Deals & Dealmakers

Part 10: M&A in the financial sector

May 30 2012

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FINANCIAL TIMES WEDNESDAY MAY 30 2012

FINANCIAL TIMES WEDNESDAY MAY 30 2012

DEALS & DEALMAKERS | OVERVIEW

CONTENTS

DEALS & DEALMAKERS | OVERVIEW

Restructuring could lift M&A market

2 OVERVIEW Can financial sector dealmaking match expectations raised by regulatory changes? 4 INSURANCE Observers believe we may see renewed zombie wars over closed life funds 6 BANKING The M&A potential of bank streamlining is only now beginning to translate into deals 7 CASE STUDY RBSs drastic overhaul seen from the inside 8 PRIVATE EQUITY Buyout groups are fundraising furiously with the aim of targeting financial institutions 9 PROFILE The veteran investor J. Christopher Flowers 10 ASSET MANAGEMENT There may be plenty of buyers and sellers, but they are struggling to agree a price 11 OPINION Why crisis and regulation create opportunity CONTRUBUTORS ALISTAIR GRAY is the FTs insurance correspondent DAN McCRUM is the FTs US investment correspondent STANLEY PIGNAL is the FTs private equity correspondent BARBARA RIDPATH is chief executive of the International Centre for Financial Regulation ANOUSHA SAKOUI is the FTs mergers and acquisitions correspondent DANIEL SCHAFER is the FTs investment banking correspondent ILLUSTRATIONS Nick Lowndes Special reports editor Michael Skapinker Editor Hugo Greenhalgh Lead editor Jerry Andrews Production editor Jearelle Wolhuter Picture editor Michael Crabtree Art director Derek Westwood Graphics Russell Birkett Head of solutions Patrick Collins Senior campaign manager Rachel Harris Head of professional services Robert Grange

Banks selling assets to meet new regulatory pressures may provide

INANCIAL INSTITUTIONS, BE they banks, asset managers or insurance companies, have always been an important source of deals. The market reached its peak with the takeover by Royal Bank of Scotland of ABN Amro in 2007 a year when $731.2bn worth of deals were done. But since the banking crisis, dealmaking has become difficult and volumes have fallen away. To May 2 this year, so-called FIG (financial institutions group) mergers and acquisitions came to a total of $69.3bn, accounting for 10.2 per cent of all M&A. The FIG proportion of global dealmaking 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 in both 2009 and 2008 it was more than 20 per cent, according to Thomson Reuters, the data provider. The biggest deals this year have come from Asia, including Singapore bank DBS Groups $7.3bn bid for Indonesias Bank Danamon and Japans Sumitomo Mitsui Financial Groups $7bn bid for RBSs aviation capital unit. Advisers expect the restructuring of the banking sector in the wake of the financial crisis to trigger dealmaking. RBSs disposal of its aviation business is just one example. The combination of liquidity pressures, a tough economic environment and ongoing regulatory change will continue to have a profound impact on banks business models and are key factors driving M&A in the sector, says Tadhg Flood, head of Deutsche Banks financial institutions group for Europe, Middle East and Africa (Emea). In the last couple of years, there has been a steady stream of activity and that is unlikely to change. Most M&A in the sector will be mid-sized, tactical transactions as banks refocus on their core operations. Many European banks that accepted state bailouts have agreed restructuring deals with the European Union that force them to shed assets. Following its state rescue, Dexia, the FrancoBelgian lender, is in the process of selling off healthy units, such as its asset management arm, a stake in Turkeys DenizBank and an investor services joint venture with Royal Bank of Canada. Such disposals provide opportunities for other lenders keen to grow, some bankers say. The asset management industry has provided large disposals, such as Deutsche Banks sale of its asset management division, although the bank has backtracked on plans to sell the whole unit. As regulators shift banks towards a smaller size, it is hard to see a repeat of the large-scale takeovers in the financial sector that defined the height of the takeover market in the mid-2000s. However, the wave of regulation facing the banking and insurance industries means banks are streamlining and disposing of businesses, keeping advisers busy. While it is not a perfect environment for M&A, there are many different drivers for transactions. Banks are having to decide what their core businesses are, says Gilles Graham, chairman of FIG for Emea at Citi. That means that there are plans for franchise disposals as well as product/geographical portfolio reviews. But completing deals in the sector is tricky. FIG transactions in this environment are challenging and complex, and invariably require funding, says Mr Graham. Banks are looking for complete solutions, so we are quite busy. Banks have faced a series of potential regulatory overhauls. The most important is the implementation in coming years of the Basel III capital proposals, which require banks to hold more capital against riskier businesses, making the latter less attractive to run. Another is the Volcker rule, first proposed by Paul Volcker, the former US Federal Reserve

a boost after a slow start to 2012. By Anousha Sakoui

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

More online An interactive graphic mapping trends in global dealmaking, plus The Dealmaker column and podcasts featuring big names from the world of mergers & acquisitions www.ft.com/dealmakers

A wave of regulation means banks are streamlining and selling businesses

chairman. It limits the risks banks can take, prohibits them from owning businesses such as hedge funds or private equity funds and points towards smaller banks in the future. These reforms have led some banks to consider disposing of their insurance units and asset management businesses, for example. Bankers say the buyers for such units tend to be specialists in those areas, trying to build scale. But some bankers question whether the pressure on the industry to shrink, along with falling growth prospects, could encourage consolidation. There is still a great deal of uncertainty around the banking sector, so it is difficult to see large cross-border M&A deals between banks taking place in the near term, says Todd

Leland, global co-head of FIG at Goldman Sachs. There is still a significant amount of recapitalisation to be done in the industry, and to draw new capital into the sector you have to evidence adequate returns to investors, which could be a trigger for market consolidation.

