Financial Institutions and The Meaning of Failure: Closure Versus Merger

With all this talk about prospective bank failures in Europe and otherwise, plus concerns about contagion effects, I hope that some of the lessons from financial institution history will be remembered. It seems to be all in the optics. If the doors don’t close, but there is a merger or sale, people don’t see this as the financial institution failure that it generally is. I know this from my doctoral dissertation, where I reviewed the history of financial institution failures in Canada, plus analyzed in particular the failures of the Canadian Commercial Bank, the Northland Bank and the Principal Group, from the mid-1980s. All three of these involved closures of the institutions and much public concern as to what had transpired. I concluded that, had these been mergers or sales, without the branches being closed, the public would have been less concerned. Form over substance.

Historically, and particularly after l900, Canadian financial institutions in difficulty have generally been the subject of mergers or sales, rather than closure and liquidation. The merger or sale of a financial institution would appear to involve a lesser degree of erosion of public confidence than does the closure and liquidation of such an institution. This is so notwithstanding that the amount of public financial support contributed to the merger may be quite significant if not more costly. Three of the six largest banks in Canada (the Toronto-Dominion Bank, the Canadian Imperial Bank of Commerce and the National Bank of Canada) are themselves products of mergers or amalgamations–in l955, l961 and l979, respectively. Furthermore, the lessons of the shock to the system of actual bank failures in Canada in the 1980s seemed to cause regulators to be mindful of optics when it came to the trust company industry. With few exceptions (such as Standard Trust), most failed and failing trust companies disappeared via mergers, involving generous government guarantees as to doubtful loan portfolios. Hence one ends up with TD Canada Trust, involving a particularly advantageous, government-supported trust company rollover to the Toronto-Dominion Bank.

Here are some extracts from my doctoral dissertation. The references are at the end:

At the time of the l986 Estey inquiry into the failures of the Canadian Commercial Bank and the Northland Bank, the majority of banks founded in Canada or its predecessor regions had failed or were merged, with such failures or mergers occurring subsequent to the l867 establishment of Canada. As of l867, there were 35 active banks in Canada, growing in 11 years to 51 by l878. The number of active banks then began to decline, until l980 regulatory reform which permitted foreign-controlled banks to operate in Canada (Estey, l986: 364). Of 79 banks founded between l831 and l984, only 10 were active subsequent to the failures of the Canadian Commercial Bank and the Northland Bank (Estey, l986: 359-364). The smaller four of these ten (the Bank of British Columbia, the Continental Bank of Canada, the Western and Pacific Bank of Canada and the Bank of Alberta) were shortly thereafter the subject of mergers, leaving but 6 banks of 79 originally founded, with 73 “disappearances”. In October, l986, the Continental Bank commenced merger proceedings with the newly-formed Lloyds Bank Canada, after the former had received nearly $3 billion in Bank of Canada support (Waddell, l986). One month later, in November, l986, after management disclosed that it had been seeking a merger candidate since the early fall of l985, the Bank of British Columbia merged with the Hongkong Bank of Canada. The merger was forced by the federal government, which passed special legislation to permit the merger without shareholder approval, and provided $200 million in public support through the Canada Deposit Insurance Corporation to effect the sale. At the time of the merger, the Bank of British Columbia owed in excess of $400 million in advances from the Bank of Canada (Chisholm, l986). In l988, the Western and Pacific Bank of Canada and the Bank of Alberta were merged to form the Canadian Western Bank (Galt, l988; Bloomfield, l990). In early 1990, the merged Lloyds Bank of Canada itself merged with Hongkong Bank of Canada (McNish, l990).

Relative to the closures reviewed, the eight remaining banks are as follows:

Bank of Montreal
Bank of Nova Scotia
Toronto-Dominion Bank
Canadian Imperial Bank of Commerce
Royal Bank of Canada
Banque Nationale
Hongkong Bank of Canada
Canadian Western Bank

The Canadian banking system is generally identified as being associated with a history of solvency, subsequent to the Home Bank failure and liquidation of l923. However, in the years prior to this failure there were 53 bank closures in Canada, 24 by way of liquidation and 29 by way of merger (Estey, l986: 359-362). The majority of Canadian bank closures (47 of 74 or 64%) have been by way of merger rather than liquidation. The failures of the Canadian Commercial Bank and the Northland Bank are considered to be significant because there had been no bank failures subsequent to the failure of the Home Bank in l923. Such a view must be qualified by the meaning ascribed to the term “failure”: may both liquidations and mergers be considered to be actions in response to financial institution failure?

