By Richard Levychin, CPA
Currently, it appears that with no sign of further bail out money coming, and with the prospects of a continued sluggish economy, the only solution for a struggling bank's survival is to combine itself with another bank, preferably one that is healthy. And, with the new federally approved guidelines for private-equity firms seeking to invest in U.S. banks, banks now have available to them a source of capital to fund these mergers.
The Deterioration of the Banking Industry
With regulators having shut 81 banks this year, 2009 is the year with the largest number of bank failures since the savings-and-loan crisis. Additionally, the FDIC's deposit-insurance fund has become strained by expensive and frequent failures, while the government fund that protects consumer deposits fell to its lowest level since 1993.
The banking industry continues to deteriorate, with federal regulators adding 111 lenders to their list of endangered banks in the third quarter of 2009, even as the economy shows signs of stabilizing.
The FDIC said it had 416 banks on its "problem list" at the end of June 2009, equivalent to about 5% of the nation's banks, up from 305 at the end of March and 117 at the end of June 2008. Problem banks had a combined $299.8 billion of assets at the end of June, compared with $78.3 billion a year ago. Appearing on the FDIC's “problem list” means that a bank is at a high risk of insolvency. And experts think that there are hundreds of failures still to come.
New Federal Guidelines for Private-Equity Firms Seeking to Invest in U.S. Banks
Federal regulators have approved new guidelines for private-equity firms seeking to invest in U.S. banks. This opens up a new and controversial source of capital for financial institutions. However, the new rules still impose significant restrictions on private-equity ownership of banks.
The new rules would require buyout firms to hold on to banks they purchase for at least three years. Investors would also be required to maintain larger amounts of high-quality capital at their acquired banks. In both cases, the rules are substantially tougher than those for regular banks competing for the same spoils.
The special standards for private-equity firms highlight a dilemma facing regulators: They need to find buyers for failed banks, while ensuring that investors are not playing the game to turn a quick profit and potentially imperiling, once again, already weakened institutions.
Advantages and Disadvantages of Mergers
Some of the advantages to such a combination include the enormous savings that would come from cutting overlapping operations, extra branches, and redundant workers. These savings would accrue to shareholders and add to their capital cushions. Another area to focus on are the technological synergies possible.
However, such combinations can have distinct disadvantages. For example, although technology synergies are widely cited as a benefit of mergers, any benefits can be overwhelmed by the challenges of selecting and integrating computer systems. Mergers can also undermine the cultural strengths that create effective organizations. Excessive size, combined with modern technology, can also make it easy for top executives to overlook their risk-management challenges.
In addition, the likelihood of customers switching banks increases by up to three times after their bank merges with, or is acquired by, another financial institution, according to the J.D. Power and Associates 2009 Bank Mergers and Acquisitions report.
“Overall, customers of acquired banks perceive that acquiring institutions are far less focused on customer interests and personal service than their previous bank,” says Rockwell Clancy, executive director of financial services at J.D. Power and Associates. “As a result, these customers are much more likely to change banks, particularly during the first six to nine months following the announcement of a merger or acquisition.”
Conclusion
The collapse of the housing market, and the increase in mortgage delinquencies and home foreclosures, coupled with the credit crisis have all led to a dramatic increase in bank failures over the past few years. In order to survive, banks should take a hard look at a merger as a possible solution to better strengthen themselves in this turbulent market.. With incentives in place for private equity firms to invest in failed U.S. banks, banks have a definitive opportunity to utilize newfound sources of capital.
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