Bank mergers ; Antitrust law ; Bank competition ; Crocker National Corporation ; Wells Fargo Bank

Frederick T. Furlong

English

Research Papers in Economics

FRBSF WEEKLY LETTER
May 15, 1987
Assessing Bank Antitrust Standards
The antitrust standards applied to banking mer-
gers and acquisitions have become less restric-
tive in recent years. In large part, the change has
come about because savings and loans and sav-
ings banks are now treated as direct competitors
with commercial banks by the federal banking
regulatory agencies and the Department ofJus-
tice in their antitrust analyses.
The treatment of thrifts as direct competitors
with banks was prompted by legislation in 1980
and 1982 that granted thrifts new bank-like
powers. Key among those powers are the ability
to make commercial and industrial (C&I) loans
and to offer transactions accounts (NOWs).
These two activities had traditionally dis-
tinguished the banking industry from the thrift
industry.
However, the actual extent to which savings and
loans and savings banks in the aggregate have
made inroads into traditional banking services is
limited. Recent data indicate that among FSLlC-
insured savings institutions, C&I loans com-
prised less than 2 percent of assets, and transac-
tions accounts less than 4 percent, compared
with figures of 19 percent and 21 1 /2 percent for
commercial banks.
Moreover, we still have little direct evidence
that the effects of thrifts on competition in bank-
ing markets have changed appreciably since
1980. For example, a recent study by Stephen
Rhoades at the Federal Reserve Board fails to
find evidence that variations in thrift competition
influenced the performance of commercial
banks during either the late 1970s or the early
1980s.
Do thrifts, then, really matter significantly to
banking competition? Even more importantly,
have banking antitrust standards become too
liberal?
One way to assess the current banking antitrust
standards is to examine the competitive effects
ofthose mergers or acquisitions in whose
approval the less stringent guidelines were
instrumental. This Letter considers one of the
most significant ofthe cases to date - the mer-
ger of Wells Fargo Bank N.A. and Crocker
National Bank. The merger is significant not
only because of the size of the banks involved,
but also because of the large number of banking
markets in which only by considering savings
and loans as direct competitors with commercial
banks were banking antitrust standards satisfied.
(See my Letter, November 28, 1986.)
Structure-performance framework
In general, antitrust analysis is based on the
theory that the extent of competition in a market
can be inferred from the market's structure,
where the structure is characterized bythe
degree of concentration of the market shares
among firms in the market. According to this
theory, the more the supply of banking services
in a market is dominated by a few institutions,
the more likely it is that the competitors will be
able to affect, either overtly or covertly, deposit
and loan rates and service fees, and thereby
raise profits. Within this analytic framework, a
banking merger that would raise concentration
significantly likely would be denied because the
regulatory authority would view the merger as
having a substantially adverse effect on
competition.
The measure of market concentration used in
banking antitrust cases is the Herfindahl-Hirsch-
man Index (HHI). This index is computed by
adding the squares of percent market shares of
the relevant competitors. With one firm in a
market, the index takes on a maximum value of
10,000 (100% x 100%). As the number of firms
increases, the index approaches its theoretical
minimum of zero. The antitrust guidelines set by
the Department ofJustice indicate that a merger
or acquisition in banking likely would be chal-
lenged if the HHI increased by 200 points and
the post-merger index were over 1800 points.
The addition ofthrifts as direct competitors with
banks is important because it can dramatically
decrease the measured concentration in a bank-
ing market. As a result, the presence of thrifts
makes it easier to meet the Department ofJustice
guidelines and consequently to secure approval
for mergers and acquisitions involving banks
and bank holding companies. A prime exampleFRBSF
is the merger of Wells Fargo National Bank,
N.A. and Crocker National Bank, which was
approved last year by the Federal Reserve Board
and the Comptroller of the Currency. In the
Federal Reserve's analysis, which gave a weight
ofone-half to thrift deposits in calculating mar-
