How M&A is Shaping the Banking Industry

By Alexandria Chun, Senior Online Editor

Image courtesy of stafffinders.com

In 1995, there were many banks operating in the United States, thirty-seven of which were well-known firms.  By 2009, only four of the thirty-seven remained.  Where did all those banks go?  How did such an extensive network condense into just four institutions?  Through the power of mergers and acquisitions.

If you look at the major banks on Wall Street and Bay Street – Bank of America, JPMorgan Chase, RBC, CIBC – a majority of them developed as a result of mergers and acquisitions.  As their smaller predecessors clumped together, they integrated their pools of resources and products to form some of the most powerful financial institutions we see today.

So what is mergers and acquisitions, or M&A?  As the name suggests, it’s the business of combining companies.  Although the purpose of both these processes is to join two entities, they do have slightly different procedures.

An acquisition involves the purchase of most, if not all, of a target company.  The acquirer owns all the old shares of its target.  A merger, on the other hand, is when both companies surrender their stock, and issue a new one under the name of the new company.  A true “merger of equals” is not common, however, since acquirers often seek to buy companies smaller than themselves.

If a company wants an existing product or service, they might find acquiring another company easier and more cost-effective than expanding its own.  For example, it’s a lot faster and cheaper for you to go out and buy a light bulb than try to make one yourself (unless you already have all the tools and know-how to make light bulbs).

M&A deals are also made in different directions.  Let’s say you own a lemonade stand.  A horizontal merger could be made between you and another lemonade stand down the street.  You could merge with a lemonade stand in a different neighborhood to extend your market reach, or you could merge with a vendor who makes iced tea to extend your product line.  If you were to buy the lemon farm that supplies your lemons, you would be making a vertical merger, where a company acquires its supplier.  Your lemonade business could also buy an unrelated business, such as a hat-maker.  This is called a conglomeration.

Motives for deal-making range from practical to trivial.  RBC improved its presence in Ontario and Manitoba by acquiring Traders Bank and Northern Grown Bank.   BMO increased its service line by purchasing RBC’s credit and debit processing systems.  To take advantage of a failing bank, JPMorgan Chase acquired Bear Stearns at a low price.  These are all good, practical reasons.

Other motives include: an increased market share, synergy, increased buying power, hiring new talent, and reducing tax liabilities.  Ultimately, all these motives are based on increasing shareholder value, and in turn, increasing revenue.

Occasionally, mergers are doomed by poor intentions.  A company might hastily acquire other companies to create a monopoly, or a CEO might pursue unsound M&A deals simply because it will give them a nicer bonus.  The resulting deals are often not well executed, and cost more resources than they procure.

Synergy is a very important concept in M&A.  Apart from just being a cool word, it encompasses all the benefits of merging with another company.  If done properly, a deal can increase cost efficiency by reducing overlapping staff or departments, increasing purchasing power, and acquiring new technology.  Synergy is a goal of successful deal-making.

So if Company A wants to acquire Company B, they must first look at the pros and cons of the deal.  Pros, as mentioned above, include diversification, geographical extension, larger market share, access to different technologies, reduction of financial risk, and the added incentive of a potential rise in value.