The consolidation of the U.S. banking industry now under way raises at least four broad questions of credit assessment and liability management:
1. Bank merger activity has increased dramatically, and now appears to be entering a regional interstate phase that will precede a final phase of free national competition in financial services. The phased regional consolidation approach involves -- indeed presupposes -- far more extensive merger volume than any other possible regulatory strategy.
The realistic outlook is that the industry will be concentrated by the end of the century, and the survivors will prove to have been those companies which had the most effective acquisitions are already a more important source of deposit and loan growth than are conventional internal growth strategies.
2. Bank acquisition transactions, regardless of the form of payment or other financing used by the acquiror, can themselves be viewed as an important and increasingly prevalent form of "leveraged asset expansion."
An understanding of the financial accounting and economic consequences of mergers is therefore potentially as important for understanding and managing changes in a bank's overall earnings power and soundness as an understanding of the lending and liability management policies and business strategies which guide a bank's historical internal growth through conventional means.
Because merger acquisitions can profoundly affect the acquiring bank's asset and liability structure, it is essential to ask if the tools and insights of professional credit evaluation are sufficiently employed in the development of such transactions.
3. The accounting treatment of business combinations often leads to contradictorily, confusing, or paradoxical results, particularly in the commercial banking industry. Accordingly, there is a need for a clearer understanding of the underlying economics of bank combinations.
4. For the most part, the "credit exposures" associated with bank mergers have been held within acceptable limits by the fact that the great majority of bank acquisitions has consisted, so far, of isntrastate "tactical" mergers, effected on a negotiated basis by parties who are in most cases well known to each other.
However, the industry is entering a new phase of consolidation, which will frequently be marked by larger interstate combinations. In this new phase, we can also expect growing "competition" among potential acquirors, time constraints, and imperfect financial information. In these circumstances, many of the implicit "checks and balances" that have worked to protect acquirors and public investors from merger related credit exposure in the past will not apply. The Backing Framework
It is important to begin our discussion with a grasp of the magnitude and quickening pace of bank merger activity and to establish a probable framework of the conditions under which further bank mergers will be negotiated.
In 1982 the number of bank acquisition announcements increased roughly 50% to 293 compared to the 194 announcements in 1981, itself a record so far as I can determine. If we consider only major transactions, the trend is even more dramatic. According to a recent Fortune magazine article, one study has estimated the total value of major bank merger transactions in 1982 at $3.6 billion as compared to $1.4 billion and $475 million in 1981 and 1980, respectively.
Based on the limited data available for 1983 transactions announced to date, several of which are still in a contested or negotiating stage, we currently project a slight decline in the total number of bank merger announcements but a further increase in the total value of major transactions in 1983.
It is perhaps worth reflecting on the magnitude of bank merger activity in relation to the banking system as a whole. The $3.6 billion value of major transactions in 1982 is equivalent to 88% of the increase in all domestic commercial banks' net assets in 1982 as measured by the Federal Reserve.
Since the increase in banks' net asset is due only in part to retained earnings--for instance, sales of new equity securities or stock issued in acquisitions can also increase the systems' net assets--it woould appear that the value of acquisitions volume may already exceed annual internal capital generation.
Finally, an arbitrary 7.5x ratio of loans to net assets for a "typical" acquiree bank and a "typical" 1.25x multiple of net worth paid by acquirors in major acquisitions would suggest that approximately $22 billion in loans (excluding interbank) were acquired through such transactions in 1982. A Source of Loan Expansion?
It is interesting to contrast this statistic to the $75 billion aggregate increase in loans outstanding registered by all domestically-chartered commercial banks in 1982. In other words, …