ket shares and concentration, the inclusion of
thrifts as direct competitors brought the effects of
the merger on the HHI within the Justice Depart-
ment's guideline in 15 of the 36 banking markets
involved, including the San Francisco area mar-
ket, which is the second largest in the state.
Second opinion
Because thrifts made the difference in such a
large number of markets, the Wells Fargo-
Crocker merger provides a good opportunity to
examine whether the inclusion of thrifts compro-
mises antitrust standards in banking. One way to
evaluate the approval of that merger is through
its effects on the stock market returns of the
banks in California. In essence, this method
obtains a second opinion from the financial mar-
ket on the competitive implications of the
merger.
According to the structure-performance frame-
work, a merger with anti-competitive effects
would be expected to boost future profits of all
competitors in the market, not just those of the
acquiring bank. The higher future profits would
be reflected in an abnormal appreciation in the
stock prices ofthe banks in the relevant markets.
Abnormal positive returns to the acquiring firm
but not to the other competitors would not be
indicative of an anti-competitive merger. Rather,
they would suggest that the anticipated higher
profits for the acquiring bank were specific to
the firm (and not the market) and related, per-
haps, to expected reductions in the firm's costs.
Stock returns
To determine how the financial market viewed
the Wells Fargo-Crocker merger, we examined
the performance of common stock prices for
Wells Fargo Corp. and a sample of other Califor-
nia banking organizations around the time the
merger was announced (February 7, 1986). To
control for factors affecting banking generally,
the performance of a sample of large, non-Cal-
ifornia banks also was examined. The abnormal
rate of return on a bank's stock was measured by
the difference between the actual rate of return
and the estimated expected rate of return. Esti-
mates of the expected rates of return were based
on the historical relationships between the per-
cent changes in the stock prices for the banking
organizations and the percent change in the
value of a market portfolio of stocks represented
by S&P 500.
Using the historical relationships, the abnormal
returns were cumulated separately over two
three-day periods. The first period covered the
three days prior to the announcement ofthe
Wells Fargo-Crocker merger to allow for possi-
ble leaks regarding the merger. There is no
indication of abnormal positive returns for Wells
Fargo in this first period.
The second three-day period includes the day of
the announcement and the following two busi-
ness days. The estimates of the abnormal rates of
return among the banks examined in this period
are presented in Chart 1. The chart shows that
the price of Wells Fargo Corp. stock was over 20
percent higher than would have been expected
given the movement in the S&P 500. In dollar
terms, the change represents about $275 mil-
lion. The higher-than-expected gains, however,
are not evident for the other very large banks in
California (the three largest banks excluding
Wells Fargo). On average, this set of banks
shows a lower-than-expected gain that is not sta-
tistically different from zero.
For the set of medium-sized California banks,
the average abnormal return shown in the chart
is positive, but of only marginal statistical signifi-
cance. Moreover, if the Wells Fargo-Crocker
merger were viewed by the financial market as
having anti-competitive effects, it is unclear why
the medium-sized banks, but not the large ones,
would have been anticipated to benefit.
Overall, the evidence in Chart 1 suggests that
financial market participants generally agreed
with the Federal Reserve, the Comptroller of the
Currency, and the Department ofJustice that the
Wells Fargo-Crocker merger would not have a
substantially adverse effect on competition in
the California banking markets.
Pricing of retail deposits
More direct evidence on the competitive
implications of the Wells FCl-rgo-Crocker merger
can be obtained by looking at how the Califor-
nia banks have priced deposit, loans, and otherChart 1
Abnormal Stock Price Returns
Percent
25
6-month account:
...................
7"''':';'"""----- __
4.5
5.0
5.5
6.0
Chart 2
Interest Rates on Retail Deposits
Percent
6.5
* Statistically significant at the 90% level
** Statistically significant at the 99% level
2
4
o
20
-2 Wells Other Medium- Non-California
Fargo Large sized Banks
Corp. California California
