banking M&A

What should executives focus on to navigate the ‘perfect storm’ of M&A opportunities?

2020 Nuno Fernandes headshot

Bank mergers, like mergers in general, typically come in waves. And the European financial sector is currently riding a big one.

An expanded CaixaBank appeared on the Spanish stock market this year following the approval of its €4.3bn acquisition of Bankia. And the prospect looms that the beleaguered Credit Suisse might merge with UBS.

This activity is all but certain to continue throughout 2021 on the back of a confluence of merger-friendly factors affecting financial services: the need to reduce costs, technological change, consumer demands and overall sector disruption.

Economic headwinds also make the time ripe for consolidation. Interest rates are low. Debt funding is plentiful. And Covid-19 has made the need for digital realignment and organisational restructuring more necessary than it was before the pandemic.

Yet while these deals offer huge potential for growth and enhanced profitability, they also expose acquisitive banks to perennial merger risks. However, there are a number of steps banks can take to increase the odds of a successful merger.

Before outlining those steps, it’s important to lay out why the time for bank consolidation is now.

The key drivers

There are four main drivers behind mergers in 2021 (and 2022).

Mergers and acquisitions (M&As) can be used to achieve economies of scale and greater profitability. Banks increasingly face the need to reduce costs by combining customer bases and offering them less costly services through branch network optimisation. Improving the division of large fixed costs through a larger customer base is also key. The CaixaBank-Bankia merger is an example, but there are others: in the Czech Republic, Air Bank’s takeover of Moneta Money Bank; and in Italy, Intesa Sanpaolo’s acquisition of UBI Banca.

Another driver involves boosting competencies. The banking sector transformation underway at the present time requires established players to change quickly in order to compete. Mergers allow the relatively simple acquisition of modern competencies and technologies often unavailable in-house. Bank of America, for instance, is acquiring the German healthcare technology company Axia Technologies to advance its payment solutions for healthcare clients.

A third motivation for M&A deals involves extending the product range. Bank mergers also occur for the purposes of capital optimisation. With regulators requiring banks to maintain specified capital ratios, institutions are increasingly searching for fee-related business that, unlike lending, does not consume much capital. One example is Toronto-Dominion Bank’s acquisition of Chicago-based Headlands Tech Global allowing the bank to enter into the municipal- and investment-grade corporate bond market.

Finally, the post-pandemic economic outlook fosters consolidation. Thanks to the moratoria on debt offered to customers during the pandemic, European banks have yet to see the full fallout from the 2020 recession on their balance sheets. Once the moratoria ends, several defaults are expected from residential and commercial customers. The ratio of non-performing loans will likewise increase for some banks.

While [M&A] deals offer huge potential for growth and enhanced profitability, they also expose acquisitive banks to risks

Once that happens — and you can expect it in 2022 — banks with robust capital ratios are bound to target those with weaker balance sheets and loan portfolios. Additionally, it’s widely recognised that the European Central Bank (ECB) is seeking consolidation in Europe’s banking sector. In January, the ECB published its guide on supervisory tools to facilitate consolidation, including the recommendation that credible integration plans will not be penalised with higher capital requirements. 

Navigating the storm

How can banks smartly navigate this ‘perfect storm’ of M&A opportunities? With the bulk of megamergers failing to deliver hoped-for synergies (and up to 70% eroding shareholder value), the pressure is on.

My analysis of large mergers, and the actions of executives behind the busts and successes, allows me to offer some advice for the people steering the deals.

Business leaders involved in a merger should ask themselves if they’re looking to bulldoze an acquisition or leave it alone. Banks looking to expand their technological reach or services should avoid merging too rapidly at the expense of deliberate cultural integration.

The foundational question acquirers should ask themselves is: what is the source of a deal’s value? Close integration suits deals where the aim is improved efficiency. Mergers seeking enhanced creativity, on the other hand, may benefit from setting up a ringfence. 

A laser-like focus on the fair value of the deal also helps acquiring banks avoid ‘strategic deals’ that don’t in truth make financial sense. Once a deal’s honest value is determined, buyers should install a team to work on the transaction that will steer the project from A-Z, including being in charge of the valuation (an element that should not be outsourced to an investment bank), developing integration plans, and being accountable for post-merger integration. This consistent approach also works towards meeting the crucial goal of communicating efficiently and transparently the benefits of the deal to outside observers and nervous employees.

M&A will always present challenges. But the practices I have outlined provide a robust framework for bank executives and board members during a period that is uniquely optimal for consolidation.

Nuno Fernandes is a full professor of finance at IESE Business School.

Continue reading: US bank M&A surges as tech investment drives deals

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