may 30 2012 deals& dealmakers

Deals &DealmakersPart 10: M&A in the financial sector

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May 30 2012

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OVERVIEWCan financial sector dealmaking matchexpectations raised by regulatory changes?INSURANCEObservers believe we may see renewed“zombie wars” over closed life fundsBANKINGThe M&A potential of bank streamlining isonly now beginning to translate into dealsCASE STUDYRBS’s drastic overhaul seen from the insidePRIVATE EQUITYBuyout groups are fundraising furiously withthe aim of targeting financial institutionsPROFILEThe veteran investor J. Christopher FlowersASSET MANAGEMENTThere may be plenty of buyers and sellers,but they are struggling to agree a priceOPINIONWhy crisis and regulation create opportunity

CONTRUBUTORSALISTAIR GRAY is the FT’s insurancecorrespondentDAN McCRUM is the FT’s US investmentcorrespondentSTANLEY PIGNAL is the FT’s private equitycorrespondentBARBARA RIDPATH is chief executive ofthe International Centre for FinancialRegulationANOUSHA SAKOUI is the FT’s mergers andacquisitions correspondentDANIEL SCHAFER is the FT’s investmentbanking correspondent

ILLUSTRATIONSNick Lowndes

Special reports editor Michael SkapinkerEditor Hugo GreenhalghLead editor Jerry AndrewsProduction editor Jearelle WolhuterPicture editor Michael CrabtreeArt director Derek WestwoodGraphics Russell BirkettHead of solutions Patrick CollinsSenior campaign manager Rachel HarrisHead of professional services Robert Grange

All editorial content in this report is produced bythe FT. Our advertisers have no influence over or priorsight of the articles.

More onlineAn interactive graphicmapping trends inglobal dealmaking, plusThe Dealmaker columnand podcasts featuringbig names from the worldof mergers & acquisitionswww.ft.com/dealmakers

DEALS & DEALMAKERS | OVERVIEW DEALS & DEALMAKERS | OVERVIEW

FINANCIAL INSTITUTIONS, BEthey banks, asset managers orinsurance companies, havealways been an importantsource of deals.

The market reached its peakwith the takeover by Royal Bankof Scotland of ABN Amro in 2007

– a year when $731.2bn worth of deals were done.But since the banking crisis, dealmaking hasbecome difficult and volumes have fallen away.

To May 2 this year, so-called “FIG” (financialinstitutions group) mergers and acquisitionscame to a total of $69.3bn, accounting for 10.2 percent of all M&A. The FIG proportion of globaldealmaking volumes has fallen over recent years.In 2011, Fig accounted for 14 per cent of all M&A,while in 2010 the figure was 15.9 per cent and inboth 2009 and 2008 it was more than 20 per cent,according to Thomson Reuters, the data provider.

The biggest deals this year have come fromAsia, including Singapore bank DBS Group’s$7.3bn bid for Indonesia’s Bank Danamon andJapan’s Sumitomo Mitsui Financial Group’s $7bnbid for RBS’s aviation capital unit.

Advisers expect the restructuring of the bank-ing sector in the wake of the financial crisis totrigger dealmaking. RBS’s disposal of its aviationbusiness is just one example.

“The combination of liquidity pressures, atough economic environment and ongoing regula-tory change will continue to have a profoundimpact on banks’ business models and are keyfactors driving M&A in the sector,” says TadhgFlood, head of Deutsche Bank’s financial institu-tions group for Europe, Middle East and Africa(Emea). “In the last couple of years, there hasbeen a steady stream of activity and that isunlikely to change. Most M&A in the sector willbe mid-sized, tactical transactions as banksrefocus on their core operations.”

Many European banks that accepted state bail-outs have agreed restructuring deals with theEuropean Union that force them to shed assets.Following its state rescue, Dexia, the Franco-Belgian lender, is in the process of selling offhealthy units, such as its asset management arm,a stake in Turkey’s DenizBank and an investorservices joint venture with Royal Bank of Can-ada. Such disposals provide opportunities forother lenders keen to grow, some bankers say.

The asset management industry has providedlarge disposals, such as Deutsche Bank’s sale ofits asset management division, although the bankhas backtracked on plans to sell the whole unit.

As regulators shift banks towards a smallersize, it is hard to see a repeat of the large-scaletakeovers in the financial sector that defined theheight of the takeover market in the mid-2000s.However, the wave of regulation facing thebanking and insurance industries means banksare streamlining and disposing of businesses,keeping advisers busy.

“While it is not a perfect environment forM&A, there are many different drivers for trans-actions. Banks are having to decide what theircore businesses are,” says Gilles Graham, chair-man of FIG for Emea at Citi. “That means thatthere are plans for franchise disposals as well asproduct/geographical portfolio reviews.”

But completing deals in the sector is tricky.“FIG transactions in this environment are chal-lenging and complex, and invariably requirefunding,” says Mr Graham. “Banks are lookingfor complete solutions, so we are quite busy.”

Banks have faced a series of potential regula-tory overhauls. The most important is the imple-mentation in coming years of the Basel III capi-tal proposals, which require banks to hold morecapital against riskier businesses, making thelatter less attractive to run.

Another is the “Volcker rule”, first proposedby Paul Volcker, the former US Federal Reserve

chairman. It limits the risks banks can take,prohibits them from owning businesses such ashedge funds or private equity funds and pointstowards smaller banks in the future.

These reforms have led some banks to considerdisposing of their insurance units and asset man-agement businesses, for example. Bankers saythe buyers for such units tend to be specialistsin those areas, trying to build scale.

