Banking M&A: Banks scramble for the last of the rich pickings

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By:
Sudip Roy
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Many of the most attractive banking assets in emerging Europe have already been bought. Acquirers must look further east for their next target. But investment bankers are already thinking of the next big play – a global bank trying to buy a presence across the region. Sudip Roy reports.

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Flip forward five years. A spate of revolutionary transactions is reshaping the banking industry in central and eastern Europe. Citigroup has just bought OTP, Crédit Agricole is in talks with Banca Intesa, and HSBC is poised to take over KBC.

Sounds ridiculous, doesn’t it? But then, at the turn of the millennium, people would have laughed at the idea that Santander would buy Abbey National or that RBS would become one of the 10 biggest banks in the US.

Looking at central and eastern Europe today, it’s clear that consolidation in the banking industry is reaching saturation point. Buying opportunities are apparently limited to a handful of banks in a handful of markets. Romania, Turkey, Ukraine, the Balkans and, to a lesser extent, Russia and Kazakhstan will see some action over the next 12 to 18 months. But once the remaining attainable assets in those countries have been bought, what next?

Given that the traditional route into the region – buying directly in the local market through a privatization or from an entrepreneur – will be restricted to these riskier east European markets, banks will have to think of more radical or subtle ways of building an influential presence. Institutions that already have a foothold, such as Austria’s Erste Bank and RZB International, Belgium’s KBC, France’s Société Générale (SG) and Italy’s Banca Intesa, will have to decide what their strategy will be: whether to take the plunge in the east (as some are doing), whether to tie up with banks of similar size and stature in the style of UniCredit and HVB, or whether to sell their business and reap the rewards.

Banks that have a smaller presence, such as Allied Irish Banks or Millennium BCP, have less flexibility but could also find themselves caught up in the drama. ABN Amro, for example, last month announced that it would be selling its 40.2% stake in its Hungarian subsidiary, K&H, to KBC. The Dutch bank, which sold its stake for €510 million, said its decision was “in line with its strategy to divest non-core assets”.

One intriguing possibility could be that the global banks, particularly Citigroup and HSBC, make a play for the regional powerhouses that have a ready-made portfolio of local assets. Although present in a number of markets, neither Citigroup nor HSBC has a dominant position in the increasingly attractive area of retail banking. Neither is among the top five biggest banks by assets in central and eastern Europe. Both have the financial muscle to surge to the top in one fell swoop. These are the two most obvious candidates, but other big banks with deep pockets can also be thrown into the mix. No observer expects a groundbreaking deal soon, largely because the regional banks are under no pressure to sell, in fact many are still expanding. Valuations are so high as to be prohibitive for any potential transaction. But some say it’s not unrealistic to think that things might change within the next few years.

“Can already committed players be bought by some bigger bank? It’s possible,” says Jiri Klumpar, a director at PWC in Prague. “At the moment banks such as SG, KBC and so on are focused on consolidating their holdings, so it will be another two or three years before they would even consider selling their central and eastern European units. But it could happen.”

Jonathan Warburton, MD and head of CEEMEA financial institutions at Citigroup, says: “Global banks may well at some point decide to widen their presence in the region and could adopt the portfolio approach rather than buy on an individual asset basis.”

For the time being, these banks appear to be more interested in building their presence in Asia. Citigroup, for example, intends to pursue more acquisitions in China and expand rapidly in India. HSBC too is keen to cement its leading position in the world’s most populous region. Other top-tier US and UK banks, such as Bank of America and RBS, have also bought stakes in the big Chinese banks.

But central and eastern Europe’s appeal is getting stronger. The consumer credit markets in the region are still relatively immature. Retail loans as a percentage of GDP for the Czech Republic, Poland, Slovakia, Hungary and Slovenia, for example, are just 9% to 15%, according to Standard & Poor’s, and these are the more developed markets in the region. With stellar economic growth expected over the next few years, central and eastern Europe’s potential is clear. And to be successful in retail, scale and risk diversification will be of critical importance.

“There will be a time when global banks may focus more on central and eastern Europe,” says Warburton. “Then the regional players will become more vulnerable.”

