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May 15,1987

Federal Reserve Bank of Cleveland

[SSN 0428-1276

ECONOMIC
COMMENTARY
Changes in state banking laws have
allowed interstate banking to spread
rapidly throughout the United States
during the past two years. As the process continues, and the geographic restraints on the banking industry fall
away, there is increasing pressure for
banks, particularly medium and large
institutions, to move into new markets,
and to compete on a regional, or even a
national scale for retail deposits.
The pressure for expansion is being
fueled in part by the threat of direct
competition from, and possible acquisition by, money-center banks. If a
regional banking organization can
expand, and amass more assets while
maintaining profitable operations, the
probability of it being a takeover target
of a money-center bank can be reduced.
In 1985, Ohio joined more than half
the nation's states allowing out-of-state
entry by commercial banking organizations. Shortly after Ohio's interstate
banking law became effective in late
1985, the state's major banking organizations went on an interstate buying
spree, purchasing 36 out-of-state banking organizations in Indiana, Kentucky,
and Michigan by year-end 1986.
In this Economic Commentary, the
interstate acquisitions of Ohio bank
holding companies (BHCs) are examined. The interstate options presently
available to Ohio banks are detailed,
and the stages that Ohio banks will

Thomas M. Buynak is a vice president at McDonald & Company Securities, Inc. in Cleveland,
Ohio, and a former staff economist at the Federal
Reserve Bank of Cleveland. John N. McElravey is

Map 1 Ohio's Interstate

Ohio Banks: Hitting
the Interstate
Acquisition Road
by Thomas M. Buynak
and John N. McElravey

Banking Region

(As of January 1, 1987)

Indiana
$36.0

1. Dollar figures in billions.
2. Percentages are of state
commercial bank deposits
controlled by Ohio BHCs.

SOURCES: Summary of Deposit Data (as of June 30, 1985); and Federal Reserve Bank of
Cleveland.

a research assistant at the Federal Reserve Bank of
Cleveland. The authors would like to thank Mark
Sniderman, Henry Dickson, Gary Whalen, and
Michael Pakko for helpful comments.

The views stated herein are those of the authors
and not necessarily those of the Federal Reserve
Bank of Cleveland or of the Board of Governors of
the Federal Reserve System.

Table 1 Financial Profile of Acquired and Unacquired Banks
in Indiana, Kentucky, and Michigan
(As of December 31, 1985)
Financial Variables

Total assets- .
Profitability
Return on assets
Return on equity
Net interest margin
Net loan charge-offs/totalloans
Nonperforming loans/total loans
Total loans/total assets
Loan portfolio
Consumer loans/total loans
Commercial & industrial loans/
total loans
Residential mortgages/total loans
Commercial mortgages/total loans

Acquired
Mean Value

Unacquired
Mean Value

$291

$136

0.95%
13.00%
3.63%b
0.47%
1.75%b

0.83%
8.90%
3.90%b
0.85%
2.48%b

51%

22%
27%
8%

20%
30%
9%

Deposit Structure
Retail deposits/total deposits
Large CDs/total deposits
Other
Capital/assets
Overhead expenses/total assets
Note: number of banks

7.31%b
2.89%
35

8.39%b
2.97%
1021

a. Dollars in millions.
b. A t-test with statistical significance at the 10 percent level found that these mean values were statistically different from zero.

