announced deal number is around 3,000 and total rank value is about $160,000 million per month (Figure 6).
Thomson ONE Banker Database)
M&A Activities In UK Banking Industry
Banking industry is the most active sector in M&A market. And UK, despite of US, is more involved in M&A process than any other EU country in financial service industry (Ahammad and Glaister, 2008).
During 1999 to 2007, the number of UK incorporated banks which include commercial banks, investment banks, foreign owned banks and banks operated by retail companies declined from 200 to 157 mostly due to the severely competition and M&As in its banking industry (IFSL, 2008). Also, the rapid economic expansions during this period drive peaks in both domestic and cross-border M&A activities in UK banking industry (Harford, 2008). At the end of 2007, the total announced M&A deals in UK financial industry was 1,806, which represented as 38.3% of all M&A deals announced in this year. And among 1806 ones, UK banking industry contributed significant amount of deal values comparing to other financial sectors.
However, the following global financial crisis hit the UK banking industry significantly. Although the number of M&A activity is less during economic contractions than expansions, it still has its market due to various business strategies. There were 79 M&A deals totally in UK banking industry for 2008, and the number for 2009 as so far is 35. According to Economics Outlook, the post-crisis restructuring, recapitalization and seeking for re-strengthening business positions in UK banking industry will provide substantial opportunities for M&A activities both domestically and internationally. This will produce an urgent demand for identifying right potential merger and acquisition targets which gives great practical value for this study.
M&A Activities In Chinese Banking Industry
While the economic market get more international and worldwide, to be globalization has become an irreversible trend for all nations in the world, especially for developing countries (Bonin and Hasan, 2005). Although Chinese banking industry has achieved sustainable development during these years even in the global financial crisis, it’s still far away from globalization.
Entry to WTO in 2001 and new policy for foreign investment in Chinese banking industry in 2003 brought momentums for encouraging Chinese banks to participate in global competitions. To strength their own positions in global financial market, most Chinese banks took actions of within or cross border M&A activities which led by Industrial and Commercial Bank of China (ICBC) acquiring 20% share of South Africa’s Standard bank for $5.6 billion, the largest M&A deal in Chinese banking industry in 2007 (Munroe, 2008). Further opening up in Chinese banking industry also attract strategic foreign investors invest in Chinese domestic banks through M&As. At the end of 2007, foreign financial institutions invested in 25 domestic banks totally through partially acquisition (People’s Bank of China, 2008).
With the rapid development and increased opening-up of Chinese banking sector, banks’ M&A activities will be increasingly active. According to People’s Bank of China, effort will be made to vigorously support qualified commercial banks to conduct M&A and create favourable policy environment based on international experiences to encourage cross-border M&As in China. Moreover, the ongoing strength of Chinese economic will help to fund or attract domestic and overseas acquisitions in China (Wilson, 2008). It can be expected that China will be the most active M&A area in the emerging market in future.
To sum up, both UK and Chinese banking industry have the great potential for future M&A activities. To secure the successful performance in the present and future M&A waves in order to obtain sustainable business growth, identifying the right potential acquisition targets is crucial (Rossi and Volpin, 2004). However, investigating the relationship between bank and the features of market where banks are within and the likelihood of being a right potential acquisition targets in banking industry is relatively under-researched(Pasiouras et al., 2007). And it will be interesting to investigate and compare the determinants of potential M&A targets between UK and China’s banking industries which have significant differences in characteristics, and also for two special periods which are before and during the global financial crisis.
Research Objectives And Value
The purpose of this study is to identify the determinants of bank’s domestic and cross-border acquisitions in China and UK, and detailed analysis will also be provided for the difference of determinants between China and UK, the two relatively different banking sectors. Moreover, it will compare the difference between two time periods which are before global financial crisis (2005-2007) and on crisis (2008- August 2009).
Three aspects will be examined for the likelihood of domestic bank M&As which included bank’s characteristics, market characteristics and management incentives. Another two aspects which are geographic factors and regulatory barriers will be also considered in cross-border bank M&As. Same Logit analysis model will be employed to analyze the domestic and cross-border M&As for the purpose that the comparisons have the same base.
