Arguably, every significant decision made should have one or more strategic driver and those decisions relating to buying and selling books or portfolios are no exception. So can an acquisition or disposal impact on balance sheet, costs, yield and future viability? Undoubtedly!

Balancing the Books

The ‘holy grail’ is to achieve equilibrium between both sides of the balance sheet from business-as-usual (BAU) activities. Most organisations either find it easier to gather deposits or to originate and retain lending – there are very few examples of financial institutions balancing their books effectively through these BAU activities.

In the secured lending space, for example, the organisations with a direct business and/or those who have strong relationships with brokers need access to deposits to continue to write new business. The contraction of the wholesale funding market since the near collapse and rescue of Northern Rock has emphasised that reliance on ready access to funding. Further, the closing of the Term Funding Scheme (TFS) from the Bank of England compounds the problem by restricting relatively cheap funds which financial institutions have relied upon.

Conversely, many financial organisations find it easier to take deposits through their current accounts and savings products yet have found it more difficult to lend these out. For example, Metro Bank now seem to have got close to balancing deposits and loans (£11.7MN vs. £9.6MN in 2017) but it has taken them the 5 years from launching to do so.

Acquisition or disposal of books of business can be an effective way of achieving this equilibrium without the significant complexity that accompanies the merger or acquisition of an existing business. In part one of this three part series, we analyse the market and internal drivers of book or portfolio sales/purchase.

Optimising Costs

The adoption of digital as a channel has led many firms to review their cost structure and their competencies for future success. Once again, the spotlight falls on costs that attach to legacy parts of the business model that add no demonstrable value to the organisation (and customers) and those that do.

Closed or back books can, in many cases, involve hybrid processes and additional cost to service, and lead to complexity in handling for people and existing technology.

If that book no longer positively contributes business value or towards the achievement of a strategic goal, advantages must exist in considering a disposal of the book and applying displaced effort and capital in other strategic areas that help the organisation build economies of scale and achieve balance sheet equilibrium.

On the other hand, if the financial institution decides upon a category or type of business or proposition as core to their strategic direction, then effort should be expended on identifying the most attractive books for purchase. This will reduce the marginal cost of their operation by building economies of scale and at the same time, assuming their strategic planning is sound, help achieve equilibrium on the balance sheet.

Re-deploying Capital Effectively

Good retailers and property investors know intimately the yield they get from their capital employed or sales space. Similarly, good financial services firms actively monitor their return on capital employed/invested (ROCE or ROI) and constantly look for opportunities to redeploy their capital elsewhere for a higher return. Optimisation decisions should be taken even when a book is performing, especially if better returns could be achieved by applying that capital elsewhere, operations simplified and costs reduced.

Further, best in class financial institutions are acutely aware of the cost of capital and how it differs across their various portfolios. They understand the extent to which their current book diversifies their risk - thereby affecting the overall cost of capital calculation.

Understanding the current state of capital intensity is, therefore, crucial to any firm looking to balance their books by buying or selling a portfolio. If a book that is for sale is likely to reduce the overall cost of capital by producing a significant diversification benefit then it should be considered. Conversely, if an existing book is capital intense then the sale of the book will improve the cost of capital equation.

Diversification of Risk

Best in class firms also intimately understand the risk diversity of their current customer base and liabilities, and where they fit as part of the strategic direction of the organisation. For those organisations currently specialising in one or two niche products, buying a portfolio could be a useful strategy to diversify risk without the business risk of sinking cost into markets that are difficult/near impossible to grow organically.

Further, for those businesses sitting on a number of ‘cash cow’ (high turnover, low growth) books, buying a book of higher growth-potential business can act as a shield against the risk of long-term decline.

Practical Considerations for Portfolio Acquisition or Disposal

The path of M&A is littered with successes and failures and many an organisation has enhanced or damaged their viability by a deal that has proved relentlessly stubborn to integrate or where due diligence has been insufficient (e.g. RBS acquisition of parts of ABN Amro and Lloyds Bank’s acquisition of HBOS led to the UK Government’s intervention).

Given the more contained nature of transactions involving books or portfolios, they tend, generally, to be more straightforward to acquire or sell than companies. However, in order to achieve a successful outcome for both buyers and sellers, pre-sale preparation, effective marketing and due diligence should never be scrimped on. Whilst the decision to buy or sell is one thing, executing a transaction is another.

Conclusion

Overall, two factors are combining to currently make book or portfolio acquisition/disposal a compelling strategy:

  1. Economic environmental conditions – the inability to achieve balance sheet equilibrium organically through BAU activity and the low net interest margin (NIM) environment is causing investors to optimise capital and resource deployment in order to improve their returns.
  2. Internal strategic considerations – responding to the low NIM environment, institutions are placing a greater focus on cost optimisation and removing legacy activities that do not provide demonstrable value to enhance their existing capital placements.

Next Time

In our next two articles, we will use our practical experience of book acquisition and disposal to outline the key considerations and requirements for buyers and sellers of portfolios. 

In the meantime, if you would like to discuss your balance sheet strategy in more detail, please feel free to contact us at: ewen.a.fleming@uk.gt.com or our portfolio specialist antony.watkins@uk.gt.com.