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FEDERAL RESERVE BANK OF DALLLAS
DECEMBER 1996

FINANCIAL INDUSTRY

Bank Consolidation:
When Less Means More
Jeffery W. Gunther
Senior Economist and Policy Advisor

Banking's Merger Fervor:
Survival of the Fittest?
Robert R. Moore
Senior Economist and Policy Advisor

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

Financial Industry Studies
Federal Reserve Bank of Dallas

Robert D. McTeer, Jr.
President and Chief Executive Officer

Helen E. Holcomb
First Vice President and Chief Operating Officer

Robert D. Hankins
Senior Vice President

Genie D. Short
Vice President

Economists
Jeffery W. Gunther
Robert R. Moore
Kenneth J. Robinson
Thomas F. Siems
Sujit "Bob" Chakravorti
Financial Analysts
Robert V. Bubel
Howard C. "Skip" Edmonds
Karen M. Couch
Kelly Klemme
Susan P. Tetley
Edward C. Skelton
Research Programmer Analyst
Olga N. Zograf
Graphic Designer
Lydia L. Smith
Editors
Rhonda Harris
Monica Reeves
Financial Industry Studies
Graphic Design
Gene Autry
Laura J. Bell
Ellah K. Pina

Financial Industry Studies is published by the
Federal Reserve Bank of Dallas. The views expressed
are those of the authors and should not be attributed
to the Federal Reserve Bank of Dallas or the Federal
Reserve System.
Articles may be reprinted on the condition that
the source is credited and a copy of the publication
containing the reprinted article is provided to the
Financial Industry Studies Department of the Federal
Reserve Bank of Dallas.
Financial Industry Studies is available free of
charge by writing the Public Affairs Department,
Federal Reserve Bank of Dallas, P.O. Box 655906,
Dallas, Texas 7 5 2 6 5 - 5 9 0 6 , or by telephoning
(214) 922-5254 or (800) 333-4460, ext. 5254.

Contents
Bank Consolidation:
When Less Means More
Jeffery W. Gunther

Page 1

Banking's Merger Fervor:
Survival of the Fittest?
Robert R. Moore

Page 9

Lost in all the talk about reorganization and consolidation in
the banking industry is one exceedingly important fact—the most
noticeable structural change from the consumer's perspective has
been an appreciable expansion in the number of local banking
offices, together with an associated improvement in the availability
of banking services. That is the conclusion Jeffery Gunther draws
from an examination at the local market level of the massive
structural changes in the banking industry during the 1980s. In
addition, evidence presented in this article indicates that liberalization of geographic banking restrictions at the state level helped
facilitate the increase in banking offices. The concurrent trends of
reductions in the number of banking organizations at the national
level and increases in the number of banking offices at the local
market level partly reflect the breakdown of long-standing restrictions on banks' geographic expansion.

Consolidation in the U.S. banking industry has greatly reduced
the number of banks and has the potential to reshape the industry
further. Robert Moore examines the characteristics of banks that
have been acquired in mergers.
The findings show that banks with weak performance are
more likely to be acquired than are banks with strong performance.
Acquisition probability tends to be high for banks with low profitability, slow asset growth, a low market share, a low capital-to-asset
ratio, and a low ratio of non-small-business loans to assets. Small
business loans and bank size, however, do not significantly influence acquisition probability.

Bank
Consolidation:
When Less
Means More

During the 1980s, widespread accounts of
high failure rates and large-scale mergers left the
impression that the banking industry was undergoing a historic contraction. In one sense this
impression is accurate, but in another it is not.
This article examines the structural changes
in the banking industry during the 1980s to
illuminate important aspects of the consolidation wave that have been either overlooked
or underappreciated. The results suggest that,
beyond the name changes accompanying mergJeffery W. Gunther
ers, the average bank depositor saw little eviSenior Economist and Policy Advisor
dence of the large-scale consolidation occurring
Financial Industry Studies Department
at the national level. Instead, the most noticeFederal Reserve Bank of Dallas
able structural change from the consumer's perspective was an appreciable expansion in the
number of local banking offices, together with
an associated improvement in the availability of
banking services.1 In addition, a statistical analysis of the increase in the number of banking
offices during the 1980s indicates that the reiberalization of geographic moval of long-standing restrictions on banking
organizations' geographic expansion deserves
banking restrictions has lived some of the credit for the improvements in the
accessibility of services.

up to its promise of enhancing

service accessibility.

Consolidation wave leaves fewer
banking organizations—or does it?
The 1980s witnessed considerable consolidation in the U.S. banking industry. As shown in
Chart 1, the number of U.S. banking organizations fell from 12,930 in 1980 to 9,982 in 1990, a
reduction of 23 percent.2 A wave of bank failures and reductions in legal restrictions on the
ability of banking organizations to expand geographically were among the factors that fueled
the consolidation wave.3
Chart 1

Number of U.S. Banking Organizations,
1980-90

Thousands

It should be acknowledged, though, that
in certain cases consolidation may have
negatively affected other bank custom-

14-,

ers, such as small business borrowers.
For example, if a bank's lending focus
was redirected following its acquisition
by another institution, then some of the
bank's original borrowers may have
faced transitional costs associated with
locating alternative sources of funds.
2

Banking organizations are defined here
as banks aggregated to the company
level.

The erosion of geographic banking
restrictions at the state level during the
1980s paved the way for legislation at
the federal level, which came ultimately
in the form of the Riegle-Neal Interstate

DATA SOURCE: Federal Deposit Insurance Corp.,
Summary of Deposits.

FEDERAL RESERVE BANK OF DALLAS

FINANCIAL INDUSTRY STUDIES DECEMBER 1995

Banking and Branching Efficiency Act
of 1994.

Previous studies using the HerfindahlHirschman Index to measure market
concentration have reached similar
conclusions regarding the lack of any
noticeable effect of bank consolidation in
reducing competition at the local market
level (for example, see Klemme 1995).

The appropriate geographic definition for
a local banking market is far from clear.
Here, a county-level definition is used,
as counties represent the smallest geographic unit for which the population
data used in this article are consistently
available. The county-level analyses in
this article are restricted to the continental United States. Also, the analyses are
restricted to counties having at least one
banking office in both 1980 and 1990.
Only twenty-nine counties fail to meet
this latter criterion.

Metropolitan counties are defined here
as counties, or areas classified as county
equivalents, that are part of either metropolitan statistical areas (MSAs) or, in the
case of New England, New England
county metropolitan areas (NECMAs).
The MSAs and NECMAs are identified
according to the standard definitions, as
revised by the Office of Management and
Budget in June 1994.

Banking offices are defined here to
include all head offices, branches, and
facilities reporting deposit activity.

For examples of the studies addressing
the accessibility of banking services, see
Lanzillotti and Saving (1969), Savage
and Humphrey (1979), Seaver and
Fraser (1979), and Evanoff (1988).