OLYON LUKE, MANAGING DIRECTOR of the FIG team at Citi, notes that ongoing liquidity operations by central banks are delaying the need for banks to take action. Under the European Central Banks longer-term refinancing operations (LTROs), more than 1tn was pumped into the eurozone financial system in two operations in December and February. The LTRO exercise has moved the agenda on from capital and liquidity and reduced the need for many financial institutions to make any portfolio disposals in the near term, says Mr Luke. Ben Davey, head of FIG for Emea at Barclays Capital, says US and Asian investors are looking to take advantage of some of the opportunities presented as the sector restructures. We have seen inflows of North American and Asian capital chasing high-quality available

platforms and portfolios SMBCs [Sumitomo Mitsui Banking Corporations] acquisition of RBS Aviation Capital, being a notable example, says Mr Davey. Delivery of capital targets against the European Banking Authority stress tests and preparation for the implementation of Basel III will add momentum to this activity for the rest of 2012. In the insurance industry, Mark Flenner, insurance M&A partner at KPMG, the consultancy, says companies are also considering opportunities to grow through M&A. Non-life insurers are in rude health. They have weathered the storms of 2011 well one of the worst natural-catastrophe underwriting years and are now looking for inorganic growth opportunities, he says. Insurance faces a similar capital overhaul to banks in coming years, known as Solvency II. Capital buffers remain unspent and, coupled with the advancing Solvency II deadline, we expect M&A to accelerate in the next 12 to 24 months, says Mr Flenner. Already there has been a hive of M&A activity within the Lloyds market and there are early signs the private equity community is starting to look for value in this niche sector. Overseas interest in buying

into one of the largest insurance markets in the world remains undiminished. The EU-wide Solvency II regime is designed to better match the capital that insurers hold with the risks they take. One example of a large disposal is expected to be RBSs planned sale of its Direct Line insurance business. Despite dealmaking being stymied by global market turmoil, the FIG sector will, over time, be forced to respond to regulatory change. M&A is already proving to be part of the solution.

World view
STEPHEN CARTER Head of financial institutions M&A, Credit Suisse, London FIG M&A activity remains subdued relative to historical levels due to the impact of the European sovereign crisis, changing regulation particularly for capital and a lack of chief executive confidence. Banks continue to selectively divest businesses due to European Union state aid requirements, the need to recapitalise, to reduce wholesale funding requirements and/or to adjust their business portfolios to meet target capital levels.

FINANCIAL TIMES WEDNESDAY MAY 30 2012

FINANCIAL TIMES WEDNESDAY MAY 30 2012

DEALS & DEALMAKERS | INSURANCE

A fresh crop
Bankers believe that closed life funds are once again ripe for consolidation. By Alistair Gray
HEY WERE KNOWN AS THE zombie wars: bid battles involving some of the UKs most colourful entrepreneurs for pools of life assurance funds that had stopped writing new policies. Over the past 15 years or so, at least 77 UK life assurance companies have closed to new business, estimates Ned Cazalet, the veteran financial services consultant among them household names such as Scottish Mutual, Scottish Provident and Clerical Medical. In almost every case, the closures involved somebody buying them, he says. The numbers are actually quite staggering. As with other sectors, dealmaking in the closed life assurance consolidation industry went through a relatively dry spell in the wake of the financial crisis. Multibillion-pound deals have not returned, but there have been signs that activity has picked up in recent months. There has definitely been a re-emergence of back-book consolidators in the last 12 months, although funding can still be a constraint, says Richard Locke, managing director at Fenchurch Advisory Partners, the corporate finance firm. The increased level of demand is encouraging a number of life companies to explore whether a closed-book sale could be attractive. Recent deals include the 275m purchase of Guardian Financial Services from Aegon, the Dutch life assurer, by Cinven, the private equity house. Guardian stopped taking on customers a decade ago but has more than 500,000 legacy clients. This month it emerged that Sun Life Financial, the Canadian insurer, was examining plans to sell its UK business, which has 11.8bn of assets under management but stopped writing new business in December 2010. Funds may opt to stop writing new policies because profitability levels are disappointing, capital positions inadequate or they are making strategic changes. Life companies are required to set up and hold capital reserves for the duration of the policies, in order to meet the long-term liabilities associated with them. It tends to take several years to recoup the marketing and other expenses that arise from writing new business. If a life company decides to put a fund in run off, it accepts premiums only for existing policies, whose assets it administers until maturity. Consolidators argue that both policyholders and shareholders ultimately miss out when closed funds run off individually because the process is inefficient. They seek to merge the funds to make capital, tax and operational savings. The closed books of businesses throw off a lot of cash, says Andy Briggs, chief executive of Resolutions Friends Life. If the new business being written is not profitable, then the shareholders would probably rather have the cash back off the back book than invest it in new business at a poor return. Significant barriers remain to a fresh bout of dealmaking. Phoenix, one of the biggest closed life funds, has held talks in recent months with prospective buyers including rival insurance consolidation vehicle Resolution and private equity house CVC Capital Partners. But the failure of both Resolution and CVC to seal a deal underscores the fact that buyers and sellers are struggling to reach agreement on valuation amid the economic uncertainty. Regulatory uncertainty is another stumbling block, adds Mr Briggs of Friends Life. John Tiner, chief executive of Resolution and former head of the Financial Services Authority, raises a further issue. Leverage has to be established at quite a prudent level these days, he says. The game has changed from before the financial crisis in terms of leverage and debt and that may have made it less attractive to the private equity sector.