But some bankers question whether the pres-sure on the industry to shrink, along with fallinggrowth prospects, could encourage consolidation.

“There is still a great deal of uncertaintyaround the banking sector, so it is difficult to seelarge cross-border M&A deals between bankstaking place in the near term,” says Todd

Leland, global co-head of FIG at Goldman Sachs.“There is still a significant amount of recapitali-sation to be done in the industry, and to drawnew capital into the sector you have to evidenceadequate returns to investors, which could be atrigger for market consolidation.”

JOLYON LUKE, MANAGING DIRECTORof the FIG team at Citi, notes that ongo-ing liquidity operations by central banksare delaying the need for banks to takeaction. Under the European Central

Bank’s longer-term refinancing operations(LTROs), more than €1tn was pumped into theeurozone financial system in two operations inDecember and February.

“The LTRO exercise has moved the agenda onfrom capital and liquidity and reduced the needfor many financial institutions to make any port-folio disposals in the near term,” says Mr Luke.

Ben Davey, head of FIG for Emea at BarclaysCapital, says US and Asian investors are lookingto take advantage of some of the opportunitiespresented as the sector restructures.

“We have seen inflows of North American andAsian capital chasing high-quality available

Banks selling assets to meet new regulatory pressures may provide a boost after a slow start to 2012. By Anousha Sakoui

Restructuring could lift M&A market

A wave of regulationmeans banks arestreamlining andselling businesses

platforms and portfolios – SMBC’s [SumitomoMitsui Banking Corporation’s] acquisition of RBSAviation Capital, being a notable example,” saysMr Davey. “Delivery of capital targets againstthe European Banking Authority stress tests andpreparation for the implementation of Basel IIIwill add momentum to this activity for the restof 2012.”

In the insurance industry, Mark Flenner, insur-ance M&A partner at KPMG, the consultancy,says companies are also considering opportuni-ties to grow through M&A. “Non-life insurers arein rude health. They have weathered the stormsof 2011 well – one of the worst natural-catastro-phe underwriting years – and are now lookingfor inorganic growth opportunities,” he says.

Insurance faces a similar capital overhaul tobanks in coming years, known as Solvency II.“Capital buffers remain unspent and, coupledwith the advancing Solvency II deadline, weexpect M&A to accelerate in the next 12 to 24months,” says Mr Flenner. “Already there hasbeen a hive of M&A activity within the Lloyd’smarket and there are early signs the privateequity community is starting to look for value inthis niche sector. Overseas interest in buying

World viewSTEPHEN CARTERHead of financial institutions M&A, Credit Suisse, London

“FIG M&A activity remains subdued relative to historicallevels due to the impact of the European sovereign crisis,changing regulation – particularly for capital – and a lackof chief executive confidence. Banks continue toselectively divest businesses due to European Union stateaid requirements, the need to recapitalise, to reducewholesale funding requirements and/or to adjust theirbusiness portfolios to meet target capital levels.”

into one of the largest insurance markets in theworld remains undiminished.”

The EU-wide Solvency II regime is designed tobetter match the capital that insurers hold withthe risks they take. One example of a large dis-posal is expected to be RBS’s planned sale of itsDirect Line insurance business.

Despite dealmaking being stymied by globalmarket turmoil, the FIG sector will, over time, beforced to respond to regulatory change. M&A isalready proving to be part of the solution.


DEALS & DEALMAKERS | INSURANCE

THEY WERE KNOWN AS THE“zombie wars”: bid battlesinvolving some of the UK’s mostcolourful entrepreneurs for poolsof life assurance funds that hadstopped writing new policies.

Over the past 15 years or so,at least 77 UK life assurance

companies have closed to new business, esti-mates Ned Cazalet, the veteran financial servicesconsultant – among them household names suchas Scottish Mutual, Scottish Provident and Cleri-cal Medical. “In almost every case, the closuresinvolved somebody buying them,” he says. “Thenumbers are actually quite staggering.”

As with other sectors, dealmaking in the closedlife assurance consolidation industry wentthrough a relatively dry spell in the wake of thefinancial crisis. Multibillion-pound deals have notreturned, but there have been signs that activityhas picked up in recent months.

“There has definitely been a re-emergence ofback-book consolidators in the last 12 months,although funding can still be a constraint,” saysRichard Locke, managing director at FenchurchAdvisory Partners, the corporate finance firm.“The increased level of demand is encouraging anumber of life companies to explore whether aclosed-book sale could be attractive.”

Recent deals include the £275m purchase ofGuardian Financial Services from Aegon, theDutch life assurer, by Cinven, the private equityhouse. Guardian stopped taking on customers adecade ago but has more than 500,000 legacyclients. This month it emerged that Sun LifeFinancial, the Canadian insurer, was examiningplans to sell its UK business, which has £11.8bnof assets under management but stopped writingnew business in December 2010.

Funds may opt to stop writing new policiesbecause profitability levels are disappointing, cap-ital positions inadequate or they are making stra-tegic changes. Life companies are required to setup and hold capital reserves for the duration ofthe policies, in order to meet the long-term liabil-ities associated with them. It tends to takeseveral years to recoup the marketing and otherexpenses that arise from writing new business.

If a life company decides to put a fund in “runoff”, it accepts premiums only for existing poli-cies, whose assets it administers until maturity.Consolidators argue that both policyholders andshareholders ultimately miss out when closedfunds run off individually because the process isinefficient. They seek to merge the funds tomake capital, tax and operational savings.

“The closed books of businesses throw off a lotof cash,” says Andy Briggs, chief executive ofResolution’s Friends Life. “If the new businessbeing written is not profitable, then the share-holders would probably rather have the cashback off the back book than invest it in newbusiness at a poor return.”

