Thinning margins, depleting capital and the need for new growth sources amid the lingering pandemic may lead some Asia-Pacific financial institutions to consider mergers or acquisitions, particularly in China and Southeast Asia, analysts say, after deal activity in the third quarter fell to the lowest level in at least three years.
In the three months ended Sept. 30, there were 26 M&A transactions in the banking and specialty finance sectors in Asia-Pacific, the fourth consecutive quarter of decline, according to S&P Global Market Intelligence data. The deal count was also at the lowest since at least the fourth quarter of 2017.
Specialty finance drove deals in the region, with 22 transactions in the third quarter, the same as in the three months prior, according to the data. However, bank deals fell to 4 in the July-to-September period, down from 9 in the previous quarter and was also the lowest in at least three years.
The COVID-19 pandemic has slowed deal activity across the world. The U.S. banking industry, for example, disclosed 81 deals worth an aggregate $7.75 billion during the first three quarters, compared with 200 deals worth $47.05 billion over the same period in 2019, according to Market Intelligence data.
Deals activity may, however, pick up as the pandemic increases stress among lenders. "We believe that the forces sapping strength from Asia-Pacific banks point to possible consolidation, as they exert pressure on banks to achieve scale benefits," Joydeep Sengupta, senior partner at McKinsey & Company in Singapore, told S&P Global Market Intelligence. "The gap between the stronger and weaker banks is growing, and will likely accelerate consolidation," he said.
Most active M&A markets
China has been leading the region in terms of deal activity among both banks and nonbanks. In the three years ended Sept. 30, 42 bank deals and 97 specialty finance transactions were sealed in the world's second-largest economy.
In the banking space, the second most-active market is Indonesia, where relatively high net interest margins and economic growth have attracted acquisitions by Japanese and Korean banks, which have been battling weak growth prospects at home.
In the specialty finance sector, which includes peer-to-peer lenders and auto financiers, India clinched 91 deals over the past three years, a close second to China.
China leads the pack
China is likely to remain the hotspot for both bank and nonbank lender deals, analysts say. The Chinese economy was among the world's first to reopen after it was also the first to be hit by the pandemic in late 2019. Many small-to-midsize banks and nonbank lenders are open to buyers as they face financial crunch and escalating U.S.-China trade tensions.
Barnaby Robson, a partner of deal advisory at KPMG China, said acquisition of troubled smaller lenders by state-owned institutions, or by larger lenders with "encouragement" from the government, comprised a substantial portion of finance M&A deals in the region.
"We expect this form of consolidation to continue, and perhaps accelerate in markets where smaller lenders are increasingly becoming liquidity challenged," Robson said.
In recent years, several bank M&A deals in China involved government-affiliated buyers where state-owned entities injected capital in smaller, troubled lenders in return for equity. For instance, government-linked entities acquired 18.51% and 9.98% stakes in Harbin Bank Co. Ltd. for $1.93 billion and $743.1 million, respectively. Separately, Bank of Jinzhou Co. Ltd. sold stakes to Industrial & Commercial Bank of China Ltd. and others.
China will push for reforms and M&A among smaller lenders hit by the pandemic, The Nikkei reported in April, citing Cao Yu, vice chairman of the China Banking and Insurance Regulatory Commission. Cao also said the regulator was eager to have market involvement. In November 2019, Bloomberg reported that authorities were considering measures to address risks at small banks, which may include encouraging troubled banks to merge or restructure, after China's central bank identified 586 "high risk" banks and financial companies.
Southeast Asia will likely remain another bright spot for bank deals, thanks to attractive lending margins, loan growth potential and relatively high unbanked populations. Indonesia, in particular, fielded 22 deals over the past three years, as its fragmented banking sector attracted many Japanese and South Korean lenders.
Southeast Asia was home to most of the big-ticket bank deals during the period. The deals included Japan-based Mitsubishi UFJ Financial Group Inc.'s acquisition of PT Bank Danamon Indonesia Tbk, Japan-based Sumitomo Mitsui Financial Group, Inc.'s purchase of Indonesia-based PT Bank BTPN Tbk, Thailand's TMB Bank PCL's acquisition of Thanachart Bank PCL and Bangkok Bank PCL's acquisition of PT Bank Permata Tbk in 2020.
"Governments are also recognizing [foreign direct investment] is needed to offset weak consumption and introducing reforms and incentives to attract foreign investment," Robson said. "North Asian lenders in particular are allocating capital and eyeing opportunities in ASEAN."
Analysts expect more M&A activity involving smaller banks in Indonesia. Three Islamic banking units of bigger commercial banks recently announced that they would merge. "M&A in the banking industry, in general, will likely occur more often in the future, not only with Shariah banks," said Harry Su, head of equity capital markets at Samuel Sekuritas Indonesia. "The widening gap between the big [four lenders] and smaller banks' capital would force continued M&As in order for these smaller banks to remain competitive through the increased capital base."
"In most markets, nonbank M&A has been more attractive due to a combination of less foreign ownership restrictions and lower capital requirements, compared to banks," said KPMG's Robson. "This has increased the pool of eligible investors, including creating openings for financial investors."
McKinsey's Sengupta said banks' inability to meet strong credit demand, especially from the SME segment in India and China, makes nonbank lenders "critical in satisfying the funding needs." In addition, M&A in the nonbank space is relatively easy to execute, with less stringent regulatory approvals and lower capital requirement, he said.
Nonbank lenders are commonly associated with rising default risks, especially peer-to-peer lenders, auto-financing platforms and shadow lenders. Sengupta, however, said rising credit risk and nonperforming loans in the nonbank lender segment are actually favorable for M&A activity.
"Restructuring and consolidation are common when the financial industry is going through major credit cycles," he said, noting that smaller players are likely to be under severe financial and regulatory pressure, whereas established lenders will seek inorganic growth opportunities in such an environment.