Evaluating Merger vs De Novo Branching

By Steve Reider

For a financial institution quickly seeking to build branch density in a market, mergers and acquisitions can offer a faster option than de novo branching. Further, for new-market entry, mergers can bring not only an initial customer base, but also skilled managers with strong preexisting relationships with local business and civic leaders.

In evaluating merger opportunities, a financial institution can compare target franchises by the proportion of their branches that would prove beneficial, where a branch is considered beneficial if it either:

  • Serves a viable submarket and would thus replace the need to build a branch.


  • Sits in a currently served submarket, and would thus create a “two-for-one” expense consolidation efficiency opportunity.

For example, consider a bank with four branches in the Denver, Colorado metro.

After studying the market’s demographic and competitive environment, the bank determined it needed 15 branches to establish a competitive network. Further, it identified the 11 top submarkets in which to add branches to bring its network to the target 15-branch level.

Now consider a merger target that maintains:

  • Two branches in close proximity to the bank’s current offices
  • Four others within those 11 target expansion submarkets
  • And five others either in lower-opportunity submarkets in the Denver metro or outside the market

This target bank would show a 55% beneficial branch proportion: (2 overlaps + 4 target submarkets) / 11 total branches = 55%. The bank could gauge each prospective merger target in that same context—and then focus its efforts on those institutions with the greatest proportion of beneficial branches, i.e., the greatest ability to accelerate the bank’s path toward the optimal franchise configuration.

Mergers represent one component of a growth strategy, and bankers should avoid viewing mergers and de novo branching as an either/or strategy.

Rather, the two tactics can leverage one another, and a merger should foster rather than forestall those additional branches that would complete the franchise. Thus, in the example above, completion of the merger would address four of 11 target submarkets. So the bank should concurrently plan for seven de novo branches in its long-term horizon.

Beyond specific branch locations, any assessment of franchise value should also include an estimate of growth potential within the acquired branches.

Keep in mind, any seller with an astute investment banker (and there’s no reason to presume your investment banker is any more or less astute than theirs) will derive a premium reflecting the current value of all balances in the franchise, plus the natural balance growth the institution could achieve on its own.

Thus, for the buyer to recover that premium, it needs to be able to realize balance growth above and beyond what the seller could attain on its own—rendering it critical to confirm that the target’s collective branch submarkets hold sufficient upside balance potential to do so.

In addition, savvy purchasers will enter a transaction with a ready disposition plan for any non-beneficial branches.

The Denver example hypothesized one or more branches outside the metro area, and presumably outside the acquirer’s target markets. If those markets have no role in the acquirer’s long-term strategy, then in the merger evaluation phase it should consider prospective banks in those non-target markets to which it could “spin off” the unwanted branches.

Finally, for the overlapping branches, it is critical to understand the full costs of consolidation and ensuing disposition. A branch of the target bank may sit across the street from one of the acquirer’s branches, offering a low-risk consolidation from an attrition standpoint. However, if that branch carries a book value well in excess of market value, or a lengthy remaining lease term with penalties for failure to operate (often referred to as a “dark clause”) and no sublease provision or potential—or any other situation that would create an untenable charge against net income—such costs could negate the financial savings that may have initially justified the merger.

Thus, it remains imperative to understand such impacts in advance of finalizing any transaction.

Steve Reider is president of Bancography, based in Birmingham, Ala. Bancography provides consulting services, software tools, and marketing research to financial institutions.