Significant barriers remain to a fresh bout ofdealmaking. Phoenix, one of the biggest closedlife funds, has held talks in recent months withprospective buyers including rival insuranceconsolidation vehicle Resolution and privateequity house CVC Capital Partners. But thefailure of both Resolution and CVC to seal a dealunderscores the fact that buyers and sellers arestruggling to reach agreement on valuation amidthe economic uncertainty.

Regulatory uncertainty is another stumblingblock, adds Mr Briggs of Friends Life.

John Tiner, chief executive of Resolution andformer head of the Financial Services Authority,raises a further issue. “Leverage has to be estab-lished at quite a prudent level these days,” hesays. “The game has changed from before thefinancial crisis in terms of leverage and debt andthat may have made it less attractive to the pri-vate equity sector.”

Pearl, which was built up by “pizza-to-pubs”entrepreneur Hugh Osmond, took on more than£3bn of debt to buy Clive Cowdery’s first Resolu-tion project in the sector’s biggest deal to date in2008. Phoenix, as Pearl has been renamed, is stillseeking to renegotiate the hefty debt burden.

MANY BANKERS, EXECUTIVESand analysts are sure the sector isripe for consolidation, and that itis a matter of time before morebig acquisitions. Their optimism is

based on the conviction that more life companieswill stop writing new policies and sell blocks ofclosed business, and that the consolidators willthemselves ultimately seek to consolidate.

“What we see in this market is that the UKlife assurance market for new business is verychallenging,” says Caspar Berendsen, partner at

Cinven. “People are buying fewer savings prod-ucts and few mortgage- or home-purchase relatedlife insurance products.”

He adds: “You would expect life assurancecompanies to divest non-core operations.” Withprivate equity groups keen on the guaranteedcash flows of closed portfolios, Cinven is amongthe companies actively looking at more closedlife deals. It is expected to use Guardian as aplatform from which it can grow.

Many analysts say recent rule changes areencouraging consolidation. They argue the greatercorporate governance and capital requirementsarising from Solvency II may prompt more insur-ance companies to stop writing new business. TheEuropean insurance sector’s forthcoming rulechanges are due to take effect in January 2014.

“There will be more consolidation, as more lifecompanies close their doors because of regulationand increasing costs,” says Barrie Cornes, insur-ance analyst at Panmure Gordon, the stockbroker.

Steve Groves – who as a senior actuary atAdmin Re, the closed fund operation of Swiss Re,the reinsurer, oversaw the acquisition of compa-nies including Windsor Life and Zurich Life –says: “It’s going to be resurgent.”

Given that without fresh deals, dedicated run-off funds will no longer exist several decadeshence as policies mature, some analysts expect a“super consolidator” to emerge. They believethere remains sound logic in combining Phoenixwith the closed part of Resolution’s Friends Life.All eyes are on Resolution’s next move.

Bankers believe that closed life funds are once again ripe for consolidation. By Alistair Gray

A fresh crop

Graham KettleboroughChief executive, Chesnara, London

“There have been some notable deals recently, such asCinven’s acquisition of Guardian, but generally the sectorhas not been that active as, in recent volatile markets,pricing is difficult. The introduction of Solvency II will giverise to more opportunities in the market due to theassociated capital requirements, and there are certainlymore deals to be done.”

World view


DEALS & DEALMAKERS | BANKING

We have so far had only a foretaste of the potential M&A from bank restructuring. By Daniel Schäfer

A small slice of the actionDEALS & DEALMAKERS | BANKING

WHEN BANKINGstress tests in Europelast year revealed aconsiderable capitalshortfall at a seriesof banks, it wasexpected to triggera number of sales to

bolster their balance sheets.And so far this year, a number of larger trans-

actions, including the $5.4bn disposal of a two-thirds stake in Cimentos de Portugal, the cementcompany, by Portuguese banks Caixa Geral deDepósitos and Banco Comercial Portugues, haveindeed pushed bank divestment deal volume inEurope to the highest level in four years.

With $25.3bn in deal volume until April 25 thisyear, Europe has accounted for a record 79 percent of global bank divestments, according toDealogic, the data provider.

“The deleveraging in Europe has only juststarted. The stress test has been a catalyst whilethe central bank’s financial stimulus has pro-vided some relief,” says Stefan Wintels, co-headof the European financial institutions groupat Citigroup.

Despite the increase, the amount of activityhas so far failed to live up to the expectationsthat had been elevated by the regulatory andeconomic pressure on banks to bol-ster their capital base and getout of businesses and regionswhere they lack scale.

One reason is the €1tn lifelinethe European Central Bank threwto the continent’s banks in late2011 and early this year that hassomewhat reduced the urgent need forsome banks to get out of businessesthey could no longer afford to fund.

But while this short-term boost to confidencehas stopped some banks from selling assets, itis now the resurfacing of worries over Europe’ssovereign debt that hampers deals.

“The elevated levels of uncertainty in currentmarkets make it more challenging to completetransactions,” says Tadhg Flood, head of thefinancial institutions group for Europe, the Mid-dle East and Africa at Deutsche Bank.

It is therefore no wonder that the busiest mar-ket this year has been outside the troubled euro-zone. The UK’s banks embarked on a recordnumber of 27 divestments until April 25, accord-ing to Dealogic. These included several sales bystate-owned Royal Bank of Scotland, one of whichwas its disposal of Hoare Govett, the UK broker-age group, to Jefferies, the US investment bank.