pass through as the state moves
toward unrestricted nationwide banking are identified. The premiums paid
for the interstate acquirees by Ohio
banking organizations are calculated,
and the average interstate
acquiree of Ohio banks is profiled.
Finally, the acquirees' financial and
market attributes are analyzed to
determine what variables might be
important in choosing an interstate
target. 1
Ohio's Interstate Banking Phases
When Ohio's interstate banking law
became effective on October 17, 1985,
only Kentucky had a reciprocal interstate banking law with Ohio. On January 1, 1986, Indiana and Michigan
extended reciprocal interstate banking
privileges to Ohio banks. This completed "Phase One" of Ohio's move
towards interstate banking." Ohio
banks found themselves competing
within a limited, contiguous-state
region. In Phase One, Ohio's largest
banks had asize advantage over the
largest banks in Kentucky and Indiana,
and had size parity with the larger
Michigan banks."
"Phase Two" began in late August
1986 when two mid-Atlantic states,
Pennsylvania and New Jersey, extended
reciprocal banking privileges to Ohio
banks. Phase Two was completed on
January 1, 1987, when Wisconsin's
regional interstate banking law became
effective, extending the region beyond
contiguous states. In Phase Two,
Ohio's largest banks maintain a size
advantage over commercial banks in
New Jersey and Wisconsin, but are at a
size disadvantage as compared to Pennsylvania's largest banks.
Ohio's interstate banking law also
extends reciprocal banking privileges to
commercial banks and savings and
loans in seven other states and the District of Columbia. The states include

SOURCE: Condition and Income Reports of Commercial Banks, Board of Governors of the Federal
Reserve System.

1. There are only a few studies that analyze premiums paid on interstate acquisitions. For a
related and more general study on acquisition
premiums, see Stephen A. Rhoades, "Deterrninants of Premiums Paid in Bank Acquisitions,"
Atlantic Economic Journal, vol. XV, no. 1, March
1987, pp. 20·30.

2. The "Phase" terminology is that of the
authors, and not that of Ohio's interstate bankinglaw.

3. For a description of the commercial banking

structure in these states, see Thomas M. Buynak, "Interstate Banking: Its Impact on Ohio
Banks," Economic Commentary, Federal Reserve
Bank of Cleveland, September 15, 1985.

Missouri, Illinois, Tennessee, Virginia,
Maryland, Delaware, and West Virginia.
Ohio banking organizations presently
can enter the District of Columbia
under one of its two interstate banking
laws if they pay an "entrance fee."
This entrance fee requires Ohio banking organizations to invest in the district and to hire in part from the local
work force. West Virginia's nationwide
reciprocal law becomes effective on
January 1, 1988. The remaining states
listed in Ohio's interstate banking law
have interstate laws presently excluding Ohio banking organizations.
"Phase Three" will begin October 17,
1988, when Ohio grants reciprocal entry
on a nationwide basis. At that time, or
shortly thereafter, Ohio banking organizations will legally be allowed to enter
Washington, Louisiana, Nevada, West
Virginia, New York, Oklahoma, Rhode
Island, Utah, Texas, Maine, Arizona,
Wyoming, Vermont, and Alaska. Ohio
banks may enter California on January
1, 1991, when that state's nationwide
trigger becomes effective.
The remaining states in the country,
especially southeastern states such as
Florida and Georgia, have chosen to
exclude Ohio bariks from their banking
regions. Their legislation contains no
trigger for nationwide banking. Consequently, full-service entry by Ohio
banking organizations into southeastern states will be possible only if the
states in question change their law, or
if federal legislation is enacted to allow
unrestricted nationwide banking.
The pattern of interstate acquisitions
by Ohio banks reflect in part the timing
of nationwide trigger dates. Regional
banking organizations want to take
advantage of the time before the trigger
date to make their purchases without
competition from banks in other
regions. To illustrate, Ohio banking
organizations may have entered Kentucky more quickly than they did other
states because Kentucky's interstate
banking law had a two-year trigger
date. Ohio banks may try to accelerate

