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Why Are More Mergers & Acquisitions (M&A) Taking Place?

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Singapore Safehaven Finance Sector

Singapore Safehaven Finance Sector

Banks worldwide are grappling with the double-edged sword of rising interest rates and inflation in 2024, forcing them to rethink their strategies for survival. In this uncertain climate, mergers have become less of an option and more of a survival tactic. With borrowing costs skyrocketing due to central banks’ relentless rate hikes, many financial institutions are finding their traditional revenue streams drying up. The fallout? An uptick in Mergers & Acquisitions (M&A) as banks look to pool resources and safeguard their financial health.

According to Deloitte’s 2024 M&A Trends Survey, there is an optimistic outlook for global M&A activity, with expectations of increased deal volume and value in the financial sector. This trend is driven by strategic pivots and the use of advanced technologies across the M&A lifecycle. Mid-sized banks, in particular, are feeling the squeeze, as their smaller balance sheets make it harder to absorb the cost hikes that come with inflation and rate hikes. The trend toward consolidation is being accelerated by a growing need to cut operational costs and boost competitive positioning, especially as the economic environment becomes more challenging.

However, cross-border mergers remain a different beast. While they offer the promise of diversification, they also come with a unique set of challenges, from regulatory complexities to political risks. Despite these hurdles, some banks are pushing forward, hoping that expanding their international footprint will help them buffer against localized economic risks. 

Take UniCredit’s recent increase in its stake in Commerzbank to around 21% — a stake that, pending regulatory approval, may be boosted up to 29.9% — for instance. This deal illustrates both the complexity and the necessity of such mergers in today’s financial landscape, especially considering the German government’s opposition to a full takeover

Rising Interest Rates: The Spark Behind the Merger Frenzy

Rising interest rates have lit a fire under the banking industry in 2024, pushing many institutions into merger talks they might have once avoided. With central banks around the globe raising rates to combat inflation, borrowing costs have soared, leading to tighter profit margins for banks. For many, the only way to survive is by merging with other institutions to scale up and cut down on operational expenses.

Let’s face it, banks thrive on lending. But with customers less eager to take out loans at these higher rates, banks are struggling to maintain their margins. Recent analysis shows that the net interest margin for U.S. banks declined by up to 1 to 9 basis points (0.01% to 0.09%) in Q2 2024, with some banks experiencing slight growth. While margins remain compressed, they have not fallen to the lowest levels since 2018, as they are still above the pandemic lows. In response, mergers are increasingly being used to boost capital efficiency. Projections by KPMG suggest that as long as interest rates remain elevated, M&A activity in the banking sector will continue to grow, with many banks seeking mergers to stay relevant in a digital-first environment.

US Sector Leader, Banking and Capital Markets, KPMG LLP, Peter Torrente posits that “The path to growth for banks is accelerating their enterprise transformation to be the bank of the future. […] allowing banks to leverage the latest technologies to enhance operational efficiency, customer retention and attraction, and resilience through the next wave of challenges.”

UniCredit’s acquisition of a stake in Commerzbank is a clear example of this shift. Despite dealing with regulatory hurdles and political risks, UniCredit saw the deal as a way to strengthen its position in a high-interest-rate environment. By merging with a major player in Germany, they’ve gained more access to capital at a lower cost. A senior analyst at UniCredit commented on the deal: “It’s not just about becoming bigger; it’s about becoming more efficient and competitive in a world where every basis point counts.”

Banks are also feeling pressure from investors to find ways to stay profitable. Higher rates make it harder for banks to grow organically, so they’re turning to M&A to expand their customer base and reduce costs. A PwC study from June 2024 noted that many banks pursuing mergers this year are doing so due to the pressures of high interest rates. These rates have pushed banks to seek mergers as a way to strengthen their balance sheets and adapt to the evolving economic landscape.

Market uncertainty is splitting the FS deals market into movers and non-movers. I see opportunities for active dealmakers to use acquisitions or disposals  — or both — to solidify their future positioning and gain a competitive edge,” comments Christopher Sur, Global Financial Services Deals Leader, Partner, PwC Germany.

Cross-Border Mergers: The Road Less Traveled

While domestic bank mergers are picking up pace, cross-border deals remain a trickier proposition. The challenges are many — different regulatory environments, cultural clashes, and geopolitical tensions all conspire to make these mergers more complex. Yet, for banks willing to navigate these hurdles, the rewards can be significant. Cross-border mergers offer a way to diversify risk and gain access to new markets, which is crucial in an increasingly interconnected global economy.

Take UniCredit’s acquisition of 90.1% of Alpha Bank Romania, for example. This deal, expected to be finalized in 2024, highlights the potential benefits of cross-border mergers in today’s volatile economic landscape. For UniCredit, expanding into Eastern Europe offers a way to diversify its risk and tap into a new, emerging market. However, the deal was far from straightforward.

Reports indicated that the acquisition by UniCredit faced regulatory scrutiny, a common challenge in cross-border deals, and there were considerations about the economic landscape in Romania. Nevertheless, the deal is expected to go through in 2024, allowing UniCredit to expand its reach into Eastern Europe and reducing its reliance on other markets facing economic pressures.