This study has the value for bank managers in China and UK to identify the most suitable targets or to check if their own bank has developed a profile that similar to typical target. And also, it’s meaningful for policy makers to understand which factors would increase the possibility for bank acquisitions (Scott, 2007).
The study has the originality in three aspects. First, it combines all the important factors that will influence the likelihood of acquisitions in banking industry and distinguishes the domestic and cross-border acquisitions according to the gaps in the literatures. Second, this study investigates and compares two important banking sectors (China and UK) which haven’t done by any researchers before. Last but not the least, this research focus on bank acquisitions over a most recent time period, from 2005 to August 2009, which is the period includes prior global financial crisis when M&As rose to a new high record and on-crisis period. This differs from the prior studies that focused on earlier time periods and will reflect the new trend for M&As. According to Hagendorff et al. (2008), the more recent M&As may be qualitatively different from those in earlier periods which suggests that studies focusing on more recent M&As may provide more relevance to likely future takeovers.
The relationship between the bank and features of the market where banks are within and the probability that a bank will be a potential target remains an open question (Cyree et al., 2000; Wheelock and Wilson, 2000). Few studies in the literature have examined the major features of banks which are acquired by other organizations (Hannan and Rhoades, 1987; Moore, 1996; Hadlock et al., 1999; Wheelock and Wilson, 2000, 2004) are focused on the US market, while Pasiouras et al.(2006), Shen and Lin (2007) and Hernando et al.(2009) have studied the Greece, Asia and EU banking industry respectively.
Gaps In Previous Studies
Hanna and Rhoades (1987) examined the likelihood of an acquisition based on the banks performance using a sample which was consisted 1046 acquired and non-acquired banks in Texas between 1970 and 1982. The results showed that market concentration and high capital asset ratios have negative relationship with the probability of bank’s acquisition. Moore (1996) also investigated the characteristics of US banks acquired between 1993 and 1996 using multinomial logit analysis. However, both studies mainly focused on financial characteristics of banks, but ignoring the external factors such as regulations. Based on these, some other studies focused on the search of the best predictive variables included bank characteristics, market features and regulatory factors (Bartley and Boardman, 1997; walter, 1998; Cudd and Duggal, 2000).
Hadlock et al. (1999) researched a sample of 84 acquired and non-acquired US banks during 1982 and 1992 by employing both univariate and multivariate methods to identify the determinants of acquisitions. However, the variables they analyzed mainly focused on the management incentives. In more recent studies for US banking sector, Wheelock and Wilson (2000, 2004) used proportional hazard models and a two-part hurdle model by collecting massive amount of available data and employing relatively comprehensive variables included financial, market and regulatory factors to investigate the determinants of likelihood of bank’s acquisitions. They found that regulatory approval process and market concentration are negatively related to the likelihood of M&A activities, while management incentives, location, banks’ size, and capital strength are positively related. However, they didn’t identify the difference of determinants between domestic and cross-border acquisitions.
More recently, Pasiouras et al.(2006) investigated the Greece banking industry to analyze the determinants of bank acquisitions, but they ignored the management incentives and corporate governance factors due to lack of data available. In a later study, Parisouras and Gaganis (2007) also investigated the financial characteristics of bank acquisitions covering the 5 principal EU banking sectors (France, Germany, Italy, Spain and UK). However, they didn’t distinguish domestic from cross-border takeovers in their studies.
Shen and Lin (2007) studied the determinants of financial institutions which engaged in cross-border M&A activity before and after the 1997 Asia financial crisis. They found that regulation barrier and market opportunities have less impact on the takeovers after crisis while geographic factors are important determinants both prior to and post Asian crisis.
