Taking another bank as an equity partner is perhaps not an obvious solution for those facing tough strategic choices. That makes it all the more worth considering, writes Arnold van Os.
Globalisation, changes in the regulatory environment and technological innovation are among the drivers that have triggered restructuring throughout the financial services sector. International expansion, increased competition, consolidation, financial distress and strategic re-positioning have become increasingly apparent on a global basis. Managing boards of financial institutions are under ever more pressure to preserve and enhance profitability.
Numerous examples exist of banks, particularly in Asia, that have seen a major part of their equity erased by the impact of non-performing loan (NPL) portfolios. Strong growth in loan portfolios combined with inadequate risk management capabilities created a high vulnerability to the economic downturn that occurred in the late 1990s. In a number of Asian countries and also in several European countries, NPL portfolios still have to be addressed. It is widely expected that such risk issues will continue to impact the industry for several years to come.
Consolidation has been another trend clearly visible for a number of years. Fewer but larger domestic/regional players are being created, many of which have energetically expanded their international footprint.
Especially in the US, Europe and Asia, the banking landscape is increasingly dominated by a limited number of international players. Domestic players aiming to remain independent are often forced to either build scale or become a niche provider.
Challenging changes
As a consequence of these trends, many financial institutions are confronted with multiple high-value-at-stake issues simultaneously, providing major challenges to management. For example, financial institutions impacted by large NPL issues typically undergo severe restructurings, risk losing their independence or even face bankruptcy. Other challenges may call for international expansion, strategic repositioning or large-scale technology investment; all major changes. Addressing these challenges successfully will require an injection of capital, reduction of costs or a clear focus on distinctive qualities – and most likely a combination of these.
One (valid) strategy is to establish partnerships to address one or more of the critical areas. Outsourcing of activities (e.g. payments, securities processing, mortgage processing, NPL servicing, IT development and maintenance) is increasingly used; other examples of partnerships deal with distribution agreements, product insourcing/white labelling, obtaining specific capabilities (eg, risk management), or improving financial strength.
Teaming up with an intermediate-term equity partner whose interests are aligned with the company can open the door to these types of solutions and secure the necessary capital in a single step. It is by no means a “standard” solution, but all the more worth considering for that.
As a shareholder and trusted partner, a bank equity partner can play a valuable “coalescing” role, leveraging capabilities, experience, resources and facilities available in its own organisation on behalf of its partner institution. Being a shareholder aligns the interests of both parties and ensures competitive pricing, structuring flexibility, and so on.
ABN AMRO’s Merchant Banking Group was recently set up as an equity partner for this specific purpose. Typically it (co-)invests in opportunities with one or more of the following characteristics:
- Turnaround or distressed situations where a client has experienced significant difficulties (for example, related to bad credits or financial mismanagement) with a view to turning the company around;
- Clients executing buy-outs or making strategic acquisitions, where additional equity or an equity bridge is required;
- Clients who operate in a niche with favourable growth prospects.
Value-added partner
In all these circumstances, in addition to making equity available, a partner should have proven capabilities to successfully add value from a number of different angles, for instance:
- Specialisation in evaluating and managing stressed or distressed assets;
- The creation of strategic partnerships based on outsourcing and white labelling, such as trade outsourcing and FX white-labelling, as well as additional services where processing scale can be offered. Such partnerships help clients to reduce costs, increase product breadth and minimise investment spend;
- Risk advisory services to assist partner banks in creating an efficient and effective risk management framework and build their own team of “qualified” risk managers by sharing expertise;
- Access to different types of capital, for instance through complex debt and equity structures including hybrids, derivatives, asset securitisation, leveraged finance, and so on.
Portfolio examples
To give further insight into how these partnerships may work in practice, two portfolio investments by ABN AMRO’s Merchant Banking Group are outlined below. Two transactions which are in a preliminary stage are also briefly described.
Korea Exchange Bank (KEB) is one of Korea’s largest commercial banks. KEB’s capital base was severely eroded by NPL losses. A consortium in which ABN AMRO acted as the largest co-investor and sole bank investor invested $1.2bn, enabling KEB to significantly improve its capital ratios. The combination of new capital and new management facilitated a to-date very successful restructuring around the company’s core strengths in FX and trade finance.
KEB also benefited from the bank’s experience with respect to the restructuring of its balance sheet and the divestment of non-core assets.
Another portfolio investment is GFKL Financial Services, a successful German leasing and financial outsourcing company. Here, ABN AMRO invested €50m, providing shareholder liquidity and capital to finance additional growth. This will allow the company to optimally prepare for an IPO in a few years and benefit from a banking shareholder’s ability to provide capital markets funding, strategic input and potentially strategic alliances. The two institutions are continuously investigating strategic opportunities which leverage both parties’ capabilities.
A further example is the envisaged buy-out of NIB Capital, a leading merchant bank in the Netherlands. A consortium in which ABN AMRO plays a key role is enabling the management team to buy the business, complete the strategy implementation and bridge the period before an IPO can be done. This is an interesting example of how a medium-sized bank can retain its independence in a rapidly consolidating environment with the help of financial investors.
There is also the recapitalisation and restructuring of a distressed bank in Greater China whose inherent franchise is fundamentally sound. ABN AMRO is supporting a strategic acquirer in the provision of equity capital as well as providing expertise in areas of maximum value realisation such as risk management, distressed asset recovery, business process insourcing and bank capital structure reconstitution.
The strength of these solutions lies in the combination of typical private equity characteristics (eg, equity investment with strong focus on financial return, two to five-year holding period with pre-agreed strategy and governance framework) with characteristics of a value-creating investor (leveraging the knowledge and capabilities of the entire investing organisation and capturing synergies between both parties).
Managing boards facing tough decisions about the future of their organisation will need to consider a wide range of possible solutions. Bringing on board a bank equity partner should be one item for discussion.
Arnold van Os, Managing Director, Merchant Banking Group, ABN AMRO. arnold.van.os@nl.abnamro.com