HSBC was another source for a series of dealsrecently, including several smaller emergingmarket operations. They are part of a strategyput in place by Stuart Gulliver, chief executive,to focus on markets where the bank has asignificant presence and businesses where it canmake the most money.

Bankers say that besides the ongoing sale ofportfolio assets such as underperforming and per-forming loans, exits from regional markets wherea bank is sub-scale are going to pick up pace inthe next few years. “The effects of the crisis areforcing banks to really consider what is core andnon-core,” says Mr Flood.

Jérôme Hervé, senior partner at the BostonConsulting Group in Paris says: “In the past 20years, most banks have accumulated businesslines and regions. This is now coming to an endas it has reached a point of too much complexityand there are often very few synergies. A lot ofbanks have built beautiful pearl strings but theseare not integrated businesses.”

Besides Asian and other emerging markets, oneregion where banks are likely to sell regionaloperations is eastern Europe.

In those markets, experts are forecasting a con-solidation wave. This trend has been presaged by

January, Mr Owen had prepared informationmemoranda and data rooms for the businessunits and approached some potential buyers – aprocess that left him and his team working flatout during the Christmas and New Year period.

BUT THANKS TO THIS PREPARATORYwork, most units were sold within a fewmonths after a series of quick auction

processes. In early February, the sale of HoareGovett, the UK broker with around 50 staff, toJefferies, the US investment bank, was sealed.As it quickly became clear that there was nobuyer for European equity capital markets andcash equities, the unit with several hundredemployees, ended up being wound down.

In March, RBS signed a memorandum ofunderstanding to sell the Asian equities unit,consisting of roughly 400 people, to CIMBGroup, and its Dutch-based equity capital mar-kets and deals advisory business of 70 people,to ABN Amro.

In the same month, the bank decided that thelast remaining piece of the puzzle – the UK

M&A advisory group – would bekept until the year-end

and then be spun offindependently. DS

Case study An inside story of a dramatic RBS restructuring

John Owen was incharge of the RBS

restructuring

‘There are far toomany banks trying todo too many thingsin too many areas’

Some lenders are also considering sellingminority stakes in foreign banks in Asia andother regions that they accumulated before thecrisis. “There is a whole raft of discussions goingon where banks want to sell equity stakes inother banks outside of their home markets,” saysMr Harrison at HSBC.

With the International Monetary Fund predict-ing that European banks would shed €2tn ofassets over the next 18 months, bankers forecastan accelerating trickle of deals.

“I would expect the European deleveraging tocontinue for another few years,” says Citigroup’sMr Wintels.

Maged LatifManaging director, global co-head of financial institutionsadvisory, HSBC, London

“FIG M&A activity continues to evolve, dominated byclean-up and portfolio-reshaping divestitures by banks andto some extent insurers, mainly in Europe. The ongoingfinancial crisis, coupled with material regulatory change, issharpening CEOs’ focus on business scope, strategic fitand economic returns on allocated capital. There is also atrend to increasing the share of capital deployed in homemarkets, and a near-universal aversion to transformationalmergers due to significant regulatory hurdles.”

World view

JOHN OWEN HAS HAD MANYintense moments in his three decades asan investment banker. But not muchcan compare to the first half of thisyear, when the co-chief executive of

international banking at Royal Bank of Scot-land’s investment bank was overseeing a drasticrestructuring at the mostly state-owned lender.

Within a matter of months, the bank hadshut down or sold a sizeable chunk of theinvestment banking arm, getting out of areassuch as UK brokerage, cash equities and equitycapital markets.

“This process was very different from a typi-cal M&A deal where you advise a client. It wasvery emotionally charged, because what you dohas an impact on colleagues who you knowvery well,” the 50-year-old banker says.

It all started with the strategic decision justbefore Christmas last year to dispose of under-performing business units. It is part of aprogramme to remove £70bn of risk-weightedassets in the investment bank at an estimatedcost of £550m.

One big weakness was easily spotted: in cashequities, RBS ranked outside the league of top-10players globally and it was not foreseeable howit could move up any time soon, or indeed makeany money with the business.

With the decision to step away from this area,it also became clear that the bank no longerneeded equity research, brokerage, equity capi-tal markets and its sub-scale merger and acqui-sition advice unit.

“There are far too many banks trying to dotoo many things in too many areas for toomany clients,” says Mr Owen, who cuthis teeth as a banker at Bank of Amer-ica in the 1980s.

Instead, RBS decided to concen-trate on its strengths – which itdefined as debt financing, riskmanagement in currencies andinterest rates, and transactionsservices.

The former UBS and CreditSuisse banker, who joined RBSjust over a year ago, knew he hadto act fast. “These are people busi-nesses and you risk destroyingthem the minute you announce thedecision to exit them.”

Even before the bank announcedthe overhaul and appointed Lazard, theinvestment bank, by the middle of

‘What you do hasan impact oncolleagues youknow very well’

addressed. But vendor financing is often tootough an ask for many banks.”

Giles Harrison, global co-head of financialinstitutions at HSBC, says: “Some salesprocesses never got started because there isthe realisation that they could not operate ona standalone basis.”

THE FAILED BHF DEAL UNDERLINEDhow the regulator can sometimes spoila transaction – as might happen withLloyds Banking Group’s so-far flawedattempt to sell a UK network of 630

branches to The Co-operative, the retail group.The other issue is simply price. “Everyone

wants to go out of the same markets whereprices are low,” says Mr Martin at KPMG. “Manybanks bought those operations before the crisisat two times book value and now they are oftenworth half the book value.”

