Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Understanding the Effects of the Merger Boom on Community Banks

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Understanding the Effects of the Merger Boom on Community Banks

Article excerpt

The merger boom in the U.S. banking industry has caused the number of banking organizations in the nation to fall by nearly a third since 1990. Most of this contraction has involved small community banks, whose numbers have fallen by more than 3,000 banks. A common perception is that most of these small banks are being absorbed by large banks. Their disappearance is raising concerns in many communities because small banks are often a major source of personal services and relationship lending to local businesses and depositors.

In contrast to this general perception, the effects of the merger boom may be quite different. Despite reducing the number of small banks, the merger boom may to a large extent be joining successful small banks with less successful ones, thereby creating stronger, more efficient, and better managed banks.

This article investigates the merger boom in detail, examining who purchased community banks, the relative performance of the merging banks, and the stock price premiums paid for community banks by large and smaller acquirers. The article suggests that the merger boom has the potential to strengthen the community banking sector, as some community banks are taken over by other, more efficiently run community banks located in the same state. Thus, the community banks that have survived the merger boom may be in a good position to continue serving the local businesses and depositors who value personal service and relationship lending.

The first section of the article recounts the fall in the number of small community banks during the bank merger boom and discusses some of the related public concerns. The second section shows that many of the community banks taken over during the boom were purchased by other community banks from the same state and not by larger banking organizations. The third section discusses the characteristics of community banks that merge with each other and provides evidence that these mergers have the potential to create even stronger banks. The fourth section presents additional evidence in support of this view by examining the merger premiums that acquiring banks have been willing to pay over the stock prices of acquired community banks.

I. CONCERNS OVER SMALL BANK MERGERS

The total number of community banks and their share of banking assets have fallen markedly since 1990. This section reviews the evidence of these declines, shows that they resulted from mergers, and discusses some of the reasons for public concern.

The number of U.S. banking organizations has declined by 32 percent during 1990-2006 (Table 1). Banking organizations include bank holding companies and independent banks-thrifts and saving organizations are not included. Small, medium-sized, and large banking organizations are defined as those with assets of less than $ 1 billion, between $1 billion and $10 billion, and larger than $10 billion, respectively, where assets are measured in 2006 prices. For convenience, in this article banking organizations are sometimes referred to as banks. Small banks are referred to as community banks.

Most of the contraction has occurred in the community bank sector. The number of community banking organizations fell from about 9,200 at the end of 1989 to 5,900 at the end of 2006, a 36 percent decline. The share of community banks in total domestic banking assets also declined significantly over the period, from 18.5 to 10.5 percent. In the case of medium-sized banks, the number increased by more than 60 percent, but the share of domestic banking assets nevertheless shrunk (from 15.0 to 9.5 percent). Unlike community banks and medium-sized banks, large banking organizations increased their share of U.S. banking assets significantly during the 17-year period (from 66.5 to 80.1 percent).1

Mergers were the primary reason for the decline in the number and asset share of community banks during the period 1990-2006. This article focuses on those mergers that involved publicly traded banking organizations (either the acquirer or the target or both are traded on the exchanges or over the counter). …

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