For the future

Some have already tried to buy them but failed. Klumpar says that two years ago, a US bank (he declines to name which one) tested the water with Erste about a potential deal but was quickly rebuffed. One investment banker recalls taking a look at OTP for a global bank client. Although ostensibly a Hungarian outfit, OTP also has a presence in Bulgaria, Croatia, Slovenia and Romania. When the banker initially approached OTP’s management the answer was “No”. One stumbling block to a potential acquisition is OTP’s chief executive, Sandor Csanyi. Arguably Hungary’s most powerful man and one of its richest, he has iron-fist control over OTP, even though the management and employees own only 2.8% of the stock compared with foreign investors, who own 88.9% (significantly the state owns a golden share). It is widely known in the industry, says the banker, that Csanyi would only consider an offer if it included a considerable premium to the growth that he thought the bank would achieve and if he retained a very senior position, such as chairman, in the merged entity. This seems a fair argument when you consider that OTP is the highest-valued bank in central and eastern Europe and is trading at four times its book value.

Would-be acquirers of OTP, however, should not give up hope. While a sale today is unlikely, the bank’s circumstances could change in the next few years. “Within the next four or five years OTP could be a candidate [for a deal],” says another investment banker. “At some point Csanyi will retire. There’s a chance he may want to leave the scene with a landmark transaction.”

If OTP is one potential prey, which other regional banks could also become targets over the next few years? KBC is often touted. The Belgian group is active in many fields including retail banking, asset management and bancassurance. In central and eastern Europe, KBC has built a strong position in the Czech and Slovak Republics, Hungary, Poland and Slovenia. For the first nine months of this year, the region contributed 23% of the group’s overall profits. One issue, according to Herbert Stepic, chairman of RZB International, is whether or not the group will be able to marry its insurance and banking businesses in central and eastern Europe. “There is a question mark over KBC,” he says.

KBC’s management, though, has made it clear that it has no intention of selling its banking business. “We have always made our position on this very clear. We have very stable shareholders, and want to remain independent,” André Bergen, managing director of KBC Group and deputy chief executive of KBC Bank, told Euromoney recently (see Euromoney, September 2005, “UniCredit advances – but must stay on its toes”, p286). The bank is deepening its franchises in Poland and Hungary and is interested in expanding its scope to include Croatia and Romania.

Stepic at RZB: a predator at the moment, but could the success of his bank make it a target?
Apart from KBC, who else could be in the firing line? SG, Erste Bank and RZB International are attractive businesses simply because of their extensive reach in the region. But these would be difficult banks to swallow. One hurdle would be cost. It’s impossible to predict just how much money it would take to buy these banks or even just their central and eastern European assets. However, the fact that, at $18.7 billion, UniCredit’s bid to buy HVB is $3 billion more than that paid by Santander for Abbey National is one indication of how high valuations are for banks with a big presence in the region. Another problem for any potential buyer is the shareholder structure of these banks, especially for the Austrian banks. RZB International, for example, is 70%-owned by Raffeissen Zentralbank; institutional investors hold the rest. And although 61.8% of Erste Bank is in free float, the biggest single investor is a charitable private foundation established in the 19th century that derives its mandate from the tradition of the savings banks. As central and eastern Europe contributes over 50% of both Raffeissen Zentralbank’s and Erste Bank’s profits it is difficult to imagine either selling for the time being. “We have no intention to sell,” says Michael Mauritz, spokesman at Erste Bank. “It wouldn’t make sense to our shareholders. We are interested in staying independent.”

But strategies evolve and a bank committed to staying independent today could change its mind if the timing and package offered is right. As Warburton says: “At some point there will come a crunch time for these regional players. If they have delivered on their initial strategy, what do they say to their shareholders? They need to offer something more. That’s why a lot of these banks are looking at where growth will come from over the next five to 10 years. The key question is then: do we push into more exotic and hence more uncertain markets to find growth, or do we accept that independence will be increasingly hard to maintain?”

Here and now

The prospect of a global bank buying a regional player may be a few years away, but what about the here and now? One trend to look out for is more tie-ups between continental European banks that have a presence in central and eastern Europe. Any deals involving these institutions will have big ramifications for the banking landscape in the region, even if the push is more attributable to events in their home markets than because of the prospect of generating more value out of their central and eastern European subsidiaries.

Analysts expect more consolidation among banks in western Europe. Davide Taliente, managing director and head of European banking at Mercer Oliver Wyman, told Euromoney in November: “The question is no longer whether a new wave of consolidation will unfold [in Europe], but rather when it gets rolling and what shape it will eventually take.” Further bank merger activity is expected especially in France, Germany and Italy.

