There is a substantial literature examining performance after a banking merger. An offshoot of this is a second group of studies that look at the impact of bank mergers on operating costs and efficiency. The area of credit quality, hoerver, has received little attention. Credit quality is a key determinant of banking profitability. Weakness in this area can be disastrous. Southeast Bank in Florida failed in 1991 because of problems with its commercial real estate loan portfolio. Bank of America was sold to Nations Bank in 1997 primarily because of credit problems resulting from the acquisition of Security Pacific. Little attention, however, has been paid to the question of credit quality after a merger.
Credit quality can be difficult to manage and requires constant management attention to keep it under control. For this reason, it seems likely that quality could slip right after the merger as the two institutions are combined. However, in the long run, one would expect quality to return to its pre-merger level, or perhaps to improve a bit as the merged BHC combines the best practices of the buyer and target. This paper tests this hypothesis by looking at the changes in credit quality from pre-merger levels to the levels 1, 2, and 3 years after the merger. It also examines whether the combined institutions have credit ratios that differ from those of industry-wide BHCs in the year before the merger.
One of the main motivations for BHC mergers suggested in the literature is to obtain a reduction in risk through added diversification. Bank of New England failed largely because of a sharp regional recession. Continental Illinois failed because of an excessive concentration of loans in the energy industry at a time when this industry suffered a sharp downturn. Both situations could have been avoided with a greater diversification in the loan portfolio.
Alternatively, portfolio diversification presents an opportunity to increase returns while maintaining the pre-merger risk levels by taking on more loans and shifting the mix of loans to types with higher returns and higher risk. Craig and dos Santos (1997) found that merging banks tend to increase the ratio of loans to assets after the merger. We test this hypothesis with a more recent sample, and extend the logic to see if merging bank holding companies (BHCs) also shift their loan portfolios to take on more risk.
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