Tue. Dec 7th, 2021


Are the tables going to turn around? Investment banks have prospered in recent years, thanks to transactions and trading boom, turbo-charged by ultra-low interest rates and quantitative easing.

But did they finally reach their peak? And will their retail and commercial banking cousins, who have suffered under pressure on lending margins due to the same ultra-low rates, eventually thrive? If the smart brains of private equity are any guideline, the answer may be yes.

The US Federal Reserve said last week he would start an immediate kick-off of his QE bond buying program. In the UK, the Bank of England surprised markets not increase base rates last week, but there is a consensus expectation that rates will rise at the central bank’s December meeting. In other countries – from Norway to Poland – increases have already taken place.

It is clear that we are at a crucial time for global economies. This is also a big moment for banks.

The ransomware environment has driven a boom in investment banking. JPMorgan dropped profit expectations for the third quarter last month, reporting a 26 percent return on equity in its investment bank and a group return of 18 percent. JPMorgan’s market capitalization was $ 500 billion last month after doubling in just 18 months. Bank of America, Morgan Stanley and Goldman Sachs also flourished.

Wall Street executives know the best can be over – the exuberant bond and merger and takeover markets will be curtailed by stricter monetary policies and they may have to increase staff pay in a more inflationary environment.

Conversely, if interest rates have bottomed out, retail and commercial banking – all else being equal – must be put in place for a recovery as the gap between the cost of funding and what they make from loans widens. In Europe, where such models predominate, it could help close a long-standing valuation gap with U.S. giants.

It is against that backdrop that the mid-level UK banking market is becoming the unlikely focus of interest for major US transaction makers, especially private equity firms that want to deploy their abundant “dry powder”.

Last week, Metro Bank announced it received a takeover approach from Carlyle. A few weeks earlier, Co-op Bank – backed by JC Flowers and Bain Capital and a bunch of hedge funds – had approached Spanish Sabadell about A £ 1 billion plus potential purchase of its British subsidiary TSB.

These are small transactions for large firms. Metro, for example, has a market capitalization of barely £ 200 million. So why bother? Well, there is the appeal of cheap price tags and a core logic of the arbitration of the firm’s ample cheap funding on an operation with lending margins that will apparently increase.

But buyout managers will also look at the consolidation opportunity to set up other lenders. If Carlyle did buy Metro, he could also look to the Co-operative and TSB, not to mention other mid-level lenders. Flowers and Bain, via the Cooperative, can do the same.

For a listed lender like Metro, with capital levels stretched by thin interest rate margins and persistent losses, the prospect of a private equity capital injection solves the Catch-22 alternative of trying to raise capital from existing shareholders at a stubborn one. low valuation. Its shares are currently trading 93 percent below a March 2018 high and the lower the valuation, the more dilution existing shareholders will suffer from a share issue if they do not participate in it.

The pandemic increased the opportunity to make cost savings on branch networks in a nutshell. At Lloyds, nearly three-quarters of customers now bank online, at less than two-thirds before the pandemic.

There are some examples of private equity reversal of banks that are upset – from JC Flowers’ takeover of Japan’s Shinsei and Cerberus’s acquisition of Austria’s Bawag. But regulators tended to be nervous about large-scale buyouts, given concerns about the potential “double leverage” stemming from private equity’s normal operating model and banks’ capital structures. They also tend to prefer the diversity of capital support associated with a listed shareholder base.

However, beggars cannot be voters. Both Co-op and Metro have come close to failure in recent years, following scandals and capital mismanagement. A solid owner can fix that and can also help consolidate Britain’s weak midfield into a viable challenger for the big players. As long as interest rate hikes are limited, it sounds like an attractive investment case. However, if economic tensions get out of control, it can be a high-risk one.

patrick.jenkins@ft.com



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