Between the Home Bank liquidation and those of the Canadian Commercial Bank and the Northland Bank, there were 12 bank mergers, or nearly 25% of the 49 bank mergers in the history of Canada. Furthermore, prior to l900, the vast majority of bank closures were by way of liquidation (17 of 23 or 74%) rather than by way of merger. Subsequent to l900, the major period of bank liquidations is the l905-l9l0 period, when 6 of 13 bank closures were by way of liquidation. Also of interest is the fact that there were no bank closures whatsoever, either by liquidation or merger, in the l932-l954 period, which period includes both the Great Depression and the Second World War. While resolute government support of financial institutions is to be expected during times of war, the willingness and the capacity of a government to support financial institutions generally in an economic depression is of interest.

A similar bias in favour of merger over liquidation is evidenced in the United States, in connection with closures of Savings and Loan Associations. For example, between l970 and l988, 264 California-based Savings and Loan Associations were closed–with but 17 closed by way of liquidation and the balance by way of merger (Haveman, l992: 59). Economic considerations do not appear to be the determining factor since, as noted, there is evidence that the liquidation of a savings and loan association is less costly than an assisted purchase or merger (Kormendi, Bernard, Pirrong and Snyder, l989: 67-69). Regulator-induced merger activities have been expanded in the United States, involving compulsory mergers of several savings and loan associations into one institution, and known as “the phoenix plan” (Kane, l989: 153; Eichler, l989: 78). The extent of government guarantees in such “phoenix plan” mergers means that the deposits of both insured and uninsured depositors are effectively insured by the government, the latter bearing most of the risks of loss (Eichler, l989: 82).

From the foregoing, a question arises as to why, given past practice in Canada and contemporary practices in the United States, a regulator would ever liquidate a financial institution, when faced with merger or sale alternatives. From the perspectives of both the regulators and the public, a merger or sale of a financial institution appears to be viewed as something other than the failure of that institution. In short, the liquidation of a financial institution is “framed” as a failure, with consequent attributions of fault, but not otherwise.

In circumstances where regulators are discouraging liquidations to preserve public confidence and in an effort to reduce deposit insurance costs, Rao and Neilsen (l992: 461) note that the distinction between a liquidation and a forced merger is “somewhat thin”. This becomes evident if one compares similar amounts of support funds at risk in the context of different financial institution “bailout” arrangements. For example, the initial support program for the Canadian Commercial Bank amounted to a proposed $255 million “buy down” of bad loans by other participating banks and government agencies. Such a “buy down” was accomplished after many meetings and the expressions of grave concerns by the participants and the public. By contrast, shortly after the Canadian Commercial Bank and the Northland Bank failed, in excess of $200 million was contributed by the Canada Deposit Insurance Corporation to the “buy down” of loans prior to the 1986 Bank of British Columbia-Hongkong Bank of Canada merger, with few concerns expressed by the public or to the public by regulators. The predominant view appeared to be that the payment of $200 million by the Canada Deposit Insurance Corporation to the Hongkong Bank of Canada was cheaper than to pay out all depositors in the event that the Bank of British Columbia failed. Paradoxically, the bank’s difficulties were attributed in part to public reports in the spring of l986 that the bank had been refused an $800 million federal assistance package (Chisholm, l986).

In l985, shortly after the failure of the Canadian Commercial Bank, the Mercantile Bank was merged with the National Bank of Canada. Prior to this merger, the Unity Bank had merged with the Provincial Bank of Canada, with the merged organization later merging with the National Bank of Canada. Also in l985, shortly after the failure of the Canadian Commercial Bank, the Morguard Bank, with assets of $336 million, associated with and funded by some of the same persons and pension funds originally capitalizing the Canadian Commercial Bank, was purchased by the Security Pacific Corporation of Los Angeles, to thus become a “Schedule B” (foreign-owned) Canadian bank (Johnson, l986: 243-244). In October, l986, the Continental Bank commenced merger proceedings with the newly-formed Lloyds Bank Canada, after the former had received nearly $3 billion in Bank of Canada support (Waddell, l986). One month later, in November, l986, after management disclosed that it had been seeking a merger candidate since the fall of l985, the Bank of British Columbia merged with the Hongkong Bank of Canada. The merger was forced by the federal government, which passed special legislation to permit the merger without shareholder approval and, as previously noted, provided $200 million through the Canada Deposit Insurance Corporation to effect the sale. At the time of the merger, the Bank of British Columbia owed in excess of $400 million in advances from the Bank of Canada (Chisholm, l986). In early 1990, the merged Lloyds Bank of Canada itself merged with Hongkong Bank of Canada (McNish, l990).