When Deutsche Bank recently aimed to sell itsinternational asset management unit to Guggen-heim Partners, the financial services firm, bothsides failed to agree on price and ended updiscussing only a smaller potential deal forRreef, the bank’s alternative assets arm (seeasset management, p10).

Bankers say asset management has becomeone non-core area where lenders are rethinkingtheir options, alongside smaller private bankingoperations, insurance units, consumer credit andleasing businesses.

‘The effects of the crisis areforcing banks to really considerwhat is core and non-core’

Spain’s Banco Santander’s recent deal to takecontrol of Poland’s Kredyt Bank from Belgianbank KBC and combine it with its Polish busi-ness to create the country’s third-largest bank.

But in the more saturated western markets,such consolidation deals are not on the cards.

“The strategic demand for bank businesseshas been drastically reduced,” says Citigroup’sMr Wintels.

Deutsche Bank’s talks to sell BHF, the Germanlender, to RHJ, the private equity group,collapsed last year on funding concerns andproblems to obtain regulatory approval.

The deal underlined how cash-rich privateequity groups often struggle to come to an agree-ment on a price and get wholesale funding.

“There is a lot of private equity money chasingthis opportunity but the reality is that it hasnot happened in this waterfall scenario that hasbeen predicted,” says Graham Martin, globalco-head of the portfolio solutions group at KPMG,the consultancy.

Mr Wintels adds: “If private equity is to investin going concerns the funding issue needs to be


DEALS & DEALMAKERS | PRIVATE EQUITY

THE STORM THAT ENVELOPEDthe financial sector in thewake of the Lehman Brotherscollapse in September 2008 hashad far-reaching implicationsfor private equity.

The easy credit that fuelledthe buyout boom suddenly ran

dry. Even four years later, the patchy availabilityof bank credit continues to stem activity levelsin private equity, most notably in Europe.

But the financial sector’s ongoing woes havehad a silver lining for buyout groups: theupheaval has created many opportunities forthem to take over assets from banks, often atknockdown prices.

Whether it be portfolios of loans extended bybanks in happier times, businesses taken over bylenders after they defaulted on their debts, orfinancial institutions themselves, potential salesfor buyout groups have been plentiful.

Add to that the new regulations brought in toprevent a repeat of the meltdown, and the flowof transactions in the financial space is rapidlyoutstripping the rest of the market.

“In the context of increased regulation andcontinuing uncertainty regarding the eurozonecrisis there is plenty of scope for private equityfirms making attractive deals involving bankassets,” says Alex Jones, senior analyst atPreqin, the data provider.

Preqin’s data show that there are 163 fundscurrently trying to raise $134bn from investors totarget financial services. Nearly 70 deals havebeen done globally since the start of the year, ona par with the pre-2007 boom years of privateequity, despite the rest of the market havingshrunk to a fraction of its former size.

There are many factors driving the banks’ newwillingness to sell their assets. The most promi-nent is the need to meet new regulations oncapital requirements, chiefly the so-called BaselIII rules, which demand banks hold larger capitalcushions to ensure they can absorb future losses.

That often means they want to cut back theirloan books. They can do this by selling packagesof loans to outside investors – some of whomcome from private equity.

One recent example was the purchase by TPGand Patron Capital of Opera Finance (Uni-Invest),a Netherlands-based commercial mortgage-backedsecurity, or CMBS. The two buyout firmsacquired a complex vehicle of troubled loansbacked by a pool of commercial mortgages thatwas being sold by its creditors, mainly banks andhedge funds.

The loans were purchased for significantly lessthan their face value: senior noteholders receivedonly 40 per cent of the $602m owed to them.More junior debtholders were wiped out.

Industry insiders expect it will be the first ofseveral banking assets snapped up. A clutch of“credit opportunities” funds and mezzanineoperators, investing between debt and equity,have popped up, affiliated either with hedgefunds or private equity.

“Credit opportunities funds raised a lot ofmoney a few years ago, however banks were nottypically ready or willing to sell portfolios ofassets and realise losses, even if such assets hadbeen identified as non-core,” says Andrew Sealey,managing partner of Campbell Lutyens, a privateequity advisory firm.

Beyond trying to cut down the size of theirbalance sheets, financial groups are also tryingto streamline their businesses. A fashion fordiversification prior to the crisis, pushed bycredit ratings agencies’ penchant for financialconglomerates, made it difficult for private equityto compete with trade buyers for whom biggerwas invariably better.

Now that the credit ratings agencies’ methodol-ogy has been found wanting, it is becoming mucheasier to separate financial services businesses

from their conglomerate parents, eager to sellthem to free up cash.

“There has been a significant move in largefinancial groups to focus on core businesses.That has opened opportunities for private equitybuyers. It’s a relatively new market,” saysCaspar Berendsen, partner and co-head offinancial services at buyout group Cinven.

Alongside CVC and Oak Hill Capital Partners,in May 2010 Cinven paid $2.5bn for Avolon, anaircraft-leasing business that took over much ofthe team at RBS Aviation Capital – itself at thetime on the chopping block as a “non-core” asset.

London-based Cinven subsequently took over

Guardian Financial Services, a provider of lifeinsurance and pension products in the UK.Cinven bought the Lancashire-based company,worth £275m, from Aegon, the Dutch insurancegroup, as a basis for further acquisition.

A NOTHER CATEGORY OF ASSETSbanks are trying to sell are compa-nies that they end up owning aftera loan has soured. With insolvencyrates increasing as the economy con-

tinues to lag, banks are reluctant to managecompanies they accidentally come to own, saysDave Lamb, partner at Vision Capital, whichbuys entire portfolios of companies from finan-cial groups and private equity firms.

