Why Bank M&A Is Complex

Stronger capital positions and rising stock prices don't necessarily help with the operational side of a merger.

Consolidation of the banking sector advanced two giant steps in 2004 with the mergers of JPMorgan with Bank One and Bank of America with Fleet. Bank mergers and acquisitions rebounded in 2004 because of strong capital positions and related strong stock prices, and forecasts for 2005 indicate continued consolidation in banking and related consumer finance industries.

But stronger capital positions and rising stock prices don't necessarily help with the operational side of a merger, the successful integration of which often can be the key to success for the whole transaction. And the evidence indicates that not all banks are operationally ready to successfully emerge from the merger process unscathed and with goals reached.

Have banks learned their lessons from past merger booms, including the late 1990s? Yes, in many cases. Smart acquirers realize that:

• Failed synergies from bank mergers result from unfamiliarity with the operational considerations that should have been examined pre-merger.
• Pre-merger planning is particularly important in areas like ensuring compliance with current regulatory, legal and accounting requirements, upgrading technology (if the IT system is not current), and building up capital.
• The value of customer acquisition is affected by the impact of the merger itself as well as competitive and channel trends in the industry as a whole.

Never before has the process of merging two banks been more complex, and acquirers must balance a multitude of strategic issues during the planning, due diligence and post-acquisition phases. While the list of the complex issues that need intense focus in all three phases is long, the actions taken depend on the answers to the following three questions:

1. Are the information technology systems of both companies compatible, and is there sufficient capacity in either system to handle the integration (i.e., scalability)?

With the reliance on IT systems to handle everything from in-branch transactions to online banking, technology is central to today's modern banks. Resolving IT issues after a merger is a big exercise, and the identification of numerous, sometimes countless systems for accounting, operations and servicing, for example, can lead to unwanted surprises.

Therefore, it is imperative that companies immediately address inventorying systems -- addressing the compatibility of their technology platforms, identifying the number of system redundancies and estimating integration costs. Although a target that is technologically advanced can offer IT expertise, the challenge remains whether existing infrastructure in either company has sufficient scalability to handle the integration and growth of the combined entity for the foreseeable future.

This is a critical factor. In one merger with which we are familiar, failure to integrate IT systems resulted in lower customer satisfaction and loyalty, which in turn substantially dropped the number of expected customer accounts of the merged banks.

2. Will the target present opportunities to enhance top-line growth or simply be a means to improve the current operating efficiency?

Banks need to ensure that a proposed transaction is in line with their business objectives. The key to top line growth lies in understanding the nature and profitability of each division, and challenging each assumption in the projection and forecasting process during due diligence. A merger of two banks that offers the same products and services can result in higher earnings because of cost savings, while a merger between companies that offer different or complementary products and services may boost earnings from cost reductions and revenue growth. Cost savings may take years to realize, and mergers that offer immediate revenue growth may lead to earlier earnings increase as cross-selling of products and services can be implemented immediately. At the same time, the divisions within a bank will vary in risk and profitability. One can easily underestimate the complexities in a trust department or investment banking division, not to mention the exposure and risk that lies in both.

3. Does the target have adequate resources to address regulatory, legal and accounting requirements?

As one of the most highly regulated industries, banks must stay compliant and proficient in all regulatory, legal and accounting issues. Simply staying up to date with changes requires large forces in those areas.

Add to those compliance issues the complexity and number of business lines, geographic locations, system constraints, the limited number of experienced skilled employees and the challenges abounding in today's complex banking environment and you understand why layering together two banks will be the solution to some problems and the creation of others. Even so, it goes without saying that a company that is well equipped to understand and comply in these areas will increase the chances of a successful merger/acquisition.

Contacts:
Todd Williams, Partner
Phil Weaver, Director
Richmond Young, Senior
PricewaterhouseCoopers, New York 646-471-1000
Transaction Services, Financial Services Due Diligence