Similar merger trends are noted in other financial institution domains, such as that of credit unions (Alberta Report, l987), where “phoenix plan” regulatory actions comparable to those in the United States, earlier discussed, are evident. For example, between l984 and l989, the number of credit unions in British Columbia decreased from 136 institutions with 314 branches to 118 institutions with 280 branches, with the decrease attributable to various “consolidations” (Schreiner, l989). As of l989, there was but one credit union in the city of Calgary, First Calgary Financial Savings and Credit Union Ltd., formed in l987 from the merger of seven money-losing credit unions in that city. The merged institution continued to record losses (Financial Post, l989a).

Based on the foregoing, the liquidations of the Canadian Commercial Bank, the Northland Bank and the Principal Group become all the more surprising. The decision to liquidate appears to be related to the escalation of commitment to so act, whereby other options are more readily discounted. Merger options were considered and then rejected by the regulators of the Canadian Commercial Bank and the Northland Bank, who opted instead to close the institutions, rather than to effect a merger which no merger candidate would accept without government support (Estey, l986: 174, 529, 598-599). In March of l985, some five months prior to their actual closures, the governor of the Bank of Canada and other government officials made public declarations as to the solvency of the institutions and the willingness of the federal government to provide support, as required (Estey, l986: 498-499). Instead of providing continued unqualified support, the government became unreservedly committed to the closure of the two institutions, rejecting merger options presented which would have seen the banks “folded” into other banks on a liquidation basis (Estey, l986: 477, 529, 597). With respect to the Canadian Commercial Bank, government regulators assisted in the search for merger candidates, while with respect to the Northland Bank, management was provided with a “grace period” subsequent to the appointment of a curator to find a merger candidate through management’s own efforts. The dispute by Northland management as to the appointment, objectivity and cost of the curator was met by government resolve to liquidate the bank. For example, court challenges by Northland Bank management were met by government actions which involved assumptions as to liquidation, irrespective of the result of court proceedings (Cox and Barnes, l985; Canadian Press, l985).

References

Alberta Report, l987
Battling for a credit union. March 30: 21-22.

Bloomfield, P., l990
Canadian Western Bank a sleeper? “Inside The Markets”, The Financial Post April 18: 23.

Canadian Press, l985
CDIC to pay Northland depositors. The Globe and Mail, October 7: A3.

Chisholm, P., l986
End of a dream for Bank of B.C.. Financial Times of Canada, December 1: 8, 59.

Cox, K. and A. Barnes, l985
Bank questions accountant’s objectivity. The Globe and Mail, October 1: B1.

Eichler, N., l989
The Thrift Debacle. Berkeley and Los Angeles, CA: University of California Press

Estey, Hon. W.Z. l986
Report of The Inquiry Into The Collapse of The CCB(sic) and Northland Bank. Ottawa: Supply and Services Canada.

Financial Post, l989a
Credit union records second straight loss. The Financial Post, March 16: 7.

Galt, V., l988
New western bank ties 6-month loss to clean-up, merger. The Globe and Mail, June 8: B4.

Haveman, H.A., l992
Between a Rock and a Hard Place: Organizational Change and Performance under Conditions of Fundamental Environmental Transformation. Administrative Science Quarterly 37: 48-75.

Johnson, A., 1986
Breaking the Banks. Toronto, ON: Lester & Orpen Dennys Limited.

Kane, E.J., l989
The S & L Insurance Mess: How Did It Happen? Washington, DC: The Urban Institute Press.

Kormendi, R.C., V.L. Bernard, S.C. Pirrong and E.A. Snyder, l989
Crisis Resolution in the Thrift Industry. Dordrecht: Kluwer Academic Publishers.

McNish, J., l990
Hongkong Bank, Lloyds Canada tie knot in $190-million deal. The Globe and Mail, February 16: B9.

Rao, H and E.H. Neilsen, l992
The Ecology of Agency Arrangements: Mortality of Savings and Loan Associations, l960-l987. Administrative Science Quarterly 37: 448-470

Waddell, C., l986
Lloyds to repay Continental debt to central bank. The Globe and Mail, October 24: B5

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About brucelarochelle

Practising Lawyer and Part-Time University Instructor (Accounting, Commercial Law, Organizational Behaviour); Part-Time Federal Tribunal Member. Non-practising Chartered Professional Accountant (Chartered Accountant and Certified Management Accountant).
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