Accessibility often has been measured
either as the number of banking offices
operating in a given market area or as

Chart 2

However, while recent reductions in the
overall number of banking organizations are
dramatic, they may be of little interest to the
average bank customer. Of broader significance
are changes at the local market level, because it
is from this perspective that consumers view
the banking industry and interact with it. Did
consolidation leave the consumer with fewer, or
more, banking alternatives?
As it turns out, the average number of
banking organizations operating at the local
market level held steady during the consolidation of the 1980s.4 The average number of banking organizations serving individual counties
provides a reasonable measure of the number of
local banking alternatives consumers face.5 For
metropolitan counties, the average number of
banking organizations rose slightly, from 11.1 in
1980 to 11.8 in 1990.6 The average number of
banking organizations serving rural counties was
4.1 in both 1980 and 1990.
It is not difficult to see how the overall
number of banking organizations could shrink
while leaving the average number of organizations operating at the county level unchanged.
When a given banking organization acquires
another, the overall number of organizations is
reduced by one. However, if prior to their merger the two organizations had operated in different local markets, then the acquisition would
leave the average number of organizations operating at the county level unchanged. The stability in the number of banking organizations
operating at the county level during the consolidation of the 1980s is partly attributable to the
frequency of mergers involving organizations in
different markets.

Number of U.S. Banking Offices, 1980-90
Thousands

70-i

DATA SOURCE: Federal Deposit Insurance Corp.,
Summary of Deposits.

acterized as contracting during the 1980s only in
the sense of the reduction in the overall number
of organizations. As argued in the next section,
the substantial rise in the number of banking
offices during this period suggests that banking
organizations were seeking to expand geographically, in an effort to enhance the availability of
financial services.

Geographic expansion increases
accessibility of banking services
Does the consumer have more or less convenience following the bank consolidation wave?
One indicator of customer convenience—the
accessibility of banking services—has been the
subject of numerous academic studies.8 Below,
both growth in the number of banking offices
per county and growth in the ratio of county
population to banking offices are used as indicators of changes in the accessibility of banking
services.9 The averaging of growth rates at the
county level helps provide an accurate picture
of the changes occurring in local markets.10

the ratio of local population to banking
offices. A notable exception is Evanoff
(1988), who argues that the number of
offices per square mile is a superior
measure. However, because the analysis
here focuses on changes in accessibility,
Evanoff's measure becomes equivalent
to a measure based on the number of
banking offices per county; that is, the
growth rate of the number of offices in a
given county is equal to the growth rate
of the number of offices per square mile
of the county, given that the size of
individual counties typically is constant.
10

In principle, the average growth rate at
the county level could be less than,
greater than, or equal to the growth rate
for all counties combined.

Note that the resulting 26 percent
increase in the average number of
banking offices represents the growth
rate for all metropolitan counties
combined, as opposed to the average
rate of growth at the individual metropolitan county level, which, as mentioned in the text, was 36 percent.

Consolidation leaves more banking offices
Despite the large reduction in the overall
number of banking organizations during the
1980s, the number of banking offices actually
increased substantially over the same period." As
shown in Chart 2, the number of U.S. banking
offices rose from 49,104 in 1980 to 60,108 in
1990, an increase of 22 percent, as the establishment of branches more than made up for reductions in the number of head offices. Ironically,
this large increase in the number of banking
offices occurred during a period when technological innovations, such as the automated teller
machine, supposedly had reduced the importance of "brick and mortar" locations.
Given the substantial increase in the number of offices, together with the stability in the
number of organizations operating at the local
market level, the banking industry can be char-

Metropolitan counties. The number of bank-

ing offices operating in metropolitan counties
grew an average of 36 percent during 1980-90.
This significant growth in offices at the county
level is in stark contrast to the 23 percent decline
in the number of organizations operating at the
national level. By 1990, the average number of
banking offices in metropolitan counties was
fifty-three, compared with forty-two in 1980, as
shown in Chart 3 11
Although the increase in offices for metropolitan counties could simply reflect rising population levels, changes in the ratio of population
to banking offices can provide a better indication of trends in the accessibility of services. If

growth in the number of banking offices failed
to keep up with population growth, then the
ratio of population to offices would rise. In
contrast, if growth in the number of offices
exceeded population growth, the ratio of population to offices would fall. In this sense, a
falling population-to-office ratio would suggest
an increase in service accessibility, while a rising
population-to-office ratio would indicate a reduction in accessibility.
For metropolitan counties, growth in banking offices tended to exceed local population
growth in the 1980s. The average county-level
change in the ratio of population to banking
offices from 1980 to 1990 was - 1 1 percent.
Reflecting relatively strong growth in the number of banking offices, the average populationto-office ratio in metropolitan counties was 4,711
in 1990, compared with 5,572 a decade earlier,
as shown in Chart 3- These county-level data
indicate that, within local metropolitan markets,
the banking industry expanded fairly aggressively during the 1980s, despite the contraction
in the overall number of banking organizations.

Chart 4

Service Accessibility in the Average
Rural County, 1980 Versus 1990
Number of offices

1990

DATA SOURCES: Federal Deposit Insurance Corp., Summary
of Deposits; U.S. Bureau of the Census,
Census of Population and Housing.

counties was 3,147 in 1990, compared with 3,694
a decade earlier.

Geographic restrictions and
service accessibility

Rural counties. Data indicate that service
accessibility increased for customers in rural areas as well. The average county-level growth
rate between 1980 and 1990 in the number of
banking offices was 20 percent. By 1990, the
average number of offices operating in rural
counties was 7.6, compared with 6.5 in 1980, as
shown in Chart 4. Moreover, the average change
between 1980 and 1990 in the ratio of population to offices was - 1 1 percent, as was the case
for metropolitan counties. As shown in Chart 4,
the average population-to-office ratio for rural

During the 1980s, a large number of states
relaxed long-standing restrictions on banking
organizations' geographic expansion. 12 Restrictions on holding companies' operation of multiple banks were relaxed in twelve states during
this period. In addition, twenty-two states provided for greater branching powers, with fifteen
removing virtually all restrictions on the number
and location of branches. All but five states
passed laws allowing interstate banking, either
on a regional or national basis. Greater holding
company and branching powers within individual states, together with the legislative changes
allowing various forms of interstate banking,
undoubtedly affected the structure of banking at
the local market level.
Good reasons exist to suspect that a liberalization of geographic banking restrictions would
promote service accessibility. Consider a relatively small rural market area, which in the absence of branching could support only a single
banking organization. Suppose that a change in
law allowed branching or holding company expansion within the market area. If the cost of
operating a branch or a bank subsidiary were
less than the cost of operating a separate banking organization, then the lone organization operating in the market might find it profitable to
open a branch or another bank subsidiary, perhaps in a somewhat distant, but reasonably well
populated, portion of the market area. In this

Chart 3

Service Accessibility in the Average
Metropolitan County, 1980 Versus 1990
Number of offices

1980

Population per office (Thousands)

1990

1980

1990

DATA SOURCES: Federal Deposit Insurance Corp., Summary
of Deposits; U.S. Bureau of the Census,
Census of Population and Housing.

FEDERAL RESERVE BANK OF DALLAS

Population per office (Thousands)

FINANCIAL INDUSTRY STUDIES DECEMBER 1995

Data on the liberalizations are from
Amel (1993).

