Mergers and Acquisitions in British Banking: Forty Years of Evidence from 1885 until 1925

1. Mergers and Acquisitions in British Banking: Forty Years of Evidence from 1885 until 1925 Fabio BraggionNarlyDwarkasing Lyndon Moore CentER, EBC &CentER, University of Melbourne Tilburg University Tilburg University

2. M&As in U.K. Banking 1885-1925 A Study of M&As in Banking in a unregulated environment

3. M&As in U.K. Banking 1885-1925 What happens if banks are allowed to merge during a 40 year period, without the regulator (almost) ever saying no?

4. M&As in U.K. Banking 1885-1925 • What happens if banks are allowed to merge during a 40 year period, without the regulator (almost) ever saying no? • Who gained from mergers – acquiring shareholders, target shareholders, consumers? • Why did they gain? • What were the effects on banks’ risk taking?

5. Preview of the Results • Both Bidder and Target banks experienced gains in the month of the M&A announcement • Wealthcreation appears to be related to both: • efficiency gains • increased oligopoly power. • As the degree of competition decreased, banks became safer

6. Motivation • Laissez-faire environment(no restrictions on mergers, no capital requirements, no deposit insurance) • Only after 1917 the Treasury started to look into the phenomenon • Bank managers faced few constraints from shareholders • Timing of information release is unambiguous

7. Motivation We provide a useful benchmark to compare the results of studies on contemporary M&As

8. Issues and Puzzles in (contemporary) Banking M&As • M&As in banking do not appear to be associated with performance improvements: • At the M&A announcement bidders’ returns are negative or zero (between 0 and -2.5% ; Houston and Ryngaert, 1994, 2001) Not clear if: • Methodological issue: difficult to time the event • Methodological issue: not clear if the deal will succeed • Or M&As really are destroying value

9. Merger Process Release of information was full and spontaneous Boards met in private, settled the terms, and then communicated the terms to the shareholders No tender offers, just private negotiations The process was very quick: no more than 2-3 months from announcement to completion Although shareholders had to vote to ratify the merger this was a formality (only 1 out of almost 200 M&A agreements was disallowed by shareholders of the target bank)

10. The Merger Wave 1870: 387 banks operating in the U.K. 1885 – 1900: Many takeovers of private banks by public banks 1900-1925: Mostly mergers between joint-stock banks 1920: Only 20 public banks operating in England and Wales Large rise in banking sector concentration

13. What do we do? We collect data on British banks Accounting data (profits, balance sheet info) Asset prices (of joint-stock banks) Public announcements of mergers Original merger agreements Number of Shareholders

14. What do we do? • We estimate wealth effects related to the announcement of Banks’ M&As • We identify the sources of wealth effects • Cross-sectional analysis of bidders and targets wealth effects • What happens to the returns of uninvolved banks? • We estimate the impact of the mergers activities and reduction of competition on banks’ risk taking

15. Data Accounting data: The Economist Banking Supplement Asset Prices: The Investors’ Monthly Manual Announcement Dates: Times of London, Manchester Guardian and bank archives Merger Agreements: Original documents retrieved from bank archives (Barclays, HSBC, Lloyds, RBS) and the Times of London Number of Shareholders and Branch Data: London Banks and Kindred Companies and The Bankers’ magazine

16. Summary Statistics

17. Wealth Effects – Bidders

18. Wealth Effects – Bidders

19. Wealth Effects – Bidders

20. Wealth Effects – Bidders

21. Wealth Effects – Bidders

22. Wealth Effects - Targets

23. Wealth Effects - Targets

24. Wealth Effects - Targets

25. Wealth Effects – Combined

26. Wealth Effects • Both bidders and targets gain from mergers • Combined Wealth effects increase in the time period • Distribution of wealth gains shifts from bidders to targets

27. Did merger announcements leak?

28. What determines these gains? • We tackle this issue in two ways: • We relate the cross-section of bidder and target wealth effects on bidder, target and deal characteristics • We check what happen to the returns of rivals/uninvolved banks at the announcement of M&As