Pearl, which was built up by pizza-to-pubs entrepreneur Hugh Osmond, took on more than 3bn of debt to buy Clive Cowderys first Resolution project in the sectors biggest deal to date in 2008. Phoenix, as Pearl has been renamed, is still seeking to renegotiate the hefty debt burden.

M
World view

ANY BANKERS, EXECUTIVES and analysts are sure the sector is ripe for consolidation, and that it is a matter of time before more big acquisitions. Their optimism is based on the conviction that more life companies will stop writing new policies and sell blocks of closed business, and that the consolidators will themselves ultimately seek to consolidate. What we see in this market is that the UK life assurance market for new business is very challenging, says Caspar Berendsen, partner at

Graham Kettleborough Chief executive, Chesnara, London There have been some notable deals recently, such as Cinvens acquisition of Guardian, but generally the sector has not been that active as, in recent volatile markets, pricing is difficult. The introduction of Solvency II will give rise to more opportunities in the market due to the associated capital requirements, and there are certainly more deals to be done.

Cinven. People are buying fewer savings products and few mortgage- or home-purchase related life insurance products. He adds: You would expect life assurance companies to divest non-core operations. With private equity groups keen on the guaranteed cash flows of closed portfolios, Cinven is among the companies actively looking at more closed life deals. It is expected to use Guardian as a platform from which it can grow. Many analysts say recent rule changes are encouraging consolidation. They argue the greater corporate governance and capital requirements arising from Solvency II may prompt more insurance companies to stop writing new business. The European insurance sectors forthcoming rule changes are due to take effect in January 2014. There will be more consolidation, as more life companies close their doors because of regulation and increasing costs, says Barrie Cornes, insurance analyst at Panmure Gordon, the stockbroker. Steve Groves who as a senior actuary at Admin Re, the closed fund operation of Swiss Re, the reinsurer, oversaw the acquisition of companies including Windsor Life and Zurich Life says: Its going to be resurgent. Given that without fresh deals, dedicated runoff funds will no longer exist several decades hence as policies mature, some analysts expect a super consolidator to emerge. They believe there remains sound logic in combining Phoenix with the closed part of Resolutions Friends Life. All eyes are on Resolutions next move.

FINANCIAL TIMES WEDNESDAY MAY 30 2012

FINANCIAL TIMES WEDNESDAY MAY 30 2012

DEALS & DEALMAKERS | BANKING

DEALS & DEALMAKERS | BANKING

A small slice of the action

We have so far had only a foretaste of the potential M&A from bank restructuring. By Daniel Schfer
HEN BANKING stress tests in Europe last year revealed a considerable capital shortfall at a series of banks, it was expected to trigger a number of sales to bolster their balance sheets. And so far this year, a number of larger transactions, including the $5.4bn disposal of a twothirds stake in Cimentos de Portugal, the cement company, by Portuguese banks Caixa Geral de Depsitos and Banco Comercial Portugues, have indeed pushed bank divestment deal volume in Europe to the highest level in four years. With $25.3bn in deal volume until April 25 this year, Europe has accounted for a record 79 per cent of global bank divestments, according to Dealogic, the data provider. The deleveraging in Europe has only just started. The stress test has been a catalyst while the central banks financial stimulus has provided some relief, says Stefan Wintels, co-head of the European financial institutions group at Citigroup. Despite the increase, the amount of activity has so far failed to live up to the expectations that had been elevated by the regulatory and economic pressure on banks to bolster their capital base and get out of businesses and regions where they lack scale. One reason is the 1tn lifeline the European Central Bank threw to the continents banks in late 2011 and early this year that has somewhat reduced the urgent need for some banks to get out of businesses they could no longer afford to fund. But while this short-term boost to confidence has stopped some banks from selling assets, it is now the resurfacing of worries over Europes sovereign debt that hampers deals. The elevated levels of uncertainty in current markets make it more challenging to complete transactions, says Tadhg Flood, head of the financial institutions group for Europe, the Middle East and Africa at Deutsche Bank. It is therefore no wonder that the busiest market this year has been outside the troubled eurozone. The UKs banks embarked on a record number of 27 divestments until April 25, according to Dealogic. These included several sales by state-owned Royal Bank of Scotland, one of which was its disposal of Hoare Govett, the UK brokerage group, to Jefferies, the US investment bank. HSBC was another source for a series of deals recently, including several smaller emerging market operations. They are part of a strategy put in place by Stuart Gulliver, chief executive, to focus on markets where the bank has a significant presence and businesses where it can make the most money. Bankers say that besides the ongoing sale of portfolio assets such as underperforming and performing loans, exits from regional markets where a bank is sub-scale are going to pick up pace in the next few years. The effects of the crisis are forcing banks to really consider what is core and non-core, says Mr Flood. Jrme Herv, senior partner at the Boston Consulting Group in Paris says: In the past 20 years, most banks have accumulated business lines and regions. This is now coming to an end as it has reached a point of too much complexity and there are often very few synergies. A lot of banks have built beautiful pearl strings but these are not integrated businesses. Besides Asian and other emerging markets, one region where banks are likely to sell regional operations is eastern Europe. In those markets, experts are forecasting a consolidation wave. This trend has been presaged by