The categorization of states according
to expansion opportunities, irrespective
of whether they spring from branch
banking or holding company expansion,
is a somewhat novel aspect of this
article. Reflecting the arguments
pointing to the potentially stronger
effect of branching laws on service
accessibility, previous studies of
accessibility have tended to focus
exclusively on branching laws. However,
because the efficiency and diversification arguments apply to both forms of
expansion, albeit to potentially different
degrees, both branching laws and the
laws governing holding company
expansion may significantly affect
service accessibility. Although not
reported here, a separate analysis for
metropolitan counties in states that
prohibited branching at the beginning of
the 1980s indicates that liberalizations
of holding company laws were associated with relatively high growth in
banking offices, even after controlling
for the effects of population growth and
branching liberalizations. This finding
supports the explicit consideration given
here to the laws governing holding
company expansion.

These categories are necessarily broad
and imprecise. For example, states that
prohibited expansion at the beginning of
the 1980s may nevertheless have contained branches or multibank holding
companies if previously existing offices
had been exempted. Similarly, the
category of limited expansion includes a
wide range of expansion laws, including,
for example, laws allowing expansion
only in limited regions or only through
acquisition, as opposed to the establishment of new offices. Unlimited expansion refers to laws generally allowing
expansion with no limitations on the
number or location of offices.

case, the removal of geographic restrictions within
the market area would precipitate an increase in
the number of banking offices.
In addition, if the restriction on expanding
into the market area from other regions were
removed, then banking organizations headquartered outside the market conceivably could find
it profitable to enter the area by establishing
branches or bank subsidiaries. This also would
increase the number of banking offices serving
the local market.
Similar arguments apply to larger, less limited market areas. Consider a given metropolitan
market area served by several banking organizations, each consisting of a single bank. And
assume again that both branching and holding
company expansion offer efficiency gains over
the operation of independent banks. Then, if
branching or holding company expansion were
allowed, competitive forces would be expected
to result in the conversion of many of the independent banks into branches or bank subsidiaries. Also, because organizations now would be
able to expand, both within the market and into
the market from other areas, additional offices
most likely would appear at particularly advantageous locations.

tors suggest that branching represents the more
effective structure for multiple offices. Regulatory restrictions on banks, including charter requirements, capital adequacy guidelines,
reporting requirements, and other compliance
issues, may make geographic expansion through
a subsidiary more costly than expansion through
a branch. Similarly, bank-level expenses that
could otherwise be centralized in a head office—for example, the costs associated with a
board of directors or additional levels of senior
management—may also make the cost of operating a subsidiary bank higher than the cost of
operating a branch.

An empirical test of the
liberalization-accessibility relationship
To test empirically for a positive effect of
geographic liberalizations on changes in the
number of banking offices at the local market
level, states are categorized according to whether
they were affected by liberalization during the
1980s. In this analysis, no effort is made to
identify differences in the effects of branching
versus holding company liberalizations. Rather,
the term expansion refers to expansion within a
state or smaller area through either branching or
the establishment of bank subsidiaries.13 Later,
in the following section, additional empirical
tests are conducted for branching liberalizations
in particular.
The experience of individual states is categorized as follows: (1) no liberalization, (2) the
removal of prohibitions on expansion to allow
limited expansion, (3) the removal of prohibitions on expansion to allow unlimited expansion, and (4) the removal of laws allowing only
limited expansion to allow unlimited expansion.14 The expansion status of the individual
states, at both the beginning and end of the
1980s, is determined by the extent of expansion
allowed through either branches or holding companies. For example, a state falls in the second
category—the removal of prohibitions on expansion to allow limited expansion—if it moved
from the prohibition of branching to allow limited branching and, at the beginning of the
period, had not allowed holding company expansion in any form. However, a state falls in
the first category—no liberalization—if it moved
from the prohibition of branching to allow limited branching and, at the beginning of the
period, already had allowed limited expansion
through multibank holding companies. Because
states that liberalized their branching laws, but
only to a degree comparable to previously existing holding company laws, are lumped together

Insofar as the cost of operating a network
of branches or affiliated banks is lower than the
cost of operating an equivalent number of independent banks, the removal of geographic restrictions might promote the establishment of a
relatively large number of banking offices. One
reason to suspect the operation of multiple offices would result in greater efficiency is the
potential effect of a large asset base in reducing
average cost. If a large asset size helps banking
organizations operate more efficiently, then, by
helping establish and support a large asset base,
branching or holding company expansion might
result in efficiency gains. Put another way, because branches and bank affiliates can share
resources at the company level, the cost of
establishing an additional branch or bank subsidiary might be lower than the cost of establishing an independent bank representing an entirely
new organization. Additionally, geographic expansion by banking organizations can yield
benefits by facilitating risk diversification at the
company level. As a result, the removal of branching restrictions and the removal of restrictions
on holding company expansion both have the
potential to increase the number of banking
offices at the local market level.
While both branching and holding company expansion hold the promise of increasing
the accessibility of banking services, other fac-

with states that experienced no change in law,
comparisons of structural changes across the
four categories may understate the true effects
of geographic liberalization.15
The states categorized as liberalizing experienced significant changes in the laws governing geographic expansion. As of 1980, only five
states prohibited all forms of both branching
and holding company expansion, and these
states alone are candidates for the second and
third categories.16 As it turns out, each of the five
states experienced a liberalization. Kansas,
Nebraska, and Oklahoma moved from the prohibition of expansion through either branches or
holding companies to allow limited branch
banking and also limited forms of holding company expansion. As a result, these three states
fall under the second category—the removal of
prohibitions on expansion to allow limited
expansion. In addition, Illinois moved from
the prohibition of expansion through either
branches or holding companies to allow limited
branching and unlimited holding company expansion, while West Virginia moved from the
prohibition of expansion to allow unlimited
branching and limited holding company expansion. As a result, these two states fall under the
third category—the removal of prohibitions on
expansion to allow unlimited expansion.

calculated. If the liberalization of geographic
restrictions had a positive impact on the accessibility of banking services, then the average percentage change in the population-to-office ratio
should be lower for the liberalization categories
than for the first category. The differences across
categories are tested for statistical significance at
the 5 percent level using the Wilcoxon rank sum
test.18 All the tests are conducted separately for
metropolitan and rural counties.19

Metropolitan counties. As shown in the

first row of Table 1, the proportion of metropolitan counties experiencing a reduction in the
ratio of population to banking offices between
1980 and 1990 is lowest for the states with no
change in expansion laws, as expected under
the view that geographic liberalizations facilitate
the expansion of banking offices. The proportion of metropolitan counties experiencing a
reduction in the population-to-office ratio is
highest for the category of full liberalization—
the removal of prohibitions on expansion to
allow unlimited expansion. For 98 percent of
the metropolitan counties in this category, growth
in banking offices exceeded growth in population. This relatively high proportion is statistically different from the 69 percent calculated
for the no-liberalization category. Also, 76 percent of the metropolitan counties in states that
moved from the prohibition of expansion to
allow limited expansion experienced a reduction in the population-to-office ratio. However,
this proportion is not significantly different from
the relatively low proportion calculated for the
no-liberalization category. Similarly, while the
proportion of metropolitan counties with reductions in the population-to-office ratio is slightly
higher for states that moved from limited to
unlimited expansion than for states with no
change in expansion law, the difference is not
statistically significant. Overall, though, these findings provide evidence of a positive effect of
geographic liberalization on the accessibility of
banking services in metropolitan counties.

