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HPS Mergers Ahead

HPS Mergers Ahead

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Published by: Hamilton Place Strategies on Apr 09, 2012
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Hamilton Place Strategies | 1
 April 2012
Caution: Mergers Ahead
How to establish a regulatorycompetitive advantage during thecoming wave of consolidation
Merger activity in the banking sector faces a fundamentaltension in the years to come: new regulation has madeefficiency gains from mergers more attractive; and at the sametime, regulatory scrutinyof mergers hasincreased, especially for larger firms. Theimplication of thisdynamic is that firms thatare better able tonavigate public scrutinyand the regulatoryapproval process for mergers will be at astrategic advantageversus their competitors.This paper provides a brief overview as to why consolidation inthe banking industry will continue, and brings in to focus whysmall and mid-sized firms will have an advantage in receivingregulatory approval compared to larger peers. Increasedscrutiny surrounding “too-big-to-fail” (TBTF) and“systematically important financial institutions” (SIFI) will makeit harder for large institutions to merge. In addition, increasedmarket concentration over the past decade will raise aniti-competitive concerns. Already, we find that the the time ittakes for deal completion has grown longer for mergersinvolving larger instutions. The successful management of thisprocess will significantly alter the playing field.
Firms which arebetter able tonavigate publicscrutiny and theregulatory approvalprocess for mergerswill be at a strategicadvantage versustheir competitors.
 
Hamilton Place Strategies | 2
The Incentives for Consolidation
 
Over the past several years, M&A activity in the financial sector has beenextremely low due to a weak economy. However, industry observersbelieve there is pent up demand for deals, and the fundamentals of theindustry back up this assertion.Regulatory data from top-tier banks at 2011 year-end show that, onaverage, larger banks were better able to manage costs and growprofitability by 49 percent, according to operating efficiency ratios. Largebanks also outperformed small banks by 75 percent, based on returns toaverage equity (Exhibit 1).Large banks also tend to carry a diversified loan portfolio, exposed to awide-range of creditors and geographic areas, thus losses can beabsorbed more easily. For example, Florida and Georgia alone saw 60and 78 bank failures since the start of the financial crisis in 2008,respectively; the highest among all states, making up 32 percent of totalbank failures in the U.S.Still, the impact of a large crisis on the scale we recently witnessed cancause even large institutions to come under financial pressures, leading to
 
Hamilton Place Strategies | 3
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 firmswith only a handful of employees. Since 2008, many new regulations havebeen put in place. For example, the Dodd-Frank Act of 2010 was 848pages before the thousands of pages of rules were even written. Comparethat to just 29 pages for the creationof the U.S. banking system in 1864,32 pages for the Federal Reserve Act of 1913 and 37 pages for theBanking Act, which transformed American finance through Glass-Steagall in 1932.
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The increasedburden of compliance costs on smallfirms will provide the incentive for greater consolidation.

 
1
“The Dodd-Frank Act, Too Big Not to Fail.” The Economist. February 18, 2012.
The burden of increasingcompliance costs onsmall firms willprovide the incentivefor greater consolidation.

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