Case study An inside story of a dramatic RBS restructuring

The effects of the crisis are forcing banks to really consider what is core and non-core
Spains Banco Santanders recent deal to take control of Polands Kredyt Bank from Belgian bank KBC and combine it with its Polish business to create the countrys third-largest bank. But in the more saturated western markets, such consolidation deals are not on the cards. The strategic demand for bank businesses has been drastically reduced, says Citigroups Mr Wintels. Deutsche Banks talks to sell BHF, the German lender, to RHJ, the private equity group, collapsed last year on funding concerns and problems to obtain regulatory approval. The deal underlined how cash-rich private equity groups often struggle to come to an agreement on a price and get wholesale funding. There is a lot of private equity money chasing this opportunity but the reality is that it has not happened in this waterfall scenario that has been predicted, says Graham Martin, global co-head of the portfolio solutions group at KPMG, the consultancy. Mr Wintels adds: If private equity is to invest in going concerns the funding issue needs to be

addressed. But vendor financing is often too tough an ask for many banks. Giles Harrison, global co-head of financial institutions at HSBC, says: Some sales processes never got started because there is the realisation that they could not operate on a standalone basis.

HE FAILED BHF DEAL UNDERLINED how the regulator can sometimes spoil a transaction as might happen with Lloyds Banking Groups so-far flawed attempt 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 where prices are low, says Mr Martin at KPMG. Many banks bought those operations before the crisis at two times book value and now they are often worth half the book value. When Deutsche Bank recently aimed to sell its international asset management unit to Guggenheim Partners, the financial services firm, both sides failed to agree on price and ended up discussing only a smaller potential deal for Rreef, the banks alternative assets arm (see asset management, p10). Bankers say asset management has become one non-core area where lenders are rethinking their options, alongside smaller private banking operations, insurance units, consumer credit and leasing businesses.

Some lenders are also considering selling minority stakes in foreign banks in Asia and other regions that they accumulated before the crisis. There is a whole raft of discussions going on where banks want to sell equity stakes in other banks outside of their home markets, says Mr Harrison at HSBC. With the International Monetary Fund predicting that European banks would shed 2tn of assets over the next 18 months, bankers forecast an accelerating trickle of deals. I would expect the European deleveraging to continue for another few years, says Citigroups Mr Wintels.

OHN OWEN HAS HAD MANY intense moments in his three decades as an investment banker. But not much can compare to the first half of this year, when the co-chief executive of international banking at Royal Bank of Scotlands investment bank was overseeing a drastic restructuring at the mostly state-owned lender. Within a matter of months, the bank had shut down or sold a sizeable chunk of the investment banking arm, getting out of areas such as UK brokerage, cash equities and equity capital markets. This process was very different from a typical M&A deal where you advise a client. It was very emotionally charged, because what you do has an impact on colleagues who you know very well, the 50-year-old banker says. It all started with the strategic decision just before Christmas last year to dispose of underperforming business units. It is part of a programme to remove 70bn of risk-weighted assets in the investment bank at an estimated cost of 550m. One big weakness was easily spotted: in cash equities, RBS ranked outside the league of top-10 players globally and it was not foreseeable how it could move up any time soon, or indeed make any money with the business. With the decision to step away from this area, it also became clear that the bank no longer needed equity research, brokerage, equity capital markets and its sub-scale merger and acquisition advice unit. There are far too many banks trying to do too many things in too many areas for too many clients, says Mr Owen, who cut his teeth as a banker at Bank of America in the 1980s. Instead, RBS decided to concentrate on its strengths which it defined as debt financing, risk management in currencies and interest rates, and transactions services. The former UBS and Credit Suisse banker, who joined RBS just over a year ago, knew he had to act fast. These are people businesses and you risk destroying them the minute you announce the decision to exit them. Even before the bank announced the overhaul and appointed Lazard, the investment bank, by the middle of

There are far too many banks trying to do too many things in too many areas
January, Mr Owen had prepared information memoranda and data rooms for the business units and approached some potential buyers a process that left him and his team working flat out during the Christmas and New Year period.