Four states qualify for the fourth category—
the removal of laws allowing only limited expansion to allow unlimited expansion. Louisiana,
New Hampshire, and Washington moved from
limited branching to unlimited branching, while
New Jersey moved from limited to unlimited
holding company expansion.
With the states categorized according to
their changes in expansion laws, their respective
counties can be grouped accordingly. It is then
a simple matter to calculate, for each of the
categories, the proportion of counties experiencing a reduction in the ratio of population to
banking offices. If the liberalization of geographic
restrictions had a positive impact on the accessibility of banking services, then the proportion
of counties experiencing a reduction in the population-to-office ratio should be higher for the
liberalization categories than for the first category, which represents no change in expansion
laws. The differences across categories in the
proportion of counties experiencing greater accessibility are tested for statistical significance at
the 5 percent level using the standard chi-square
test for differences in probabilities.17

Additional evidence that geographic liberalizations facilitate expansion in the number
of banking offices is provided in the second
row of Table 1, which shows, for each category,
the average percentage change in the ratio of
metropolitan county population to banking
offices. The category representing full liberalization—the removal of prohibitions on expansion to allow unlimited expansion—shows a 30
percent average reduction in the populationto-office ratio, compared with an average reduction of only 9 percent for the no-liberalization
category, a statistically significant difference. Simi-

Similarly, for each of the different categories, the average rate of change in the ratio of
county population to banking offices also is

FEDERAL RESERVE BANK OF DALLAS

FINANCIAL INDUSTRY STUDIES DECEMBER 1995

A large number of categories could be
formed to reflect the peculiar characteristics of the various types of liberalizations that occurred during the 1980s.
However, to maintain tractability, the
analysis here proceeds on the basis of
the four categories defined in the text.

Altogether, thirteen states prohibited
branch banking as of 1980, while
holding company expansion also was
prohibited in thirteen states.

See Conover (1980,144-46).

' 8 See Conover (1980,215-18).
19

It should be noted that a positive correlation between geographic liberalizations
and improvements in accessibility would
not necessarily imply that the liberalizations caused the improvements. Nevertheless, a positive association between
liberalizations and accessibility improvements would be consistent with the view
that the liberalizations were effectual.

Table 1

Liberalization of Restrictions on Bank Expansion
Type of liberalization
Prohibited
to limited

None

Prohibited
to unlimited

Limited
to unlimited

Metropolitan counties
Percentage of counties experiencing
a reduction in the population-to-office

76
(.60)

ratio, 1 9 8 0 - 9 0 1
Average percentage change in the
population-to-office ratio, 1 9 8 0 - 9 0 2
Number of counties

-19*

-9

(-2.25)
683

98**
(14.7)

-30**
(-6.23)

-11

(.36)
(-.37)
59

Rural counties
Percentage of counties experiencing
a reduction in the population-to-office

89**
(27.2)

ratio, 1 9 8 0 - 9 0 1
Average percentage change in the

-13**

-9

(-2.98)

population-to-office ratio, 1 9 8 0 - 9 0 2
Number of counties

244

1,800

97**
(30.9)
-27**

71
(.32)

(-7.68)

-7
(.44)

117

* Significantly different at the 5 percent level from the base case of no liberalization.
** Significantly different at the 1 percent level from the base case of no liberalization.
NOTES: 1 The values of the chi-square test statistic for differences in proportions relative to the base case of no liberalization
are in parentheses. The large sample approximation for the test statistic is the chi-square distribution with one degree
of freedom. See Conover (1980,144-46).
2 The values of the Wilcoxon rank sum test statistic for differences in location relative to the base case of no liberalization
are in parentheses. The large sample approximation for the test statistic is the standard normal distribution. See
Conover (1980, 215-18).

experienced a reduction in the population-tooffice ratio. This proportion also is significantly
different from the relatively low proportion calculated for the no-liberalization category. However, as was the case for the metropolitan
counties, no statistically significant difference in
the proportion of rural counties with reductions
in the population-to-office ratio occurs between
the group of states that moved from limited to
unlimited expansion and the group of states
with no change in expansion laws. Overall,
though, these findings for rural counties also
point to a positive impact of geographic liberalization on the accessibility of banking services.
The fifth row of Table 1 provides additional evidence that geographic liberalization
helps boost the number of banking offices in
rural counties. The category representing full
liberalization—the removal of prohibitions on
expansion to allow unlimited expansion—shows
a 27 percent average reduction in the population-to-office ratio, compared with a reduction
of only 9 percent for the no-liberalization category, a statistically significant difference. Simi-

larly, the 19 percent average reduction for the
metropolitan counties in states that moved from
the prohibition on expansion to allow limited
expansion also is significantly different from
the average reduction calculated for the noliberalization category.
Rural counties. The results for rural counties are similar to those for metropolitan counties. As shown in the fourth row of Table 1, the
proportion of rural counties experiencing a reduction in the ratio of population to banking
offices between 1980 and 1990 is relatively high
for the two groups of states that removed prohibitions on expansion, as expected under the
view that geographic liberalization facilitates
growth in the number of banking offices. The
growth in offices exceeded population growth
in 97 percent of the rural counties in states that
moved from prohibited to unlimited expansion.
This relatively high proportion is statistically different from the 74 percent calculated for the noliberalization category. Similarly, 89 percent of
the rural counties in states that moved from the
prohibition of expansion to limited expansion

Table 2

Liberalization of Branch Banking Restrictions in States
Allowing Unlimited Holding Company Expansion
Type of branching liberalization
Prohibited
to limited

None

Prohibited
to unlimited

Limited
to unlimited

Metropolitan counties
Percentage of counties experiencing
a reduction in the population-to-office
ratio, 1 9 8 0 - 9 0 1
Average percentage change in the
population-to-office ratio, 1 9 8 0 - 9 0 2
Number of counties

72*
(6.11)

46
(1.99)
-3
(.18)

-4

78*
-16**

-12**

-4.50)

-4.09)

239

(5.80)

193

Rural counties
Percentage of counties experiencing
a reduction in the population-to-office
ratio, 1 9 8 0 - 9 0 1

84**
(13.9)

Average percentage change in the

-5

-15**

-10*

- 8

(-4.87)

(-2.04)

(-.66)

138

190

population-to-office ratio, 1 9 8 0 - 9 0 2
Number of counties

586

74
(2.12)

67
(.13)

305

larly, the 13 percent average reduction for
rural counties in states that moved from
prohibition on expansion to allow limited
pansion also is significantly different from
relatively small average reduction calculated
the no-liberalization category.

the
the
exthe
for

positive impact on the accessibility of banking
services, even after holding company expansion had been allowed, then the proportion of
counties experiencing a reduction in the population-to-office ratio should be higher for the
liberalization categories than for the category of
no change in branching laws. Similarly, if the
liberalization of branching restrictions had a
positive impact on the accessibility of banking
services, then the average percentage change in
the population-to-office ratio should be lower
for the liberalization categories than for the nochange category.

