VIEWPOINTS : Will Merger Mania Strike U.S. Banking? : Arbitrageurs, Weak Profits Make It Likely

Mergers of banks and bank holding companies have long been arranged in what was once described as a gentlemanly manner, but hostile takeovers are likely to become a fact of life in the industry.

Until now, merger negotiations have been conducted in talks between chief executives of the two companies, joined perhaps by one of several major stockholders of the bank being acquired. The talks have covered both social and business issues.

Social issues have included matters such as board membership for a few directors of the acquired bank, title and salary for its chief executive, degree of continuing autonomy, name and headquarters location. Business issues have centered on the price and means of payment for the shares being bought. Recently, investment bankers have joined many of these discussions, but the agenda has not changed materially.

There apparently have been instances in which boards chose from among offers to accept one with smaller benefits for owners but more acceptable proposals on the social issues. These are brave boards, for this is obviously a perilous course in a litigious society.

Occasionally, just occasionally, a merger offer that has not been successful in negotiations has been taken directly to the shareholders through a tender offer. Such offers have been rare because a tender offer involving a bank is a complicated, expensive and time-consuming process.

Faces Major Hurdles

In addition to Securities and Exchange Commission procedures, the proposed merger must be approved by banking regulators. If the merger is opposed by the acquisition target, this approval can take six to nine months after submission of an application that may have taken several months to prepare. During that time, of course, the target bank may actively oppose the application and solicit other offers more to the liking of management and the board. The board may effectively lock out an undesired offer by giving warrants for stock to another suitor.

All of this has meant that unfriendly takeovers of banks have been restricted to a few instances in which:

- The acquiring bank really wanted the target bank.

- There was support for the takeover by the owner of a substantial block of stock in the target bank or another obstacle preventing the entry of a white knight.

Two new factors at work today, however, increase the likelihood of hostile takeovers.

Arbitrageurs, stock speculators who play a pivotal role in mergers, have come to consider large banks with widely traded shares as potential takeover candidates. If arbitrageurs decide that a tender offer for a bank is likely to succeed, even though delayed, they can buy up enough shares in the target bank to force the deal. They will demand a merger at the highest price attainable. Boards that stand in the way will find themselves under attack by sophisticated, gain-oriented investors who will be quick to use the courts to further their interests.

The second factor is bank earnings.

Deregulation and increased competition during the past five years have not been good for all banks. Some banks have grown rapidly in size and earnings, but from 1981 to 1985 the majority have seen their profit margins narrow.

Profits Declining

Banks of all sizes have suffered declining profits. The declines were widespread among banks with $100 million or less in assets, which included many that were also hurt by a depressed farm economy. At the same time, a number of larger banks have been hit by increased loan losses.

Lower earnings and losses, in turn, have led to regulatory pressure for new equity and perhaps improved management. Failing that, regulators press for a merger with a stronger bank.

These developments make a board of directors more receptive to merger proposals and less able to fend off an unfriendly offer. They also will increasingly push regulators to expedite the processing of approval for mergers, friendly or unfriendly.

In short, the bank merger movement is likely to accelerate, and tender offers likely will become important in the process.

What of life after a shotgun wedding? Bankers have always insisted that one of their strong defenses was that no one wanted to take over a service company without all of the strong personal ties developed with its customers, and unfriendly acquisition could jeopardize those relationships. There’s an element of truth in this--but only an element.

The fact is that people deal with a particular bank for many reasons, only one of which may be the relationship with the person who is the customer’s contact. New ownership and management may suffer the loss of that contact person and not miss a beat with the customer so long as--and it’s an important proviso--the service delivery system remains at least as good and the new contact person is at least as competent. It’s likely that both will improve after the merger of a poorly performing bank.

Pay Premium Prices

In every merger, the acquiring bank pays more than the market says the acquired bank is worth, even though the use of unusual securities as part of an offer may make it difficult to determine how much more. The acquiring bank has every reason to improve service and to upgrade people as the means of increasing earnings to validate the price paid. This is a fact whether the merger is contracted at the altar or in the courtroom.

Every corporate merger, bank or otherwise, involves different corporate cultures. There is always a shock in the acquired bank as its people adjust to new ways of doing things, new measurements of performance and a new set of expectations. Pre-merger commitments may delay or complicate the process, as efforts to preserve the old ways obscure the fact that the merged company has disappeared into the structure of the acquiring company.

A hostile takeover removes this kind of uncertainty. The surviving management is completely free to go ahead and do what it is going to do anyway, and that is to shape the acquisition along the lines of its own culture.