4. It is important to understand that the only
non-emergency (that is, not involving the interstate acquisition of a failed or failing bank) legal
means to acquire a full-service interstate presence is through a bank holding company, because
the Douglas Amendment to the Bank Holding
Company Act of 1956 is the only legislation that
presently allows banking organizations to acquire

their entry into New Jersey because
recent events shifted New Jersey's
nationwide trigger date from July 1,
1988 to January 1, 1988.
It is uncertain at the present time,
however, how extensively Ohio banking organizations will leapfrog Pennsylvania and other geographically
closer markets to compete in moredistant, less-familiar financial markets,
such as New Jersey. Ohio acquirers
might not enter New Jersey to any significant degree until they have
exhausted attractive interstate targets
closer to home.
Ohio BHe Acquisitions
From October 17, 1985 to December 31,
1986, Ohio banking organizations purchased 36 out-of-state, full-service
commercial banking organizations.' In
contrast, there were only five in-state
multi-holding company acquisitions
and mergers by all Ohio banking organizations in 1986. Two large Ohio banking organizations were particularly
aggressive out-of-state buyers during
Phase One of Ohio's interstate law,
together accounting for 22 of the 36
out-of-state acquisitions.
During Phase One and the early
stages of Phase Two, Ohio interstate
acquirers were particularly aggressive
buyers in Indiana, where they bought 24
banking organizations and now control
almost 18 percent of the state's commercial bank deposit base. Ohio interstate acquirers were less aggressive in
Kentucky and Michigan, purchasing
seven and five banking organizations,
respectively. Ohio banks have yet to
purchase any banking organization in
Pennsylvania or Wisconsin (see map 1).
So far, no existing Ohio bank has
been acquired under the state's interstate banking law. The only fullservice, out-of-state entry into Ohio is
by a Pennsylvania banking organization that has agreed to provide the capital for a de novo bank."

banks. Under present banking law,
neither the merger of two independent banks in
different states, nor interstate branch banking, is
legally permissible. See Thomas M. Buynak, et
al., "Banking without Interstate Banking Barriers," Economic Commentary, Federal Reserve
Bank of Cleveland, March 12, 1984.
out-of-state

Premiums Paid By Ohio Acquirers
An acquirer's willingness to pay a purchase premium is directly related to the
perception of how much the acquired
entity will add to the acquirer's market
value. The greater the perception of the
value added by the acquiree, the higher
the premium paid for it. In the case of
an interstate bank acquisition, a premium will be paid based on the financial condition of the bank, and the
competitive position it will give the
acquirer in the new market. This study
employs the conventional definition of
a purchase premium, which is commonly expressed as the ratio of purchase price to book value of equity.
On average, Ohio BHCs paid moderately high prices for their interstate
acquisitions, although there was a wide
range of acquisition prices. On a priceto-equity basis, Ohio BHCs paid on
average 183 percent for out-of-state
acquirees (see table 1). The highest
price to equity was 282 percent; the
lowest was 95. percent. A survey of
premiums paid for other midwestern
interstate acquisitions indicates that
the Ohio acquirers paid premiums close
to the average for this. part of the country. The average for the midwest
region was 190 percent. This was low,
however, compared to the average premium paid in the northeast (270 percent), and the southeast (260 percent)."
Financial Profile of the Average
Acquiree
The financial characteristics of the
acquirees were analyzed to develop a
profile of the average interstate acquiree,
and to determine the variables that
are important in choosing an interstate
acquisition. Twenty-nine of the acquirees were BHCs, and only three of the
BHCs had more than one bank subsidiary. None of the acquired BHCs had
any significant percentage of the holding company's assets in nonbanking
activities (that is, mortgage banking,
leasing, or consumer finance)." Conse-

5. See Mike Casey, "Pennsylvania firm to start
Chardon bank," Crain's Cleveland Business, Feb.
16·22, 1987, pp. 1 and 19.
6. See Bart Fraust, "Some Banking Myths Shattered in '86," American Banker, January 20, 1987,
pp. I, 19-29, and 40.

