Banking: Private Equity’s Final Frontier?

Background

Heightened activities in cross-border banking mergers is now signalling a new phase in European retail banking. Recent transactions such as the purchase of Abbey by Santander and of HvB by Unicredito are creating pan-European retail banks, a trend in consolidation that could create new mega-banks to challenge the likes of Bank of America and Citibank. There is another new element evolving - shareholder activism - which has played a key role in the ongoing ABN Amro process.

Could we potentially see a new force entering the banking M&A arena? Having invested heavily in most other industries, will the private equity community now turn its attention to banks?

The business case

Private equity could potentially access significant value from a variety of different targets including: banks with under-managed assets; banks where there is an opportunity to reduce significantly cost:income ratios through centralisation/ synergies; or where the bank is significantly overcapitalised. In all cases however the funds will be conscious of having a clear exit route a few years down the line from either a listing or a trade sale. In this sector, private equity firms have already bought specific portfolios, e.g. residential portfolios or a minority interest in banks, e.g. the JC Flowers-led club investment in HSH Nordbank.

Two key dynamics in the bidding process will be the regulatory environment and whether the value that private equity can deliver would outweigh the synergy available to a trade player.

The opportunities

Most banks are overcapitalised when considered against the regulatory minima, current research indicates that there is 74bn of excess capital in the European banking system. The reasons include the following: management may be highly prudent, the rating agencies may demand levels of capital well above the regulatory minima in order to attain the higher credit grades, or the regulator may have set the bank a target capital level in excess of the minimum.

Initial indications are that the Basel II requirements would, in many cases, result in a lower capital requirement. Whilst it is considered unlikely that the regulator would permit a fund to release capital from a bank, it is conceivable that an increase in assets without increasing capital might be permitted.

Whilst the major banks currently in play are arguably much too large for a PE fund to swallow at present, shareholder activism is emerging as one means by which a fund...