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Large banks also tend to carry a diversified loan portfolio, exposed to a wide-range of creditors and geographic areas, thus losses can be absorbed more easily. For example, Florida and Georgia alone saw 60 and 78 bank failures since the start of the financial crisis in 2008, respectively; the highest among all states, making up 32 percent of total bank failures in the U.S. Still, the impact of a large crisis on the scale we recently witnessed can cause even large institutions to come under financial pressures, leading to
an eventual collapse. That being said, small banks made up 82 percent of total failures since 2008 (Exhibit 2).
Compliance costs alone can become overly burdensome for small firms with only a handful of employees. Since 2008, many new regulations have been put in place. For example, the Dodd-Frank Act of 2010 was 848 pages before the thousands of pages of rules were even written. Compare that to just 29 pages for the creation of the U.S. banking system in 1864, The burden of 32 pages for the Federal Reserve increasing Act of 1913 and 37 pages for the compliance costs on Banking Act, which transformed American finance through Glasssmall firms will Steagall in 1932.1 The increased provide the incentive burden of compliance costs on small for greater firms will provide the incentive for greater consolidation. consolidation.
The Dodd-Frank Act, Too Big Not to Fail. The Economist. February 18, 2012.
In a 2008 study, the Small Business Administration calculated that small businesses paid 37 percent more than the regulatory cost paid by larger firms (defined as firms with 500 or more employees) (Exhibit 3).2
As long as cost reductions, increased profitability, diversification and costeffective management of regulatory compliance favors larger firms, small companies will continue to strive for growth through mergers.
Crain and Crain. The Regulatory Impact on Small Firms The Small Business Administration. September 2010. 3 Summary Tables. Federal Deposit Insurance Corporation. June 30, 2011.
4). Therefore, all other banks have collectively lost 17 percentage points in terms of market share.
Mergers also contributed to the build-up in deposits at large banks. Just 208 bank deals in 2008 (the decade low at the time) were for an industry total of $742 billion in deposits; the most in U.S. history (Exhibit 5). As the financial system neared collapse in 2008, many large banks stepped in to buy troubled peers. According to Jaret Seiberg, a respected Washington Regulators were said D.C.-based financial services policy analyst, regulators used any excuse to use any excuse to sign off on deals due to the severity they could to sign off of the crisis, violating maximum size on deals due the rules in the process. This was in reference to the Bank of severity of the crisis. America/Countrywide deal ($57.75 billion in deposits).4 Other notable deals at the time were Wells Fargos acquisition of Wachovia ($447.79 billion in deposits), JPMorgan Chases governmentassisted acquisition of Washington Mutual Bank ($159.87 billion in
4
Carter. Will Bank of America Dodge a Deposit Cap Bullet in the Countrywide Deal? SNL Financial. January 11, 2008.
deposits) and PNC Financial Groups acquisition of National City ($95.81 billion in deposits).
Since the crisis, deal activity has remained below historical levels as sellers are slow to accept low premiums and buyers are reluctant to use cash with uncertainty surrounding regulatory policy and economic volatility (Exhibit 6). Many in the industry believe there is pent up demand for deals, which will take hold in the coming years. This is particularly relevant for small and mid-sized players as slow growth in the U.S. lending market and Consolidation has post-crisis tightening of lending made markets more standards has driven down profitability. Moreover, new regulation concentrated, thus requiring higher capital levels will only making it more likely squeeze lending further. Therefore, for anti-competitive while M&A activity is down, regulation and market fundamentals should issues to arise. incentivize increased M&A activity as the economy recovers.
In sum, although banks of all sizes have grown over the past decade in absolute values, the largest banks have benefited most. Whether viewed as positive or not, it is relevant as to how the banking industry will change going forward.
Policy Measures to Address Systematically Important Financial Institutions. Financial Stability Board. November 4, 2011.
Dodd-Frank went further by putting pen to paper, requiring the Federal Reserve to provide further system-wide risk examinations for the largest institutions through regularly conducted stress tests of the largest bank holding companies with the results publicly released. Concerns of too-bigto-fail were recently brought to light through the Federal Reserves financial stress tests (CCAR 2012). These tests targeted the largest bankholding companies in the U.S. holding $50 billion or more in assets, calculating their hypothetical capital levels in the event of a world-wide crisis leading to a depression. The Fed publicly released the results for the largest 19 banks, which underwent a similar test the year prior. Fifteen of the 19 banks passed the review, allowing those who passed to use excess capital for dividends and share buybacks; however, it also incited concerns over the four that did not pass, and if methods used for those that passed were tough enough.6 An example of increased regulatory scrutiny for larger banks can be seen in the amount of time it takes for a deal to complete. This analysis includes over 2600 bank deals announced and completed since the year 2000. While, on average, deals for banks with assets ranging in size between $1 to $10 billion take 31.5 days longer than for deals less than $1 billion, The time it takes for deals for banks with assets of greater deal completion than $10 billion take 74.2 days longer increases with the for those on the lower end to complete (Exhibit 7). Only in 2008, under size of the deal. abnormal financial stress, did larger Medium-sized bank deals take a shorter amount of time to deals take 31.5 days complete. A culmination of increased market concentration and a public wary of too-big-to-fail has caused the deal process to lengthen. Expect this trend to continue as the market for deals picks up steam.
longer, and large bank deals take 74.2 days longer than deals for small banks.