One such business Vision acquired from BancoPopolare, a bailed-out Italian lender, wasBormioli Rocco, a glass and plastics specialistwith sales of more than €500m a year. With moreexpertise than a lender in running a company, itrelieved Popolare of a task – managing a complexbusiness that includes a unit making elaboratecoloured drinking glasses – that it was notequipped to take on.

“Looking at a business through a debt lensrather than an equity lens are two entirelydifferent things,” says Mr Lamb. “Lenders toa business focus on getting their money back.

Buyout groups are focusing on financial sector targets. By Stanley Pignal

Pursuing rich pickings

Equity investors are concerned with growingthe business.”

Banks are ill-suited to own businesses: evenfinding staff to go to board meetings, let alonedevise a new strategy, can be difficult. Whereas asingle financial specialist can manage up to 40debt positions, says Mr Lamb, the same personcan realistically take on only four equity roles.

The buyout groups are also keenly interestedin running financial services businesses inEurope, where prices for certain types of assetsremain at credit-crunch lows. J. ChristopherFlowers (see profile), the high-profile US finan-cier who once quadrupled his money by scoopingup the failed Long-Term Credit Bank of Japan,moved to London this spring with the intentionof becoming active in the European market.

Despite the appetite for financial groups to selland private equity firms to buy, taking on spun-out units is not as straightforward in the finan-cial sector as it is in other parts of the economywhere private equity hunts for deals.

Financial services are complex businesses, saysCinven’s Mr Berendsen. They require a specialistunderstanding of a sector that is not alwaysreadily available to generalist buyout funds.

“Investing in financial services requires long-standing expertise. It is more innovative than astandard corporate transaction,” he says.

DEALS & DEALMAKERS | PRIVATE EQUITY

‘Looking througha debt lens ratherthan an equity lensis entirely different’

That year he even bought a local bank inrural Missouri, not for its $17m in assets, butfor the bank charter that would enable him toroll up other casualties of the economic crisis.

However, Mr Flowers has not been immuneto the problems that have plagued finance.JC Flowers’ second fund, which raised $7bn, hasseen more than half of the capital eaten awayby losses, according to some estimates.

SHINSEI HAS STRUGGLED SINCEMr Flowers upped his investment, handinghis later investors losses as shares languish

at a fraction of their peak. A near $1bn bet onGermany’s Hypo Real Estate disappeared whenit was nationalised, and the potential value ofan almost $2bn investment in another Germaninstitution, HSH Nordbank, remains uncertain.

The $2.3bn third fund, however, is doingbetter, with a successful listing of BTG Pactual,a Brazilian investment bank, already under itsbelt and showing a profit.

A renewed focus on European deals has nowbought Mr Flowers from New York to Belgra-via, London. Recent purchases include EquitaSim, an Italian broker, and Kent Reliance, theUK building society.

The move is yet another signal of the privateequity cash circling Europe’s financial institu-tions in search of assets that will be ejected as

banks and insurersretrench and seek to

raise capital. It isalso a sign of thecontinent’s finan-cial health. Whenregulators,bankers andpoliticians aretrying to stopthe bleeding,Mr Flowers is

sure to befound close by,

waiting to lenda hand.Dan McCrum

Profile J. Christopher Flowers, private equity investor

FEW MEN HAVE RIDDEN THE ARCof banking, finance and dealmakingquite like J. Christopher Flowers,the veteran private equity investor.

After Harvard, he became aGoldman Sachs man in 1979, back when theinstitution was still a partnership and theinvestment bankers had yet to cede power totheir brash trading counterparts.

His early career began shaping financialdeals as Wall Street remade itself, and at just31, he was one of the youngest to ever makepartner at the bank in 1988, a class thatincluded Lloyd Blankfein, Goldman’s currentchief executive, and Gary Gensler, futurechairman of the US Commodity Futures Trad-ing Commission.

But after a power struggle at Goldman on theeve of it going public, he left in 1998 andstarted the private equity firm that bears hisname. And it took only two years to strike thetransaction that assured his fame and fortune,as well as setting the template for his careerever since: a deal to buy Japan’s failed Long-Term Credit Bank in 2000.

Nationalised following Japan’s banking crisis,it was scooped up by a consortium led byRipplewood Holdings and Mr Flowers. Revived,and renamed Shinsei, it was floated on theTokyo stock market in 2004, handing thepartners billions of dollars in profits.

Mr Flowers then built on his success with aseries of banking deals for his private equityfirm. He doubled down in Shinsei, and addedstakes in NIBC, a Dutch bank, and Enstar, anAlabama insurer.

Where financial entities were on life support,Mr Flowers was to be found pacing the waitingroom and buttonholing the doctors. Strugglinginvestment bank Bear Stearns, student loanoperator Sallie Mae, doomed insurer AIG andeven failing UK mortgage lender Northern Rockwere all looked over by Mr Flowers, although hedid not end up completing a deal in every case.

After Lehman Brothers filed for bankruptcyin 2008, he was at the heart of the response tothe crisis, even returning for a short stint as aninvestment banker by helping to steer MerrillLynch into the arms of Bank of America.

Long career:J. Christopher Flowersbuilt his success in aseries of banking deals

He has not beenimmune to theproblems that haveplagued finance

Simon HaversChief executive, Baird Capital Partners Europe, London

“The UK recessionary environment is creating a greatbuying opportunity, but many M&A firms are cuttingheads, reducing their ability to originate deals. More thanever, what we’re doing is sourced from direct contact withthe companies we want to buy: UK firms with the potentialto benefit from international expansion and particularlyfrom the higher rates of growth forecast in Asia.”

