In our previous article, we described the key market and internal business drivers that are combining to make portfolio sale and / or acquisition an important strategic lever for many financial institutions looking to achieve balance sheet equilibrium. These include:
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, removing legacy activities that do not provide demonstrable value. They are also using portfolio sale and / or acquisition as a lever for diversifying their current customer base and liabilities.
In this article, we will explore the core considerations for sellers in order to avoid an interminable game of whether the price should be ‘higher or lower’, which can cloud judgement and strategic thinking (we will look at buyer considerations in our next article).
If you are an organisation thinking of selling a portfolio, the following requirements should be top of your actions list:
Create the ‘Sale Story’
Establish a Minimum Valuation
Identify Potential Buyers
Conduct Vendor Due Diligence
Establish Deal Structure & Process
Plan for Separation and Integration
1. Create the ‘Sale Story’
Why is the portfolio for sale? What are its main strengths and features? What benefits and growth opportunities would acquiring the portfolio generate for the buyer? Why will the prospective buyer flourish when the seller wants out?
In order to maximise value and reduce the risk of being perceived as a ‘fire sale’, the above points need to be clearly articulated and reinforced to the prospective buyers throughout the sale process. This can be achieved by producing a formal Information Memorandum or a short-form briefing pack.
Our experience shows that the number of attractive offers received is positively correlated to the quantity and quality of information provided at all stages of the sales process.
2. Establish a Minimum Valuation
A seller should establish its minimum acceptable valuation ahead of going to market by using a combination of methodologies.
One way for sellers to establish a minimum valuation for a portfolio is by reference to its carrying value (the value of the portfolio found on the balance sheet). Selling below this value would lead to a loss on disposal. A potential pitfall of this approach, however, is that the carrying value may be out of date and not a reflection of a portfolio’s true market value.
An alternative approach is for the seller to perform some kind of run-off analysis, which can entail calculating the present value of all estimated future cash flows generated by the current portfolio. This is arguably a more ‘scientific’ approach than using the carrying value and, once indicative offers are received, should help influence a seller’s decision as to whether to sell now (and at what price) or retain and collect money from the portfolio over time. However, there can be practical difficulties in establishing and agreeing the key assumptions behind the cash flow forecasts.
Finally, sellers should aim to benchmark their minimum valuation against valuations paid for similar portfolios (although this information is not always easy to obtain) in order to sense check that they are in line with prevailing market pricing.
3. Identify Potential Buyers
Who are the most likely buyers and why? Who has been buying what recently, how often and at what price?
Some form of deal precedent analysis, combined with market intelligence, is likely to throw light on possible buyers or buyer groups. In addition, it is also important to consider the reasons why an organisation may want to acquire a portfolio and use this insight to develop the list of potential buyers and the best prospects.
Typical reasons for a buyer acquiring a portfolio include:
- Acquisitions may offer instant growth, market share and balance sheet equilibrium
- Strategic fit for growth, diversification or specialisation ambitions
- Access to new customers and markets (e.g. home owners, mortgages etc.)
- The potential for cross-selling opportunities
- Product or geographical expansion / diversification (e.g. a non-performing loan acquirer seeking to acquire performing loans)
- The opportunity to develop a ‘buy and build’ strategy in a specific market or niche
A buyer seeking one or more of the above is more likely to pay an attractive price to acquire a portfolio.
4. Conduct Vendor Due Diligence
The seller’s preparation of some form of legal, regulatory or financial Vendor Due Diligence (VDD) report ahead of going to market could create significant benefits for both the buyer and seller. Not only should the VDD report facilitate the sale and due diligence process, it also helps to identify and resolve potential issues with the portfolio before a sale process goes ‘live’.
5. Establish Deal Structure and Process
Sellers must also consider the mechanism by which they will sell the book / portfolio. Running a structured auction process often provides the best prospect of maximising value and is less risky. However, ‘off-market’ / bilateral transactions can be much quicker.
This is a key trade-off that the seller must consider – is speed more important than maximising value (or vice versa)?
6. Plan for Separation and Integration
The seller must also determine the level of difficulty associated with separating the portfolio from their business. On the other hand, they must also consider the ease of integration into a potential buyer's business.
A review of how and where the portfolio is embedded in the current organisational design will be key to understanding ‘current state’. This will inform the level of effort required to de-couple the portfolio and the integration design requirements (e.g. IT infrastructure requirements, governance process requirement etc.).
These transitional arrangements demonstrate a degree of understanding of the operational challenges associated with the portfolio sale and should provide confidence to prospective buyers.
Consideration should also be given to any potential knock-on issues from the sale, including regulatory, tax or people (TUPE) issues.
Whilst portfolio sale is currently a compelling strategy, sellers must not rush into it without paying consideration to Grant Thornton’s six key requirements for selling portfolios. Doing so could diminish value and leave the business open to considerable operational, reputational and regulatory risk.
In our next article, we will explore the key considerations and actions for buyers 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: email@example.com or our corporate finance specialist firstname.lastname@example.org.