Table 1 Financial Profile of Acquired and Unacquired Banks
in Indiana, Kentucky, and Michigan
(As of December 31, 1985)
Financial Variables

Acquired
Mean Value

Unacquired
Mean Value

$291

$136

0.95%
13.00%
3.63%b
0.47%
1.75%b

0.83%
8.90%
3.90%b
0.85%
2.48%b

51%

22%
27%
8%

20%
30%
9%

Deposit Structure
Retail deposits/total deposits
Large CDs/total deposits
Other
Capital/assets
Overhead expenses/total assets
Note: number of banks

7.31%b
2.89%
35

8.39%b
2.97%
1021

a. Dollars in millions.
b. A t-test with statistical significance at the 10 percent level found that these mean values were statistically different from zero.

SOURCE: Condition and Income Reports of Commercial Banks, Board of Governors of the Federal
Reserve System.

2. The "Phase" terminology is that of the
authors, and not that of Ohio's interstate bankinglaw.

3. For a description of the commercial banking

structure in these states, see Thomas M. Buynak, "Interstate Banking: Its Impact on Ohio
Banks," Economic Commentary, Federal Reserve
Bank of Cleveland, September 15, 1985.

quently, the analysis of the acquirees'
financial characteristics uses data
relating only to the commercial bank
subsidiaries of the holding company."
Three key financial aspects of the
acquirees were analyzed: profitability,
loan composition, and deposit structure.
The acquired banking organizations in
the sample were compared to the unacquired banking organizations in Indiana,
Kentucky, and Michigan, to determine
if the average interstate acquiree was
any better than the average unacquired
bank in these three states.
As reported in table 1, the average
acquiree had reasonably good earnings,
had a balanced loan portfolio, had a
high percentage of total deposits as
retail deposits, had low overhead
expenses, and had conservative loan
policies as reflected by high loan
quality.
The profitability of the average
acquiree (0.95 percent return on assets)
was fairly high when viewed relative to
the asset size of the average acquiree,
which was $291 million. The average
acquiree's asset size was more than
twice that of the average unacquired
bank ($136 million). The leveraging of
the average acquiree, measured as a
percentage of its assets that are loans,
was low (51 percent), but equal to the
loan-to-asset ratio of the average unacquired bank. The average acquiree, however, had a higher-quality loan portfolio
as reflected by a lower percentage of
loan charge-offs to total loans, and a
lower percentage of total loans classified as nonperforming than did the
average unacquired bank (see table 1).
The consequence of the moderate
leveraging and conservative lending
policies was a healthy, but lower-thanexpected net interest margin for the
averageacquiree (3:63%). This was
almost seven percent less than the
average unacquired bank's net interest
margin. The average acquiree's lower
net interest margin seems to be offset,
though, by the lower amount of net
loan charge-offs. As a result, the

7. Each acquiree's non banking activities represented less than 1 percent of combined banking
and nonbanking assets, except for one acquiree
that had approximately 3 percent of its assets in
non banking activities.

Table 2 Financial Profile of High-Premium
state Acquisitions

and Low-Premium

Inter-

(As of December 31, 1985)
Financial Variables

Total assets"
Price to equity
Profitability
Return on assets
Return on equity
Net interest margin
Net loan charge-offs/totalloans
Nonperforming loans/total loans
Total loans/total assets

High-Premium
Mean Value"

Low-Premium
Mean Value"

$447
236%

$160
138%

0.98%
14.13%C
3.54%
0.33%C
1.36%C
53%

0.93%
12.06%C
3.71%
0.59%C
2.08%C
50%

Loan portfolio
Consumer loans/total loans
Commercial and industrial loans/
total loans
Residential mortgages/total loans
Commercial mortgages/total loans

30%

33%

27%C
25%
8%

18%C
30%
9%

Deposit structure
Retail deposits/total deposits
Large CDs/total deposits

79%
11%

80%
9%

Other
Capital/assets
Overhead expenses/total assets
Note: number of acquirees

6.92%C
2.94%

7.64%C
2.84%

a. High-premium acquisitions were those with price-to-equity greater than or equal to 175 percent.
Low-premium acquirees were those with price-to-equity less than 175 percent.
b. Dollars in millions.
c. A t-test with statistical significance at the 10 percent level found that these mean values were statistically different from zero.