Hernando et al. (2009) analyzed the determinants of bank acquisitions both within and across 25 members of the European Union during the period 1997 to 2004. Their results suggested that determinants of domestic and cross-border takeovers appear to be different in several aspects such as market concentration and profitability of banks performance. However, they examined all the variables according to the experiential model which generated from the US banking sector. The model can be argued if it is applicable to the EU banking industry. Other studies about the determinants of bank acquisitions mainly focused on the search of the most effective empirical method for the development of the prediction models (Cheh et al., 1999; Doumpos et al., 2004; Espahbodi, 2003).
This study is based on previous research, and will cover the above identified gaps which include examining domestic and cross-border M&As respectively by using the same Logit analysis model, studying the two typical and representative banking markets in UK and China, and analyzing all the various factors typically found to be the most likely determinants of bank M&A activities in the literature. And these factors will be detailed in the following section related to previous studies.
Possible Determinants Of Banking M&As In Literature
Seven factors of bank features are mainly analyzed in the literature which are related to the likelihood of being acquired.
The main motive underlying acquisitions is the target bank is underperforming. The inefficient management hypothesis (Manne, 1965) argues that if management can’t maximize the shareholders’ wealth by using the resource it has, then the firm is more likely to be acquired so the inefficient management will be replaced. Then there will be the space for the acquirer to improve the performance and efficiency of target and increase total profitability. Therefore, indicators of bank performance should contain explanatory power on the likelihood of being required. But the empirical results are mixed. Hannan and Rhoades (1987) found no evidence to support this hypothesis while Moore (1996), Focarelli et al. (1999), Wheelock and Wilson (2000), Pasiouras et al. (2006) and Hannan at el.(2007) found that less efficient and profitable banks are more likely to be acquired.
However, while underperforming banks may provide greater opportunities for further improvement of profitability, they are also more risky, especially if the source of the underperformance is a high level of loans (Hernando et al, 2009). Hannan and Rhoades (1987) demonstrated that a high level of loans would indicate the aggressive business strategy of target bank and a penetrated and strong established client networking which will make it more attractive as a target while a bank with a low level of loans due to its conservative management may also be attractive to the acquirers since acquirers can use more aggressive way to increase returns of the target. And they found loan activity was negatively related to acquisition likelihood but not ‘statistically significant’. But Moore (1996) found a negative and significant relationship for both in-market and out-of-market acquisitions. Moreover, the results of Wheelock and Wilson’s studies (2000, 2004) were mixed. They found it depended on the specification of the estimated model, in some cases it was negatively related but in others, it was positively related with not always statistically significance.
As stated by Pasiouras et al. (2007), liquidity is an additional factor that can affect the attractiveness of banks as targets since ‘the process of managing assets and cash flow to maintain the ability to meet current liabilities as they come due’ is an important decision for managers. This argument is supported by Wheelock and Wilson (2000) in their study. But it is also possible that some banks be acquired because they have liquidity issues and turn to help to acquirers. In the study of Pasiouras et al.(2007), it found no significant correlation between liquidity and likelihood of being acquired.
Another important bank characteristic for likelihood of being acquired is the capital strength while there are different hypotheses associated with this (Hernando et al, 2009). Several hypotheses predict a positive relationship between banks’ capitalization and the likelihood of involving into acquisitions. One is that if high capitalization indicates inefficiency of a bank to diversify its assets, then better diversified acquirers will be attracted by such banks. Another one is that if acquirers face regulatory pressure of capital requirement, they may seek highly capitalized targets. Finally, banks with high capital ratios may be operated further below their potential profit due to less pressure to managers. While on the other hand, some hypotheses predict a negative relationship. One of them is an acquisition by a well capitalized acquirer might be stimulated by the supervisor if the target has low level of capitalization. And Hanna and Prilloff (2007) also argue that ‘acquirers prefer low capitalized targets because it enables them to maximize the magnitude of post-acquisition performance gains relative to the cost of achieving those gains’. The empirical results for this are mixed as well. Akhigbe et al. (2004) found a positive relationship between capitalization and the likelihood of being a target in study of publicly traded banks in the U.S. While most studies found the relationship is negatively related (Hanna and Pilloff, 2007; Lanine and Vander, 2007; and Pasiouras et al., 2007).
