Difficult to Digest: Takeovers of Distressed Banks

1. Difficult to Digest: Takeovers of Distressed Banks Giang PHUNG, Paris 1 & ESCP Europe Michael TROEGE, ESCP Europe

2. Table of content1. Motivation & Overview2. Theoretical background3. Data & Methodology4. Result5. Robustness6. Conclusion

3. 1. Motivation & Overview • Takeovers of distressed banks – implicit bailouts • Takeovers of distressed banks (usually government-induced) are frequently used to stabilize a financial system without explicitly bailing out a bank. • Our study shows that: • these takeovers substantially weaken the profitability and liquidity of the acquiring banks • this negative effect persists over a prolonged period of time

4. 2. Theoreticalbackground • M & A in the banking system • Opposing views: • “Acquire to restructure” hypothesis: • the takeover of failed banks by solvent institutions can reinforce stability (Perotti and Suarez, 2002), and • enhance profitability (Caiazza et al., 2012) • Concerned for the “concentration-fragility” hypothesis, TBTF: • significant increase contribution to systemic risk (Weiß et al., 2014), • post-merger SIFIs undermine financial stability (Gomez, 2015), • safety-net subsidies (Behr and Heid, 2011)

5. 2. Theoreticalbackground • Vietnam’s 2011-2015 banking M & A program • Forced and voluntary mergers • GFC 2008 had important consequences for Vietnam: • Numerous emergency loans from the SBV providing short-term liquidity • Commercial banks could avoid instantaneous failures, but the bad debts crisis was declared in 2011 • The government approved the restructuration of the credit institutions system in the period 2011 – 2015. • Followed ‘acquire to restructure’ hypothesis: 11 mergers, expected to be an effective measure to recover weak banks • 1) voluntary mergers among healthy banks, 2) voluntary acquisitions of a bank in difficulties by a healthy bank, 3) forced takeovers of distressed banks by the SBV • Do the advantages outrank the drawbacks in these mergers? • Bad debts recovery vs. a quick increase in market share and customer network

6. 3. Data & Methodology • Empirical Strategy • Random-effect Regressions of Operation/ Profitability and Liquidity ratios on banks’ acquiring status dummies, ownership, and control variables • Eq. (1) • Eq. (2)

7. 3. Data & Methodology • Data set – Dependent variables • Period 2000-2017, more than 40 commercial banks - 581 observations

8. 3. Data & Methodology • Data set – Dependent variables • Sources of data: BankScope, Orbis Bank Focus, State Bank of Vietnam, World Bank and author’s calculation from these sources

9. 3. Data & Methodology • Data set – Independent variables: • Independent variables:

10. 3. Data & Methodology • Data set - Summary Statistics • Continuous variables

11. 3. Data & Methodology • Data set - Summary Statistics • Dummy variables frequency

12. 4. Results • Takeovers and banking performance

13. 4. Results • Takeovers and banking performance – prolonged effects

14. 4. Results • Acquiring banks are worse off post-merger • Acquiring banks are worse off post-merger: lower profitability, less efficient cost management, and lower liquidity. • return on assets, cost income ratio or recurring earning power strongly deteriorate • higher ratios of net loans to total assets, deposit and short-term funding or total deposit and borrowing, reflecting lower liquidity in the short- and medium term • lower growth in deposit and short-term funding than comparable banks • Furthermore, this negative effect persists over a prolonged period of time, at least for 6 years after the takeovers • the efficiency of financial intermediation and the allocation of capital will be reduced.

15. 4. Results • Acquiring banks are worse off post-merger – Profitability ratios

16. 4. Results • Acquiring banks are worse off post-merger – Cost ratios

17. 4. Results • Acquiring banks are worse off post-merger – Liquidity ratios

18. 4. Results • Acquiring banks are worse off post-merger – Liquidity growth

19. 5. Robustness • Fixed-effect regressions • ‘Fixed-Effect’ estimations with the entity (bank) fixed effects using the same variables as in the main regressions • Consistent with the baseline results: • acquiring status is strongly associated with lower profitability (ROAA, ROAE, and Recurring Earning Power) • higher cost ratios (Non-Interest Expense / Average Assets, Cost to Income Ratio) at a high significance level • liquidity indicators of acquirers are all below par • Besides, many other regressions using multiple Asset Quality, Capital Quality, Operation/ Profitability and Liquidity ratios, none of which is significant: • no positive outcome has been found to make up for the negative consequences of merger-acquisition on banking performance that we have discovered in our analysis

20. 6. Conclusion • Challenge for using takeovers as a method of implicit bailouts • Financial constraints post-merger in acquirers of failed banks: a prolonged effect • The detrimental influence of the weak acquired banks under the crisis context: • Non-performing loans: extremely high in failed banks, poor legal framework in debts securitization and debts trading • higher cost ratios indicate failures in transmitting efficient decisions through the M&A process • These negative long term consequences may at least partially offset the positive effect of avoiding a financial shock after a bank failure.

21. ANNEX • List of banking M&A deals in Vietnam