World view

After Lehman filedfor bankruptcy,he was at the heartof the response

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DEALS & DEALMAKERS | ASSET MANAGEMENT

THERE ARE PLENTYof buyers and sellersin asset managementbut, like the US’s war-ring political parties,they appear to behaving entirelydifferent con-

versations that show little signof meeting in the middle.

The experience of DeutscheBank is a case in point. TheGerman financial institution, likeseveral of its peers in Europe,gave serious thought to the util-ity of its asset management busi-ness, itself the product of aseries of deals. Following a stra-tegic review, bids were invited, anda putative €2bn price tag mooted.

The unit, which has more than $400bn inassets under management, attracted plenty ofinitial interest, but when it came to putting anactual price on the table this year, the list of bid-ders dwindled rapidly.

Deutsche Bank wanted to sell the entire arm inone piece, even though there were few buyersinterested in the underperforming combination ofinstitutional accounts, insurance assets andRreef, an alternative property investor.

After strategic bidders, such as State Street,JP Morgan and Ameriprise dropped out, DeutscheBank was left with three interested buyers: Mac-quarie, the Australian bank looking to expand;Power Corporation of Canada, a mutual fundcompany for whom the US asset managementbusinesses would be a good fit with PutnamInvestments, the money manager it pur-chased in 2007 for $3.9bn; and GuggenheimPartners. Guggenheim is a business that hasacquired everything, including its name, fromthe famous foundation for which it also man-ages money. But its tactics illustrate theproblem sellers, such as Deutsche Bank, face.

The two entered into exclusive negotia-tions in March, after Guggenheim put ina large bid for the whole business thatMacquarie and Power Corp had no interestin trying to match, according to peoplefamiliar with the situation.

However, two months later Deutsche Bankannounced that it was now in exclusive nego-tiations just for Rreef, which some had con-sidered the most attractive asset all along.

Some bankers put the fraught processdown to Deutsche Bank’s decision to use itsown mergers and acquisitions team. “Younever want your employer as a client, theydon’t listen and you can’t fire them,” saysone. However, the difficulties also reflect thebroader environment and insiders point to aDeutsche management change in March thatcontributed to a reassessment.

Banks, contemplating new regulations for theamount of capital they must hold, are among thechief sellers of asset management businesses asthey consider what banking will look like in thepost-financial-crisis world, and conclude it doesnot involve investing money for clients.

Yet 2011 was the worst year for global deal-making in asset management for five years, bothin terms of value and volume, according to PwC,the accounting and consulting firm.

Spanish counterpart Santander, haveconsidered the sale of their asset man-agement businesses but then thoughtbetter of it. Société Générale said lastyear that TCW, its US asset manage-ment arm, was not for sale

“There is simply too much of a dis-connect between the price that sellersexpect for these businesses and whatbuyers are willing to pay,” says DenisBastin, a consultant to asset managers.

PART OF THIS REFLECTSthe market environment, asmoney managers simply arenot valued as highly as theyused to be. The world has

changed after a 30-year bull mar-ket in which it was an

asset manager’s job tobeat whatever

rising bench-mark he or she

was judged against.Now that choosing which

asset classes to be invested in isfar more important than the composition

of the assets within a particular sector, assetmanagement has become far tougher. Investorsnow prefer to put their money into cash prod-ucts, or bonds, that offer lower margins thanactively managed equities.

The shift has also coincided with disruption tothe business by exchange traded funds, and themove to individual defined-contribution pensionschemes, rather than the big pots of defined-benefit pension money of the past.

In US mutual funds, for instance, industry feelevels barely changed even as the business grewfrom $200bn to $12tn in assets.

Valuations have dropped. In 2005, buyers werewilling to pay more than 25 times net earnings,according to PwC, but now prices are far morelikely to be in the 10-15 times range. In the sec-ond half of last year, the median multiple of

Buyers and sellers are struggling to find a solution to their differences. By Dan McCrum

A difficult matchearnings before interest, tax, depreciation andamortisation was a lowly eight times, down fromaround 13 times before the financial crisis.

Sellers may not have caught up with the newreality, particularly European banks where a cap-tive client base is of little use except to a directcompetitor to whom they would least like to sell.

But bankers expect plenty of activity shouldthe economic outlook become less uncertain, andthere are still areas of interest at a smaller scale.

The boutiques continue to add smaller“shops” to their platforms, for instance therecent purchase of a controlling interest in thehigh-performing Yacktman Funds by theAffiliated Managers Group, which has been apersistent acquirer of mid-sized investmentmanagement firms.

Collateralised loan obligation managers are indemand as a revival in the business appearspossible: the $11bn of new CLO issuance thismonth is already more than that completed inthe whole of 2011. With that in mind, Apollo, thelisted alternative manager, completed a deal forStone Tower, a $22bn CLO manager, in April foran undisclosed sum.

“There is a tremendous war for talent,” saysKevin Quirk of Casey Quirk, a consultant toasset managers. “That war means a lot of peopleare using the volatility in the business to pick upgood talent. They’ll look at smaller transactionsand teams, picking up individuals to really buildtheir business organically, rather than doingtransformational transactions.”

DEALS & DEALMAKERS | OPINION

THE GREATEST IRONY OF THEfinancial crisis is that the events thatraised concerns about large banksbeing “too big to fail” are resulting infewer, bigger banks. Consolidation in

the banking sector was driven by shotgun mar-riages, where larger banks saved smaller, failinginstitutions. In the US, JP Morgan bought BearStearns and Washington Mutual at bargain-basement prices. Bank of America took overMerrill Lynch, and Barclays acquired the USoperations of Lehman Brothers. In the UK, theSantander group acquired Alliance & Leicesterand the savings business of Bradford & Bingley.

