Last week’s business press featured two major stories, the purchase of Sallie Mae (by a partnership of two private equity firms and two banks) and the intensifying tussle over ABN Amro. These stories indicate that bank-related private equity activity may begin to quickly heat up, particularly if revenue and earnings growth remains problematic. Looking for the next target, The Wall Street Journal mentioned Countrywide, CIT, and Key Bank as companies of interest to private bankers.
Sallie Mae: Private Equity moves to new areas
Some analysts evaluating the Sallie Mae purchase underscore its uniqueness and view the company as distinctly different from a bank. A Financial Times columnist cited some of the unique characteristics of both the company and the deal: Sallie Mae has high quality and highly liquid assets; the deal results in a reduced need for a high credit rating; it does not take FDIC-insured deposits. That columnist rightly notes: “Those that do [gather insured deposits], such as commercial banks, are accountable to regulators who insist on capital and leverage ratios as well as constraints on who can legally own a bank. These would be harder nuts to crack for LBO artists.” We agree: harder but not impossible and less impossible every day. Given the amount of liquidity available, more funding options exist than ever before.
Today, virtually every industry, now including banking, offers private equity investors potential opportunities. Example: the currently discussed sale of Chrysler and investors’ interest in what can be kindly described as a distressed industry. Example: the increased private equity and LBO focus on technology. As another FT column stated, “[The Sallie Mae] deal reverses the received wisdom that the markets would not tolerate a financial services business being levered up.”
Breaking up the bank: ABN Amro
Last week’s accompanying story to the Sallie Mae deal centered on the potential merger of Barclays with ABN Amro and the recent interest of a group of three international banks (Royal Bank of Scotland, Banco Santander, and Fortis) in buying and splitting up the bank. Under that scenario, related to the US market, RBS would obtain LaSalle Bank and become the largest bank in Chicago.
Can you break up a bank? “Investment bankers agree that a break-up is feasible because ABN is a confederation of businesses, assembled through acquisition, which were never properly integrated.” While most US banks operate with greater operational and strategic integration than the bankers suggest may be the case with ABN, our experience indicates that within many banks business units and geographies can be separated from the parent organization. Another FT article title summarizes one possible deal approach: “Cut-out-and-keep could be on the cards.” Financial and strategic players could combine, as they did with Sallie Mae to purchase a bank and divide it among several interested parties, for example, the branch system to one bank, commercial banking to another.
If they do not pursue a breakup, the private equity managers would focus on dramatically improving line-of-business performance and productivity levels. Of course, bankers could do that themselves, but the sense of commitment and urgency (and bottom line profit) that drives private equity investors does not seem to exist as strongly at commercial banks.
Who’s a target?
The third article (or series of articles) of note from last week concerns the first quarter reports that banks have been releasing. It is no surprise that many banks are experiencing a downtown in earnings due to the yield curve, lower interest margins, and increased provisions, among other factors. The good (and easy) times for bankers had to come to an end, and they have. However, with that slowdown comes new requirements for management and, potentially, new opportunities for outside investors.
You can bet that, right now, private equity groups are crunching their SNL databases and evaluating other information sources to uncover potential banking opportunities. What are they looking for? Elements include:
- Banks that are underperformers versus their peers
- Geographically disbursed banks and/or those that have failed to take advantage of organizational efficiencies by eliminating geographic “independence”
- Banks with “separate-able” business lines
- Banks with relatively high operating efficiency numbers
- Banks with NIMs and deposit growth numbers that are misaligned with their peers
- Banks with no clear succession strategy
In short, they will first evaluate performance outliers and assess the opportunity to “fix” the bank either with their own management team or through teaming up with one or more other banks.
Learning from Private Equity
Bank management should be looking at itself with the critical intensity of a private equity firm. At many banks, performance is down and the outlook is cloudier than it has been for years. If a bank is ever going to move quickly to consider changes in strategy and tactics, now should be the time.
Evaluating your company from the perspective of a Private Equity player provides an opportunity to reconsider the “traditional” approaches that may now be hamstringing performance, whether related to strategy or tactics. We’ll stick with a few tactics here, including: job responsibilities (often inconsistent across the bank), productivity standards (usually too low), incentives (often inadequate in what they incent and in the degree to which they encourage a strong sales effort).
Bank management should use the tougher environment not to promote across-the-board cost cutting but to rethink the strategic direction (and supporting tactics) that can define and decommoditize the bank long into the future. Most won’t do so. Hence, the opportunity for outsiders.