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UK banking sector to face consolidation amid financial, digitalisation pressures

  • Challenger, mid-tier banks struggling to differentiate
  • Barclays, HSBC among potential buyers
  • European banks choose to pay dividends over acquisitions

The UK’s banking sector is expected to see consolidation driven by financial and digitalisation pressures, industry bankers told this news service.

This comes after Nationwide Building Society made a GBP 2.9bn cash bid for Virgin Money [LON:VMUK] last week. The rationale behind the proposed 220 pence per share offer is largely around the benefits of scale, Mergermarket reported.

The need for scale to offset the cost of high capital requirements, regulatory burdens and shareholder returns, is a theme for a number of players in the UK’s banking landscape, which are struggling to be profitable, two sector bankers said.

“The UK has a surprisingly large amount of smaller, challenger and mid-tier banks, with many struggling to differentiate themselves from each other,” Mark Crowhurst, Director at Baringa, said.

The Nationwide/Virgin Money announcement last week could point the way for consolidation of the smaller players as larger players look to distinguish their offering and technology in the wake of digitisation, he said.

Many retail banks are facing an ongoing struggle to break into business banking, for example. Nationwide Building Society had previously tried to accomplish this organically, but last week’s deal shows it has decided to achieve it by acquisition instead, one sector banker said.

Challenging times

Banks globally have pursued large-scale changes in an attempt to capture the benefits of digitisation, Stephen Barrett, Director of Research at Cavendish PLC, said.

“The market is changing so quickly that banks are having to increase spending to transform digitally, resolving core bank complexity from the merger of different businesses and systems, and competing on different client interfaces, all at the same time, which doesn’t really work and makes it hard to respond to changing client needs,” Barrett said.

Traditional UK-based banks could acquire challenger banks to gain access to their technology and thus make their digitisation efforts more effective, a second industry banker said.

Digital success is also driving new business models in banking, from output to outcome-driven customer engagement, and more M&A as incumbents are increasingly looking to partner with fintechs, Barrett noted.

Many challenger banks, similarly to fintech firms, have strong new technology offerings. Challenger banks, however, lack scale, which is driving the need to consolidate, Barrett said.

But one of the main obstacles to more M&A has been the continued burn level of the companies that are selling themselves, Barrett said. Companies pursuing acquisitions have become more mindful of the amount of capital they would need to put into the business before it achieves its objectives, he explained.

Neobanks could be acquired by incumbent banks and vice versa, however, traditional players do not want to dilute their profits when acquiring less profitable challenger banks, a third industry banker agreed.

Neobanks, such as Monzo and Revolut, could seek a more fruitful niche as technology suppliers to incumbent banks rather than competing directly with them, the second banker said. Earlier this month, Monzo raised USD 430m at a USD 5bn valuation and became profitable at the end of its 2023 financial year – a key milestone in its journey, the group said in its annual report.

The third banker expected Monzo to continue growing independently ahead of an IPO.

Meanwhile, Revolut, whose spokesperson told Mergermarket that the company is not looking to revive IPO plans anytime soon, was reportedly looking to make acquisitions in the BNPL (buy now pay later) fintech space.

Bidders and targets

Most European banks are capital-constrained and suffer from depressed valuations, and thus have been building up capital and using it to pay for dividends or share buybacks rather than acquisitions, a fourth banker said.

Last year, Credit Suisse was taken over by UBS [SWX:UBSG] for CHF 3bn (USD 3.2bn) in an all-stock deal. This was an emergency takeover, which made sense because it was done below book value, the banker said.

Meanwhile, following its exit from its US and Canada businesses, HSBC [LON:HSBA] might be among the buyers for UK-based businesses, the third industry banker said. HSBC could find a logic in acquiring Standard Chartered [LSE:STAN], the fourth banker agreed.

Smaller deals, however, are more likely in the sector with few buyers with both the appetite and firepower to execute significant deals, the banker said, pointing to Tesco‘s [LON:TSCO] GBP 700m sale of its banking operations to Barclays [LSE:BARC] as an example of the type of transactions more likely to take place.

Barclays would benefit from buying other businesses and ramping up in retail banking to shift away from investment banking to make it a more balanced business, this banker and the third banker said.

In November last year, local media reported that Metro Bank [LON:MTRO] entered exclusive talks to sell a GBP 3bn residential mortgage portfolio to Barclays.

Some European banks, for example UniCredit [BIT:UCG] and BNP Paribas [EPA:BNP], or large US-based players, might also have the capacity to and see the logic in acquiring UK challenger banks, the fourth banker said, adding this would depend on their appetite for UK assets.

When it comes to potential targets, Banco Sabadell‘s [BMAD:SAB] TSB could be next in line, a fifth sector banker said.

The current incarnation of TSB was created from Lloyds Banking Group’s sale of UK retail branches in the aftermath of the financial crisis when the UK government stepped in to rescue the bank, though TSB’s heritage dates back to the 1800s. Today’s Spanish owner might want to exit the UK operations to focus on its own region, the third sector banker said.

OSB Group [LON:OSB] is also a potential target, the third banker said. Virgin Money is being acquired at P/E multiple of about 8x, while OSB trades at forward looking price-to-earnings ratio of 4.6x and 4.2x for FY24 and FY25 for year ending 31 December, according to data provided by Fidessa* and compiled by FactSet.

Metro Bank has been talked about as a target for a long time, but its number of branches with long-term leases and low profitability might have deterred buyers, the third banker said. Metro Bank previously received multiple takeover approaches from Shawbrook Group, a UK-based savings and lending provider, that were all rejected, according to local media reports in October last year. In the same month, Metro Bank’s new controlling shareholder Jaime Gilinski Bacal told local media that it is looking for acquisitions itself.

Metro Bank was not the only business that Shawbrook looked to acquire last year, as it also submitted a revised merger offer to The Co-operative Bank in October last year.

Meanwhile, Shawbrook is reportedly in early stage IPO explorations after its owners Pollen Street Capital and BC Partners previously abandoned sale or float plans in 2022.

With its strong performance and BC Partners and Pollen Street Capital having held Shawbrook since 2017, it would be “natural to be considering exit options”, with an IPO viewed as most likely “given the history and profile of the business”, a source familiar with the situation noted.

Despite signs of life in European IPOs, the market conditions are not yet considered ideal for such a listing, this source added.

HSBC, Barclays, Revolut, OSB, Shawbrook, Pollen Street Capital, BC Partners, and Standard Chartered, declined to comment. Banco Sabadell, Monzo, Metro Bank, and UniCredit, did not respond to requests for comment.

*ION Analytics and Fidessa are ION Group companies