Turkish Economy Bank and Fortis Bank Managing a Complex Merger

Introduction

Following the announcement of the merger of the Turkish Economic Bank (TEB) and Fortis Bank, Varol Civil, is faced with the task of executing this merger with a risk control method. In addition to settling the economic terms of this merger, Civil and his team must find a way to smoothly combine the operations of two banks with minimum losses. The potential for cost savings and synergies is significant considering the meaningful overlap between these two banks. But the losses may arise as well.

Benefits of the merger between Fortis Bank and TEB

As the ninth-largest commercial bank and the tenth-largest bank respectively, in Turkey, TEB and Fortis Bank merged in operations would provide significant improvements in operating efficiency and profitability. Also, the combination of two giant banks aimed to become a new brand bank with significant size, being the sixth-largest bank in Turkey, and to enlarge their market shares for further growth by serving the customers of both banks. A stronger bank was thought to be created through utilizing the advantages of Fortis Bank in its retail banking and the strength of TEB in SME and corporate banking businesses.

What’s more, mergers between banks usually provide cost reductions in form of employee layoffs, such as fewer managers and downsizing of HR team. For example, 13 or 14 senior executives would be enough for the new merged bank compared to the total number of 24 for two banks, which might save TRY 3.3 million per year. Meanwhile, annual cost savings resulted from branch closures and consolidating headquarter facilities would be above TRY 10 million, no mention to the reductions in operating costs (including advertising fees). The management team believed that the annual cost synergies could reach 130 million euros in next three years but the downside influence was a certain decline in revenue, with a PV of TRY 97 million, nearly. In spite of the inevitable reduction in income due to loss of business and defections by customers, the merger might still be able to increase annual revenue by EUR 13 million if potential revenue can be fully realized in lending business.

How the profitability of TEB increased

According to the data of TEB bank from 2011 to 2017, several key ratios can reflect the profitability of the bank. To examine the profitability, it is important to know the efficiency a bank is using its assets and equity to generate profits. For this reason, there are some key ratios to look into, such as ROA, ROE, ROAE and NIM.

ROAE refers to the return on average equity, describing the performance for a company over a financial year. The average equity needs to be computed as the sum of the equity value at both of the beginning and closing of a year, divided by two. It is more accurate to measure when share holders’ value changes significantly within one year.

ROAE= Net Income/ Avg shareholders’ equity

Firstly, according to the balance sheets and income statements, calculate the average common shareholders’ equity for the most recent year and the previous year. Secondly, find the net income for the estimated year. Thus, the increasing ROAEs are caused by the indicators which lead to a larger NI or a smaller equity or both. For instance, from 2011 to 2017, TEB’s net interest income, net insurance income, operating profits has increased in each year, all resulting in the greater NI year after year. Besides, the spreads between assets and liabilities also keep growing and the retained earnings as well as shareholders’ equity have become larger and larger. However, generally, the growing speed of NI is greater than the growing speed in equity, also off-balance sheet activities gained great amount of profits, thus leading to the increasing ROAEs.

Other reasons for a larger ROAE may be a higher financial leverage, a greater profit margin, a declining tax rate and improving asset turnover rate.

Inflation and loans making

Turkey suffered unstable financial situation in 2000 and 2001 due to diverse governing run by three-party coalition. During that period, Turkey’s inflation rate was extremely high, around 55%. The interbank lending market lost function because the healthy banks were afraid to lend to the unprofitable banks concerning their abilities to repay. While in 2001, the political instability led an explosion in overnight interest rates, which jumped up from 50% to 7500% and fifteen large banks had to go bankruptcy. The incident could explain most of bank collapses in the case cause the majority of banks’ assets made up of loans and investments which relied on interest rate deeply. Especially for the banks with significant portion of loans in their assets, it was common to lose large amount of profits. However, some bank survived gaining positive net profits under horrible economic condition, such like HSBC bank. (Maybe thanks to the diverse cross-border banking and investing activities or financial support from its mother bank)