European regulators’ openness to PE investors is presenting attractive banking sector opportunities, but such opportunities require careful regulatory planning and local issue navigation.
Ten years ago, a PE investment in a European bank would have been a rare occurrence. However, more recently, PE firms have deployed capital in the banking sector, encouraged by changing regulatory perceptions of PE bidders. Apollo, together with parallel investors, acquired the former German subsidiary of KBC Bank NV, which since then has completed several add-on acquisitions, kicking off a series of German bank deals. PE firms including Cerberus, JC Flowers, and Blackstone have also completed bank buyouts, as European regulators become more open to financial sponsors — a trend we see continuing in 2019.
What Is Driving European Bank Transactions?
Disposal requests from the European Commission — as a consequence of breaching subsidy regulations — and regulatory reform have produced deal opportunities. The emergence of new growth markets has drawn the interest of PE, underlined by Blackstone’s €1 billion deal for Baltic lender Luminor. New technology and digital products have also attracted interest, as demonstrated by Cerberus’ acquisition of French consumer business GE Money Bank. Further, control of non-performing loans has meant less unpredictable downside risk for acquirers, but potential upside through enhanced operational efficiency (e.g., adopting FinTech) and exploiting scalability (e.g., through consolidation). As ever, distressed situations also present opportunities.
Navigating Regulatory Requirements
PE firms may be tempted by attractive opportunities, but must plan for potential challenges through targeted diligence and transaction planning. If a target falls within the European Central Bank’s (ECB’s) Single Supervisory Mechanism, the ECB will play a central role in approving the deal, the terms of operation following the buyout, and plans for consolidation or buy-and-build strategies. Regulators generally prefer a bank’s owner to be long-term, open to injecting additional cash, and fully accountable in a worst-case scenario. However, in our view, regulators are becoming more open to the needs of PE investors.
Funding — The Major Economic Issue in Bank Transactions
Post-closing funding of the bank must be considered. Firstly, the acquisition may have implications for the bank’s rating — securing a favourable rating is a key milestone. Secondly, if the bank had a large shareholder, such as a public shareholder (e.g., the respective German states in West LB, Hamburg Commercial Bank, NordLB)or a conglomerate, it may not be as willingto provide support as it has been previously(e.g., with parental loans, guarantees, etc.). In order to mitigate such issues, private equity owners will customarily shrink the bank’s balance sheet post-closing in order to reduce the financing needs. Further, securing membership of a bank in a deposit protection system will be crucial in keeping funding affordable. In our view, regulators are becoming more open to the needs of PE investors
Doing the Deal — Protecting Investors
Given the regulatory environment, bank purchasers should seek protection against burdensome conditions imposed by regulators. The obligation to complete the transaction should be made subject to no burdensome condition being imposed. Indemnities may be sought against significant skeletons, such as mis-selling of financial products, FX, and LIBOR manipulation. Given the importance of the regulatory equity of a bank target, it is — in contrast to other industries — customary to measure equity at closing on the basis of a closing balance sheet.
PE firms must also factor in additional time, as satisfying regulatory demands can take nine months to a year. Regulators require satisfaction of “fit and proper” tests and may ask PE firms to reveal business plans or provide information about a firm’s representatives and officers. Prospective buyers will need to consider management incentive plans in light of remuneration laws for bank officers and representatives, and carry and management fees in light of regulatory requirements.
Local Issues Are Key
PE firms need to position messages appropriately at the early stages of an offer. Accordingly, PE firms must engage with local advisers who understand the target’s position in the local economy and the regulators’ perception of that target.