By Jan Bellens, EY Global Banking & Capital Markets Sector Leader

In light of the anticipated global economic slowdown triggered by the COVID-19 pandemic, banks are adopting a range of strategies to shore up their balance sheets, stay connected with customers and prepare their organizations for the ongoing impacts.

The good news is that most banks were on solid ground heading into 2020, with relatively strong revenue and capital levels at record highs, though many faced profitability pressures. Since the pandemic hit, banks have been instrumental in distributing relief and have set aside capital to protect themselves against losses from bad loans, as well as supporting employees to work remotely. It is  yet to be seen if banks reserved sufficiently; this will become clear once government subsidies around the world have ceased and foreclosures resume.

Looking ahead and preparing for a more stable market, banking leaders recognize the need to strengthen their business through investment. In addition, they are focused on sustaining the organization’s financial strength, boosting operational efficiency and expanding their digital capabilities.

Rebalancing their portfolios through strategic divestments is one way banks can achieve this set of objectives. The results of the latest EY Global Corporate Divestment Study – an annual global survey of C-level executives from large companies in financial services and other sectors – confirm that banks view divestments as a powerful strategic lever for these unprecedented times. This year’s study was originally conducted in late 2019 and then augmented by an online survey of 300 executives following the onset of the COVID-19 crisis in May 2020.

Why banks are divesting

There are several reasons banks undertake divestments, including financial security and exercising the freedom to invest. Preserving liquidity and shoring up the balance sheet are certainly priorities. However, banks also divest to raise funds to invest in their core business, a driver cited by 70% of banking and capital markets (BCM) survey respondents.

Another common motivation for divestment in today’s landscape is the need to invest in stronger digital capabilities and modernized technology. These investments are critical because the constraints of outdated technology limit operational efficiency and banks’ ability to deliver rich and personalized customer experiences. The COVID-19 pandemic has placed a premium on such capabilities. It’s no surprise, therefore, that 43% of BCM survey respondents say they are likely to divest to fund a new technology investment in the next 12 months. Of course, the large price tags associated with the most advanced tools and technology may facilitate more divestments.

Other factors come into play, such as so-called “addition by subtraction” strategies, through which banks look to unload distressed or underperforming assets. Just more than half of survey respondents say they’re more likely to divest business units that deliver suboptimal returns on capital, while 41% expect the number of distressed asset sales to grow in the next 12 months. Such sales can present shrewd buying opportunities, which helps explain why 43% of banks expect to see more buyers from outside the banking sector over the coming months.

The role of private equity and responding to activist pressure

In regard to external buyers, many private equity (PE) companies are now actively looking toward banking sector deals. Some of the most successful PE-led deals to date were borne out of executing on very complex and messy carve-outs from banks. However, today’s deals are likely to be more elaborate than the simple disposals from banks that occurred during the last global financial crisis of 2008. Buyers may need to conduct more extensive due diligence to find attractive targets and to build strong business cases for disposal.

Based on an analysis of the Global Corporate Divestment Study survey results and EY teams’ experience in the market, it is likely that PE will consider businesses that are currently embedded within banks, such as wealth and asset management, asset servicing, insurance and payments businesses. Future deals may also involve software, technology and regulatoary technology businesses, for which banks are both the primary user or customer, as well as being the asset owner.

While PE activity is on the rise, activist campaigns have been stalled by the pandemic. More than half of respondents (57%) say they are less likely to divest due to activist pressure in the next 12 months than they were pre-crisis. However, it is likely that the appetite for change will return to normal levels of intensity before long. The attention of activists within the banking sector will turn to underperformance and poor management, including in businesses where such shortfalls were highlighted by the pandemic.

Activists will perhaps be more ambitious than before. Though their investment rationale can differ from one target firm to the next – agitating for divestments of noncore assets – underperforming businesses and even breakups to drive shareholder value have long been key objectives.

The question for banks is, as always, how to best respond to activist pressure? The first step is to formulate and articulate a clear strategy with detailed timelines, objectives and rationales for exiting a business or proposing a new business structure. Banking leaders can also set out a road map and timeline for business improvements, even if they do not necessarily address the issues highlighted by activists. Indeed, strategies that aim to simplify banking activities and explicitly focus on the needs of the customer base are generally well-received by the market. Such value creation strategies are also useful for positioning assets to generate the right price – an increasingly significant consideration given the growing gap between buyer and seller expectations. The survey highlights just how banks try to secure an optimal price. Typically, the top two priorities are the ensuring quality of the management team in the business (49%) and optimizing the asset’s legal structure (41%), which could mean separating it partially or fully.

COVID-19 crisis set to accelerate divestment planning

It is important to note that banks were closely examining their portfolios even before the crisis hit. A full 90% surveyed in late 2019 by EY claimed they review their portfolios more frequently and more closely than in previous years. Similarly, at the beginning of the year, 61% of respondents reported major divestment plans within the next two years.

In May, however, that number rose to 87%, with 60% pushing their divestment plans into the next 12 months. It is clear that the COVID-19 crisis has made divestments an even more important part of banks’ resilience and growth strategies. The implication is that divestment plans are likely to be accelerated by the COVID-19 pandemic, though a number of delays in deal making are to be expected.

The upshot should be another round of robust divestment activity, potentially including large, transformational carve-out deals. The financial crisis of 2008 resulted in both mandatory and voluntary divestments that were relatively easy and obvious to identify. This crisis, combined with ongoing digital and cost challenges, will mean banks need to think much harder than previously about what assets are core and noncore. Leaders will have to make far more profound strategic decisions around what sort of bank they want to be in the future, and how easy that transformation will be to execute.

The Global Corporate Divestment Study survey results make clear that more divestments are likely on the way. They also provide some insights into how banks can make use of divestments, as they seek to reorient and even accelerate their transformation agendas to become more digital, agile and resilient. In this sense, the COVID-19 pandemic means divestment is no longer just part of the management toolkit for banks, but a strategic imperative as well.