An empirical test of the
branching-accessibility relationship
Because a good number of states allowed
unlimited holding company expansion at the
beginning of the 1980s and subsequently relaxed restrictions on branch banking, the types
of empirical tests applied in the previous section
to geographic liberalizations in general can be
applied exclusively to branching liberalizations.
In 1980, thirty-one states already allowed unlimited holding company expansion. Of these, eighteen experienced no change in branching laws.
However, three of the thirty-one states—Minnesota, North Dakota, and Wyoming—moved from
the prohibition of branching to allow limited
branching, while Texas moved from the prohibition of branching to allow unlimited branching.
In addition, nine of the states moved from limited branching to unlimited branching.20 If the
liberalization of branching restrictions had a

FEDERAL RESERVE BANK OF DALLAS

Metropolitan counties. The statistics in Table
2 are generated in the same manner as those in
Table 1, except that the analysis is confined to
the states that allowed unlimited holding company expansion in 1980 and the categories refer
to the liberalization of branching laws only. As
shown in the first row of Table 2, the proportion
of metropolitan counties experiencing a reduction
in the population-to-office ratio is highest for the
category of full liberalization—the removal of
prohibitions on branching to allow unlimited
branching. This relatively high proportion of 78
percent is statistically different from the 61 percent calculated for the no-liberalization category.

FINANCIAL INDUSTRY STUDIES DECEMBER 1995

These states are Connecticut, Florida,
Massachusetts, Michigan, Ohio, Oregon,
Utah, Virginia, and Wisconsin.

Moreover, a relatively high 72 percent of the
metropolitan counties in states that moved from
limited to unlimited branching experienced a
reduction in the population-to-office ratio. For
states that removed prohibitions on branching to
allow limited branching, the proportion of metropolitan counties experiencing a reduction in
the population-to-office ratio is 46 percent. However, the associated chi-square test indicates that
the difference between this relatively low proportion and the 6 l percent calculated for the noliberalization category is not statistically
significant. Finally, the average percentage reduction in the population-to-office ratio is significantly greater for metropolitan counties in
the two groups of states that moved to unlimited
branching than for metropolitan counties in states
with no change in branching law, as shown in
the second row of Table 2. These findings provide evidence of a positive effect of branching
liberalization on the accessibility of banking services in metropolitan counties.

number of banking offices at the local market
level often exceeded growth in the local population. Finally, the evidence presented here indicates that liberalizations of geographic banking
restrictions at the state level helped facilitate the
growth in the number of banking offices that
occurred during the 1980s. The concurrent trends
of reductions in the number of banking organizations at the national level and increases in the
number of banking offices at the local market
level partly reflect the breakdown of longstanding restrictions on banks' geographic
expansion. Thus, liberalization of geographic
banking restrictions has lived up to its promise
of enhancing service accessibility.

References
Amel, Dean F. (1993), "State Laws Affecting the Geographic Expansion of Commercial Banks" (Board of Governors of the Federal Reserve System, August, mimeo).
Conover, W. J. (1980), Practical Nonparametric

Rural counties. The branching results for

Statistics,

2nd ed. (New York: John Wiley & Sons, Wiley Series in

rural counties also indicate a positive branchingaccessibility relationship. As shown in the fourth
row of Table 2, the proportion of rural counties
experiencing a reduction in the ratio of population to banking offices between 1980 and 1990
is relatively high for states that moved from the
prohibition of branching to allow limited branching. In addition, the average percentage reduction in the population-to-office ratio is significantly
greater for rural counties in the two groups of
states that eliminated prohibitions on branching,
as shown in the fifth row of Table 2.

Probability and Mathematical Statistics).
Evanoff, Douglas D. (1988), "Branch Banking and Service
Accessibility," Journal of Money, Credit, and Banking

(May): 191-202.
Klemme, Kelly (1995), "Has Consolidation Reduced
Competition in Texas Banking?" Federal Reserve Bank of
Dallas Financial Industry Issues, Third Quarter.
Lanzillotti, Robert F., and Thomas R. Saving (1969),
"State Branching Restrictions and the Availability of
Branching Services," Journal of Money, Credit, and

Conclusion

Banking 1 (November): 7 7 8 - 8 8 .

The term contraction, as applied to recent
trends in the banking industry, is in many ways
a misnomer. This article's examination of the
structural changes in the industry during the
1980s reveals far more expansion than contraction. Although the overall number of banking
organizations declined, the average number of
organizations operating at the local market level
held steady. Moreover, the accessibility of banking services rose substantially, as growth in the

Savage, Donald, and David Humphrey (1979), "Branching Laws and Banking Offices," Journal of Money,

Credit,

and Banking 11 (May): 2 2 7 - 3 0 .
Seaver, William, and Donald Fraser (1979), "Branch
Banking and the Availability of Banking Services in
Metropolitan Areas," Journal of Financial and

Analysis 14 (March): 1 5 3 - 6 0 .

Quantitative

Banking's Merger
Fervor: Survival
Of the Fittest?

The banking industry operates in an environment that has changed dramatically over the
past decade. Improvements in communication
and computing technology make it possible to
process information today that would have been
either impossible or prohibitively expensive to
process a decade ago. Major changes in banking
regulation have come about in the past ten
years. The Financial Institutions Reform, RecovRobert R. Moore
ery, and Enforcement Act of 1989 (FIRREA) and
Senior Economist and Policy Advisor
the Federal Deposit Insurance Corporation ImFinancial Industry Studies Department
provement Act of 1991 (FDICIA) have altered
Federal Reserve Bank of Dallas
the rules governing banking nationwide. At the
state level, changes in laws governing intrastate
branching and interstate banking have created
new opportunities for geographic expansion of
banks.1 And the Riegle-Neal Interstate Banking
and Branching Efficiency Act of 1994 will further
enhance banks' ability to expand geographically
Evidence from the merger
by allowing interstate branching in 1997 unless a
market suggests that acquisitions state opts out.
Forces for change have also swept through
tend to focus on banks with the U.S. economy as a whole, leading some
scholars to claim that the U.S. economy is prorelatively weak performance. ceeding through a "third industrial revolution."2
As these forces move through the economy,
they have both direct and indirect effects on
banking as banks and their customers adapt to
the new environment. As a result, significant
changes in the industry are likely.
Jensen (1993) argues that mergers provide
an avenue through which an industry can change.
In the banking industry, banks that are out of
step with the new environment could be acquired by another institution, thereby filtering
them from the industry. Moreover, as the new
owners reshape the acquired banks, the industry
could move in new directions. If the acquiring
banks push the acquired banks to provide the
services demanded in the new environment,
mergers could promote better use of resources
and enhance industry profitability.
Mergers have been an important part of
the banking landscape recently. Between June
1993 and June 1996, 1,645 U.S. banks were
acquired in mergers, creating the potential for
significant changes in the industry. If firms at
odds with market forces tend to be acquired,
a study of the acquired banks' characteristics
can provide evidence on the changes the industry may make.
My analysis begins with a discussion of
mergers and how they can help the industry
adapt to changes in the banking environment.
_