29. Determinants of Bidder’s Wealth Effects

30. Cross Sectional Results: Bidder • Bidder’s Returns were higher if the ROE of the target is lower • “Restructuring” hypothesis • If the target was London-based, bidder’s returns were lower • London target→ “ more sophisticated” • Membership of the Clearing House • Gave them more bargaining power

31. Determinants of Target’s Wealth Effects

32. Determinants of Target’s Wealth Effects • If the targetwas London-based, returnswerehighercompared to non-London basedtargets • Large economiceffect: A London experienced on average 10 percentage points higherabnormalreturnsthan an identical provincial target • Targetswith a largerbranch network hadlowerreturns, ceterisparibus • LookingatCombinedwealtheffectsthereisalso an indication of a restructuringhypothesis

33. Analysis of Uninvolved Banks Mergers may have 3 effects on non-involved banks: • Increase their returns • due to increased opportunities for collusion • Increase their returns • due to learning opportunity for uninvolved banks • Decrease their returns • due to the merged entity being a stronger competitor for other banks • This usually indicates gains in a efficiency of the merged entity

34. Effect on Uninvolved Banks • Wecalculate the abnormalreturns of uninvolvedbanks over the month in whichsomeotherbanksannouncedthattheyweremerging.

35. Effects on uninvolvedbanks? I Bank HHI : Measures a bank’s local marketcompetition. Calculatecounty-level HHI, and then Bank HHI weighting by % of bank’s branches in eachcounty: Bank HHI=1 (no local marketcompetition)

36. Effects on uninvolvedbanks? II Bank HHIi,j, pre : The Bank HHI of rival i beforemergerjtook place Bank HHIi,j, post : The bank HHI of rival i aftermergerj has been completed ∆ Bank HHI : Bank HHIi,j, post - Bank HHIi,j, pre

37. Effects on uninvolvedbanks? Example • In 1918 the London City and Midland bankmergedwith the London Joint Stock bank • Bothhad branches in Yorkshire • Affected the HHI highly of banksthatmainlyoperated in Yorkshire:

38. Regress AR of uninvolvedbanks on characteristics

39. Interpretation • A positive relation between ∆ Bank HHI and the abnormal return for an uninvolvedbank • Uninvolved bank shares jump in value most when the market will experience a big increase in concentration. • Greaterabilityto facilitate and maintain collusive agreements. • Some evidence for a lender of last resort effect, as uninvolved banks with more loans to assets benefit the most from an announced merger

40. Impact of Mergers on Balance Sheets • Trend decrease in bank capital ratios over the period 1885-1925.capital(mkt.) / assetsdeclinesfrom 20% to 10%capital(book) / assetsdeclinesfrom 28% to 14% • Decrease in loans/assetsdeclined 10% • Increase in investments/assetsfrom 15% to 20%

42. Impact of Mergers on Balance Sheets • Weregress balance sheet ratios on variousbanks’ characteristics • First: banksfixedeffectsregressions • Second: 2SLS withAverageOverlap (1885) used as an instrument for Bank HHI • Banks with certain balance sheet ratios maybe more/lesslikely to undertake acquisitions • Sameresults

43. FixedEffectsResults

44. Effect of Competition on Ratios • Less local competition (higher Bank HHI) leads to holdings of more safe marketable securities (govt. securities) and less loans to firms. • Results consistent with the charter value of hypothesis • Bank system (probably) become more stable, since risky loans replaced with less risky government debt.

45. Whatdidwelearn? • We studies 40 years of mergers in a virtually unregulated environment: • Mergers were beneficial for acquirer and target shareholders • Wealthcreation appears to be related to both: • efficiency gains and increased oligopoly power. • As the degree of competition decreased, banks became safer • Lending support for the so-called “Charter Value Hypothesis”

46. Some Robustness It is unlikely that the results are due to uninvolved banks learning about the benefits of consoldiation. Did it take them 30 years to learn? It is unlikely that the results are due to a “too big too fail type of argument”. Counterparty risk appears to be low It is unlikely that univolved banks gained because targets’ employees abandoned the new bank