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Financial market transactions driven by rationalization

As indicated by Hungary-related M&A transactions in the first quarter of this year, Europe’s financial sector is finally showing signs of activity. Companies in the financial sector based in Europe were engaged in deals of the same value in Q1 as they were a year ago – however, if one looks at the motives, it turns out that they mostly derive from efforts to rationalize operations.

The total disclosed value of European financial services’ M&A announced during the first quarter of 2012 was €9.7 billion. Although this represents a 40% decline from the prior quarter’s figure of €16.3 billion, it is only a marginal fall of 1% from the comparative figure of €9.8 billion recorded in the first quarter of 2011.

In spite of encouraging news in early summer, such as the cooperation agreement between Gránitbank and Coop Gazdasági Csoport – the two companies agreed to acquire ownership in each other to a value of HUF 100 million each – and OTP Bank’s announcement about further Serbian acquisitions, there were still fewer transactions in the first quarter of 2012 than before the crisis, an analysis by PwC on European financial services M&As reveals.

At a regional level, one of the largest deals last year was when Russia’s Sberbank acquired the Eastern European operations of Volksbank, including its Hungarian unit. Also, there was news in February about France’s Credit Agricole pulling out of several markets, Hungary among them. MKB Bank also sold its Romanian subsidiary Romexterra to United States-based fund manager PineBridge in April.

The total value of insurance deals with disclosed values also fell during the first quarter of 2012, in contrast to the sector’s busy previous quarter, according to the PwC study. The quarter’s most notable insurance deal was KBC’s sale of Polish insurer Warta for €770 million to Talanx of Germany and its minority partner Meiji Yasuda of Japan. This interesting transaction illustrates the attractions of Eastern European growth to insurers from more mature markets in Western Europe and Asia. Several other international groups were reported to have expressed an interest in Warta.

Two main drivers

There are two main trends that can be spotted in mergers and acquisitions in the financial sector, says Ervin Apáthy, PwC Hungary’s M&A director, commenting on the company’s analysis.

“On one hand, companies that received life-saving capital injections earlier need to carry out restructuring and asset sale obligations that were the conditions of the bailout package,” Apáthy explains. “On the other hand, there are the rationalization efforts dictated by large Western European banks – putting it less loftily, this basically means the cutback or sale of loss-making or less profitable business units. This includes simplifying the operations of parent banks, too.”

But as part of the restructuring scenarios, financial institutions in many cases get rid of non-core business units or assets in order to strengthen capital ratios, even though they were making some profit. The reason for such an exit is usually a smaller-than-expected market share in a certain segment, or, occasionally, a certain market is seen as carrying too many risks, Apáthy adds.

Fewer but larger deals in Europe

At face value, it is encouraging that, despite the decline, the quarter’s total of €9.7 billion still exceeded the figures of €6.7 billion and €5 billion recorded in the second and third quarters of 2011, respectively. However, the total disclosed value for the first quarter of 2012 is distorted by one very large deal – Royal Bank of Scotland’s €5.8 billion sale of RBS Aviation Capital to Sumitomo Mitsui. Without this transaction, the first quarter of 2012 would have seen a total value of just €3.9 billion for European financial services’ M&A – one of the weakest quarterly results in nine years of data.

Quarter-on-quarter, the main driver of weaker deal values and volumes was a comparative absence of M&A involving banking targets. The total value of banking deals with disclosed values was €1.9 billion, compared with an average figure of €6.6 billion for the previous eight quarters. Furthermore, most of this €1.9 billion was due to two deals, CaixaBank’s merger with local counterpart Banca Civica, valued at €977 million, and KBC’s sale of Polish banking unit Kredyt Bank to Santander’s local subsidiary Bank Zachodni in a share exchange valued at €790 million.

Given that quarterly figures in banking transactions are usually much higher than this amount, the movements that can be spotted in this segment are utterly cautious, the PwC study notes. The firm says this is an understandable response to ongoing valuation difficulties, which in turn reflect factors such as financial market volatility, an uncertain economic outlook and the limited availability of debt finance.

Private equity looks for new strategies

Private equity firms continue to play a modest but influential role in European financial services’ M&A, particularly in habitual areas of interest such as wealth management and transaction processing. However, limited access to debt finances significantly reduced the possibilities of PE firms, the PwC study observes. But in spite of the fact that their activity has been tempered by uncertainty over the sovereign debt crisis since last year, deal making has continued, especially at the middle and lower end of the value spectrum. While access to debt finance is more constrained than a year ago, many PE funds are sitting on significant pools of uninvested capital accumulated in the lead-up to the financial crisis.

PE investors have always been reluctant to take on the costs and complexities of compliance or to tie up funds and curtail yields through high capital charges.

Within financial services, less capital- and compliance-heavy service-based businesses with strong and predictable cash flows have, as a result, tended to attract the most interest from PE buyers. This includes companies with recurring fee income such as asset managers and fund administrators. It also includes intermediary businesses such as IFAs and insurance brokers, or companies servicing underwriters such as claims managers and loss adjusters. In contrast, balance sheet-intensive businesses such as banks, insurers and reinsurers, which are subject to tighter regulation, capital charges, business model complexity, inherent leverage and long-term risks, have tended to be less attractive to PE buyers. According to PwC, further opportunities for PE investors come from the desire of governments to promote greater competition and encourage new entrants into the financial services market.

Modest recovery ahead

Although PwC emphasizes the current unpredictability of European financial services M&A, the study predicts a modest rise on the market. Barring any major economic shocks, there are several reasons to hope for at least a modest improvement in deal activity in the near future, the company says. The study identifies specific prospects for upcoming M&A activity: these include Deutsche Bank’s anticipated disposal of its alternative asset management business RREEF, the possible sale of the LME, and the ongoing battle for control of Italian insurer Fondiaria. Also, several European financial services markets have particular potential to generate deals. The Spanish banking sector is among the most obvious, but Italian banks, under pressure from ratings agencies, also continue to offer scope for consolidation.

In general, PwC expects to see a rebound from the exceptionally low level of banking M&A in the first quarter of 2012. “We also question how long the decline in small- and medium-sized transactions can continue, especially considering the gradual improvements in financing conditions. At this point in the cycle, an improvement in the volume of deals could be a more significant indicator of a recovery in European financial services’ M&A than an uptick
 in deal values,” the study reads.

As for the foreseeable future in Hungary, current tendencies are expected to continue, says Apáthy.

“In a basically depressed economic environment, we expect to see deals deriving from the rationalization efforts of those large international banks that dominate the market,” he concludes. “Several foreign banks are expected to give up their positions in Hungary, but this also means great expansion opportunities for those competitors who have already taken the necessary steps earlier or weathered the crisis in a better condition.”

This article is based on PwC’s Sharing deal insight report issued in May 2012