Post Merger Changes in the Riskiness of the Loan Portfolio

Abstract

The recent problems in the financial sector suggest that various types of loans present different types of risk over and above the normal charge-offs. This paper examines the risk associated with post-merger variability in the charge-off rate and the non-performing loan rate, and the implications this variability has for the institution. It develops a new measure of risk to profitability in a bank's loan portfolio based on traditional portfolio theory. This measure is used to examine the risk levels in the loan portfolios of merging bank holding companies (BHCs) and the change in risk that occurs in the years following the merger. The paper finds that the combined loan portfolios of merging BHCs have higher than average levels of charge-offs and higher than average risk in their portfolios in the year prior to the merger. Using the new measure of risk, our research finds that the level of risk is increased after the merger as the surviving banks shift their portfolios toward loans with potentially higher risk and higher returns.