Against a global backdrop that saw M&A slip 9% by both value and volume year on year, the financial services sector was one of a few outliers. M&A value in the industry climbed 14% in 2019, to a total of US$343.3 billion globally. And despite an edging down of volume by 6% to 1,486 deals, this was nevertheless the third-most active year of deal flow by volume on record.
The market is firing on all cylinders, with much of this momentum owed to US domestic activity. Deal count in 2019 came in at 491 acquisitions, the highest annual total on Mergermarket record (since 2006). Moreover, the US$140.1 billion invested in 2019 represents a massive 81% year-on-year gain. Indeed, the three largest transactions of the year involved US parties on both sides of the deal.
Digital disruption is having a demonstrable impact in financial services and is therefore a major motivator for strategic plays. Subsectors including banking, asset management and insurance have all faced disruption from financial start-ups. This disruption will continue to put pressure on traditional players to pursue defensive M&A, whether by consolidating with established competitors or by acquiring start-ups to build out their tech capabilities.
The largest financial services transaction of the year, not only in the US but worldwide, is a textbook example of the pressure that this disruption is affecting. Valued at US$30 billion (including net debt), brokerage The Charles Schwab Corp. took over close rival TD Ameritrade in November in a merger of equals. Post-deal, the company will have US$5 trillion in assets under management, making it the third-largest asset manager in the world after BlackRock and Vanguard, assuming it closes as expected (at the time of publication the US Department of Justice was seeking additional information about the deal).
This mammoth deal is emblematic of pressures in the asset management industry amid sector-wide disruption. Charles Schwab had earlier in the year eliminated stock trading fees in the face of heavy competition from low-cost index funds and digital-first operators like Robinhood. Investors have been shifting their assets from active to passive investing products, as fund managers have struggled to outperform ascendant stock markets, forcing established operators to seek scale and cut costs.
The second-largest deal in the industry represents the biggest US bank merger since the financial crisis. Two regional banks in the southeast US, BB&T and SunTrust, combined in a deal valued at US$28 billion. The newly merged entity, Truist, is now the sixth-largest commercial lender in the country. While no strategic decisions have been finalized, there are considerable synergistic advantages to exploit. There is significant regional overlap: of the 3,000 branches the banks share around a quarter of them are in close proximity, leaving potential for consolidation.
US banking mergers have been thin on the ground in recent years as regulators sought to mitigate concentration and liquidity risk in the sector following the financial crisis. However, a recent relaxation of rules appears to be encouraging M&A activity. Measures have included lower liquidity coverage ratios and less onerous stress testing.
Crucially the Federal Reserve proposed a rule in October 2018 to raise the threshold at which it imposes tighter capital and liquidity requirements, from US$250 billion in assets to US$700 billion. As we anticipated, this change made consolidation among banks below the increased threshold achievable.
This is important for the BB&T and SunTrust tie-up, agreed in June, the lenders having assets of US$228 billion and US$220 billion respectively. In October 2019 the Fed approved the revisions to its Enhanced Prudential Standards, ensuring the combined entity's circa US$450 billion in assets fall well below the regulatory thresholds, freeing the bank from burdensome compliance costs.
There are more than 5,000 mostly small and mid-sized banks in the US. The unravelling of existing red tape in what remains a highly fragmented sector is likely to sustain US banking M&A activity well beyond 2020.
While US banks have made great progress in deleveraging since the financial crisis, many major lenders in Europe continue to face significant challenges. The region's accommodative monetary policy (the European Central Bank has kept interest rates in negative territory) has weighed on profits and forced lenders to stake out value-creating deals. This led Germany’s two largest banks, Deutsche Bank and Commerzbank, to consider a merger in early 2019, only for talks to end unsuccessfully.
Germany's government has a vested interest in Commerzbank, its 15% holding making it the troubled lender's largest shareholder following a state-backed bail-out more than a decade ago. The country's Federal Finance Agency officially announced in August 2019 that it was seeking expert advice on Commerzbank's business model and how the government should manage its equity stake.
Germany is not alone. Several European states still hold stakes in banks they rescued in the immediate aftermath of the financial crisis, including RBS in the UK, Bankia in Spain, the Netherlands’ ABN Amro and Austria’s Volksbank.
More recently, China has been forced to take on state exposure to the private financial sector. The fourth-largest deal of 2019, and the biggest in China, saw the injection of US$14.3 billion into Hengfeng Bank, a troubled regional lender, by a group led by government-backed China SAFE, established to shore up troubled financial institutions. The lifeline deal was the country's third of the year, following interventions with Baoshang Bank and Bank of Jinzhou.
These legacy positions will have to be sold eventually, suggesting that privatizations will likely be an important source of banking deal flow in the years ahead.