• 1

I then discuss the factors I consider in my
model of banking acquisitions, as well as the
empirical findings. The results indicate that the

FEDERAL RESERVE BANK OF DALLAS

FINANCIAL INDUSTRY STUDIES DECEMBER 1995

1 Merger, Kashyap, and scaiise (1995)

discuss these and other changes in the
banking environment
have trans-

1979.
Jensen (1993).
pired since

that

Chart 1

If a bank is not geared toward providing
the services demanded in the new environment,
it is likely to have low profitability. Hence, if
mergers are motivated by acquirers seeking to
profit from improving a bank's operations, then
acquisitions should be more likely among banks
with low profitability. Such acquisitions would
promote efficiency as the new owners improve
the acquired bank's operations.3
If mergers promote efficiency by shifting
resources to their best use, however, bank characteristics beyond direct measures of profitability could influence acquisitions. If a bank's
overall performance is hampered by a trait that
could be changed more readily by a new owner,
then it would be a likely acquisition target. For
example, if a bank devotes a large fraction of its
portfolio to small business lending primarily
because it finds lending to larger firms difficult,
then that bank is likely to be acquired by a party
that is more able to lend to larger firms. If, on
the other hand, small business lending provides
a competitively viable market niche for certain
banks, then such lending should not have any
relationship to the probability that the bank will
be acquired.

Mergers and Consolidations Reduce the
Number of Banks Nationwide
N u m b e r of b a n k s

Mergers and consolidations*

* I n c l u d e s b a n k s e l i m i n a t e d a s t h e result of m e r g e r or c o n v e r s i o n
to b r a n c h offices.
S O U R C E S : R e p o r t of C o n d i t i o n a n d I n c o m e ; N I C (the F e d e r a l
R e s e r v e ' s N a t i o n a l I n f o r m a t i o n C e n t e r for
S y s t e m w i d e Structure a n d Financial Information).

probability of being acquired tends to be higher
for banks with low profitability, slow asset
growth, low market share, a low capital-to-asset
ratio, and a low ratio of non-small-business loans
to assets. Small business loans and bank size,
however, do not significantly influence acquisition probability.

In addition to mergers, there are other
avenues for changes in corporate control that
can redirect the management of banking organizations operating out of step with market forces.
Prowse (1995) studies the operation of these
forces in large bank holding companies. He
finds that poor performance is associated with
an increased probability of management turnover or regulatory intervention but not with an
increased probability of a friendly merger. In
one sense, Prowse's results could be viewed as
conflicting with mine because I find poor performance associated with an increased acquisition probability and he does not. It is not
surprising, however, that the two studies reach
seemingly different conclusions, given that they
are based on different samples of banks (large
bank holding companies with publicly traded
stock versus independent banks) and different
periods (1987-92 versus 1993-96). One way the
different time frames may affect the results is
that banking conditions were not as favorable
during 1987-92 as they were during 1993-96;
it is possible the merger market operates differently when an industry is up than when it
is down. Finally, I classify banks as either
acquired or not acquired; in the Prowse study,
banks can also fall into the category of "regulatory intervention." Given the industry's difficulties in banking during 1987-92, some troubled
banks would have fallen into the regulatory

Mergers: an avenue for adaptation?

Mergers could be motivated, however,
by forces that would not promote
economic efficiency. Siems (1996)
reviews some of the alternative
motivations for bank mergers that have
been raised in the literature. These
motivations include managerial utility,
where managers seek to maximize their
own utility by expanding the size of the
firms they manage; managerial hubris,
where managers believe incorrectly that
their valuation of target firms is better
than the market's and then make
misguided acquisitions; and market
power, where banks merge with a
competitor to reduce price competition.

Although this article examines the determinants of being acquired in a merger between
June 1993 and June 1996, the abundance of
mergers during this period is part of a longer
trend of rising merger and consolidation activity.
As Chart 1 shows, between 1980 and 1995, not
only were 5,863 banks eliminated by either
merger or conversion to branch offices, but the
number of banks nationwide declined from
14,407 to 9,822.
Given the large number of bank mergers
and the arguably substantial industry changes
needed to adapt to the new environment, the
question of whether mergers are facilitating the
adaptation takes on increased importance. Jensen
(1993) argues that mergers can help an industry
adopt needed changes. At the most fundamental
level, a bank acquisition indicates that the new
owner places a higher value on the bank than
did the former owner. This valuation may be the
result of the acquirer's belief that bringing additional resources to the acquired bank could
make it more profitable. If the acquirer's belief
in the potential for improved performance is
accurate, such mergers can improve efficiency.

Table 1

Predicted Influence of Bank Characteristics
On Acquisition Probability
In-market

Out-of-market

Profitability

Negative

Asset growth

Negative

Market share

Negative

Capital-to-asset ratio

Negative

Market concentration

Negative

Positive

Loan-to-asset ratio
(excluding small business loans)

Negative

Small business loan-to-asset ratio

Undetermined

Size

Undetermined

Rural location

Undetermined

Negative

NOTES: Negative indicates that higher levels of these variables are predicted to be associated with a lower probability of being
acquired. Positive indicates that higher levels of these variables are predicted to be associated with a higher probability of being acquired. Undetermined indicates the absence of a predicted relationship between the variable and
acquisition probability.

intervention category but eventually would have
been acquired. Thus, weak performance would
still lead to merger, but with the intermediate
step of regulatory intervention.
Other studies look at the relationship
between mergers and the merging companies'
stock prices. Siems (1996) reviews some of these
studies and examines large bank mergers that
occurred in 1995. He finds that the market tends
to react favorably to mergers of holding companies with significant office overlaps, which he
attributes to the potential gains from the elimination of redundant operations.

urban locations. They do not find, however, a
statistically significant relationship between a
firm's profitability or growth and its probability
of being acquired.4
Hannan and Rhoades' model provides a
starting point for my examination of bank mergers. Using national data from 1993 to 1996 permits an exploration of merger trends that are
more recent and geographically broader than
those Hannan and Rhoades study. In addition,
the availability of data on a bank's small business lending in my sample allows the examination of such lending as a potential influence on
a bank's chances of becoming a merger target.5
Hannan and Rhoades' model allows for
the estimation of the probability of a bank's
being acquired by a bank in its own market as
well as by one outside its market.6 Thus, the
model has the flexibility to allow the effect of a
variable on the probability of being acquired to
differ for in-market and out-of-market acquisitions. These variables, shown in Table 1, and
their relationship to acquisition probability are
explained below.
Profitability. A bank's profitability, measured by its return on assets, is examined for its
influence on the probability of being acquired.
As discussed earlier, the relationship between a
bank's acquisition chances and its profitability
provides a simple test of the efficiency view—
that is, there should be a negative relationship
between a bank's profitability and its chances of
becoming a merger target. A firm with low
profitability would be a likely acquisition target
of a firm that could operate it differently from

Empirical approach
Data are not available for gauging the relationship between stock price performance and
mergers of privately held banks. Direct measures of performance from call report data, however, can be used to test whether banks at
variance with market forces are the likely candidates for acquisition. If banks with weak performance are likely to be acquired, then there
should be a negative relationship between the
probability of acquisition and measures of financial strength. Moreover, if mergers are an important force for moving the banking industry toward
a new equilibrium, then looking at the characteristics of acquired banks can provide evidence
on the direction of the industry.
Hannan and Rhoades (1987) examine the
characteristics of banks acquired in Texas from
1970 to 1982. They find that a bank's chances
of being a merger target are higher for banks
with large market shares, low capital ratios, and

FEDERAL RESERVE BANK OF DALLAS

FINANCIAL INDUSTRY STUDIES DECEMBER 1995

Rose (1989) also studies the characteristics of acquired banks. His approach is
based on the difference in means
between acquired banks and other
banks and thus cannot isolate the effect
of a particular variable on acquisition
probability, unlike the approach taken by
Hannan and Rhoades.