SOURCE: Condition and Income Reports of Commercial Banks, Board of Governors
of the Federal Reserve System.

8. One small acquiree in Kentucky was deleted
because it was purchased as a failed bank. The
sample size is 35.

acquired and unacquired banks
recorded similar returns on assets.
The average acquiree had a balanced
loan portfolio that was tilted toward
retail lending. Consumer loans represented almost one- third of the loan
portfolio, and were a significantly
larger percentage of total loans for the
average acquiree than for the average
unacquired bank. Commercial and
industrial loans accounted for less than
one-fourth of the average acquiree's
total loans.
Ostensibly, interstate acquirers
would more aggressively pursue interstate targets that had a stable, retailoriented deposit structure. (Retail deposits include demand deposits, savings
deposits, and small time deposits.)
Thus, interstate acquirees with a high
percentage of deposits held either as
large-denomination certificates of deposit (deposits over $100,000), or as
borrowed funds, would be less attractive interstate targets. The average acquiree
had 79 percent of its total deposits as
retail deposits and only 10 percent of
its total deposits as large CDs.
As compared to the average unacquired bank, though, the average
acquiree had slightly more large CDs,
and slightly less retail deposits. This is
not entirely unexpected given the size
differences between the acquired and
unacquired banks. The size difference
also seems to account for the difference
in capital ratios. Typically, smaller
banks are better capitalized than larger
banks (see table 1).
High- Versus Low-Premium
Acquirees
The sample is also divided into a highpremium group, and a low-premium
group. This allows us to discern what
financial or market attributes, if any,
account for premium differences
between the two acquiree groups. We
caution that any inferences drawn
from the high-premium and lowpremium groups are tenuous because of
the small sample size.

Table 3

Market

Profile of Ohio BHC Interstate

Bank Acquisitions

All
Acquisitions •
(mean values)

High
Premium
Acquisitions
(mean values)

Low
Premium
Acquisitions!
(mean values)

5.8

5.3

18.9%
$ 1.4

18.3%
$ 1.7

6.8
19.4%
$ 1.5

Banking organizations

10.1

11.4

10.8

Three-firm concentration ratio

77.3%

78.7%

75.5%

4.0%

4.8%

23.2%

24.8%

4.5%
23.4%

Market Variables

Rank
Market share
Market deposits"

Percent of state deposits
Market share of thrifts
Note: Number of markets

1. We excluded the case of one acquiree (market share 0.7 percent) located in the Detroit MSA (total
market bank deposits $30.3 billion) because this market was completely unrepresentative of the typical market in this study.
2. Dollars in billions.

SOURCE: Summary of Deposit Data (as of Iune 30, 1985), FDIC.

The division for the sample into
high-premium and low-premium groups
used a price-to-equity ratio of 175 percent. There are 16 acquirees in the
high-premium group and 19 acquirees
in the low-premium group; the prices
paid for them were 236 percent price-toequity, and 138 percent price-to-equity,
respectively.
As evident from table 2, the two
groups exhibit several similar financial
attributes. The average low-premium
and high-premium acquiree posted similar earnings performance, net interest
margins, loan-to-asset ratios, deposit
structure, overhead expenses, and percentage of total loans as consumer
loans."
However, there are important differences between the two groups that
could explain in part why Ohio acquir-

ers paid more for the high-premium
acquirees. The average high-premium
acquiree posted a higher return on
equity, and had a significantly higher
percentage of its loan portfolio as commercial and industrial loans. Also, the
loan quality of the average highpremium acquiree was significantly
better than the loan quality of the.
average low-premiumacquiree. The
average high-premium acquiree had
lower loan charge-offs, and had a
significantly lower percentage of total
loans as non performing than did the
average low-premium acquiree.
Characteristics
Markets
The 35 acquirees
banking markets.
study, a banking

