Top Five Ways Mergers Will Achieve the Needed Economies of Scale (Because Most Don’t)

October 21st, 2015

Achieving economies of scale is one of the key strategic reasons behind a bank merger. The thinking is that a larger institution can spread costs such as investments and regulatory burdens across a larger customer and revenue base. Plus, for banks with $10 billion and more in assets, a merger offsets the lower interchange revenue from the Durbin Amendment and higher regulatory requirements.

Data from the Cornerstone Performance Report shows that the necessary improvements to productivity often fall short of the economies of scale that make a merged bank more competitive. In the report, Cornerstone compares “assets per employee” for banks of two broad asset size ranges.

  Banks $5B-$10B Banks $10B-$20B
  Peer Median 75th Percentile Peer Median 75th Percentile
Assets per employee $4,433,255 $5,500,897 $5,642,144 $7,229,156
Return on average assets 0.80% 1.07% 0.99% 1.11%

A median performer in the $5 billion to $10 billion group needs to achieve a 24 percent productivity improvement to become a 75th percentile performer and a 27 percent productivity increase to be a median performer once it breaks the $10 billion barrier. However, most merger cost savings usually target 20 to 30 percent of expenses—with 50 to 60 percent of those savings being people-related. In other words, a bank’s cost-save targets may enable it to achieve 75th percentile productivity temporarily but it will revert back to the “average” as the bank grows. Clearly, banks do not pursue mergers to sustain mediocrity. A bank that is a median performer today in the $10 billion to $20 billion asset category would need to improve by 63 percent to achieve and sustain high productivity performance.

So, how can banks turbo-charge their merger efforts to achieve high-performer economies of scale and productivity improvements? Here are five ways:

  1. Ensure that the bank is performing an integration and not just a conversion. The terms “integration” and “conversion” are often used interchangeably. However, they are very different. Integration includes conversion (i.e., getting all customers and employees on common technology platforms) and a rigorous evaluation and streamlining of the bank’s operating processes and organization. Conversions do contribute to productivity saves and scale but not to the extent that integration does. In the race to convert their core, Internet banking and other systems, many banks will not perform any significant redesign. Serial acquirers often fall into this trap as they want to convert quickly and move on to the next deal. Nine times out of 10, the serial acquirer’s processes are geared to a much smaller institution and eventually break down, requiring the bank to stop and truly integrate.
  2. Ensure that metrics related to scale benefits (both bank-wide and in key functions) are included in any merger reporting. Management and board reporting typically include progress based on achieving milestones, which usually just measures conversion priority. Tracking benefits such as productivity improvements is as important as integration costs and cost-saves. Managing conversion risk is a critical responsibility for the board and management, but so is managing the strategic risks of not being competitive because the bank is less productive than its competitors.
  3. Engage and empower younger managers in the integration process. Banks that pursue true integration often fall short of full success due to an inability to change. Senior managers 1) feel comfortable with what they do and are reluctant to change, and 2) want to change but don’t know how (i.e., don’t know what they don’t know). This occurs most often when a transaction or series of transactions increases the bank’s assets by 30 to 50 percent in a short period of time—when real change is required. Fresh perspectives in the form of newer and younger managers who are free of a “we’ve always done it that way” mindset can help drive new ways to do business that better leverage technology and/or streamline processes.
  4. Discourage “Phase 2.” Banks sometimes approach productivity savings by planning a Phase 2 after conversion to optimize processes, better leverage technology, and so forth. Phase 2 almost never happens, especially with serial acquirers because other priorities or opportunities arise, causing banks to leave money on the table. If the bank insists on a Phase 2, ensure the initiative is continually monitored and measured as part of ongoing merger reporting.
  5. Integrate to what the bank will look like in the future—not just what it will look like after a transaction. Determine the performance levels (and metrics) for a much larger institution and plan the integration efforts to achieve them.
vincenthui

Vincent Hui is a senior director with Cornerstone Advisors, a Scottsdale, Arizona-based consulting firm. He can be reached at vhui@crnrstone.com.