UT THANKS TO THIS PREPARATORY work, most units were sold within a few months after a series of quick auction processes. In early February, the sale of Hoare Govett, the UK broker with around 50 staff, to Jefferies, the US investment bank, was sealed. As it quickly became clear that there was no buyer for European equity capital markets and cash equities, the unit with several hundred employees, ended up being wound down. In March, RBS signed a memorandum of understanding to sell the Asian equities unit, consisting of roughly 400 people, to CIMB Group, and its Dutch-based equity capital markets and deals advisory business of 70 people, to ABN Amro. In the same month, the bank decided that the last remaining piece of the puzzle the UK M&A advisory group would be kept until the year-end and then be spun off independently. DS John Owen was in charge of the RBS restructuring

World view
Maged Latif Managing director, global co-head of financial institutions advisory, HSBC, London FIG M&A activity continues to evolve, dominated by clean-up and portfolio-reshaping divestitures by banks and to some extent insurers, mainly in Europe. The ongoing financial crisis, coupled with material regulatory change, is sharpening CEOs focus on business scope, strategic fit and economic returns on allocated capital. There is also a trend to increasing the share of capital deployed in home markets, and a near-universal aversion to transformational mergers due to significant regulatory hurdles.

What you do has an impact on colleagues you know very well

FINANCIAL TIMES WEDNESDAY MAY 30 2012

FINANCIAL TIMES WEDNESDAY MAY 30 2012

DEALS & DEALMAKERS | PRIVATE EQUITY

DEALS & DEALMAKERS | PRIVATE EQUITY

Pursuing rich pickings

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

HE STORM THAT ENVELOPED the financial sector in the wake of the Lehman Brothers collapse in September 2008 has had far-reaching implications for private equity. The easy credit that fuelled the buyout boom suddenly ran dry. Even four years later, the patchy availability of bank credit continues to stem activity levels in private equity, most notably in Europe. But the financial sectors ongoing woes have had a silver lining for buyout groups: the upheaval has created many opportunities for them to take over assets from banks, often at knockdown prices. Whether it be portfolios of loans extended by banks in happier times, businesses taken over by lenders after they defaulted on their debts, or financial institutions themselves, potential sales for buyout groups have been plentiful. Add to that the new regulations brought in to prevent a repeat of the meltdown, and the flow of transactions in the financial space is rapidly outstripping the rest of the market. In the context of increased regulation and continuing uncertainty regarding the eurozone crisis there is plenty of scope for private equity firms making attractive deals involving bank assets, says Alex Jones, senior analyst at Preqin, the data provider. Preqins data show that there are 163 funds currently trying to raise $134bn from investors to target financial services. Nearly 70 deals have been done globally since the start of the year, on a par with the pre-2007 boom years of private equity, despite the rest of the market having shrunk to a fraction of its former size. There are many factors driving the banks new willingness to sell their assets. The most prominent is the need to meet new regulations on capital requirements, chiefly the so-called Basel III rules, which demand banks hold larger capital cushions to ensure they can absorb future losses. That often means they want to cut back their loan books. They can do this by selling packages of loans to outside investors some of whom come from private equity. One recent example was the purchase by TPG and Patron Capital of Opera Finance (Uni-Invest), a Netherlands-based commercial mortgage-backed security, or CMBS. The two buyout firms acquired a complex vehicle of troubled loans backed by a pool of commercial mortgages that was being sold by its creditors, mainly banks and hedge funds. The loans were purchased for significantly less than their face value: senior noteholders received only 40 per cent of the $602m owed to them. More junior debtholders were wiped out. Industry insiders expect it will be the first of several banking assets snapped up. A clutch of credit opportunities funds and mezzanine operators, investing between debt and equity, have popped up, affiliated either with hedge funds or private equity. Credit opportunities funds raised a lot of money a few years ago, however banks were not typically ready or willing to sell portfolios of assets and realise losses, even if such assets had been identified as non-core, says Andrew Sealey, managing partner of Campbell Lutyens, a private equity advisory firm. Beyond trying to cut down the size of their balance sheets, financial groups are also trying to streamline their businesses. A fashion for diversification prior to the crisis, pushed by credit ratings agencies penchant for financial conglomerates, made it difficult for private equity to compete with trade buyers for whom bigger was invariably better. Now that the credit ratings agencies methodology has been found wanting, it is becoming much easier to separate financial services businesses