Bank’s size is another characteristic which may influence the likelihood of being acquired. Smaller banks may be more attractive to the acquirers since it’s easy to finance and even integrate after the acquisition. However, if the acquirer is seeking economies of scale or market power through acquisition, especially for the cross-border acquisitions, size may have a positive influence on the likelihood of being acquired. Hannan and Rhaodes (1987) and Moore (1996) have not found a significant relationship between bank size and the probability of being a target while Wheelock and Wilson (2000), Focarelli and Pozzolo (2001) and Hannan and Pilloff (2007) find that larger banks are more likely to be acquired when they estimate their model using full samples. Lanine and Vander (2007) and Pasiouras et al. (2007) also have positive results in their studies. But Hanna and Pilloff (2007) also point out that for the acquisitions by smaller banks, larger banks are less likely to be acquired due to the difficulty of post-acquisition integration.
Market share is an additional variable for the reasons of M&A activities. Bodie et al. (2008) argues that market share is one of the most important factors which impact the acquirer’s decision in domestic and cross-border acquisitions in banking industry. It is similar to the variable of bank’s size, but provides a relative standard to evaluate the target comparing with others in the same industry. In the banking industry, a bank with small share is likely to be acquired since only banks with substantial market share can compete effectively and the assets of banks with smaller shares will be more valuable after being acquired by the large bank. But regulatory concerns about anti-monopoly for banks with large market share will give the negative effect on the likelihood of being acquired and high market share. The empirical results for this factor are mixed as well. Moore (1996) and Pasiouras et al. (2007) found that it is significantly and negatively related with the probability of acquisition in in-market M&As while Hanna and Rhoades (1987) found it has positive impact on the acquisition probability.
Finally, prospects of bank’s future growth can affect the acquirers’ M&A decision as well. Banks which experience high growth may be more attractive to the acquirers as potential gains raised from the expanding markets after acquisition can be expected more than before. Consistent with this hypothesis, Hannan and Rhoades (1987) and Cheng et al. (1989) find that the likelihood of acquisition is positively related to the potential growth rate of the assets of the target banks in their studies of U.S. banks in 1980s. However, Moore (1996) argues that slower growing banks may attract a buyer who is looking to increase the target’s growth rate through efficient management. Together with Moore (1996), Pasiouras et al. (2007) find a negative relationship between bank’s growth rate and the acquisition probability. But Hanna and Pilloff (2007) and Lanine and Vander (2007) do not include this variable into their studies.
Three main independent factors are discussed in literature about market characteristics which may influence the acquisition probability of a particular bank.
First one is market concentration. Through the impact on bank competition, the degree of bank market concentration potentially affects the likelihood of acquisitions. Increased concentration may increase the attractiveness of the target banks in that market. But buyers that would want to increase the concentration further may face the pressure from anti-monopoly authorities (Hernando et al, 2009). Hanna and Rhoades (1987) found there is a negative relationship between market concentration and the takeover probability for out-of-market acquisitions while it is significantly positive for in-market acquisitions. Moore (1996) found no statistically significant relationship between them for in-market takeovers but a positive sign for out-of-market ones. Hannan and Pilloff (2007) also fail to find any statistically significant evidence that market concentration is a determinant of takeover targets. However, Pasiouras et al. (2007) stated a significantly negative coefficient on the five large banks concentration ratio in their sample of European takeovers.
Harford (2008) argues that there is a correlation between industry profitability and M&A activities within this industry. M&A deals are often greater in more profitable industries than those less profitable ones. According to Thomson ONE Banker database, there are less M&A deals in UK banking industry in 2008 than ones in 2007 when the whole banking industry was experienced the global financial crisis. This also gives the evidence that the level of industrial profitability has the positive relationship with the likelihood of acquisitions. However, Ali-Yrkko (2002) points out that in the beginning of 1990s, the entire banking was restructured due to the extremely deep bank crisis with large bankrupts. Low profitability may be one of the main reasons which lead to higher level of acquisitions in banking in