Can an Acquisition Turn Around the Profitability of a Bank in 5 Years?

Consequently, the transformation strategy is at the centre of every takeover. Private banks may ask themselves, “What are the key elements of a transformation strategy that will result in value creation and an instant impact on our performance?” This article builds a case for defining a well-structured integration framework when choosing inorganic growth as an upscaling strategy.

In an attempt to understand the impact of an M&A deal on the acquirer bank, we focus on analysing the performance trends of three different banks in the post-merger transformation period and weighing the trends against the banks' underlying transformation strategies. The varying performances of different growth strategies are also captured through a comparative analysis drawn from previous M&A deals over a five-year-period (2010- 2015) and from Synpulse industry insights.

Similar to our previous publication “How to Survive the Perfect Storm: A Perspective from an Ailing Private Bank in Asia”, where Asia Private Bank (APBank) was chosen as a baseline example for our analysis, we also used APBank as an example for the current article. APBank, a fictitious name given to a small to medium-sized Asian private bank, faced challenges, such as decreasing profit margins, high innovation costs, and an inability to achieve economies of scale. To tackle the challenges and remain competitive, APBank had three main strategies to choose from:

• To specialise and restructure or standardise their operational model
• To pursue BPO via industrialised third parties
• To extend their footprint by acquiring additional assets and a front office (M&A)

In this case, APBank chose to delve into the third path of inorganic growth through an M&A deal. In order to illustrate APBank’s performance gains after the merger, it is compared against two similarly sized peers, given here the fictitious names “Top Performer” and “Bottom Performer”. These banks also had a similar market footprint and products and services landscape as APBANK, as well as closely representing the benchmarks on the opposite ends of the growth spectrum during the period of analysis.

Top Performer is a bank of similar size to the pre-acquisition APBank. This bank has implemented a series of lean projects, such as the implementation of a new core banking system (CBS) and the acquisition of a smaller player in the period from 2010 to 2015. This wealth manager follows a very aggressive growth strategy and exhibits the high performance that can be achieved from well-implemented M&A deals and industrialisation projects. As a result, it has established itself as a market-leading bank in the region.

Bottom Performer is a bank that opted against pursuing any transformation or consolidation strategies in the same period of time. It represents an industry player with a very conservative growth strategy and a potential candidate to be acquired by a stronger market player.

Through this comparative assessment, we could conclude that if the key M&A integration areas, as shown in Figure 1, are addressed through a comprehensive transformation strategy, APBank could have shown comparatively superior performance gains compared to the other two players. In the next few sections, we present our findings in light of the key insights on the synergy gains (AUM growth, CIR, and profitability) for APBank versus its competitors.

An M&A integration that focuses on the definition of the target operating model (TOM) of the future organisation — the enhancement of the products and services landscape, as well as the alignment of the distribution channels — leads to improved efficiency in the company’s revenue generation capability. This is observed when the asset base grows steadily after transformation, coupled with an increase in productivity of each relationship manager (RM).

For APBank, the acquisition translated into a jump of 288% in assets under management (AUM). In addition to that, the bank’s AUM growth rate during the four years after the implementation (2011 to 2015) averaged 17% per year. Although slightly slower than the Top Performer (whose assets grew at 20% per year in the same period), this growth pace was considerably higher than the Bottom Performer’s, which averaged an approximate 2% growth per annum.

The explanation for such observations lies in the front-line synergies from the acquisition, the main cause being APBank’s expansion to new markets. The bank would also have benefited from a bigger customer base and a stronger product offering, including high-yield fixed-income and structured products, estate management, and discretionary portfolio management.

In Figure 2, an alternative best-case scenario (Scenario B) could be constructed based on our estimates for APBank, where the AUM growth rate for the bank would be higher than the actual growth path. This performance could have been achieved if the bank implemented a post-merger integration (PMI) strategy based on a TOM that resulted in better target and synergy achievements. Our estimates show that AUM growth rates would have doubled from 2012 onwards due to additional benefits, such as better distribution efficiencies, resulting in higher productivity of the front-line teams (higher AUM per RM) and higher performance of APBank when compared to Top Performer.