One of the biggest challenges in cross-border deals is regulatory divergence. Different countries have different rules, compliance standards, and legal frameworks, making it difficult for banks to align operations. According to a McKinsey report, many cross-border deals in 2024 hit roadblocks due to regulatory reviews. In fact, around 43% of these deals needed changes or faced challenges before getting approved. As banks continue expanding globally, handling these regulatory hurdles is becoming a bigger deal. If they don’t navigate carefully, they risk running into costly delays.

Despite these challenges, cross-border mergers are an attractive option for banks looking to hedge against localized economic risks. By spreading their operations across different countries, banks can insulate themselves from downturns in any one market. In a statement following the UniCredit-Commerzbank deal — that is, UniCredit’s acquisition of a 21% stake in Germany’s Commerzbank — UniCredit’s CEO noted: “Our strategy is to be a truly pan-European bank, able to weather storms in individual markets by having a diversified portfolio across the continent.”

Still, on the UniCredit-Commerzbank deal, the acquisition is expected to have a minimal impact on its financial stability. According to Fitch Ratings, UniCredit’s acquisition would reduce its CET1 ratio by around 15 basis points (bp), and a full takeover (up to 29.9%) would impact it by slightly more. This is manageable given UniCredit’s strong profitability and a forecasted CET1 ratio exceeding 16% by the end of 2024.

The combined entity could become a significant player in Germany’s banking sector, although it may not immediately be the second-largest privately-owned bank by assets. Since UniCredit unveiled its initial stake in Commerzbank, Commerzbank’s shares have surged by around 17%, reflecting market optimism. As of now, UniCredit’s market value sits at approximately €61 billion, roughly three times Commerzbank’s €19 billion.

While the financial impact is limited, the merger faces more political than regulatory hurdles. The acquisition is seen as having a “very limited financial impact” on UniCredit, with an estimated effect of only about 15 basis points on its CET1 capital ratio. However, political considerations, such as maintaining headquarters in Italy, play a significant role in the merger dynamics, to state the least.

However, it’s not all sunshine and rainbows, as is often anticipated. Cross-border deals also come with significant integration costs. Aligning different corporate cultures, systems, and customer bases is no easy task. A study by the Boston Consulting Group found that 30% to 40% of mergers, including cross-border bank mergers, fail to deliver the expected cost savings due to integration challenges. This makes such deals a high-stakes game, adding a layer of risk that not all banks are willing to take on.

Inflation: The Unseen Driver of M&A Activity

Inflation is the silent driver behind much of the M&A activity we’re seeing in 2024. With costs rising across the board — from wages to compliance expenses — banks are under more pressure than ever to find ways to cut costs and remain profitable. Inflation not only increases operating costs but also erodes the value of a bank’s assets, making it harder for them to maintain profitability.

A report by the World Bank in July 2024 highlighted how inflation is squeezing banks in emerging markets, where rising costs and shrinking profit margins are forcing many institutions to consider mergers. Mergers allow banks to achieve greater operational efficiency by consolidating resources, cutting redundancies, and spreading costs over a larger customer base. For instance, the UniCredit-Alpha Bank Romania merger is expected to bring cost efficiencies.

Inflation also impacts a bank’s ability to grow its loan portfolio. As borrowing costs rise, fewer customers are willing to take out loans, which means less revenue for banks. A senior economist at Morgan Stanley commented: “In an inflationary environment, banks have to think creatively about how to grow. Mergers offer a way to expand market share without relying on traditional lending activities.”

Moreover, inflation has driven up the cost of capital. Higher interest rates make it more expensive for banks to borrow money, which puts a strain on their balance sheets. Mergers provide an opportunity to pool resources and access cheaper sources of funding. According to Fitch Ratings’ mid-year outlook report in June 2024, the banking sector continues to face significant economic pressures.  The report generally observed that larger merged entities can leverage their combined size to negotiate better financing terms. However, the overall outlook for banks remains challenging due to higher interest rates and economic uncertainties

Mergers also offer a way to navigate the rising costs of regulation. As governments impose stricter rules in response to inflationary pressures, the cost of compliance is skyrocketing. A Deloitte report from early 2024 highlights that regulatory compliance costs for banks have been rising significantly, driven by a combination of factors including inflation, increased regulatory scrutiny, and the implementation of new regulations. Mergers allow banks to spread these costs over a larger base, helping them remain profitable even as regulatory burdens increase.

Yet, mergers are not a one-size-fits-all solution. While they can deliver operational efficiencies and improved capital access, they come with significant challenges, from integration costs to cultural clashes. As the economic environment remains volatile, banks must tread carefully, ensuring that their merger strategies are well-aligned with long-term goals. 

In these uncertain times, the survival of financial institutions may not only depend on their ability to grow but also on their ability to adapt, consolidate, and embrace change.

Author: Richardson Chinonyerem

#Banking #Finance #M&A #InvestmentBanking #InterestRates #Inflation

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