In spite of widespread public concern, strongincentives still exist for big banks to dominate,regardless of efforts by regulators to limit theconsequences of “too big to fail”.

The costs of regulation and supervision spreadacross large income streams and asset basesmean larger institutions can better supportthe costs of new regulatory burdens, in effectraising barriers to entry. The ability to invest inadvanced internal measurement-based risksystems means significant capital savings on risk-weighted assets not afforded to smaller institu-tions. Information technology, data systems, riskmodels and even marketing, advertising andlobbying costs have a far lower impact on returnon equity or return onassets than at smallerinstitutions, enablingthe big to continue toget bigger.

However, in some sys-tems such as those inCanada and Australia,supervisors discouragefurther domestic consoli-dation. Cross-border mergers have becomedramatically less attractive since the crisis.Supervisors increasingly require banks to createindependently capitalised domestic subsidiarieswith strong limits on the transfer of funds out ofthe country. Incremental costs limit much of thefunding advantage and cost efficiencies that usedto come with merged operations. And some bankinvestors have begun to recognise that there issuch a thing as “too big to manage” as well as“too big to fail”.

THE SECTOR IS NOT DEVOID OFopportunities. Many financial institutionsare shedding assets and businesses because

they no longer meet return criteria as a result ofnew regulation, or are selling good businesses toboost capital and reduce balance sheets. Bankstend to withdraw to home and core markets inhard times, but ongoing economic issues in mostdeveloped economies, combined with new regula-tion, has meant a deeper rethinking of strategythan at any time since the Latin American debtcrisis of the 1980s.

Opportunities abound, but they are of an orderof magnitude smaller than Megabank 1 buyingMegabank 2. With many bank shares trading atsignificant discounts to book value, raising thefunds for purchase is difficult and expensive.This implies that M&A bankers are going to haveto work harder for lower fees than before.

Indeed, M&A volumes are at a low and news-papers carry articles about key M&A bankers

leaving the business. There is also a trendtoward M&A advice from boutique firms wherethere is clearly no conflict of interest for them.Specifically, the arrival of J. Christopher Flowersin the London market last month, looking forprivate equity transactions among insurance andnon-bank financial services firms, suggests thereare opportunities in this area.

HOWEVER, EVEN MR FLOWERS HAShad trouble anticipating idiosyncraticpolitical risks. This demonstrates just

how difficult investing and advising in the finan-cial services sector can be. Governments take astrong interest when depositors’ funds are atstake. These risks are difficult to measure and toprice, and underestimating them sometimesresults in unexpected losses.

Reporting and transparency concerns alsocomplicate M&A within financial services, requir-ing extensive due diligence. Some issues areunique to certain markets, such as accumulatedpension liabilities, which in the UK have scup-pered sales, or outstanding post-crisis or conductlitigation liabilities. Others are more universal,such as agreeing the value of hard-to-value secu-rities and assets.

Nonetheless, crisis breeds opportunity. Regula-tion itself changes the economics of some busi-

ness lines, enhancingthe attractiveness of lowcapital-consuming busi-nesses. New liquidityrules are likely to createopportunities in effec-tively lending liquidassets. Regulatorychanges combined withthe current low interest

rate environment and the search for return couldresult in business and technology developmentsas radical and challenging as the internet is forthe media industry. Technology is changing theway people bank and could dramatically alter theshape of retail banking. Opportunities exist inthe non-bank financial services market for busi-ness-to-business lending platforms, which are alsobeginning to appear in small business and retailfinance as well.

But right now, uncertainty, both economic andregulatory, makes acquisitions extremely difficultto price. Until there is more clarity in the UK onthe translation of the Independent Commissionon Banking’s recommendations into law, onrecovery and resolution plans, and on the futureregulation of non-bank financial intermediation,or “shadow banking”, it is likely that M&A activ-ity in core financial services will remain muted.Across the European Union and G20 nations,transactions are likely to be limited to discreteassets and lines of business, and not wholesaleacquisition of financial institutions.

Nonetheless, once there is improved visibilityon outstanding regulatory issues, the current lowequity prices within the financial services indus-try do mean there are attractive opportunities.For those with cash and clear views on theirproduct and market positioning, the time couldbe fast approaching for strategic purchases.

Barbara Ridpath is chief executive of theInternational Centre for Financial Regulation

There is such athing as ‘too big tomanage’ as well as‘too big to fail’

In 2009, large deals were completed swiftly, atattractive prices. For instance, Ameriprisesnapped up Bank of America’s asset managementarm, Columbia, for $1.2bn, a price now seen asa bargain.

Three years on, however, and banks, particu-larly those in Europe, do not appear to be in ahurry to sell. Both Italian bank Unicredit, and its

‘There is simply too much ofa disconnect between the price...for these businesses and whatbuyers are willing to pay’

Barbara Ridpath Crisis – and regulation – can breed opportunity

Jack KlinckExecutive vice-president, State Street Corporation, Boston

“Leadership in the custody market is driven by globalscale and capital requirements. The top four competitors(as of December 31 2011) hold more than 60 per centof the assets worldwide. In an environment of risingcompliance and regulatory costs, pressure on capitalratios and slower economic growth, we expect to seefurther consolidation.”

World view

‘There is a tremendous war fortalent – people are using thevolatility to pick up good talent’

12 FINANCIAL TIMES WEDNESDAY MAY 30 2012

may 30 2012 deals& dealmakers

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