Looking through a debt lens rather than an equity lens is entirely different

Profile J. Christopher Flowers, private equity investor

EW MEN HAVE RIDDEN THE ARC of banking, finance and dealmaking quite like J. Christopher Flowers, the veteran private equity investor. After Harvard, he became a Goldman Sachs man in 1979, back when the institution was still a partnership and the investment bankers had yet to cede power to their brash trading counterparts. His early career began shaping financial deals as Wall Street remade itself, and at just 31, he was one of the youngest to ever make partner at the bank in 1988, a class that included Lloyd Blankfein, Goldmans current chief executive, and Gary Gensler, future chairman of the US Commodity Futures Trading Commission. But after a power struggle at Goldman on the eve of it going public, he left in 1998 and started the private equity firm that bears his name. And it took only two years to strike the transaction that assured his fame and fortune, as well as setting the template for his career ever since: a deal to buy Japans failed LongTerm Credit Bank in 2000. Nationalised following Japans banking crisis, it was scooped up by a consortium led by Ripplewood Holdings and Mr Flowers. Revived, and renamed Shinsei, it was floated on the Tokyo stock market in 2004, handing the partners billions of dollars in profits. Mr Flowers then built on his success with a series of banking deals for his private equity firm. He doubled down in Shinsei, and added stakes in NIBC, a Dutch bank, and Enstar, an Alabama insurer. Where financial entities were on life support, Mr Flowers was to be found pacing the waiting room and buttonholing the doctors. Struggling investment bank Bear Stearns, student loan operator Sallie Mae, doomed insurer AIG and even failing UK mortgage lender Northern Rock were all looked over by Mr Flowers, although he did not end up completing a deal in every case. After Lehman Brothers filed for bankruptcy in 2008, he was at the heart of the response to the crisis, even returning for a short stint as an investment banker by helping to steer Merrill Lynch into the arms of Bank of America.

He has not been immune to the problems that have plagued finance
That year he even bought a local bank in rural Missouri, not for its $17m in assets, but for the bank charter that would enable him to roll up other casualties of the economic crisis. However, Mr Flowers has not been immune to the problems that have plagued finance. JC Flowers second fund, which raised $7bn, has seen more than half of the capital eaten away by losses, according to some estimates.

from their conglomerate parents, eager to sell them to free up cash. There has been a significant move in large financial groups to focus on core businesses. That has opened opportunities for private equity buyers. Its a relatively new market, says Caspar Berendsen, partner and co-head of financial services at buyout group Cinven. Alongside CVC and Oak Hill Capital Partners, in May 2010 Cinven paid $2.5bn for Avolon, an aircraft-leasing business that took over much of the team at RBS Aviation Capital itself at the time on the chopping block as a non-core asset. London-based Cinven subsequently took over

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

World view
Simon Havers Chief executive, Baird Capital Partners Europe, London The UK recessionary environment is creating a great buying opportunity, but many M&A firms are cutting heads, reducing their ability to originate deals. More than ever, what were doing is sourced from direct contact with the companies we want to buy: UK firms with the potential to benefit from international expansion and particularly from the higher rates of growth forecast in Asia.

NOTHER CATEGORY OF ASSETS banks are trying to sell are companies that they end up owning after a loan has soured. With insolvency rates increasing as the economy continues to lag, banks are reluctant to manage companies they accidentally come to own, says Dave Lamb, partner at Vision Capital, which buys entire portfolios of companies from financial groups and private equity firms. One such business Vision acquired from Banco Popolare, a bailed-out Italian lender, was Bormioli Rocco, a glass and plastics specialist with sales of more than 500m a year. With more expertise than a lender in running a company, it relieved Popolare of a task managing a complex business that includes a unit making elaborate coloured drinking glasses that it was not equipped to take on. Looking at a business through a debt lens rather than an equity lens are two entirely different things, says Mr Lamb. Lenders to a business focus on getting their money back.

Equity investors are concerned with growing the business. Banks are ill-suited to own businesses: even finding staff to go to board meetings, let alone devise a new strategy, can be difficult. Whereas a single financial specialist can manage up to 40 debt positions, says Mr Lamb, the same person can realistically take on only four equity roles. The buyout groups are also keenly interested in running financial services businesses in Europe, where prices for certain types of assets remain at credit-crunch lows. J. Christopher Flowers (see profile), the high-profile US financier who once quadrupled his money by scooping up the failed Long-Term Credit Bank of Japan, moved to London this spring with the intention of becoming active in the European market. Despite the appetite for financial groups to sell and private equity firms to buy, taking on spunout units is not as straightforward in the financial sector as it is in other parts of the economy where private equity hunts for deals. Financial services are complex businesses, says Cinvens Mr Berendsen. They require a specialist understanding of a sector that is not always readily available to generalist buyout funds. Investing in financial services requires longstanding expertise. It is more innovative than a standard corporate transaction, he says.

After Lehman filed for bankruptcy, he was at the heart of the response

HINSEI HAS STRUGGLED SINCE Mr Flowers upped his investment, handing his later investors losses as shares languish at a fraction of their peak. A near $1bn bet on Germanys Hypo Real Estate disappeared when it was nationalised, and the potential value of an almost $2bn investment in another German institution, HSH Nordbank, remains uncertain. The $2.3bn third fund, however, is doing better, with a successful listing of BTG Pactual, a Brazilian investment bank, already under its belt and showing a profit. A renewed focus on European deals has now bought Mr Flowers from New York to Belgravia, London. Recent purchases include Equita Sim, an Italian broker, and Kent Reliance, the UK building society. The move is yet another signal of the private equity cash circling Europes financial institutions in search of assets that will be ejected as banks and insurers retrench and seek to raise capital. It is also a sign of the continents financial health. When regulators, bankers and politicians are trying to stop the bleeding, Mr Flowers is sure to be found close by, waiting to lend a hand. Dan McCrum

