Are mergers effective, or do they just perpetuate bad practice?

2017-10-06

HA governance structures are unsuited to M&A

When RBS bought ABN at the wrong time and for the wrong price it helped, in effect, to bankrupt RBS, and nearly led to wider catastrophic economic collapse.

When Van den Bergh and Jurgens merged with Lever Brothers in 1929, they created the basis for one of the largest and most successful multinational consumer businesses – Unilever.

I do not see mergers and acquisitions in the social housing sector having quite such momentous effects, but I do see them altering the sector in significant ways.

It is important that potential buyers, acquirees, funders and merger partners follow best practice.

There are at least two codes of practice circulating in the sector, and both are voluntary.

That is probably inevitable, given the government doesn’t want to be seen getting involved in detail in the management of associations.

However, it’s not optimal – as it is probably the associations that don’t sign up for the voluntary undertakings that are most in need of help. The codes may be voluntary, but once signed their provisions shouldn’t be optional – and the regulator should not be afraid to police them.

Private practice

In the private sector, the takeover code shows how a voluntary code can come to have the force of law.

The takeover panel has no legal power to enforce its decisions, but it has come to be the de facto arbiter of takeover bids.

But the takeover code has a clear central and focused objective: “to ensure fair treatment for all shareholders in takeover bids”.

The shareholders in the private sector can generally be trusted to act in their own individual best interests. What the takeover code tries to do is ensure that one group of shareholders is not preferred over another.

‘Onerous’ for social housing

The codes in the social housing sector have a much more onerous task. Housing associations clearly do not exist to maximise the benefits to shareholders in a public limited company. They need to balance the interests
of current and future tenants, with an eye to the wishes of central and local government.

So a merger code needs to recognise this complexity and make sure that, as far as possible, when a housing association’s “shareholders” vote for or against a merger they are likely to be working in the interests of the
association’s stakeholders taken as a whole.

Unfortunately, the governance of associations often works against this objective.

Shareholding groups in housing associations usually consist of the current board, superannuated board members such as myself and tenants. In some associations the shareholders and the board are exactly the same group. So
how can they possibly provide an independent check on the board’s merger plans?

Add in some ex-board members, and I don’t think governance improves very much. Former directors will often have little up-to-date knowledge of the business and no necessary identity of interest with the stakeholders.
Tenants may be able to provide an independent view – but they are normally not chosen in a democratic process by all the tenants. And they certainly don’t represent future tenants.

Structural change

The current governance structure of housing associations is unsuited to an environment of mergers and acquisitions. Serious work should be done trying to ensure that shareholding groups are chosen so that they are more likely to
act in the long-term interest of current and future tenants.

The National Housing Federation’s code of governance talks diplomatically about reasons for choosing particular group structures post-merger. As it points out, mergers can be achieved in a number of ways, such as amalgamations, transfer of engagements and a variety of other types of group structures.

The code correctly identifies pensions as one legitimate reason to choose a particular structure, and there may be others.

But the one I want to concentrate on is that the new structure “can have a lesser impact on loan covenants, thereby reducing the cost of the merger”. That is to say, associations are choosing merger structures (which may not be
optimal ones from an efficiency point of view) in order to avoid having to ask their bankers for permission to merge.

Banking benefits

Let us be clear about what is happening here. The banks, having lent far too cheaply and for far too long to the sector, are now using merger activity as a way of repricing their loans.

Such repricing may have some justification if the creditworthiness of the customer has deteriorated, and a small renegotiation fee may also be acceptable. But it is not unusual to see the bankers to both acquirer and acquiree trying to raise their pricing.

And I’m not sure that there are so many cases where the credit of the merged identity is worse than that of both the component parts. Furthermore, the extent of the repricing sometimes bears no relation to the
perceived change in credit risk.

I should say that banks’ behaviour is not always bad: often they are cooperative. However, there are too many cases of banks using mergers as an opportunity to correct their own past pricing errors.

Banks need to remember they are not only commercial organisations; they are part of the community and have benefitted from that position through Bank of England and, in some cases, UK government support.

Conflict of interest

One other area, which is not done well in the private sector either, is conflict of interest.

Public life is now sensitive to conflicts. Bank of England officials are sacked for not declaring conflicts; we all have to declare our activities and relevant investments.

And yet, senior executives who have huge amounts to gain or lose by a merger going ahead do not have to reveal clearly what they have to gain or lose when they recommend (or otherwise) a merger proposal. This is especially in cases where board members are also the shareholders, and the boards are therefore in effect voting themselves big pay rises.

There should be a clear, unambiguous statement of change in status and terms and conditions of all the senior managers affected. The same applies to other board members. Full disclosure of the roles and remuneration of the non-executives should also be clear to the shareholders when voting on a merger proposal. Such disclosure would not stop the behaviour I’ve mentioned, but may help reduce it.

by Ian Peacock

Are mergers effective, or do they just perpetuate bad practice?

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