AN EXAMINATION OF BANK MERGER ACTIVITY:

A STRATEGIC FRAMEWORK CONTENT ANALYSIS

Cheryl Frohlich, University of North Florida

Cfrohlic@unf.edu
C. Bruce Kavan, University of North Florida
Bkavan@unf.edu

ABSTRACT

Over the last decade, bank mergers and acquisitions have been occurring at an unprecedented
rate. The purpose of this study is to determine the underlying and driving forces or causation
based upon examination of resent banking merger activity. A content analysis was performed
utilizing the FDIC Applications for Merger/Acquisitions from 1996 and 1997. Since previous
research has not employed the content analysis approach, this study offers a fresh approach to
identifying the driving motivators behind the banking merger activity. The coding scheme
adopted for this content analysis was conceptualized in the Porter strategic model (Porter,
1980) as operationalized in a “fishbone” analysis framework (Nolan, Norton & Company,
1986). This approach utilizing the Porter Model worked well in determining the rationale behind
the merger/acquisition activity for the banking industry. For the period examined, there are four
main paths identified that explains the reasons behind the mergers/acquisitions activity. These
four paths are related to (1) creating economies of scales, (2) expanding geographically, (3)
increasing the combined capital base (size) and product offerings, and (4) gaining market
power. In examining the paths, it appears that, at a much higher level in Porter’s “fishbone”
framework, the mergers are driven by cost reductions rather than by increasing gross revenue.

INTRODUCTION
Over the last decade, bank mergers and acquisitions have been occurring at an
unprecedented rate. From 1990 through 1998, the number of banks has dropped from 12,347 to
8,774 banks resulting in a 28.9% decline. During this same period, there have been 4,625
unassisted mergers with only 569 failures. Thus the major contributor to the 28.9% decline in
the number of banks is likely attributable to the merger activity within the industry.
The perceived motivation drivers for this merger activity are generally considered to be
the acquiring banks' desire to increase its return by expanding geographically. This perception is
similar to Stewart’s premises of merger motivation. According to Stewart (The Quest for Value,
pp375-383), the actual motivating forces behind mergers should be ones that will (1) increase
financial performance (net operating profits), (2) financial benefits through borrowing against the
seller’s unused debt capacity or against an increase in the consolidated debt capacity (lending
capability for banks), and (3) tax benefits derived from expensing the stepped-up basis of assets
acquired or from the use of otherwise forfeited tax deductions or credits.

CONTEXT FRAME
Stewart’s merger motivation theory of increasing financial performance (net operating
profits) is largely accepted as being a merger motivator within the banking industry. An increase
in net operating profits may either be derived from cost savings or increase in revenue. Many of
those involved in the bank mergers agree that cost savings are a significant reason for the
activity. Downsizing (Craig, 1997) and global consolidation allowing banks to increase size and
market capabilities while creating technological efficiencies (Investor’s Chronicle, 1997) are
largely responsible for the cost savings of mergers. However, the research results on the financial
performance of the merged banks have resulted in conflicting conclusions. While some research
has found bank acquisitions are not improving the financial performance of the combined banks
(Baradwaj, Dubofshy, and Fraser, 1992; Palia, 1993; Hawawine & Swary, 1990; Toyne & Tripp,
1998; Madura and Wiant, 1994), other research has resulted in opposite conclusions (Cornett &
De, 1991; Chong, 1991; Cornett and Tehranian, 1992; Subrahmannyam, Rangan, & Rosenstein,
1997).
A non-financial (at least an immediate non-financial) merger motivator has long been
believed to be geographic diversification. The geographic diversification is an attempt to
increase the bank’s market, decrease its risk, and in the long run increase profits. Prior to the
Riegle-Neal Interstate Banking and Branching (IBBF) Act of 1994, which allowed bank holding
companies to acquire banks in any state after September 29, 1995 and allowed mergers between
banks located in different states after June 1, 1997, banks were not allowed to expand across
state line (with some exceptions). After Riegle-Neale Act, banks have the full freedom to acquire
another out-of-state bank in order to expand geographically across state lines and to diversify
geographically. The unassisted merger rate has increased since the IBBF Act. This increase in
merger rates would seem to lend credence to the geographic motivator behind bank mergers.
Besides geographic diversification benefits, Stewart’s merger motivation theory of
financial benefits derived from the consolidated debt capacity of the newly merged banks may be
an additional merger motivator. As the banks merge and their capital base enlarges, their
combined lending ability increases and they are able to offer larger loans without soliciting
additional participation from another bank partner. Thus, the bank is able to possibly increase
market share and revenue while decreasing competition.
However, the growth in the asset base of the nation’s banks through this merger activity
produces the increased risk of financial harm to the economy. If a large asset based bank should
fail, the bank’s failure might bankrupt the banking industry’s insurance fund. The ripple effect of
the failure and subsequent bankruptcy of the insurance fund would cause panic throughout the
nation. With the crisis involving Continental Illinois National Bank and Trust Company in May
1984, which was and still is the largest resolution in US history, and its subsequent resolution by
its regulatory bodies, the government policy of “Too Big to Fail”(TBTF) was born. If banks
reached a “magical size, the regulatory bodies would deem them to be too big to liquidate and
thus many banks began to earnestly merge or acquire in order to reach the TBTF size. Therefore,
an additional merger motivator behind the desire of banks to increase in their capital base may be
the notion that regulators would not allow banks of a certain size to fail. Although, after the
passage of the Federal Deposit Insurance Corporation Act of 1991, the “TBTF” motivation
should have decreased in importance, some researchers still found that the “TBTF” was an
important motivator in the larger mergers of the 1990’s (Benston, Hunter, and Wall, 1995;
Hunter and Wall, 1989; Boyd and Graham, 1991).

