How the banking sector will respond to pandemic-related recession

Divestments are a core pillar of banks’ resilience and growth strategies, along with staff safety and continuing optimal operations.

Going into the COVID-19 crisis, the banking sector was in a strong and stable state. Global and regional economic growth was supporting solid revenue and profit generation and most banks had record levels of capital set aside to help them withstand the severe financial impact of a seismic economic event.

The banking sector remains solid overall amid the pandemic. Just as crucial as staff safety and making certain that operations across businesses continue at optimal levels have been the fortification of balance sheets, confirming liquidity, allocating stimulus funding, managing funds, and understanding the need to build a strategy around what’s next and beyond the near-term challenges. More specifically, banks may need to take action to reposition their business, accelerate digital transformation and seize growth opportunities as they emerge.

The extent of this repositioning will differ from one bank to the next. Yet a common imperative is enhancing their financial strength together with operational resilience, agility and efficiency, some of which will be achieved through portfolio rebalancing and the divestment of assets better owned by others together with more capital raises to maintain key ratios in due course.

Banks have been increasingly assiduous in their overall business portfolio reviews — 90% in our survey say they review their portfolio more frequently and in greater depth than in previous years — for several reasons. In the main, they say it is to respond more quickly to changing client and customer demand and, importantly, to better navigate market disruption; an objective now under intense examination.

The upshot should be another round of robust divestment activity, potentially including large, transformational carve-out deals. The last financial crisis resulted in both mandatory and voluntary divestments that were relatively easy and obvious to pick. This crisis combined with ongoing digital and cost challenges will mean banks need to think much harder than previously about what assets are core and noncore. This is due to leaders having to make profound strategic decisions around what sort of bank they want to be in the future and how easy that transformation will be to execute.

How can banks better prepare their divestments?

With execution and active marketing of large assets still mostly on hold, the focus has turned to reviewing portfolios and, according to 49% of banks, continuing their divestment preparation.

Dedicating adequate time and resources to this process is important. Unfortunately, it is often overlooked; close to two-thirds (64%) admit they significantly underestimate the internal resources and time needed to prepare an asset for sale.

What’s more, 66% agree that they should have invested more time and resources into creating pre-sale value on their most recent divestment.

In a market where the price gap between sellers and buyers is already wide, the importance for sellers of preparing their divestments in the right way to achieve the highest possible price should not be underestimated. Indeed, sellers will most likely need to face the reality that they are unlikely to achieve pre-COVID pricing in the near term. Recognition and acceptance of the new pricing dynamics could, therefore, be critical for divestment activity to increase.

For some banks, preparation will include pursuing value creation or restructuring initiatives to make the business for sale more attractive to potential buyers.

Value creation strategies vary but the top two areas where banks are now placing greater focus before putting the business up for sale are: confirming the quality of the management team in the business (49%); and optimizing the asset’s legal structure (41%), which could mean separating it partially or fully.

Of various restructuring approaches being considered in the middle or back office, most (54%) say they may carve out capabilities (employees, assets, infrastructure) and transfer them to a managed service provider; and collaborate with industry or market peers to form a shared capability or utility.
 

For those banks ready to sell, the following advice could be valuable:

• Be rigorous in preparing for a divestment: 72% say a lack of understanding around workstream interdependencies delayed or derailed their closing.
• Deploy adequate and appropriate resources: 64% say they significantly underestimated the internal resources and time to prepare the divestments for sale, while 79% say that in their last divestment they lacked access to the right tools for data flow decision-making around project management milestones.
• Keep an open mind: 54% say a lack of flexibility in changing the deal perimeter either scared off buyers or delayed the closing.
• Get advice early: the regulatory, competitive and technological landscape is changing rapidly and it is important to understand the implications in terms of asset performance and valuations.
  

Private equity is actively looking at banking sector deals. Some of the most successful PE-led deals have come from executing on very complex and messy carve-outs from banks. As stated, the simple disposals from many banks were done in the last crisis and this round of divestments may require a lot more unpicking of businesses to create strong disposal cases.

We would expect to see PE looking very actively at embedded businesses in banks such as the wealth and asset management, asset servicing, insurance and payments businesses. Another rich area of future deals in the sector will be the software, technology and regtech sectors where the banks are the major user groups and in some cases still the owners of these assets.

Activist campaign activity has been impacted by the crisis but they will return to focus attention on the banking sector and in specific situations where underperformance and poor management during the pandemic exist.

That most banks (57%) say they are less likely to divest due to activist pressure in the next 12 months is perhaps indicative of activist campaign activity slowing as they themselves navigate the impact of financial and economic impact of the pandemic.

However, activists will be back and perhaps more ambitious. Activists’ investment rationale can differ from one target firm to the next. Yet agitating for a divestment of a noncore or underperforming business, or even a breakup, have been core objectives.

So how should firms respond?

• Formulate and articulate a clear strategy with detailed timelines, objectives and rationales for the existing or proposed business structure in terms of competitive dynamics and capital and regulatory requirements.
• Ideally, set out a road map and timeline for business improvements even if they do not necessarily address the issues highlighted by activists; strategies that aim to simplify banking activities and which explicitly focus on the needs of the customer base are best received by the market.
  
• Even if there are no opportunities for disposals, look for outsourcing or other cost-cutting opportunities.