By Alexander Jones, International Banker
According to June 29 data from Dealogic, global mergers and acquisitions (M&A) activity plummeted by a mammoth 36 percent year-on-year during the second quarter, as sharply rising interest rates worldwide and problems flaring up over US debt obligations kept dealmaking activity at bay. And with Europe among the world’s regions suffering the most from this dearth of M&A business this year—particularly within the banking sector—concerns are growing that a market ripe for a wave of consolidation not long ago will have to wait for such a wave to materialise.
The world’s total M&A value crashed to $732.82 billion in the April-June period from $1.14 trillion in last year’s second quarter, financial-markets analytics firm Dealogic noted, with high interest rates and US debt woes proving crucial in repelling dealmaking activity. “Global uncertainty is what is impacting M&A most—it just makes people uncomfortable. It’s easier to say, I’ll pass on a deal—nobody gets fired for passing on a deal. But, we all talk about the deal that never should have happened,” Michael J. Aiello, chairman of the corporate department of law firm Weil, Gotshal & Manges LLP, recently told Reuters.
Private equity has been among the most bruised sectors as the challenging environment for leveraged buyouts this year made acquisitions tougher to complete, thus leading to private-equity-led buyout volumes crashing 59 percent year-on-year to $196.66 billion. “The private equity business won’t be the same as before, but they must demonstrate that they are selling assets and investing. They have to adjust valuations and accept that the interest rate curve is what it is,” said Manolo Falcó, global co-head of banking, capital markets and advisory at Citigroup Inc.
Splitting that figure according to region, however, clarifies that Europe is the chief driver of this underwhelming global trend. Indeed, while M&A volumes in Asia and the United States declined annually by 30 percent and 24 percent, respectively, Europe’s volumes fell by a whopping 49 percent. The Dealogic figures show, therefore, that Europe’s M&A slump that prevailed throughout much of last year continued in the same vein during the first half of 2023.
And it appears the deteriorating macroeconomic environment across the continent has been chiefly responsible for such subdued dealmaking activity. With the eurozone’s annual inflation rate soaring last year, even hitting double digits during the final quarter, central banks across Europe scrambled to contain runaway prices through aggressive interest-rate hikes. The resulting steep rise in borrowing costs firmly put the brakes on dealmaking as companies struggled to obtain affordable financing. And with inflation still above central banks’ target rates—and in some cases, such as the Baltic states, substantially so—a series of further rate increases during the latter half of 2023 is all but guaranteed.
This dearth of activity has extended well into the European banking industry. According to S&P Global Market Intelligence data, M&A transactions involving European banks plunged to their lowest level in five years in 2022. “There were just 103 deals involving banks in Europe in 2022, down from 123 deals the year before and less than half the 224 deals struck in 2019,” S&P noted in a report published in January. “Deal-making in the second half of 2022 was particularly slow, with only 45 transactions reached, compared to 65 in the same period in 2021.”
It had been hoped that higher rates would improve net interest margins (NIMs) for European banks, which, in turn, would furnish them with more cash to facilitate more acquisitions in 2023. And the rescue of Credit Suisse Group at the hands of UBS Group and the Swiss authorities also raised hopes that further consolidation of European banking was around the corner. But this has proven not to be the case. Indeed, the lacklustre trend for European bank M&A deals has continued this year, with Central Europe and Southeast Europe showing particularly muted activity. In May, S&P disclosed that first-quarter (Q1) bank M&A activity in these regions—including majority stake purchases, minority acquisitions, and asset and branch takeovers—was at its lowest level since at least 2018, with a paltry two deals announced during the three-month period.
One particular obstacle to an M&A recovery in European banking this year is the set of accounting rules that presides across the continent, specifically related to what is known as the purchase price allocation (PPA) process. With banks issuing vast quantities of corporate and government bonds when rates were at rock bottom, the mark-to-market (MTM) value of such debt in today’s higher-rate environment is significantly lower than new loans being issued this year. With assets and liabilities valued at present market rates using this purchase price allocation process, any gains from acquiring a target bank for less than the value of its assets will be eliminated, as the total value of assets is lowered.
“Accounting rules and their impact on capital are a big hindrance for M&A at the moment. With rates rising, you have negative fair value adjustment when marking assets to market upon acquisition and part of the badwill evaporates,” Dirk Lievens, head of the European financial institutions group at Goldman Sachs, told the Financial Times on May 30. “If you are buying a bank at a discount to book value and the purchase price allocation reduces that, what you thought was capital—i.e., badwill—is not capital anymore. You would then have to top up the capital, which makes doing bank deals more complicated at the moment.”
On a positive note, the second-quarter figure for global M&A was higher than the first-quarter 2023 figure of $601.32 billion, which has led some to believe that a market recovery has commenced. “People tend to look at just the previous year, but if you look at activity over a 10-year period or a 20-year period, we’re in an M&A environment that’s not red hot like it was in 2021, but it’s by no means a moribund M&A market,” Steve Baronoff, chairman of global M&A at Bank of America (BofA), told Reuters on June 30. Raymond J. McGuire, president of the investment bank Lazard, holds a similar view. “We are bottoming out,” he explained. “In order for companies to continue to compete locally and globally, they will have to grow organically, especially inorganically. The market will see an increase in strategic activity.”
But whether that optimism transmits to the banking industry remains to be seen. In Central Europe and Southeast Europe, some expect rising consolidation in the medium term as smaller lenders succumb to acquisitions amidst a relentlessly challenging operating environment involving tighter capital requirements, digitalisation and an expected economic slowdown, driving heightened dealmaking over the coming 12 to 24 months. Speaking to S&P Global Market Intelligence on May 15, Raiffeisen Research’s Gunter Deuber and Jovan Sikimic confirmed they saw “some core players dedicated to further strengthening their position in core markets”. The analysts also noted that the tighter conditions on European financial markets in the wake of the banking failures in both the US and with Credit Suisse Group could bring smaller lenders under further pressure, which would stoke greater M&A activity.
Further optimism can be attributed to the buoyancy of the major stock markets. Both the benchmark US S&P (Standard and Poor’s) 500 and German DAX indices, for example, returned close to 15 percent during the first six months of the year. Those companies with share prices that lag during this market upswing can be more easily identified as acquisition targets. “Over the next six months, there’ll be a lot of share buybacks and a lot of controlling shareholders proposing buyouts of their publicly listed subsidiaries—both are indicators of beliefs that markets will be stronger by this time next year, and neither typically require extraordinary financing,” Ethan Klingsberg, co-head of US M&A at Freshfields Bruckhaus Deringer LLP, explained to Reuters.
And while M&A business has been insulated from the fallout of the recent banking crisis that emerged in the US and, to a lesser extent, in Europe, some have warned of potential spillover effects on credit availability in the industry. “Those regional banks fund some middle market M&A activity, but if there’s less credit available to the middle market, or to commercial real estate, which is heavily financed by those, there might be a bit of a cascading effect on credit availability,” according to Scott Miller, co-chair of Sullivan & Cromwell LLP.