Mid-year update on financial services M&A

The need for digital transformation will continue to fuel M&A activity for the remainder of the year, most likely in the form of strategic partnerships, consolidation and transactions designed to drive digital transformation.

Despite the urge to do deals, however, there’s plenty of uncertainty around arising from macroeconomic and inflationary headwinds and the knock-on effects of the war in Ukraine. This uncertainty is rubbing off on various aspects of mergers and acquisitions. Some deals are becoming harder to finance as interest rates rise further and lenders adopt much stricter lending policies. Investors are now having to look for additional synergies, innovation and increased efficiencies to unlock value and justify valuations. And many buyers are apparently no longer prepared to pay the kind of high purchase price multiples we were seeing in 2021, so valuations can be expected to decline further over the rest of the year.

As dealmakers focus on different avenues to value creation, due diligence processes prior to signing are becoming more in depth and extensive (now covering strategic fit, workforce and ESG factors in addition to the traditional financial performance, tax, IT and operations). There’s also more transformation work required after deals close.

Global M&A trends

Asset and wealth management (AWM)

Despite the uncertain macroeconomic and geopolitical environment globally, the AWM sector is holding its own. Capital market performance was weaker in the first half of 2022, but there’s still plenty of appetite for investments and M&A activity in the AWM space.

As investors focus on longer-term goals and ways of negotiating the current market uncertainty, they’re increasingly seeking alternatives. Alternatives and funds with a sustainability focus should attract healthy investor interest, leading to opportunities for mergers and acquisitions.

AWM firms are responding to demand for more sustainable investments by re-evaluating their product design, fund allocation and performance objectives. This looks set to drive further M&A, although a relative lack of appropriate candidates might limit some dealmakers’ ambitions.

Banking and capital markets

Tech capabilities are still crucial to M&A strategies as established players try to build market position amid disruption from FinTechs and players from outside the FS industry.

We’re also seeing business leaders attempting to respond to customer demand for secure and convenient digital banking by acquiring new digital capabilities and investing in cloud technologies.

As the digital economy grows, companies are finding opportunities to partner with digital distribution channel providers such as platforms that create transaction flows and FS opportunities such as consumer lending via digital B2C channels.

Banks have their own internal challenges to contend with when it comes to honing and digitising their business models, and are tending to steer clear of businesses with their own challenges by taking a more conservative approach to potential acquisitions. This means banks are doing more in-depth due diligence to find out how targets perform against key value drivers, as well as to improve the chances of smooth and effective integration.

Insurance

In the first half of this year, economic uncertainty, inflation and rising interest rates slowed insurance dealmaking. However, higher interest rates may actually be an opportunity for life insurance and long-duration property and casualty (P&C) targets to operate more profitably, relieving the pressure on generating investment returns and allowing them to rebalance portfolios in traditional investments. This could drive dealmaking and valuations of life insurance targets.

Private equity and asset and wealth management firms continue to expand their presence in the insurance industry as a means of growing their assets under management and thus generating higher risk-adjusted returns and increasing their income.

Insurance distribution has remained an area of strong dealmaking in recent months, and we anticipate continued interest on the part of consolidators and private equity in insurance brokerage companies.

After lively investor interest in InsurTechs in late 2020 and 2021, the valuations and stock market performance of these companies have cooled. Lower valuations might make these InsurTech companies attractive targets for established insurance players looking to harness technology, boost revenues and shape a successful future.

Swiss M&A trends

What are the M&A trends in the Swiss financial services industry?

I’d like to provide an update on my last blogpost, where I presented a number M&A trends in the Swiss financial services industry and which we have underlaid with a variety of publications in the past six months. You will also find the links to these publications below in case you missed them:

1) Private banking revamp of deal flow as markets deteriorate after record 2021:

“The strong financial market performance in 2021 led to record results mainly at large and mid-sized banks, whereas smaller private banks could defer a thorough scrutiny of their struggling profitability situations. This development refrained low-profitable smaller banks from potential selling endeavours. Thus, the transactions completed were generally driven by strategic reassessments at larger banks.

