WHEN BANKS MERGE?

The merger of Lloyds TSB and HBOS is at risk of becoming a nightmare for both banks at a time when there are nightmares a plenty in the markets and the economy. This is a time for J. Shumpeter's 'creative destruction' (see comment below). It will be two steps back for one step forward. Why?
Lloyds TSB expects to integrate HBOS and achieve 'synergies'. At the same time the whole of both banks have to be shrink-washed, assets run-down and a new economic capital model created as condition of redeeming the Government's 43+% shareholding. Lloyds is already planning what to writedown and sell-off including talking with potential buyers for this or that even before the deal is finally certain. HBOS has moved half a £billion of PFI assets off balance sheet and sold some non-banking holdings as well as Westpac Bank (for a fraction of its book value). In the merger process 20,000 jobs are expected to be cut. HBOS staff can expect to bear the brunt of this and they are all distinctly queasy, angry, and unhappy. What is the risk-value of merging with a distressed bank and uncooperative, or let's say less than enthusiastic, staff? Lloyds will use as its template how Royal Bank of Scotland integrated the operations and systems of NatWest a decade ago. That time the cost (external not internal) was somewhere in the region of £3 billions. Cost savings, called 'synergies', are expected to be worth £1.5bn a year. But it will take several years to get to that. HBOS's internal systems are probably much supperior to Lloyds, but Lloyds has the whip hand in this merger. Lloyds general ledger core accounting is reputedly a 30 year old model long past its replacement date. A 4 year old project to modernise financial reporting within the bank has been cancelled half way through? HBOS had problems in integrating with Halifax. But this was a merger of equals (financially) and much effort was expended to choose and keep the best, and anyway the two bamks had so many complementarities that integrating into a single contiguous system at all levels and across all business units was thankfully not worth doing.
Deloittes, the audit and consulting firm, emailed me recently about bank mergers to say, "...All those dreams of capturing synergies through higher revenues and lower costs may turn to dust if you don’t incorporate information technology (IT) into the integration process from start to finish. By failing to invite IT to the party, companies may overpay for an acquisition and suffer buyer’s remorse down the road. And once the transaction is completed, IT still has a crucial role to play in whether the expected synergies actually deliver on the promise of the deal. Here’s the bottom line: Integration without IT is no integration at all". Synergies, if narrowly cost-ratio determined, are illusory anyway in my extensive experience - they are demanded by stock market analysts as a fig-leaf wanting to be told the values-added of "why buy?", when the real why buy is simply for bigger market share. But, when two big players merge in markets where players trade directly with each other, the merger wipes out a large slice of the markets' in depth liquidity. And this also happens in domestic traditional banking. A lot of assets are borrowings by households and businesses merely to re-cycle other loans with other lenders. So when LTSB and HBOS merge they make UK domestic banking volume smaller. The 'velocity of capital' in the UK economy will fall significantly, and do so when it is alreday falling too much anyway (credit crunch + recession). This is not good for anyone. Mergers in such conditions will find that expected gains prove largely illusory, a mirage in a fast desertifying landscape.
M&A projects all too readily assume integration is worthwhile and forgets that one or more company cultures (internal brand value, procedures & processes - very delicate) is destroyed and a new culture has to be created. This is why it is two steps back for one step forward. It is like taking two different very fine highly elaborate swiss watches, taking them to bits and trying to build a new watch with a mix of bits from both the originals. It doesn't work. So what happens - a whole new bank infrastructure and IT systems need to be bought in, tailored, legacy data populated into new gone live systems, tested and tested again many times, rolled out operationally, training and more training, bug fixing and more bugs - an endless cycle of improvements and replacement that should take normally no more than 18 months but will take a full 5 years, by which time half of everything is outdated and needs replacing again!
Far better is to maintain the banks as separately operating entities under a holding company and only judiciously integrate beginning at the top and moving down layer by layer and business unit by unit only as and when business cases are convincing and change necessary. Cultural changes take time. Banks are not standard machines; they are people businesses with quirky and highly-elaborated unique systems that are very complicated to intergrate. There is no way that everything can be changed at the same time. This would overwhelm management resources as well as intellectual and technical skills available to the bank and available in the marketplace. Some people use the analogy of merging two railways with different gauge size of tracks. It is not like that. My advice: forget root and branch integration synergies and stick to what really matters especially at this time which are economic risk management and financial risk accounting.