Asia is abuzz with M&A activities in the banking sector with these becoming increasingly frequent since 2013. Last year, US$23 billion worth of M&A deals were announced or completed in this segment versus just about US$8.4 billion in 2012 and US$9.3 billion in 2011, Thomson Reuters data show. In the first eight months of 2014, the volume of M&A in the banking sector totalled US$14.67 billion, up from US$13.52 billion in the same period of 2013.

The revival of activities indicates the industry has finally stabilized after the global financial crisis, with more clarity achieved on the new Basel III regulatory regime. It also shows that gaps in valuation expectations between potential buyers and sellers have been reduced to some extent, thus making more M&As possible.

“In the years after the financial crisis, sellers were still looking for pre-crisis valuations but buyers think that with the new Basel III regime and higher capital requirements, they can no longer afford to pay that kind of price-to-book multiples as the return on capital now is not the same as what they could get pre-Basel III regulation,” says Willard McLane, Asia-Pacific head of financial institutions at Citi. “They have to book almost twice as much capital against the investments than they used to, pre-Basel III era.”

For example, when Singapore’s OCBC Bank acquired Hong Kong’s Wing Hang Bank in July 2014, it paid 2x adjusted price-to-book multiples. Yue Xiu Group, the trading arm of China’s Guangzhou city government, in 2013 paid a multiple of 2.08x to buy Hong Kong’s Chong Hing Bank. By way of comparison, when China Merchants Bank acquired Hong Kong’s Wing Lung Bank in 2009, it paid a price-to-book multiple of 2.91x.

Following customers

One of the key reasons driving cross-border M&As in the region is the Asian banks’ growing need to expand their presence overseas in line with the internationalization of their local customers. Ten to 15 years ago, most Asian corporates were primarily locally focused and were looking at their banks to provide domestic services. This has now changed as Asian firms require banking services across different markets. Many of these corporates are still at initial phases of their overseas expansion.

McLane: Chinese banks taking very thoughtful approach to acquisitions

Cross-border M&As such as Japan’s Bank of Tokyo-Mitsubishi UFJ acquiring Bank of Ayudhya in Thailand; Sumitomo Mitsui Banking Corporation (SMBC) of Japan taking a 40% stake in Indonesia’s Bank Tabungan Pensiunan Nasional (BTPN) in 2013, or OCBC buying up Wing Hang Bank in Hong Kong earlier this year are examples of banks growing their regional presence to make sure they capture their clients’ business flows in overseas markets.

Chinese banks have been at the forefront of this trend, with some of the mainland’s largest banks such as ICBC and China Construction Bank in recent years acquiring smaller banks both in developed and developing markets as they follow their local clients abroad. Some of these acquisitions have been driven by the banks’ interest in gaining product knowledge and footprint in areas where they miss these values.

“The Chinese financial sector is expected to go through significant reforms in the coming years. One of these reforms is interest rate liberalization of deposits which could put substantial pressure on banks’ net interest margin. As a result, there is increasing focus to further develop capabilities that generate non-interest income,” says Michael Woo, head of Greater China financial institutions group (FIG) investment banking at Bank of America Merrill Lynch.

ICBC’s purchase of a controlling stake in Standard Bank’s London-based commodity, rates and currencies business earlier this year was driven by the Chinese bank’s need to expand its trading capabilities to provide additional services to its customers expanding abroad. ICBC bought 50% of the business for US$755 million and has the option over the next five years to increase the stake by another 20%.

Indeed, ICBC has been most active and consistent among its domestic peers in pursuing overseas assets. It has expanded its international presence over the years, buying assets in multiple markets since it made its first move with the acquisition of 20% in Standard Bank in 2008. In 2012, it took control of Standard Bank’s Argentinian arm while last year, it bought a 75.5% stake in Turkish bank Tekstil Bankasi for US$316 million.

Likewise, China Construction Bank in 2013 completed the acquisition of a 70% stake in Brazil’s Banco Industrial and Commercial Bank for US$725 million as it sought to capture the flows from local customers expanding in that region.

While Chinese banks are expected to continue looking for opportunities to buy overseas operations, market observers reckon they will be taking a more systematic approach to acquisitions than they did during the pre-financial crisis period.

“Chinese banks will continue to look for bank assets outside, but in a measured sort of way,” notes Steven Sun, chairman of FIG at UBS. “They have got their hands full at home from the perspective of needing to raise capital for Basel III and having enough liquidity and from the fact that they are probably wrestling with an increasing number of problem loan situations. From a strategic point of view, Chinese banks do have an interest expanding overseas. But I would say for the next couple of years, they would be very measured in their approach. I would expect to see Chinese banks’ [overseas expansion] activities to continue but not expect it to turn into a big flood of activities.”

McLane at Citi agrees. “Chinese banks are taking a very thoughtful, systematic approach to acquisitions now. Before the crisis, there was a little bit of unpredictable element to Chinese banks’ M&As. There were lots of rumours about what they were going to buy. That stage is over. Now they really are focused on building out their global footprint in the markets where their customers are active. Asia will be a big part of that, but also selectively other markets like Brazil and some of the key financial centres of the world. On a market-by-market basis, they are evaluating the best approach for entry. In some cases, it will be just setting up the branch, for example, in the US, Europe and the Middle East. In other markets, where that is not possible or they would like to have a bigger presence, they will do an acquisition. I don’t think they are at the point of doing huge acquisitions even though they are capable of that. They are more interested to build a regional footprint that gives them enough scale to service their customers.”