Long career: J. Christopher Flowers built his success in a series of banking deals

New York Times/Redux/eyevine

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FINANCIAL TIMES WEDNESDAY MAY 30 2012

FINANCIAL TIMES WEDNESDAY MAY 30 2012

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DEALS & DEALMAKERS | ASSET MANAGEMENT

DEALS & DEALMAKERS | OPINION

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

HERE ARE PLENTY of buyers and sellers in asset management but, like the USs warring political parties, they appear to be having entirely different conversations that show little sign of meeting in the middle. The experience of Deutsche Bank is a case in point. The German financial institution, like several of its peers in Europe, gave serious thought to the utility of its asset management business, itself the product of a series of deals. Following a strategic review, bids were invited, and a putative 2bn price tag mooted. The unit, which has more than $400bn in assets under management, attracted plenty of initial interest, but when it came to putting an actual price on the table this year, the list of bidders dwindled rapidly. Deutsche Bank wanted to sell the entire arm in one piece, even though there were few buyers interested in the underperforming combination of institutional accounts, insurance assets and Rreef, an alternative property investor. After strategic bidders, such as State Street, JP Morgan and Ameriprise dropped out, Deutsche Bank was left with three interested buyers: Macquarie, the Australian bank looking to expand; Power Corporation of Canada, a mutual fund company for whom the US asset management businesses would be a good fit with Putnam Investments, the money manager it purchased in 2007 for $3.9bn; and Guggenheim Partners. Guggenheim is a business that has acquired everything, including its name, from the famous foundation for which it also manages money. But its tactics illustrate the problem sellers, such as Deutsche Bank, face. The two entered into exclusive negotiations in March, after Guggenheim put in a large bid for the whole business that Macquarie and Power Corp had no interest in trying to match, according to people familiar with the situation. However, two months later Deutsche Bank announced that it was now in exclusive negotiations just for Rreef, which some had considered the most attractive asset all along. Some bankers put the fraught process down to Deutsche Banks decision to use its own mergers and acquisitions team. You never want your employer as a client, they dont listen and you cant fire them, says one. However, the difficulties also reflect the broader environment and insiders point to a Deutsche management change in March that contributed to a reassessment. Banks, contemplating new regulations for the amount of capital they must hold, are among the chief sellers of asset management businesses as they consider what banking will look like in the post-financial-crisis world, and conclude it does not involve investing money for clients. Yet 2011 was the worst year for global dealmaking in asset management for five years, both in terms of value and volume, according to PwC, the accounting and consulting firm.

earnings before interest, tax, depreciation and amortisation was a lowly eight times, down from around 13 times before the financial crisis. Sellers may not have caught up with the new reality, particularly European banks where a captive client base is of little use except to a direct competitor to whom they would least like to sell. But bankers expect plenty of activity should the economic outlook become less uncertain, and there are still areas of interest at a smaller scale. The boutiques continue to add smaller shops to their platforms, for instance the recent purchase of a controlling interest in the high-performing Yacktman Funds by the Affiliated Managers Group, which has been a persistent acquirer of mid-sized investment management firms.

Barbara Ridpath Crisis and regulation can breed opportunity

There is a tremendous war for talent people are using the volatility to pick up good talent

There is simply too much of a disconnect between the price... for these businesses and what buyers are willing to pay

In 2009, large deals were completed swiftly, at attractive prices. For instance, Ameriprise snapped up Bank of Americas asset management arm, Columbia, for $1.2bn, a price now seen as a bargain. Three years on, however, and banks, particularly those in Europe, do not appear to be in a hurry to sell. Both Italian bank Unicredit, and its

ART OF THIS REFLECTS the market environment, as money managers simply are not valued as highly as they used to be. The world has changed after a 30-year bull market in which it was an asset managers job to beat whatever rising benchmark he or she was judged against. Now that choosing which asset classes to be invested in is far more important than the composition of the assets within a particular sector, asset management has become far tougher. Investors now prefer to put their money into cash products, or bonds, that offer lower margins than actively managed equities. The shift has also coincided with disruption to the business by exchange traded funds, and the move to individual defined-contribution pension schemes, rather than the big pots of definedbenefit pension money of the past. In US mutual funds, for instance, industry fee levels barely changed even as the business grew from $200bn to $12tn in assets. Valuations have dropped. In 2005, buyers were willing to pay more than 25 times net earnings, according to PwC, but now prices are far more likely to be in the 10-15 times range. In the second half of last year, the median multiple of

Spanish counterpart Santander, have considered the sale of their asset management businesses but then thought better of it. Socit Gnrale said last year that TCW, its US asset management arm, was not for sale There is simply too much of a disconnect between the price that sellers expect for these businesses and what buyers are willing to pay, says Denis Bastin, a consultant to asset managers.

Collateralised loan obligation managers are in demand as a revival in the business appears possible: the $11bn of new CLO issuance this month is already more than that completed in the whole of 2011. With that in mind, Apollo, the listed alternative manager, completed a deal for Stone Tower, a $22bn CLO manager, in April for an undisclosed sum. There is a tremendous war for talent, says Kevin Quirk of Casey Quirk, a consultant to asset managers. That war means a lot of people are using the volatility in the business to pick up good talent. Theyll look at smaller transactions and teams, picking up individuals to really build their business organically, rather than doing transformational transactions.