But as we consider 2021 to be an extremely good year for private banks, which cannot be considered representative for the future, we expect M&A activities to increase once the market environment deteriorates. This will primarily impact the smaller private banks among which further consolidation tendencies are expected.” Martin Schilling, market update on Swiss Private Banking 2022

I’m quoting from Martin’s recent market update on the status of the Swiss private banking industry. While I fully agree with this statement, I’d like to add that larger players in particular are displaying significant appetite for deals and are becoming more open minded and also creative when it comes to finding opportunities – always with a focus on valuable growth and digital transformation.

2) FinTech transactions surging as strategic players fear missing out:

The volume and size of FinTech transactions reached an all-time high in 2021 globally, but also in the DACH region. This trend is currently interrupted by the general market downturn ‒ particularly the downturn in the crypto market ‒ and thus lower levels of VC funding. However, our recent FinTech study shows that FinTechs are here to stay and that we can also expect deal flow to grow in the years to come. Why is that? Financial investors have so far been the key source of funds. This is changing, as strategic players are catching up: one in four investors is now strategic, up threefold from 2011. I believe that these two groups of investors, as well as the continued surge in potential targets, are likely to drive increased deal flow:
a. Financial investors have recently suffered from the market downturn, high prices and, in the case of some VC firms, also the drop in cryptocurrencies. If these recover, there will be renewed appetite for FinTech investments. Additionally, many FinTechs are growing into the target size and maturity required to be interesting for private equity funds.
b. Strategic players have growing appetite for investing or partnering with FinTech as an alternative way of innovating, particularly their product offering or in the middle office. Our survey of 30 banks in Switzerland shows that 38% intend to invest into FinTech in the next two years, although half of them don’t yet have a formal strategy in place.

3) Independent asset managers (IAMs) displaying an appetite to buy to grow out of increased regulatory burdens:

The very fragmented Swiss IAM market includes 1,800 unlicensed and 350 licensed IAMs. The unlicensed IAMs are running out of time to submit their required application for licencing by end of 2022. I considered being per-se a driver of increased deal flow in my last blog post. Thus, my colleague Christian has put a study together that included a survey of the industry. The results confirmed our assumptions: 69% stated that increased compliance costs as well as audit and regulatory reporting requirements (59%) are their key burden in the mid to long term profitability. However, what surprised us is that despite this, only 14% of the surveyed IAMs are considering selling the company while 56% would like to see themselves on the buy side. Whether this reflects the future reality I doubt, but it clearly indicates that the urge to stay independent and keep the current corporate culture is a major factor when assessing strategic options – plenty of room for creative deal makers to find angles for attractive offers.

4) Retail:

The Swiss retail banks are successful and owing to the market constellation are not the number one driver of deal flow. However, over the past two years, but also most recently, we have seen substantial deal activity in the consumer finance, cards and buy-now-pay-later industry and its underlying marketplaces (e.g. Credaris). These deals were fuelled by the need to consolidate market share. We expect this trend to continue, as the industry is still growing and there’s a lot of room for digital disruption. I am therefore assuming that this is a space to watch, as established Swiss players, international strategics as well as PEs are all keen to find angles for deals.

5) Insurance:

Insurance deals in Switzerland are rather a rare thing and as such, insurance deals with Swiss involvement are mainly driven by some of the large players involved in cross-border deals ‒ something we will continue to see in the future. This includes the sale of run-off books in both the life and non-life sector. 

Over the past 12 months we have been looking into deal opportunities in the InsurTech space. Our analysis focused on how Swiss (re)insurers are approaching InsurTech opportunities. The institutions surveyed agreed that InsurTech is particularly interesting as a way of enhancing their value chain, and this is visible in the high share of transactions with targets that play in the services and distribution segment of the value chain, thus helping insurers become more customer centric and friendly by being more data driven and efficient.

Overall, there are plenty of factors indicating that deal flow will continue to thrive. Independent of the economic environment, M&A will continue to be at the core of many financial services players’ growth and transformation strategy.

Looking ahead to the rest of 2022: dealmakers set to remain active

Financial services M&A activity should continue in the remaining months of the year, with asset and wealth managers seeking to expand into new asset classes, banks forced to modernise digitally and optimise their capital base, and insurance companies seeking avenues to divest non-core assets and refocus on their core business.

Despite the fact that tech remains in great demand, macroeconomic headwinds should lead to a reduction in deal multiples and distressed sales will be on the agenda as well. As more value opportunities emerge as a result, overall financial services M&A activity is likely to remain high in the mid term.

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