Aspiration for national supremacy

Another key driver behind some of the recent bank M&As has been governments seeking to create national and regional banking champions in their markets to take advantage of the growing integration among economies in the region.

It is particularly true for the Asean region where the proposed Asean integration expected to kick off by the end of 2015 has led governments and some domestic banks to look for opportunities to such champions. “Each market wants to make sure that before the integration takes place, they have built up some degree of national champions. This is the theme and it can be a bit contagious. When one a country does it, others follow,” remarks McLane.

Malaysia’s CIMB Group’s latest proposition to merge with smaller rivals RHB Capital and Malaysia Building Society (MBSB) is an example of such a deal, which if it proceeds, will create a financial powerhouse in Asean. At about US$190 billion of asset size, the merged entity will surpass Maybank as the largest bank by asset size in the country, and the fourth largest bank in Southeast Asia (See box).

Likewise, in Indonesia, dialogues have been going on about possible mergers and expansion of state-owned banks.

With an overbanked situation in Taiwan – about 62 local banking players are currently operating in that market – talks of a possible consolidation of government banks have been ongoing, with a view of creating banks that have sufficient scale to internationalize. Despite the regulators’ push for some time to initiate alliance, progress has been slow.

However, China Development Financial Holding’s (CDFH) US$760 million acquisition of mid-size commercial bank Cosmos Bank earlier this year is expected to trigger the long-awaited consolidation of the banking industry. The deal has set the stage for other foreign private equity buyers looking to exit their loss-making investments in Taiwanese banks.

The agreement involved PE players SAC Capital and GE Capital selling their respective stakes in Cosmos to CDFH. SAC owned 57.09% and GE Capital 22.52% while China Development Industrial Bank, a subsidiary of CDFH, had 6.77% of Cosmos prior to the deal.

In 2006-2007, several foreign private equity firms acquired substantial stakes in Taiwanese banks, hoping to use them as a gateway to the China market. For example, TPG Capital has a 24% stake in Taishin Financial Holdings; Temasek Holdings has 15% of E.Sun Financial Holdings; The Carlyle Group owns 37% of Ta Chong Bank and The Longreach Group has a 51% interest in En Tie Commercial Bank. However, most of these investments have been under water, with stocks trading below the purchase prices at which the PE buyers acquired the stakes in these banks before the onset of the global financial crisis.

Apart from GE and SAC, only TPG Capital has managed to exit its investment in Taishin Financial. The sale of Cosmos – in which sellers had to agree to sell at a loss and the buyer bought the target at a premium to its book value – has paved the way for other PE firms to make their exits, and kicked off the consolidation, market observers say.

“Local banking consolidation will happen in Taiwan. It does not make sense to have 62 banks operate in such a small island. But consolidation is never easy. It involves agreements by buyers and sellers as well as the labour unions of these banks. It is an on-going process. I believe we will see one or two transactions in the next one or two years,” notes a local banking expert.

It is not just domestic consolidation; local authorities are also encouraging some of the big Taiwanese banks to go outside the country to look for acquisition targets.

Some of Taiwan’s large financial holding companies eyeing other markets in Asia as well as the country’s regulators have been supportive of banks’ expansion overseas.

While much of the focus for Taiwanese banks and financial institutions has been emerging markets of Southeast Asia, CTBC Bank, formerly known as Chinatrust Commercial Bank, early this year went to an uncharted territory and in the process raised some eyebrows with its takeover of a second-tier local bank in Japan, a market that is struggling with stagnant growth. The US$542 million acquisition of Tokyo Star Bank is nevertheless seen to indirectly boost the Taiwanese bank’s expansion strategies in the rest of Asia. CTBC, which has 80 networks in the region, plans to use Tokyo Star’s over US$19.3 billion of customer deposits’ base to grow its network in other Asian economies.

Difficult proposition

India is another market where consolidation talks among domestic banks, in particular state-controlled banks, have been going on with little progress. Calls have been made to the new government to push for public sector reforms through consolidation among state banks.

However, it is generally viewed that it will take some time before such meaningful consolidations in India can happen due to the subsequent complexities resulting from such mergers. “There have been discussions about it. But the politics and the culture in India don’t support the kind of challenges and difficulties that banks have to go through when they consolidate,” says an FIG specialist. “Unless there is some strong pressure coming from some source – whether this be commercially driven pressure – or political or shareholder pressures, I don’t see this being very active any time soon.”

Indeed, merging government banks is never easy and requires careful consideration on what the strategic focus of the merged entity will be. “One thing about government bank mergers is sometimes there are too many government banks and everyone agrees there should be fewer of them. But they need to make sure that there is some kind of strategic focus to the combined government banks afterwards. Slamming them together does not always make sense. What is the focus or the policy rule – is it an SME bank, community-focused bank, etc., that is more important than having big banks that have no clear purpose? As much as you just want to merge them together, you should be sharpening their strategies and definition to make sure they have clear purposes and corporate advantages,” says McLane.