The jump in assets also had an impact on the productivity of relationship managers. For example, the AUM per RM increased during the period following APBank’s consolidation, from USD 130 million in 2010 to USD 175 million in 2015. This meant a growth rate of 6.5% per year between 2010 and 2015. Our analysis shows that this was made possible due to the focus on integration strategies linked to better talent retention and legacy system enhancements.

Cost efficiency is the key cost synergy that private banks hope to achieve from an acquisition. It is measured as the amount required to generate one dollar of income. A transformation strategy, which focuses on streamlining processes, removing IT redundancies, and standardisation, is likely to create cost efficiencies for a bank.

Achieving economies of scale usually translates into a decline in the cost-to-income ratio (CIR) almost immediately after the transition starts and throughout the integration period.

Although APBank’s acquisition strategy was focused primarily on market penetration and gaining financial strength, the bank still managed to reduce its CIR by almost five percentage points during the five years following the acquisition, roughly from 70% in 2010 to 65% in 2015. This behaviour is explained by an increased scale in operations and the cost synergies linked to standardisation, wide distribution channels, and cross-selling opportunities.

In comparison, the Top Performer bank, pursuing an aggressive growth strategy with a focus on industrialization, coupled with inorganic growth, reached a CIR of 59% in 2015, which is a stunning gain of 35 percentage points over five years.

A “do nothing” strategy for the Bottom Performer bank, given its limited size and the conservative growth in its managed assets, resulted in the bank struggling to reduce its operating expenses during the period analysed and a CIR of 80% in 2015. This is an increase of four percentage points over 2011 levels. Cost inefficiencies and external cost pressures, such as system changes due to new regulatory requirements, can cause similar banks to operate under a very thin profitability band and makes them appealing candidates for a merger or an acquisition.

Here, again, a best-case scenario (Scenario B) in Figure 4 for APBank, would be the cost trajectory the bank would have had if it would have adopted a comprehensive TOM strategy. It is estimated the CIR would be substantially reduced, as these strategies are effective to reduce inefficiencies and have a high impact on productivity. With an estimated CIR close to 54%, APBank would have outperformed the Top Performer and experienced a higher profit margin by 2015.

When an increase in a bank’s revenue generation capabilities is coupled with increased cost efficiencies due to economies of scale, its overall profitability should also show remarkable improvement. As expected, the profit margin (see Figure 5) for APBank increased to 29.4 basis points in 2015, which is 11 points increase from the 2010 figures. Continual growth in profitability indicates that this bank, through an effectively implemented integration strategy, managed to improve its overall financial standing from its pre-acquisition state.

In summary, after analysing APBank, Top Performer, and Bottom Performer’s performance over the last few years, and looking at how they approached transformation across the key TOM dimensions (see Figure 6), we observed a direct correlation between the transformation strategy adopted by each bank and its impact on the performance.

Given the industry dynamics in Asia, it is critical for private banks to attain a minimum size in order to be sustainable. A focus on stronger revenue generation, with a wider range of products and services, lends private banks some competitive advantage to differentiate themselves from stagnant and declining players. Alternatively, pursuing inorganic growth is a more viable and impactful option for small- to medium-sized wealth management firms or private banks to remain competitive in the years to come.

Defining the right TOM for the PMI phase is part of the recipe for achieving the intended synergies set out during the deal analysis. As highlighted in our whitepaper “Next Generation Private Banking: Riding the Consolidation Wave in Asia”, a TOM is the backbone of a post-merger integration.

A target operating model addresses challenges commonly present in most M&A deals, such as changes in the organisational structure, IT capabilities, and increased product scope. It also helps to control risks by identifying areas where an integration plan is required, such as incompatible core systems, and requires management to set up plans for common issues faced during the reorganisation, like a potential talent drain and customer service impact.

With a focused approach addressing the strategic levers of change and dealing with the key TOM dimensional requirements of the target entity, the vision of a transformed bank can be fast achieved and pave the foundation towards the establishment of a brand new and focused entity with an enhanced value proposition.

The authors from Hong Kong are Salomon Wettstein, Associate Partner and Managing Director, and Winnie Lau, Associate Consultant. The author from Singapore is Samir Sultan, Manager.