If and when that happens it will open the door for one-off opportunities in those markets in which the two merged banks have big overlaps. This is already apparent with UniCredit and HVB. In Croatia, for example, the central bank has forced the new entity to sell HVB’s subsidiary, Splitska Banka. With UniCredit already owning Croatia’s biggest bank, Zagrebacka Banka, the country’s authorities deemed it would be unfair if the new entity kept both institutions. “This is the first example of second wave disposals,” says Matteo Stefanel, a director within the European financial institutions group at Deutsche Bank. “It will be the beginning of a series of one-off sales fuelled by consolidation among western European owners of central and eastern European banks.”

A similar situation may arise in Poland, where UniCredit owns Bank Pekao and HVB’s unit is BPH. If these two subsidiaries were to merge, their market share would be 20% – the biggest bank in Poland. UniCredit is hopeful that the deal will be allowed to go through, though press reports suggest that Jaroslaw Kaczynski, winner of recent parliamentary elections, has asked the country’s authorities to block it. These, though, will be sporadic opportunities.

Local pursuits

Those banks seeking a more traditional way of building their franchise will have to turn their attention to southeast and eastern Europe. Ukraine, for example, is flavour of the month. Jim Donnet, director within the financial institutions group at ABN Amro, reckons the country could see a number of transactions over the coming months. In October, RZB International completed its A862 million ($1 billion) purchase of a 93.5% stake in Bank Aval, the leading retail bank in the country. Although the amount paid amounted to 3.6 times 2005 estimated book value, broker KBW reckons that was “a reasonable price for an 11% share in a sizeable and rapidly growing market”.

Two other leading Ukrainian banks are also set for the chopping block. A controlling stake is potentially up for grabs in Ukrsotsbank, which is owned by Vicktor Pinchuk, a multi-millionaire oligarch and son-in-law of former president Leonid Kuchma. OTP and UniCredit are reported to be interested parties. The other bank in the limelight is Ukrsibbank. BNP Paribas is understood to be buying a 51% stake in it. “Interest in Ukraine reflects the scarcity of opportunities in region,” says Donnet. “In addition, it shows that in order to grow, banks need to acquire in markets beyond the EU or current accession countries.”

Opportunities in the EU accession countries are limited. In Romania, for example, there are effectively only two state-owned banks left and these will be in private hands soon. They are CEC, the national savings banks and Banca Comerciala Romana (BCR), the country’s biggest bank. Seven banks have bid for CEC including OTP, RZB International, Erste Bank and Dexia. The government is offering at least 50% plus one share in CEC but no more than 75%. The exact size will be determined once the offers are in. The date for the sale has yet to be decided.

As for BCR, a sale was expected as Euromoney went to press. With $8.7 billion of assets, BCR has a 26% market share and is seen as a prized asset. The most interesting aspect of the sale is that one of the two short-listed banks is Millennium BCP. The other is Erste Bank.

On the surface, the bank does not seem the most natural suitor for BCR. BCP has a presence in the region following its acquisition of Millennium Bank in Poland in 2000. But the only other country it has entered is Greece. Analysts say that the bank has tried to buy other assets in central and eastern Europe but its efforts have proven unsuccessful. According to a banker at BCP, the bid for BCR is a logical extension of its strategy to pursue opportunities in Europe’s growth markets. A strap line for one of its recent presentations says: “Romania offers the last opportunity to enter a vast, under-penetrated and high growth banking market.”

BCP has also repositioned its strategy. It no longer considers itself as a Portuguese bank with overseas subsidiaries. Instead it sees itself as a multi-domestic bank, that is a bank with three local markets: Portugal, Poland and Greece. If it succeeded in buying BCR, Romania would become the fourth pillar in this strategy.

Although BCP is unlikely to succeed (if for no other reason than Erste could probably outbid it), its bid reveals that banks that have a small presence in the region can still grow their franchise, though the window of opportunity might not remain open for long. At the same, BCP is vulnerable to a bid itself and, arguably, the more it builds its presence in the region the greater the probability of a predator making a move.