METHODOLGICAL CONSIDERATIONS
To more fully explore the rationale behind the recent merger activity, a content analysis
was performed utilizing the FDIC Applications for Merger/Acquisitions from 1996 and 1997.
The unit of analysis was each independent merger/acquisition application. The FDIC provided a
random sample of the merger/acquisition applications.
 The coding scheme adopted for this content analysis was conceptualized in the Porter
strategic model (Porter, 1980) as operationalized in a “fishbone” analysis framework (Nolan,
Norton & Company, 1986). The coding of the content of application closely approximates the
use of a standardized questionnaire. Thus, content analysis has the advantage of both ease and
high reliability, but may be more limited in terms of content validity to the extent that the
applications closely reflect the underlying stated merger decision rationale. However, since the
merger/acquisitions within the banking industry must provide certain data (i.e. Community
Reinvestment Act compliance or Herfindahl Indexes) to reinforce the merger/acquisition stated
rationale, there may be more validity in the stated rationale for mergers/acquisitions of this
industry than in others using this approach. The use of the widely accepted Porter strategic
model provides an appropriate framework for both inductive and deductive conclusions. In
addition, it provides a tight linkage to the strategy literature for validity of the coding categories.
Furthermore, the use of multiple coders and a referee insure a high degree of reliability in coding
effort.
For each application, two coders independently coded each paragraph and the results
entered into a spreadsheet for data management purposes. The results of the two coders were
then compared, and, if there were any disagreement, the referee discussed the differences with
each of the coders and made a final determination. For each application, a resultant tabulation
was created and overlaid upon the fishbone for visual inspection. Figure 1 contains the total
numerical count for the entire sample.
For purposes of these proceedings, we will limit our analysis to an explanation of the
results based upon simple description. However, it is our intent to model the data utilizing
Categorical Discriminate Analysis

CONCLUSIONS
Although banks have maintained that many frameworks used for analysis of other
industries often do not work within the banking industry due to imposed regulatory constraints,
Figure 1 reveals that the Porter Model does work well in examining the rationale behind the
merger/acquisition activity for the banking industry. It can be seen from the Figure 1 that there
are four main paths, for the period examined, that explains the reasons behind the
mergers/acquisitions activity. These four paths are related to (1) creating economies of scales, (2)
expanding geographically, (3) increasing the combined capital base (size) and product offerings,
and (4) gaining market power.
It appears that decreasing costs rather than increasing gross revenue drives much of the
merger activity at a higher level in Figure 1. Many of the applications stated the reduction of
costs as a reason for the merger. In addition, many of the applications went further than a
general statement of cost reduction explaining that the combined institution would create
economies of scales that would result in a reduction in costs as justification for their
merger/acquisition request. Utilizing the synergies between the two partners is a common phrase
found throughout the applications. Often the smaller partner can combine with the larger partner
developing economies of scale and, thereby, reducing their combined costs.
The remaining three paths are related to increasing gross revenue but at a much lower
level on the fishbone framework. Many of the applications justified the merger either directly or
indirectly by referencing the combined institution’s ability to expand geographically into markets
that the individual institutions had not previously had a market presence. As a result, through the
geographical expansion, the institution would be able to decrease total risk and increase product
sales and, thus, increase overall gross revenue.
Many of the merger/acquisition either directly or indirectly justified their mergers
through the fact that the combined asset base (size) would be larger and, thus, allowing the
combined institutions to make loans to companies that the individual institutions could not have
previously serviced due to capital base lending regulatory restrictions. In essence, the larger
capital base allowed the merged institutions to offer a new product (jumbo loans) to an existing
customer or to gain new customer through the new product offering. In addition, on the same
path many of the applications justified the merger through the ability to offer a greater array of
products. The smaller partner (usually) would be able to offer products already carried by the
larger partner and that previously due to the smaller partner’s size they had not able to offer. In
both cases, the merger would allow the combined institution to offer a greater product array
increasing their sales and, thereby, increasing gross revenue.
The last path deals with the, often, indirect merger justifications of increasing market
power. Through the merger, the merged institution would be better able to compete with
institutions within their market, increasing their product sales, and, thus, their gross revenue.
As can be seen, much of our results reinforce the first two motivation theories proposed
by Stewart: (1) merging to increase financial performance (net operating profits) and (2) merging
to gain financial benefits through increasing the consolidated debt capacity (lending capacity for
banks). Further analysis and research in this area will lend even further insight into the
motivating reasons behind bank mergers and the resulting strategic benefits derived from the
merger activity.

