Technology is playing an increasingly important role in the revived M&A market in financial services . But it is not at all certain that the technology implications of the deal are fully understood-what IT can do and, perhaps more critical, what it cannot accomplish.
Recently, the M&A market has been heating up in banking. BS&T spoke to representatives from the analyst community to outline some of the main forces driving M&A activity, and prospects for future consolidation of the industry.
Senior Research Analyst, Cutting Edge Information (Durham, N.C.)
Manager, Banking Group, Celent (Boston)
Chief Operating Officer, Financial Insights, an IDC Company (Framing-ham, Mass.)
Senior Analyst, Delivery Channels Practice, TowerGroup (Needham, Mass.)
BS&T: What are some of the drivers of the renewed M&A market in banking, and will this trend continue?
Elio Evangelista, Cutting Edge Information: New market penetration certainly seems to drive M&A activity in the financial services industry. With the rise of Internet banking, large financial institutions are looking to expand into markets they otherwise could not reach. Therefore, companies like Wachovia, with a large Southern market, and First Union, with a strong foothold in the Northeast, can benefit more as a single entity. The M&A trend will remain steady until medium-sized banks learn to market their services better on a national scale, or when the customer base feels more comfortable conducting their financial transactions online.
George Tubin, TowerGroup: There are a number of factors driving the renewed interest in M&A activity. Remember that the 1990s saw a surge in merger activity after the removal of longstanding governmental restrictions. Then, in the late 1990s, merger activity slowed as the distractions of Y2K and the Internet boom refocused internal resource priorities. A poor U.S. economic climate and uncertain worldwide geopolitical conditions also contributed to the slowdown in bank merger activity. Now that the economy seems to be stabilizing, and financial institutions are looking beyond their recent forays into online services to search for new growth paths, banks will again look to mergers to provide a means to accelerate growth rates beyond organic measures.
Michon Schenck, Financial Insights: We predicted increased merger activity in the financial services industry in January for the summer of 2003 and we see this trend continuing through the next year or so. The major driver behind the increased activity is that institutions have been sitting on the sidelines for the last three years. Merger activity, according to the FDIC, had been down 11 percent in that period. We have not seen such low levels of bank transactions since 1990. The economic downturn has put such a severe pressure on earnings that no institution wanted to risk taking on another entity. This is very typical of the ups and downs of an economic cycle, where institutions will sit out any major M&A transaction until they see a better economic environment going forward.
BS&T: What role does technology play in bank M&As? Do the executives who put these deals together have a realistic view of what technology can or cannot bring to the table?
Evangelista, Cutting Edge Information: IT has to be a huge determining factor during due diligence. Some mergers lose half or more of their value due to integration delays. The faster the merged company can implement the integrated technology, the more successful the merger will be. M&A deals often fail to live up to expectations when executives neglect the complexity involved in IT integration. And because technology is vitally important to financial services companies, many are staffing their due diligence teams with IT experts.
Tubin, TowerGroup: Technology plays a central role in the entire merger process. Technology and data integration costs comprise the bulk of merger integration activities and dictate the timing of the merger process. While banks first look at the business and financial drivers in any potential merger situation, they consider the integration of technology, processes, and support functions to be critical to the realization of the merger objectives. Moreover, the new merger paradigm is no longer the old "slash and burn," do it fast, save money and worry about customer impacts later model. Mergers are now deliberate, time-consuming efforts that focus on customer retention, practical timeframes, and making no mistakes.
Alenka Grealish, Celent: Technology typically plays a secondary role driven by the particulars of the banks involved. Historically, large banks have justified mergers in part based on enhancing their technological resources while better managing their IT costs. For example, if a target bank is hard pressed to implement a new branch automation system, this factor is incorporated into the justification equation. Whether or not banks actually realize the expected IT benefits is debatable. Most merged banks continue to struggle with rising maintenance costs and system integration issues.
BS&T: Are M&A decisions being made, or not made, due to technology compatibility concerns? And are the expectations realistic?
Evangelista, Cutting Edge Information: Absolutely. Deals have certainly fallen apart due to the complexity of technology implementation, which must be approached as a serious concern. Very few technology implementations go as smoothly as predicted. Each day IT integration takes longer than expected, the merger's value suffers. Executives must understand that even though the integrated technology will not necessarily impact the bottom line to the same degree as other synergies, poor IT integration will drain the bottom line and nullify efficiencies faster than most other aspects of a M&A integration.
