The reaction by industry insiders to M&As in the European Financial Industry

2. The reaction by industry insiders to M&As in the European Financial Industry • From the beginning of the 90´s, there has been a reduction in the number of banks in the EU-15. • 1997: 9600 banks; 2005: 7100. • Concentration process mainly on a domestic scale. • 1993-2003: M&As involving domestic credit institutions represented 80% of total consolidation activity. • Shortage of cross-border operations • Complexity of the operations: differences in regulation, accounting and corporate culture. • Lower potential synergies and lower potential earnings of market power. • Recent Evidence: Cybo-Ottone&Murgia (2000), Vander Vennet (2002).

3. The reaction by industry insiders to M&As in the European Financial Industry • Campa and Hernando (2006) evaluate performance of M&As: • Wide dispersion of excess returns of the merging firms around the announcement date. • On average, these returns are positive for targets, negative for acquirers and there is no significant value creation. • There is a value transfer from the acquirers to the targets. • This value transfer is higher in the case of domestic mergers. • Focusing on completed deals between banks, the acquiring banks show a better financial situation than the targets, although the latter are not in a poorer situation than the sector´s average, observing an improvement in their returns from the second year onwards.

4. The reaction by industry insiders to M&As in the European Financial Industry • This paper complements previous evidence on the extent of value creation and on the underlying motives for mergers by looking at the reaction of other market participants to merger announcements: • Industry analysts: • Do industry analysts change their recommendations around the dates of M&A announcement? • Rival firms: • Do rival firms display abnormal returns around the M&A announcements?

5. Contents of the presentation • Approach and related literature • Data • Reaction to M&As announcements • Merging companies • Evaluation of industry analysts • Competitors behavior • Conclusions

6. Approach and related literature Evidence from industry insiders Look at changes in analysts recommendations (Stickel 1995, Womack 1996, Boni and Womack 2006) Changes in analysts’ recommendations have been shown to be predictors of future excess performance. Look at stock market reaction of competing firms (Eckbo 1983, Stillman 1983, Singal 1996) Positive (negative) excess returns signal increases (decreases) in expected future profits. Helpful to identify potential impact on degree of competition.

7. Data: Sample of Financial M&As • M&As announcements in the European (EU-15) financial sector in 1998-2002 • Both merging firms are financial firms and publicly traded • 172 transactions (120 domestic & 52 cross-border) • Market value is not available for all firms • Series of total shareholder returns

8. Data: Information on industry insiders • Information on analysts’ recommendations • Summary of the ratings by all analysts covering the firm • Scale of 1 (strong buy) to 5 (strong sell) • Monthly observations: each observations corresponds to a specific company in a given date (the Thursday before the third Friday of every month) • The database covers the period 1997-2003 • Information on rivals • The set of competing firms defined as all companies belonging to the same financial industry listed in the country of the target. • Total shareholder return for each rival firm

9. Data: Information on industry insiders

10. Abnormal Returns around the announcement date • Abnormal returns: difference between observed and expected total returns. • Expected returns: • national stock market index • national financial industry index • CAPM model (6 months prior to the event window) • Buyer, target, rivals returns. • Event windows: • (t-90, t-1), (t-1,t+1), (t-1,t+30),(t-1,t+360)

11. Abnormal Returns around the announcement date

12. Reaction by analysts to M&As • Level of ARs may help in predicting future returns. • Analysts recommendations (AR) do not measure the quality of the companies in absolute terms but in relation to its market price. • ARs may signal likelihood of being a target. • Analysts often change their recommendations upon the announcement of a major event affecting the firm. M&A transactions are one clear candidate for such an event. • Analysts’ reactions to the announcement of a merger may provide useful information on the value of the merger to investors. • However, ARs may not change if there are changes in share prices.

13. Level of Analysts Recommendations (AR): Month Prior to announcement • The average AR for both targets and acquirers is not significantly different from what is observed in non-announcement periods. • The average AR for acquirers is slightly better than for targets, especially in cross-border deals. • Similar results for the sample of completed banking deals. 1= strong buy, 5= strong sell Non-announcement periods include all observations preceding the last recommendation before announcement and all observations following the first four recommendations after announcement

14. Reaction by analysts to M&As • Changes in ARs at different time horizons • Deals typology: no changes, only upgrades, only downgrades, both ups and downs. • Changes in ARs on firms involved in merger deals are not exceptionally frequent. • Distribution of deals according to changes in ARs is very similar at the last recommendation before announcement, at the first recommendation after and in non-announcement periods. • The fraction of deals where more than 20% (or 50%) of analysts change is very small. • After four months, the fraction of merging firms without changes is smaller, but the fraction of recommendations of opposite sign is larger.

15. Analysts Recommendations: Changes around announcement

16. Reaction of competing firms to M&As • Domestic deals are more likely to induce a decline in the intensity of competition. • Entry of foreign banks usually strengthens competition.

17. Reaction of competing firms to M&As • Set of competing firms include all companies belonging to the financial industry and the country of the target company • Industry segments: Banks, Insurance, Life Assurance, Investment companies, Other finance. • Excess returns to competing firms • Focus on: • Average returns for the set of rival firms. • Fraction of rivals with positive excess returns. • Relationship between target (&acquirer) excess returns and competing firms returns .

18. Rival firms: Average excess returns Average returns for the set of rival firms are close to zero. Higher for domestic deals.

19. Share of competitors with positive excess returns Fraction of rivals with positive excess returns is close to 1/2. Higher for domestic deals

20. Analysis of Excess returns and competitors returns

21. Conclusions • Wide dispersion of excess returns of the merging firms around the announcement date. • Analysts do not significantly alter their recommendations after M&A deals. These transactions are on average “fairly priced” and stock market prices after the announcement reflect all relevant information on the assets. • Positive relationship between target (&acquirer) excess returns and competitors returns, particularly in domestic mergers. These transactions are more likely to decrease industry competition.

22. M&A activity in the financial sector • Procyclical and mainly domestic … ECB “EU Banking Structures”. Source: Bureau Van Dijk, Zephir.

23. M&A activity in the financial sector • … specially in relative terms Source: European Commission, “Cross-border consolidation in the EU financial sector”, October 2005

24. …resulting in significant increases in concentration of national banking markets