REFERENCES:

___________(1997) Global Custody: Get Big or Get Out-Global Custodians Have Been
Consolidating with Gusto over the Year. What is Behind this Battle for Giant Status, and What
Does It Mean for Clients? Investor’s Chronicle, (November, 14) n. 155,40.
Baradwaj,B.G, D.A. Dubofsky, & D. R. Fraser. (1992). Bidder Returns in Interstate and
Intrastate Bank Acquisitions, Journal of Financial Services Research, 5, 261-273.
Benston, G. J., W.C. Hunter, & L.D. Wall. (1995). Motivations for Bank Mergers and
Acquisitions: Enhancing the Deposit Insurance in Put Option versus Earning Diversification.
Journal of Money, Credit, and Banking, (August), 777-788.
Boyd, J. & S. Graham. (1991). Investigating the Bank Consolidation Trend. Quarterly Review
(Federal Reserve Bank of Minneapolis). (Spring), 3-15.
Chong, B. (1991). The Effects of Interstate Banking on Commercial Banks Risk and
Profitability. Review of Economics and Statistics,73, 78-84.
Cornett M. M. & S. De. (1991). Common Stock Returns to Corporate Takeover Bids: Evidence
from Interstate Bank Mergers. Journal of Banking and Finance.15, 273-296.
Cornett, M. M. & H. Tehranian. (1992). Changes in Corporate Performance Associated with
Bank Acquisitions. Journal of Financial Economics. 31, 211-234.
Craig, B. (1997). Where Have All the Tellers Gone? Economic Commentary (Federal Reserve
Bank of Cleveland), 1-4.
Hawawini, D.C. & I Swaey. (1990). Mergers and Acquisitions in the US Banking Industry.New
York:Elsevier Science.
Hunter, W. C. & L. Wall. (1989). Bank Mergers Motivations: A Review of the Evidence and
Examination of Key Target Bank Characteristics. Economic Review (Federal Reserve Bank of
Atlanta). (September), 2-19.
Madura,J. & K.J. Wiant. (1994). Long-Term Valuation Effects of Bank Acquisitions. Journal of
Banking and Finance. 18,1135-1154.
Palia, D. (1994). Recent Evidence on Bank Mergers. Financial Markets, Instituions, and
Instrument, 3,37-59.
Porter, M. E. (1980). Competitive Strategy: Techniques for Analyzing Industries and
Competitors, The Free Press, A Division of Macmillan Publishing Company, Inc., New York.
Nolan, Norton & Company.(1986). Introduction to NNC's Architecture Process, Boston.
Stewart, G. B.(1991). The Quest for Value A Guide for Senior Managers, Harper Business: New
York,375-382.
Subrahmanyam, V., N. Rangan, & S. Rosenstein. (1997). The Role of Outside Directors in Bank
Acquisitions. Financial Management, 26 (3), 23-26.
Toyne, M.F. & J.D. Tripp. (1998). Interstate Bank Mergers and Their Impact on Shareholder
Return: Evidence from the 1990’s. Quarterly Journal of Business and Economics,37 (4),48-58.

Figure 1 - Strategic Fishbone

(Bold Type indicates significance)

Increase Net Revenue

Increase Gross Revenue

Increase Existing Increase Margin
Introduce Franchising Product Volume Increase Price
New Product Joint Acquisition
Venture Increase Increase Demand Add Value Decrease cost
New Merge Acquire Market
Industry Current Share Eliminate Sales Government
Industry Reduce Competition Financing
New Compliance
Compliment Supply Segment Info
Product Compliment Differentiate Increase Market Product Overhead
Substitute Territory Decision
Substitute New Product Need Lines
Geographic Management Support
Product Decrease Communications
Increase Demographic Invent
Price Present Use Invent New Uses Distribution
New Uses Channel
Impair Perceived
Promotion Length
Competition Price Storage
Increase Product Scheduling
Increased
Potential Feature/Function Perceived Purchasing
Existing entry/exit Product Need Increase Power
Scale
barriers Price Companion Cost Increase Human Economics
Buyout Products Use Engineering Productivity
Competition Pre-emptive Perceived Real Improve
Market Strike Feature/Function Feature/Function Process Reduce
Distribution Increase
Power Style Waste
Speed
Channels Increase
Supplier Brand Packaging Product Reduce Increase Quality
Power Scale Promotion
Sizes Locations Waste Speed
Vertical
Warranties Increase
Buyer Economics Inventory
Horizontal Quality Options Transport Quality Adapted from Nolan,
Power Volumes Learning Features
Norton & Company
Curves