Schenck, Financial Insights: In our experience, it is rare for a bank to make an M&A decision based solely on technology issues. However, we have seen a number of instances, particularly after a protracted period of non-spending in IT, whereby an institution can no longer afford to catch up to its peers-e.g., the technology investment required to be competitive to its peer group is outside the bounds of any normal return on investment-when we have advised that institution to seek a "strategic partner."
Grealish, Celent: Bank M&A is primarily driven by growth ambitions. Growth alone, however, is not sufficient justification for shareholders. Enter in the need for detailed cost savings and revenue enhancement projections. Most acquiring banks aspire to save IT costs and hence IT fits into the equation. In reality, few can prove they did. Compatibility issues are rarely addressed during the due diligence process. The underlying assumption is that these issues are surmountable. The truth is that most banks underestimate the resources required for IT integration.
BS&T: What can technology executives do to make the consolidation easier?
Evangelista, Cutting Edge Information: IT integration has to start in due diligence. The due diligence team must select an IT integration team to develop a plan of action. Top integrators develop systems for merging technology that ensure low integration costs. Speed is also critical. Technology executives must not allow the integration to last more than the intended deadline. Even one week's delay can cost tens of millions in potential losses in some cases. Expert integrators, such as Wachovia, post an average integration rate of three months and often achieve IT cost efficiencies of more than 50 percent.
Tubin, TowerGroup: First, executive management must convey the company's technology integration strategy. A best-of-breed approach will require a different methodology than the so-called acquisition approach. Staff from both institutions must be forthcoming with information and must organize needed data to support the process. Mergers should not be the time for junior technical staff to learn the company's core applications. While junior people will certainly be part of the integration, they should never lead critical components of the integration. Merger integration is a complex process, and executives who can successfully manage components of merger integration are often recognized as effective technology leaders.
Schenck, Financial Insights: The institutions that tend to execute best in a post-merger consolidation phase are those that have technology executives who are chartered solely with the consolidation process, in that they have been removed from any other day-to-day operational role. These executives are highly incented to consolidate on time and on budget. Typically, they will retain this role through every M&A transaction that institution does (assuming they do a good job, of course). If an institution has not designated this function, we usually advise the executives to step forward and volunteer to do so. System consolidation is incredibly difficult in operational terms, in cost terms and in people terms. It should not be undertaken lightly and it should not be undertaken as an adjunct to an already stressed position.
Grealish, Celent: When it comes down to the brass tacks of post-merger integration, technology executives become precious commodities. In a well-mapped PMI process, they work closely with senior business executives to determine priorities and project sequencing. They must convey strong leadership skills to garner not only the attention of C-level executives but also adequate resources in terms of both human and dollar capital. Moreover, they must wield the power of "No" when it comes to nonsensical prioritizations and timelines. All is easier said than done, however.
Is there a set method, or decision-making process, that IT leaders can use to help them decide which duplicate systems will survive?
Evangelista, Cutting Edge Information: Sometimes companies spend too much time determining which system to use post-merger. In the end, that time can be better spent actually integrating the technology. Through our research we learned it's not critically important to choose the "best of breed" between the two platforms. What is important is just to choose one quickly and begin the implementation. As long as the technology can perform the necessary functions, there should not be any lengthy process involved to determine which system will best serve the merged entity.
Tubin, TowerGroup: The decision criteria that have been used in some of the more recent mega-mergers have really focused heavily on customer impact. Banks seek to make decisions that, at minimum, do not take anything away from what customers currently experience and that remain within budget constraints while meeting the integration schedule timelines. Banks have shown a willingness to choose inferior technology that meets merger goals over superior technology that may be more difficult to integrate and support. The bank can always readdress newer technology after the frenetic merger process, when there is appropriate time to plan and implement new technology.
Grealish, Celent: Many variables come into play in the system selection process. There is no hard-and-fast set of rules. New does not reign supreme, and best of breed does not always win the day. Rather, there are parameters specific to the different types of systems that should bind the decision-making process. For example, scalability is paramount for most systems, in particular payment and core processing. Functionality is important for customer-facing systems, but cost and utility should also be taken into consideration. Although maintenance cost looms as a key parameter when it comes to back-office systems selection, integration challenges and costs may prevent the elimination of duplicate systems. For large banks, this is not an unusual predicament.