Will private equity bank on rising interest rates?

German real-estate financier Aareal Bank is the latest quoted lender to have attracted PE interest. The company confirmed earlier this month that it was in takeover talks with a group of financial investors including Centerbridge, Advent and TowerBrook – though the latter is said to have since dropped out.

The volume and total value of PE funds' acquisitions of European banks has fallen in recent years, Dealogic data shows, but the sector continues to attract sponsors' attention. Take Cerberus's acquisition of HSBC's French retail operations via the former's portfolio company My Money Group, and JC Flowers' and Bain Capital's minority investment in The Co-operative Bank earlier this year.

The investment case suggests more deals like Aareal may be ahead. Besides gaining control of its coveted software unit Aareon, sponsors can acquire Aareal's banking business at roughly half its book value, given that public investors continue to see risks in the bank's loan portfolio even as net interest income rises.

Selection of completed/ongoing deals in 2021:

Date	Target	Acquirer	Vendor	Deal value (EUR m)
Oct 21	Aareal Bank	Centerbridge; Advent	n/a	n/d
Jun 21	HSBC French retail banking business	Promontoria MMB (Cerberus)	HSBC Holdings	1
Oct 21	N26 (10%)	Coatue Management; Third Point Ventures; Dragoneer Investment Group	n/a	776
Mar 21	Starling Bank	Fidelity Management & Research;  Qatar Investment Authority; Millennium Management; Goldman Sachs Growth Equity; Railways Pensions Investments	n/a	375
Apr 21	Co-operative Bank (10.01%)	Bain Capital Credit; JC Flowers & Co	Assured Guaranty	n/d

Source: Dealogic

Bank on it
A higher-interest-rate environment over the life of the investment might just be the cherry on top, a sector adviser said, if central banks tighten monetary policy in response to inflation. Driven by higher rates, the prospect of higher profits after years of lacklustre performance should whet other sponsors' appetites.

Banks tend to benefit from rising interest rates by increasing the yield on interest-bearing assets like mortgages and business loans. Following the financial crisis, policymakers resorted to low and even negative rates to help the economy at the expense of bank margins. For instance, the European Central Bank's (ECB) deposit facility rate, which determines the interest paid to banks for depositing cash with the ECB, has been in negative territory for a number of years to encourage lending.

The ongoing increase in prices as the pandemic recedes has revived talk of higher rates. The Bank of England could be the first to tackle inflation, with chief economist Huw Pill suggesting a decision in November. Market watchers expect the ECB to take longer to raise rates. Nevertheless, this should be no problem for PE funds buying in now and holding an asset for several years.

Moreover, Europe's banking industry is ripe for consolidation thanks to its endemic fragmentation and the opportunity to cut costs via tie-ups.

Deal them in
Even as listed banks continue to trade below book value, their share prices are recovering from the impact of Covid-19, with the Euro Stoxx Banks Index up 37% this year, according to data from Fidessa.

Lingering uncertainties weighing on bank valuations create buyout opportunities, and challenger banks' growth stories may also woo private capital. Recent decisions by banking regulators to lift dividend curbs mean lenders can now return excess capital to their shareholders or allocate it towards growth.

In the UK, TSB could come back on the block after parent Banco Sabadell confirmed over the weekend that it had rejected an approach by sponsor-backed Co-operative Bank. Meanwhile, challenger GBB told Mergermarket in July that its targeted GBP 95m equity raise had attracted PE-type funds.

Thinking bigger, Germany's Commerzbank – which has Cerberus among its top shareholders – could become a takeover target if its ambitious restructuring efforts bear fruit. This would be a big bet for private equity, but perhaps less so for an established competitor.

With data by Jonathan Klonowksi and Santosh Shetty

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