as the home county or metropolitan
statistical area (MSA) of the acquired
institution. Eight markets were singlecounties, and 12 markets were MSAs.
Twenty-five acquirees were located in
MSAs. The most active markets for
acquisitions by Ohio BHCs were the
Indianapolis MSA (eight acquirees),
and the Cincinnati MSA (six acquirees).
Kentucky entry by Ohio banks
involved primarily cross-river purchases to extend presence to the Kentucky portion of the Cincinnati metropolitan area. The out-of-state
acquisitions in Michigan gave Ohio
BHCs a presence in metropolitan
markets in the state's southern half. In
Indiana, Ohio BHCs had the most geographically diversified market entry,
entering metropolitan and rural
markets throughout the state.
The average market of the acquirees
had $1.4 billion in commercial bank
deposits, which represented 4.0 percent
of that state's total commercial bank
deposits. The average market also had
a high concentration of commercial
bank deposits, as measured by a threefirm concentration ratio of 77 percent.
Thrifts held less than one-fourth of
combined commercial bank and thrift
deposits.
'
The average acquiree held 18.9 percent of commercial bank deposits in the
market, and it ranked, on average,
sixth out of 10 organizations. In

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

smaller out-of-state markets, Ohio
BHCs were more likely to purchase
banks with more dominant market
positions. Of the 13 acquirees located in
markets with less than $1 billion in
commercial bank deposits, only one
acquiree was ranked below the
market's second-largest institution.
The average market share of these 13
acquirees was 35 percent.
There were only minor differences
between the market characteristics for
the high-premium and low-premium
acquiree groups. However, higher premiums were paid for acquirees that
had more dominant market positions,
and which were located in larger, moreconcentrated markets (see table 3).
Concluding Remarks
Soon after Ohio's interstate banking
law became effective in late 1985, Ohio
BHCs actively pursued interstate
acquisitions. No existing Ohio bank has
been acquired by an out-of-state banking organization.
The average interstate acquiree purchased by Ohio BHCs was an aboveaverage financial performer. Ohio acquirers paid moderately high premiums,
but less than the premiums paid in
other attractive interstate banking re-

gions, such as the rapidly consolidating
southeast. Ohio acquirers paid higher
premiums for acquirees with higher quality loan portfolios, and a higher return
on equity. Differences in return-onassets, loan composition, and deposit
structure did not seem to explain differences in premiums paid.
Ohio BHCs are targeting acquirees
that are typically located in metropolitan markets (MSAs). In smaller metropolitan or rural markets, the acquisition target is usually among the
market's dominant organizations, if not
the market leader. In the larger metropolitan markets, Ohio BHCs are purchasing medium to large banks that are
typically ranked in the top half of the
market's organizations. Entry by Ohio
BHCs into Kentucky and Michigan has
been more limited geographically than
their entry into Indiana.
The relatively high credit quality of
the average acquiree should allow Ohio
BHCs to rapidly integrate them into
their existing organizations. This will
permit them to take advantage of each
"window of opportunity" in Ohio's
three banking phases. As the trigger
date for nationwide banking gets
closer, some of Ohio's largest BHC's
are on the brink of becoming "superregional" banks-a size that they hope
will allow them to compete directly
with the nation's largest banks.

BULK RATE
U.S. Postage Paid
Cleveland,OH
Permit No. 385

of Acquirees'
were located in 20
For purposes of this
market was defined

9. For a statistical model of interstate purchase
premium, see Dave Phillis and Christine Pavel,
"Interstate banking game plans: Implications for
the Midwest," Economic Perspectives, Federal
Reserve Bank of Chicago, March/April1986, pp.
23-39.
Material may be reprinted provided that the
source is credited. Please send copies of reprinted
materials to the editor.

Address Correction Requested: Please send
corrected mailing label to the Federal Reserve
Bank of Cleveland, Research Department,
P.O. Box 6387, Cleveland, OH 44101.