Like Hannan and Rhoades (1987), the
statistical approach I take models a
bank's probability of being acquired
using multinomial logit analysis. For a
more detailed description of my
statistical procedure and quantitative
results, see Moore (forthcoming).

The definition of a banking market in my
study is the bank's standard metropolitan statistical area (SMSA) for urban
banks and the bank's county for banks
outside SMSAs.

A bank's growth is measured by the
year-over-year percentage change in
its assets.

I measure market concentration using
the Hirschman-Herfindahl index.

Recent enhancements to the Report of
Condition and Income provide data that
allow a broad examination of the
importance of small business lending in
banks' portfolios. The call report data
divide loans according to their original
amount: $100,000 or less; $100,000 to
$250,000; or $250,000 to $1 million.
Within these categories, the call report
divides the loans into loans secured by
nonfarm nonresidential real estate, and
commercial and industrial loans to U.S.
addresses. I include ail these components in my measure of banks' small
business lending. In one of the first
published studies using these call report
data, Klemme (1993) finds that small
banks tend to devote a larger fraction of
their portfolios to small business
lending than do large ones. In addition,
she describes some shortcomings of
the data on small business lending.
Concerns about the data shortcomings
are allayed, however, by Berger,
Kashyap, and Scalise (1995), who also
find that small banks tend to devote a
larger fraction of their assets to small
business loans than do large ones,
based on data from the Federal
Reserve's Survey of Terms of Bank
Lending to Businesses.

Bernanke (1993) reviews the literature
that argues that banks have a special
role in the provision of credit.

latory concerns about anticompetitive effects that
an out-of-market acquisition would not raise.
An additional factor operates for out-of-market
acquisitions. If higher concentration is associated with greater potential profitability, there
would be an incentive to enter concentrated
markets. Some of this entry could be in the form
of acquisitions, implying a positive association
between concentration and out-of-market acquisitions. Thus, regulatory concerns about potential anticompetitive consequences suggest that
market concentration would have a negative
effect on the probability of being acquired by an
in-market firm, but potential profitability would
have a positive effect on the probability of being
acquired by an out-of-market party.
Lending. I examine two measures of lending for their impact on acquisition probability.
Specifically, a bank's loans are divided into small
business loans and other types of loans. Under
the efficiency view of mergers, the ratio of nonsmall-business loans to assets is predicted to
have a negative relationship with acquisition
probability for both in-market and out-of-market
acquisitions. If banks with low loan-to-asset ratios lack lending opportunities, they would tend
to be acquired by another bank with better
lending opportunities.

the current owners and produce higher profits.
Growth. The model also includes a bank's
growth rate as a potential determinant of its
probability of acquisition.7 A slow-growing bank
may attract a buyer that would seek to increase
the value of the franchise by accelerating the
bank's growth rate. If potential acquirers seek
slow-growing targets, there would be a negative
relationship between a bank's growth rate and
its acquisition probability.
Market share. A bank's market share could
influence the probability of being acquired
through several channels. If the banking market
has evolved so that only banks with a substantial market share are competitively viable
(Rhoades 1985), then a bank with a small market share is likely to be acquired by an in-market
bank; the assets of the bank with a small market
share would become more valuable by merging
with the larger organization. Moreover, regulatory concerns about potential anticompetitive effects could reduce the probability of an
in-market acquisition for banks with high market share. Also, there may not be any in-market
acquirers large enough to acquire a bank with
a considerable market share. Finally, because
a bank's low market share may reflect a lack
of success in the marketplace, there may be
room for an acquirer to improve the bank's
operations. Thus, the predicted influence of
market share on acquisition probability is
negative for both in-market and out-of-market
acquisitions.

Small business lending. In their consolida-

tion hypothesis, Berger, Kashyap, and Scalise
(1995) argue that bank mergers may reduce the
amount of small business lending. Consolidation
shifts assets from small to large banks. Given
that large banks devote a smaller fraction of
their assets to small business lending than do
small banks, the shift in assets would tend to
reduce the amount of small business lending if
large banks restructure the portfolios of small
banks they acquire to match their own portfolios.9 Such restructuring would be expected if
small banks' emphasis on small business lending stems from barriers that make lending to
larger borrowers difficult. These barriers would
also suggest that an emphasis on small business
lending would attract acquirers seeking to profit
from such restructuring.

Capital ratio. If acquisitions tend to center
on banks with operations a new owner could
improve, the capital ratio would influence the
probability of being acquired. Banks with low
capital-to-asset ratios would be more likely targets than those with high ratios because the
acquirer could bring additional capital to the
acquired bank. Also, because a low capital-toasset ratio may indicate financial weakness, an
acquirer may strengthen the acquired bank's
financial position. The improvement from the
infusion of capital would apply to either an inmarket or out-of-market acquisition, implying
that the capital-to-asset ratio would have a negative influence on the probability of an in-market
or out-of-market acquisition.

On the other hand, lending to small businesses has traditionally been viewed as an important part of a bank's overall activity. Several
theories predict that banks will have a comparative advantage in lending to small firms
because banks can acquire and process information about borrowers that are too small or unknown to attract capital directly in the financial
markets.10 If banks are the best institution to
fulfill this role and small business loans are
part of banks' ideal portfolios, then these loans

Market concentration. I include market con-

centration as another potential factor that could
affect the probability of being acquired.8 One
factor regulators consider in reviewing a potential merger is the impact it would have on
competition in the affected market. In a market
that is initially concentrated, the acquisition of a
bank by an in-market acquirer could raise regu-

Table 2

Estimated Influence of Bank Characteristics
On Acquisition Probability
In-market

Out-of-market

Profitability

Negative

Asset growth

Negative

Market share

Negative

Capital-to-asset ratio

Negative

Market concentration

Insignificant

Positive

Loan-to-asset ratio
(excluding small business loans)

Negative

Small business loan-to-asset ratio

Insignificant

Size

Insignificant

Rural location

Negative

Insignificant

NOTES: Negative indicates that higher levels of these variables are associated with a lower probability of acquisition, where
the association is statistically significant at the 5 percent level. Positive indicates that higher levels of a variable
are associated with a higher probability of acquisition, where the association is statistically significant at the 5
percent level. Insignificant indicates the absence of a statistically significant relationship between the variable and
acquisition probability.