Barofsky on Federal Reserve Bank Stress Tests. Bloomberg Businessweek, May 14, 2012.
It is an important takeaway that longer periods for deal completion have come at a time when deal activity is at a historic low point. There are increased costs to the merging parties when a deal is delayed. Also, the increased time allows interest groups to voice their support or concerns to wider audiences. Its unknown if this is correlation or causation; most likely, its a mixture of both. However, it can be assumed that it has implications on approval and concessions made prior to deal completion.
extended the public comment period7, providing interested persons more than 85 days to submit written comments. Also, because of the extensive public interest, the board held public meetings in Washington, D.C., Chicago, IL and San Francisco, CA. A total of 915 individuals and organizations submitted comments on the proposal. A wide range of groups attended the hearings, including member of Congress, state legislators, community groups, nonprofits, customers and others interested parties. Both pro and anti-merger groups contributed to the public debate. Upon examination, the agency determined that the deposit-taking and lending operations of the merging banks were located in different banking markets; therefore, it did not effectively violate the thresholds set in the Herfindahl-Hirschman Index (HHI) analysis. The Fed also cited that the Dodd-Frank Act recently amended the BHC Act on Interstate and Deposit Cap Analysis, stating that a bank cannot acquire another bank outside of its home state and have a U.S. deposit market share of over 10 percent. Many large bank deals in 2008 would have breached this rule. Postmerger, Capital One would only hold 2.3 percent of the U.S. market; therefore the deal passed this test. Although regulators extended the approval period, allowing opposition groups to rally support around nonapproval or concessions, the deal was eventually approved. In its statement, the Federal Reserve concluded that no further public comment period was necessary, as The commenters requests fail to identify disputed issues of fact that are material to the Boards decision.
Opposition groups failed to identify disputed issues of fact that were material to regulators in the Capital One/ING FSB merger.
Justified only by public concern, the deal took 246 days from announcement to completion, 1.5 times, or 84 days longer than the historical average for deals greater than $10 billion in size.
Sims and White, Capital One/ING Deal 'Toxic' or 'Blessing?' Depends Whom You Ask. SNL Financial. September 20, 2011.
economists, many of whom may have worked for the Fed, Department of Justice (DOJ) or Federal Trade Commission (FTC) in the past, to present arguments to these same agencies. Often overlooked is how public opinion of deals can influence policymakers, which in turn provides significant influence on regulatory policy. A carefully crafted and coordinated message with insightful fact-based research is the favored approach. The HPS framework for establishing a regulatory competitive advantage is simple in thought, and more complex in implementation (Exhibit 8).
1. Deal Analysis The first dimension, in the upper-left corner of Exhibit 8, is an analysis for regulatory consumption. This involves calculations of efficiencies (cost-savings), synergies (revenueenhancements), competitive review (HHI Analysis) and precedent arguments. Most often, the groups representing this aspect of the deal framework are anti-trust law firms, economists and other thought leaders that can provide significant insight due to their experience in the profession. Their role is to influence regulatory agencies through complex analysis presented to lobbyists on their behalf.
2. Fact-based Research The second dimension, in the lower-left corner, represents the analysis for public consumption. Most often, the deal analysis used to influence regulatory policy lacks simplicity; it is not plain English. There is significant value in providing fact-based research; and, in combination with the grassroots campaign presented in section three, it can provide the necessary influence on public perception, and therefore, the regulatory process. It is ideal for the provider of this fact-based research to closely align with the interest groups, coalitions and influencers that make up the grassroots campaign so that all lines of communication are on message. A third-party analysis is recommended as this will ensure unbiased reporting and a commitment to accuracy. 3. Grassroots Campaign The third dimension, shown in the lowerright corner, is the public relations campaign, which often involves grassroots marketing, advertising and targeted media outreach for public-interest groups and capitol influencers. Again, the providers of the fact-based research will closely align with the grassroots campaign in order to streamline messaging through analysis. 4. Lobbying Efforts The fourth dimension, shown in the upper-right corner, is where the combined efforts of all the other dimensions come to head. This is where the federal agencies will order approval, denial or award concessions. The role of the agencies is to ensure competitive markets, and ultimately, a protected consumer. As the merger process lengthens due to external factors, there is a unique opportunity to provide a compelling case so that a firms voice is heard.
Conclusion
In the wake of the financial crisis and in the face of increased costs associated with new regulations, the U.S. banking industry will continue to consolidate. Although the amount of deal activity has remained slower than expected in recent years due to reasons cited in this report, small and mid-sized firms will continue to dominate among consolidators. These same firms will have an advantage over their larger peers in receiving regulatory approval as their combination will be less likely to trigger anticompetitive signals.
Larger firms that do an effective job at communicating merger benefits and seek to calm public anxieties about the notion of too-big-to-fail will also find the path to approval an easier one. Likewise, interest groups and coalitions that effectively voice their concerns will garner support.
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