Opportunism requires preparation
Financial services companies need to be better prepared to move when there is a receptive buyer and a strategic rationale to divest. Our study indicates that poor data is clouding value assessments for many sellers and that most companies are not seeking wider benefits from their investments in regulatory programs. Our study also points to what financial services companies can learn from last year and from expectations for the year ahead.
Opportunities may arise from unexpected places, such as sudden interest from an emerging market buyer or as a result of such market factors as improving availability of appropriately priced debt financing. Being ready to move at the right time can significantly affect the speed and price at which opportunistic divestments can be executed.
One challenge for financial services businesses is the interrelations across different businesses due to shared compliance and regulatory resources and capital usage. Understanding the value of each business, as well as the impact on value for the group of not having a business in the portfolio, is critical to assess opportunistic approaches.
Changing sentiment in equity markets has been a notable feature of 2015, such that dual-tracking of IPO and sales of businesses has been a successful tactic for a number of divestors. Management teams have been, and will continue to be, well served by being ready for both routes, depending on which offers greater value.
Q: What triggered your most recent major divestment?
Half of financial services executives say they have held on to certain assets too long. Firms have been holding on to businesses due for divestment for a number of reasons, including waiting for an improvement in the market outlook, increasing buyer appetite and underestimating the distractions of holding. Another driver has been waiting for increased availability of debt at a reasonable price, which enables private equity buyers to acquire assets such as loan portfolios.
Some firms have held on to businesses due to limited P&L capacity for losses, with the intention of improving the business, then subsequently divesting. In our experience, often improvements are not prioritized and subsequently do not materialize, leading to further losses during the extended holding period. Management also suffers the distraction and necessary time investment of running the underperforming non-core business.
In other instances, rather than divesting, firms are electing to run down certain business units. However, firms often underestimate run-off costs, whereas a more robust estimation of those costs might have supported a much earlier and sounder decision to sell.
The takeaway lesson for executives from this period is that indecision and procrastination usually lead to both direct and indirect costs (including people and regulatory costs), so when a rigorous portfolio review points to divestment, it’s time to sell.
One of the challenges in analyzing financial services companies is reconciling the contrasting views from a business held at the operational level, the country level and the legal entity level. More than half (58%) of the financial services respondents said that shortcomings with their portfolio review process resulted in a failure to achieve intended divestment results. Eighty-three percent of executives said insufficient or poor-quality data made it difficult to use analytics effectively in divestment decision-making.
The need for quality analytics is greater than ever. At the same time, firms are required to produce more data than ever before to comply with their regulatory obligations, such as Solvency II, CCAR and recovery and resolution planning.
Despite this, one of the key learnings from this year’s study is that many firms are failing to leverage this data and analysis. In fact, more than half of executives had not taken any steps to help their divestment efforts by capitalizing on their investments in required programs. This presents a major opportunity to extract value and improve divestment processes and results with little extra cost.
51% have not leveraged their required investments in regulatory programs
- Learn to leverage by breaking down barriers between risk and regulatory. Many companies need to do more to break down the barriers — organizational and cultural — that separate their risk and regulatory arms from those business units seen traditionally as “creating value.” For many large, long-established financial services firms not known for their dexterity, this can be easier said than done. Nevertheless, leading firms are investing in simple systems that capture all of the relevant information. They are also mining the information they are producing and using the learnings from the regulatory efforts to enhance their preparedness and approach to divestitures.
- Invest in predictive analytics. Predictive modeling has emerged as one of the most valuable tools to better assess business unit performance, and 69% of financial services executives plan to invest in this area. Particularly important will be considering the potential significant impact of new and disruptive competitors such as fintech businesses, as well as understanding the impact of different scenarios for key market assumptions such as interest rates. Further, data from regulatory programs can be used to inform predictive analytics.
Financial services firms are beginning to recognize that risk and regulatory capabilities need to play a greater role in deals from start to finish. Leading practices are:
- Integrate from start to finish. It is no longer sufficient to bring regulatory committees aboard early in the process; those committees need a fully integrated role. Many divesting firms need to have regulators on board before they can sell a business to the market, and having an integrated regulatory committee can help keep regulators on their side. At the very least, this can help ensure data arising from required investments in regulatory programs is fully utilized throughout the portfolio review process.
- Bulk up on risk and regulatory expertise in deal steering committees. Previously, regulatory arms of firms might command one seat on a deal steering committee. The trend now is — or should be — toward several seats. Expanded resources on this front can help clarify the value of a deal, particularly in terms of its capacity to free up capital for deployment elsewhere. It can also give comfort and encouragement to buyers who are increasingly nervous about tail-end risks relating to compliance functions and the ongoing impacts of previous breaches.
Q: In executing a recent divestment, have you altered your traditional approach in any of the following ways?
The study shows foreign emerging market financial institutions seeking expansion are seen as the most likely buyers for upcoming divestments — at a level that has almost doubled over the past year.
Given the economic strains in a number of emerging markets, we consider it likely that, in reality, large and well-capitalized financial institutions from some of the more established Asian economies, such as China and Japan (itself a developed economy), may lead the acquisition charge in European countries and the US. This would be consistent with the strong growth from 2014 to 2015 in the value of financial services acquisitions by Chinese and Japanese firms in Europe and the US, of 374% and 291%, respectively.
Major players in emerging markets have been burned by attempts to establish greenfield capabilities in developed markets, and they are also facing declining growth and returns in their own markets. As a result, a number of potential emerging market buyers are new entrants; divesting to these buyers may give rise to a new market “entry premium.”
Q: Who would you view as the most likely buyer for your next divestment?
83% of financial services companies say poor-quality data is making it difficult to use analytics effectively in divestment decision-making.
Financial services firms are continuing to refine their portfolios in the wake of significant regulatory changes since the financial crisis, and this will continue to lead to a significant number of divestments across the industry. Fifty-six percent of financial services companies expect to divest in the next two years, including 43% within the next year.
There will likely therefore be many financial services acquisition opportunities to choose from. So for potential divestors, being clear about what is core and non-core, being prepared and having a well-executed divestment process will be critical to success in the future.