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Up to the challenge: Investing in banks

Despite bleak growth prospects for banks after the global financial crisis, financial sponsors have embraced the opportunities the restructuring of the banking sector has provided, and have proven themselves adept at managing the complexity that comes with investing in banks.

One of the most striking developments in financial services M&A following the financial crisis has been the willingness of financial sponsors to invest directly in banks.

A private equity house buying a bank would have been almost unthinkable in some markets 15 years ago, but since 2008 financial sponsor investment in banks has increased steadily. According to Mergermarket, there have been 94 banking buyouts in Europe since 2008, with an impressive total investment value of nearly €12.5 billion.

UK, Spain, Italy and CEE have all seen a rise in financial sponsor-backed bank investments

Activity has been relatively widespread, with financial sponsor backed bank investments increasing in the United Kingdom, Spain, Italy and throughout central and eastern Europe. However, although bank deals occurred across Europe, the strategic reasons for transactions have varied from region to region.

In the UK, regulators have been eager to support challengers to the dominant high street banks and halved the minimum size of capital buffers for new banks relative to their established rivals. Financial sponsors have been quick to take advantage of the favourable regulatory environment.

In March 2015, Pollen Street Capital, a London-based financial services specialist, successfully floated challenger bank Shawbrook, which was founded just four years previously, on the London Stock Exchange with a market capitalization of £725 million. AnaCap enjoyed similar success with the £650 million listing of Aldermore, another challenger bank, in March 2015.

In Spain, however, regulators have made the consolidation of a disparate banking market the priority. Spain was one of the most overbanked markets in Europe, characterised by a large number of small, unprofitable and undercapitalised regional banks. In 2013, Apollo became the first foreign private equity firm to buy a Spanish bank when it acquired Evo Banco with a view to consolidating the market.

In Italy, banks have taken a positive view of private equity firms as partners and providers of capital. In June 2015, Advent International, Bain Capital and Clessidra Capital Partners acquired Italian banking business Istituto Centrale delle Banche Popolari Italiane (ICBPI) in a €2.15 billion deal prompted by a 2014 banking review that highlighted a need for new capital. Original shareholders have remained invested alongside the buyout firms and retained an 8 percent stake.

Investment in Italian non-performing loans (NPLs) is another area in which financial sponsors have played a key role in the restructuring of financial institutions. AnaCap alone has purchased €6 billion worth of Italian NPLs during the last three years, which has allowed Italian banks to direct resources to more profitable areas of business and strengthen their balance sheets ahead of the ECB stress tests. This trend is not unique to Italy, and is reflected across the whole of Europe.

A private equity house buying a bank would have been almost unthinkable in some markets 15 years ago

In central and eastern Europe (CEE), regulators who were originally explicitly against financial sponsor ownership of banks have since recognised the need for the capital that alternative investors can deploy. Banks need support and capital in a market where strategic investors have limited firepower, and indeed many strategics are withdrawing from the region. This provides good opportunities for alternative investors who see great growth potential at reasonable prices.

In the last 12 months, Apollo Global Management and the EBRD have taken control of Slovenia's secondlargest bank, Nova, after it failed ECB stress tests; the EBRD and Advent International acquired the Balkan subsidiaries of Austria's Hypo Alpe-Adria Bank, which was bailed out by the Austrian government in 2009, and JC Flowers has agreed to acquire Romanian bank Banca Carpatica (this deal had been announced but was still to complete as this report went to press).

"Regulators were conservative at first, but pragmatism has prevailed. There have been a number of banks in CEE that have been in distress, but with no strategics in the market there has been a realisation that private investors can bring capital to the table and provide institutional certainty. These assets can't be left without any direction or management. Regulators have recognised that there is no one else with the capital these banks need," says a senior FIG M&A investment banker

One region where it has been difficult for financial sponsors to gain traction, however, is Germany. JC Flowers and Lone Star have both invested in various German banking assets, but have not enjoyed the success that firms have seen in other regions.

"Even though banking regulation in Europe is harmonised, I think financial sponsors have been surprised by the banking regulation requirements in Germany," says another experienced FIG M&A adviser. "The market conditions and framework in Germany are very different. In every village there is a state-owned bank, which makes it very difficult to compete on the pure retail banking side. Then there are the co-operative banks and private banks. Each group serves as a pillar of the German banking system and it is very, very difficult to try and operate across all three pillars, which has made it tough for private equity."

Financial sponsors that have had the courage and opportunity to invest in banks since 2008 have, on the whole, delivered good returns. According to a KPMG analysis of the UK banking sector performance, small challenger banks delivered a return on equity of 18.2 percent in 2014 versus 2.8 percent for established banks. The compound annual 2014 growth rate in loans advanced to customers by small challenger banks, meanwhile, is sitting at 32.3 percent compared to a negative 2.9 percent at mainstream banks.

The flexibility of new entrants and their use of technology have helped them to operate off a lower cost base, which in turn has boosted profits and returns. Players in Germany such as ING-DiBa, which provides an online only account, and Fidor, which offers digital "crowd banking", in which customers discuss what products and services they want online, have been able to cut overheads by not having to pay for a physical branch network.

Private equity investors have recognised the advantages of this model. AnaCap's investment rationale for backing FM Bank in Poland is underpinned by leveraging the bank's innovative mobile and digital platforms. Pollen Street–backed Shawbrook placed strong emphasis on online banking by developing an online application process for customer accounts in partnership with specialist digital banking developer Sandstone Technology.

"Private equity investors have been quick to react to a supportive environment for new entrants and the impact that technology has had on the old banking model," says a partner at a major private equity firm which focuses on the financial services industry. "The old model of branch-based banking is no longer necessary. Banking has gone virtual and with the right technology in place, you can operate with much less real estate, a smaller footprint and lower costs." The track record that private equity has built up in bank investments has also dispelled concerns that financial sponsors lack the wherewithal to invest in bank operations successfully.

"If you look at the day-to-day running of a bank, I am not sure how much value financial sponsors add, but what they are excellent at doing is looking at a bank and building a very clear idea of where it needs to be in five years' time and how to get to that endpoint," says a corporate financier who has worked on numerous bank deals. "What they are also very good at doing is getting the right people involved in their due diligence and choosing good management teams. I have been very surprised at the calibre of person they have been able to bring in as consultants and board members. They know how to pull the right people in."

Financial sponsors are likely to continue seeing opportunities to invest directly in banks, but competition is likely to stiffen as strategics start to come back into the market. In 2015, for example, Sabadell surprised the market by acquiring the UK's TSB, while GE Capital's bank in the Czech Republic is expected to go to an IPO or trade buyer after receiving strong interest from potential buyers.

Financials sponsors will therefore have to find special situations or unique angles when investing in European banks in the future.

"For the last few years, financial sponsors have been able to operate in a limited buyer universe, but we are now at a stage that if there is a quality bank that comes to market, there will be strategics out there and they will probably win or it will go to IPO," says a senior FIG M&A investment banker.

"Alternative investors will have to look at banks that are deemed sub-quality and not ready for IPO, or find small players that don't have the scale to attract strategics or have a digital or online route to market. Financial sponsors will still have chances to buy banks, but the market will become more competitive."


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