" The model also includes time variables
to control for differences in merger
activity in different years that are unrelated to the other variables in the model.
12

should continue to have a place in the banking
industry as it evolves and should not be associated with merger targets. Thus, the relationship
between small business lending and acquisition
probability can shed light on the profitability of
small business lending.
Size. The model includes a measure of
bank size to see whether small size puts a bank
at a disadvantage when competing in the banking market. If small size is a competitive disadvantage, then the efficiency view would predict
that size would have a negative relationship
with acquisition probability.
Rural location. Finally, the model includes
a variable that indicates whether a bank is in a
rural or urban area. If rural banks are difficult for
outsiders to operate because of their relative
geographic isolation, there would be a negative
relationship between a bank's rural location and
the probability of being acquired by an out-ofmarket party.11

Table 2 presents the results for independent banks and shows the relationship between
various bank characteristics and the probability
of being acquired in either an in-market or an
out-of-market merger. Each row shows a variable's influence on the probability of being
acquired under either type of merger.
Table 2 shows that for both in-market and
out-of-market acquisitions, low profitability is
associated with a high probability of being
acquired. The results are consistent with the
notion that acquisitions tend to eliminate banks
with subpar profitability and create the possibility of improved profitability under new ownership.1314 Thus, the impact of a bank's profitability
on its probability of being acquired accords well
with the efficiency view of bank mergers.
The results for asset growth provide further evidence for the efficiency view of bank
mergers. Slow asset growth increases the probability of being acquired by either an in-market
or out-of-market acquirer. Hence, banks with
sluggish growth tend to be eliminated through
acquisitions.
For both in-market and out-of-market
acquisitions, high market share is associated with
a low probability of being acquired. This negative relationship aligns well with the efficiency
view. To the extent that a high market share
reflects a successful operation, there would be
little opportunity for an outsider to improve the

Results from the acquisition model
For independent banks (banks that are
either not owned by a holding company or
that are the only bank owned by its holding
company), there were 278 in-market acquisitions and 336 out-of-market acquisitions in the
sample. In addition to these 614 acquisition
observations, there were 21,293 nonacquisition
observations.12

FEDERAL RESERVE BANK OF DALLAS

FINANCIAL INDUSTRY STUDIES DECEMBER 1995

For mergers of banks belonging to
multibank holding companies, there are
difficulties in distinguishing mergers of
subsidiary banks resulting from
relaxations of branching restrictions
from those resulting from earlier
acquisitions of unrelated bank holding
companies. Also, the acquisition of a
bank belonging to a multibank holding
company would depend not only on the
characteristics of the individual bank,
but also on the characteristics of others
belonging to the same parent company.
Because of these difficulties, the
empirical analysis is limited to independent banks.

In addition to the results reported in
Table 2, an alternative specification in
which a bank's profitability is measured
as the difference between the bank's
return on assets and the average return
in its market produces similar results.
Banks with a high return on assets
relative to the return in their market are
less likely to be acquired than are those
with a low return. This rules out the
possibility that the link between low
profitability and high acquisition
probability stems primarily from the
takeover of banks operating in distressed markets.

One reason for an acquisition is bank
failure. If failed banks are excluded from
the sample, profitability loses its
statistical significance for out-of-market
acquisitions but remains significant for
in-market takeovers. Bank failure, however, starkly illustrates the room for
improved performance. The exclusion
of failed banks does not affect the sign
or statistical significance of the other
model's variables.

The empirical approach taken isolates
the effect of a particular variable, and in
doing so, holds the other variables
constant. Thus, while small size does
not increase acquisition probability,
it is possible that small banks may
attract acquirers for other reasons.
For example, to the extent that small
banks have lower market shares than
larger ones, small banks would attract
acquirers. Thus, the results here are
consistent with those in Moore and
Couch (1994) and Moore (1995),
which document declines in small
bank market share. In addition, by
focusing only on independent banks,
many of the largest banks are excluded
from the sample, and thus the results
here may not be applicable to the entire
range of bank sizes.

nificant relationship between bank size and the
probability of being acquired. So small size alone
is not a competitive disadvantage. If it were,
larger banks would have an incentive to acquire
smaller ones, increasing the value of the smaller
bank's assets. The lack of a statistically significant relationship between bank size and
acquisition probability suggests that such potential gains are not available.15
Rural location is associated with a lessened
probability of being acquired by an in-market
party. But this does not have a statistically significant relationship with the likelihood of
acquisition by an out-of-market acquirer, implying that the discipline imposed by potential
takeovers by out-of-market parties applies in
both rural and urban locations.

bank's operations and, thus, little incentive to
acquire it. In addition, for in-market acquisitions, size may be playing a role; if a bank has a
considerable share of its market, there would
not be many potential acquiring banks in that
market large enough to acquire it.
There is a negative relationship between a
bank's capital-to-asset ratio and its probability of
being acquired for both in-market and out-ofmarket acquisitions. The increased probability
of being acquired associated with a low capital
ratio implies that a lack of financial strength
tends to attract buyers. The acquirers of financially weak banks can infuse capital into the
acquired banks; thus, mergers can play a role in
increasing the capital position of thinly capitalized banks.
The effect of market concentration on
acquisition probability differs for in-market and
out-of-market acquisitions. For in-market acquisitions, no statistically significant relationship
exists between the probability of being acquired
and market concentration. For out-of-market
acquisitions, the probability is higher for banks
operating in concentrated markets. The greater
probability of out-of-market acquisition may
reflect the attractiveness of entering concentrated markets.
A bank's loan-to-asset ratio (exclusive of
small business loans) has a negative relationship
with the probability of being acquired by either
an in-market or out-of-market party. Thus, banks
that devote a low fraction of their assets to
lending have a greater chance of being acquired
than do those that devote a high fraction of their
assets to lending. This result is consistent with
the idea that banks with unfavorable lending
opportunities tend to be acquired by banks with
better ones.
Unlike the non-small-business loan-toasset ratio, the ratio of small business loans
to assets does not have a statistically significant relationship with the probability of being
acquired. Therefore, the merger market neither
rewards nor punishes banks that pursue small
business lending. If some banks' emphasis on
small business lending stems from a constraint
that limits their ability to make more profitable
types of loans, then there would be an incentive
for those banks to be acquired so that the
constraint could be relaxed. The lack of a statistically significant relationship between small
business lending and the probability of being
acquired suggests that the emphasis some
banks place on small business lending is a
viable banking strategy.
The results do not show a statistically sig-

Conclusion

Consolidation is sweeping through the
banking industry, resulting in the acquisition of
hundreds of banks. Given that these acquisitions
have the potential to reshape the banking industry significantly, the question of what type of
bank is likely to be acquired takes on heightened importance. This article shows that the
probability of being acquired tends to be higher
for banks with low profitability, slow asset
growth, low market share, a low capital-to-asset
ratio, and a low ratio of non-small-business
loans-to-assets. Small business loans and bank
size, however, do not significantly influence the
probability of being acquired. Thus, evidence
from the merger market suggests that acquisitions tend to focus on banks with relatively
weak performance. By doing so, mergers can be
viewed as a market mechanism that is helping
strengthen the industry.

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FEDERAL RESERVE BANK OF DALLAS

FINANCIAL INDUSTRY STUDIES DECEMBER 1995

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