Banks Banks
4.0
May Jun Jul Aug Sep Oct Nov Dec Jan
1986 1987
services since the merger. The data on certain
accounts come from a monthly survey of
deposit rates at a sample of banks.
To test for possible anti-competitive effects of
the Wells Fargo-Crocker merger, we compared
the pricing of money market deposit accounts
(MMDAs) and other retail deposit accounts
before and after the consummation of the mer-
ger (May 30,1986). To do this, the relationship
between the rates on the deposit accounts and
short-term market rates were estimated using
monthly data prior to January 1986, the month
before the announcement of the merger. The
estimated relationships were then used to simu-
late dynamically the rates on the deposit
accounts for the months after the merger. A find-
ing that the actual rates were consistently below
the predicted rates would tend to support the
idea that the merger reduced competition for
retail deposits in California.
The evidence from Chart 2 suggests that this was
not the case. The chart shows the predicted and
actual weighted average rates on MMDAs and
on six-month time deposit accounts of less than
$100,000 at the four largest California banks.
Following the Wells Fargo-Crocker merger, the
average rate on MMDAs did fall initially some-
what more sharply than predicted. However, for
most of the latter part of 1986 and into 1987,
actual MMDA rates were higher than those pre-
dicted based on the pre-merger relationships
between MMDA rates and open market interest
rates. A comparison of the predicted and actual
rates on the six-month time deposit accounts
also does not support the view that interest rates
were set consistently lower than what would
have been expected given the pricing practices
of the California banks prior to February 1986.
Conclusion
The treatment ofthrifts as direct competitors
with commercial banks has made banking anti:
trust standards less restrictive. The significance
of this change was particularly evident in the
Wells Fargo"Crocker merger. However, in that
case, neither the evidence on the pricing of
retail deposit accounts nor that on the stock
marketperformance of a sample of California
banks indicate that the merger had a substan-
tially adverse effect on competition in California
banking markets. These results do not directly
demonstrate the actual importance of thrift com-
petition. However, they do suggest that the
easing of antitrust standards through the inclu-
sion of thrifts was not detrimental to competition
in banking in this. instance.
Frederick T. Furlong
Opinionsexpressed in this newsletterdo not necessarily reflecttheviews ofthe managementofthe Federal Reserve BankofSan
Francisco,orofthe Board ofGovernorsofthe Federal Reserve System.
Editorialcommentsmay beaddressedtotheeditor(GregoryTong) ortotheauthor....FreecopiesofFederal Reservepublications
can be obtainedfrom the Public Information Department, Federal Reserve BankofSan Francisco, P.O. Box 7702,San Francisco
94120. Phone(415) 974-2246.uo~6U!ljsom ljo~n uo61?1JO OpOAI?IU
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollaramounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Amount
Outstanding
4/22/87
Change
from
4/15/87
Change from 4/23/86
Dollar Percent!
Loans, Leases and Investmentsl 2 205,016 - 142 1,063 0.5
Loans and Leases1 6 183,286 - 230 - 2,185 - 1.1
Commercial and Industrial 54,252 201 908 1.7
Real estate 68,081 - 62 1,722 2.5
Loans to Individuals 37,148 179 - 3,619 - 8.8
Leases 5,427 - 13 - 227 - 4.0
U.S. Treasury and Agency Securities2 14,511 94 3,915 36.9
Other Securities2 7,219 - 6 - 668 - 8.4
Total Deposits 209,866 - 6,411 6,829 3.3
Demand Deposits 54,783 - 4,748 5,635 11.4
Demand Deposits Adjusted3 38,891 722 4,909 14.4
OtherTransaction Balances4 20,828 - 609 4,647 28.7
Total Non-Transaction Balances6 134,255 - 1,054 - 3,453 - 2.5
MoneyMarket Deposit
Accounts-Total 45,448 - 1,031 - 739 - 1.6
Time Deposits in Amounts of
$100,000ormore 31,941 31 - 5,430 - 14.5
Other Liabilities for Borrowed MoneyS 25,021 2,357 - 4111 - 14.1
Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+)/Deficiency (- )
Borrowings
Netfree reserves (+)lNet borrowed(-)
Period ended
4/20/87
89
72
17
Penod ended
4/6/87
9
9
1
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading accountsecurities
3 Excludes u.S. governmentand depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
S Includes borrowing via..FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items notshown separately
7 Annualized percentchange

Assessing bank antitrust standards

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