Commerzbank is another institution with a relatively small presence planning to expand. Its chief executive, Klaus-Peter Mueller, said in November the German bank would make an acquisition in Russia, Ukraine and Turkey within the next three years. “Our first priority is buying another bank in Germany,” he said. “And the second priority is expanding in Russia, Ukraine or Turkey.”

The bank already has a greenfield operation in Russia and one in Hungary. It also has a presence in Poland through its ownership of Bre Bank. One Commerzbank source says the bank’s planned assault on the Russian, Ukrainian and Turkish markets makes sense given Germany’s strategic importance as a trade partner. “In eastern Europe, Germany is the number one trading partner. Why not take that and develop a commercial banking franchise [in these countries]?”

As the last part of this statement suggests, by focusing primarily on commercial banking Commerzbank is adopting a different strategy to that of many of its rivals. Over the past few years, almost every bank has identified the retail market as the holy grail, even those outfits, such as RZB International, that started out focused more on corporate banking. But Commerzbank is convinced that there’s still plenty of value in servicing corporates. The source says that because it is difficult to identify value-for-money local corporate banks, the German institution will probably buy a small retail institution instead and develop a commercial banking platform from that. “We will buy small and expand rather than buy a big bank,” he says.

Russian dilemma

The bank’s moves in Russia will be particularly closely watched. Russia is the unknown quantity in the region. The political and legal risks, as well as its sheer size, mean it can be too intimidating a market for some players. The other issue on the retail banking side is that state-owned Sberbank dominates that market. Opportunities, therefore, are limited. “Everyone wants to be in retail but there are very few Russian banks that have interesting retail franchises,” says Chris Birney, a ratings director at Fitch Ratings.

So far, those institutions that have been snapped up, such as Home Credit and Finance Bank and DeltaCredit, are leading players in specialist areas. For example, DeltaCredit, which was bought by SG, is the leading institution in Russia’s mortgage lending market. There are few banks with all-round retail strength. Obvious candidates are the two big private banks, Alfa Bank and MDM. Earlier this year, there were strong rumours that MDM and HSBC were in talks about a potential deal. The rumours were triggered after a board shake-up at the Russian bank in May, which led to the election of a former head of HSBC’s international strategy to a director’s position. A former MDM executive said then: “Preparations for a sale have been going on for three years. I would bet on HSBC as the most likely buyer.”

Others are less convinced. “HSBC has to date indicated that it is more likely to pursue organic growth in Russia than take the M&A route,” says an investment banker.

Another institution attracting admirers is consumer finance provider Russian Standard Bank. The bank was poised to clinch a deal with BNP Paribas last year but it fell through after both sides failed to reach an agreement over the financial details. BNP also blamed the failure on Russian Standard Bank owner Rustam Tariko, alleging that he had violated liabilities. Things got so bad that BNP Paribas took out a lawsuit against Russian Standard Holding (which has a 90% stake in Russian Standard Bank). But in September BNP and Tariko agreed to end legal proceedings.

Russian platform

Opinion is mixed as to what is the best strategy to tackle Russia. Some analysts agree with the Commerzbank approach. “In Russia, you would need a small platform [from which to grow],” says Thomas Raab, managing director at Oliver Mercer Wyman in Frankfurt. “On the one hand, it’s a big country but, on the other, if you want to be successful in retail you only need to focus on six cities. Therefore, if you can buy a small platform, you could build on that organically. You don’t need to buy a big banking network.”

RZB International, however, has taken a different approach. It has grown organically. So far the strategy has worked; RZB is the second biggest foreign bank in Russia. It’s also focusing on the regions – where the real potential in Russia lies. “We are going into the provinces – this is untapped land,” says Stepic. “Very few other banks are there – mostly regional players – but it’s a difficult road to pursue. There’s a lot of resistance.”

“You can succeed organically [in Russia] if you know your business,” adds Stepic. “You need some guts and professionalism.”

What makes the organic route even more attractive for foreign players is that few Russian banks will be willing to sell majority stakes to their western counterparts. Gazprombank, for example, is selling about one-third of its shares to Dresdner Bank for $800 million next year as the first step towards an IPO in 2007.

Stepic is completely against taking the minority shareholder route. He argues that buying a small slice involves as much work as a takeover but you end up with much less influence and control.

But given how frenzied the race for market share is becoming, some banks will have no choice.

The scramble for bank assets in central and eastern Europe is still very much alive.