HE GREATEST IRONY OF THE financial crisis is that the events that raised concerns about large banks being too big to fail are resulting in fewer, bigger banks. Consolidation in the banking sector was driven by shotgun marriages, where larger banks saved smaller, failing institutions. In the US, JP Morgan bought Bear Stearns and Washington Mutual at bargainbasement prices. Bank of America took over Merrill Lynch, and Barclays acquired the US operations of Lehman Brothers. In the UK, the Santander group acquired Alliance & Leicester and the savings business of Bradford & Bingley. In spite of widespread public concern, strong incentives still exist for big banks to dominate, regardless of efforts by regulators to limit the consequences of too big to fail. The costs of regulation and supervision spread across large income streams and asset bases mean larger institutions can better support the costs of new regulatory burdens, in effect raising barriers to entry. The ability to invest in advanced internal measurement-based risk systems means significant capital savings on riskweighted assets not afforded to smaller institutions. Information technology, data systems, risk models and even marketing, advertising and lobbying costs have a far lower impact on return on equity or return on assets than at smaller institutions, enabling the big to continue to get bigger. However, in some systems such as those in Canada and Australia, supervisors discourage further domestic consolidation. Cross-border mergers have become dramatically less attractive since the crisis. Supervisors increasingly require banks to create independently capitalised domestic subsidiaries with strong limits on the transfer of funds out of the country. Incremental costs limit much of the funding advantage and cost efficiencies that used to come with merged operations. And some bank investors have begun to recognise that there is such a thing as too big to manage as well as too big to fail.

leaving the business. There is also a trend toward M&A advice from boutique firms where there is clearly no conflict of interest for them. Specifically, the arrival of J. Christopher Flowers in the London market last month, looking for private equity transactions among insurance and non-bank financial services firms, suggests there are opportunities in this area.

There is such a thing as too big to manage as well as too big to fail

World view
Jack Klinck Executive vice-president, State Street Corporation, Boston Leadership in the custody market is driven by global scale and capital requirements. The top four competitors (as of December 31 2011) hold more than 60 per cent of the assets worldwide. In an environment of rising compliance and regulatory costs, pressure on capital ratios and slower economic growth, we expect to see further consolidation.

HE SECTOR IS NOT DEVOID OF opportunities. Many financial institutions are shedding assets and businesses because they no longer meet return criteria as a result of new regulation, or are selling good businesses to boost capital and reduce balance sheets. Banks tend to withdraw to home and core markets in hard times, but ongoing economic issues in most developed economies, combined with new regulation, has meant a deeper rethinking of strategy than at any time since the Latin American debt crisis of the 1980s. Opportunities abound, but they are of an order of magnitude smaller than Megabank 1 buying Megabank 2. With many bank shares trading at significant discounts to book value, raising the funds for purchase is difficult and expensive. This implies that M&A bankers are going to have to work harder for lower fees than before. Indeed, M&A volumes are at a low and newspapers carry articles about key M&A bankers

OWEVER, EVEN MR FLOWERS HAS had trouble anticipating idiosyncratic political risks. This demonstrates just how difficult investing and advising in the financial services sector can be. Governments take a strong interest when depositors funds are at stake. These risks are difficult to measure and to price, and underestimating them sometimes results in unexpected losses. Reporting and transparency concerns also complicate M&A within financial services, requiring extensive due diligence. Some issues are unique to certain markets, such as accumulated pension liabilities, which in the UK have scuppered sales, or outstanding post-crisis or conduct litigation liabilities. Others are more universal, such as agreeing the value of hard-to-value securities and assets. Nonetheless, crisis breeds opportunity. Regulation itself changes the economics of some business lines, enhancing the attractiveness of low capital-consuming businesses. New liquidity rules are likely to create opportunities in effectively lending liquid assets. Regulatory changes combined with the current low interest rate environment and the search for return could result in business and technology developments as radical and challenging as the internet is for the media industry. Technology is changing the way people bank and could dramatically alter the shape of retail banking. Opportunities exist in the non-bank financial services market for business-to-business lending platforms, which are also beginning to appear in small business and retail finance as well. But right now, uncertainty, both economic and regulatory, makes acquisitions extremely difficult to price. Until there is more clarity in the UK on the translation of the Independent Commission on Bankings recommendations into law, on recovery and resolution plans, and on the future regulation of non-bank financial intermediation, or shadow banking, it is likely that M&A activity in core financial services will remain muted. Across the European Union and G20 nations, transactions are likely to be limited to discrete assets and lines of business, and not wholesale acquisition of financial institutions. Nonetheless, once there is improved visibility on outstanding regulatory issues, the current low equity prices within the financial services industry do mean there are attractive opportunities. For those with cash and clear views on their product and market positioning, the time could be fast approaching for strategic purchases. Barbara Ridpath is chief executive of the International Centre for Financial Regulation

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FINANCIAL TIMES WEDNESDAY MAY 30 2012