THE PROPOSED MERGER between JPMorgan and Bank One has forced every bank CEO in Europe to reconsider strategy. They have a choice – to bulk up now and try to get too big for a US bank to easily buy them, or to fizzle out, either by waiting to be bought by a bigger firm or by accepting a smaller and smaller share of corporate and capital markets business.
The other strategy they can pursue is to try to make acquisitions in the US, but few have the balance sheet strength or the business model to make that a realistic goal – and the precedents are not encouraging.
Faced with this do-or-die dilemma, most seem to have decided to do nothing. As one global head of the financial institutions group (FIG) at a leading investment bank says: "If you think about the JPMorgan/ Bank One deal, in what way does it affect Europe? In no way."
In the short term, and on an operational level, this might be true. But in the long term, the growing size of US banks is alarming. "American banks are becoming really big," says Michael Esposito, managing director of FIG at Goldman Sachs. "Three of them now have over $100 billion in capital. On the European side, only HSBC can compete with that. RBS comes close with $85 billion to $90 billion." That makes acquisitions by US firms of European banks increasingly likely.
Most senior FIG bankers are reluctant to speak publicly on this topic, because these relatively small European banks are good clients of theirs, and because they work at firms that could easily become bidders or targets themselves. But they broadly agree that the growing size of US banks is very significant for Europe. "Citi can put $10 billion here and there and not lose any sleep over it," says one. "But for Barclays or Santander, it does matter. Size matters, and Europe is losing."
The same investment banker adds that recently he worked out that it was possible to buy the entire eastern European banking system for $5 billion – not a bad price to gain access to 25 million people. Citigroup's theoretically spare $10 billion could go a long way.
The best and the rest
Luckily for the heads of eastern European banks, Citigroup is not so flippant with its shareholders' money, although it is of course interested in making acquisitions that make sense.
And those acquisitions might not necessarily be in emerging Europe. "Citigroup can easily swallow a bank like Barclays or Lloyds, and these are some of the biggest names in Europe," says Vasco Moreno, head of European banks research at Fox-Pitt, Kelton. "Commerzbank and Hypo[Vereinsbank] are worth maybe e20 billion together. That is just a little over a year's profit for Citigroup."
The recent Parmalat scandal in Italy provides a further timely reminder that it is useful for a bank to have large reserves of funds available. Citigroup itself wrote off $242 million after tax from credit and trading losses related to the Parmalat scandal: that is just around two weeks' worth of profit for the bank. "Other banks are finding it harder and harder to play in that league where you have large concentrated risks," says Simon Harris, head of the corporate and commercial banking practice at consultancy Mercer Oliver Wyman.
Scandals aside, the changing nature of European corporates sets challenges for European banks that few can meet. "Companies that have $1 billion in turnover and upwards are very multinational," says Harris. "They think like global banks. Nokia is not really Finnish – it is more sophisticated than the local banks. The treasury operation of, for example, Shell, is more sophisticated than any bank's. In the face of that, European banks are suffering a steady and slow decline... We are part of the way through a decade-long squeeze. Ten years ago, Spanish companies would have dealt exclusively with Spanish banks. Now they deal with the bulky American banks."
A research report by Citigroup dated January 8 this year notes that the top 15 European bank stocks outperformed the bottom 15 by more than 50% in 2003, which empahsizes widening divergence between the best and the rest in the sector.
Given that these problems have been developing for some time, it is interesting that consolidation has not yet picked up pace, especially in the fragmented markets of Germany and Italy. Big deals are difficult to structure and execute, and they will still be difficult to structure after the JPMorgan/ Bank One merger has been completed.
Small deals will certainly happen over the next 12 months, especially involving German Sparkassen and other small privately owned banks. They might be bought by HypoVereinsbank (HVB) or Deutsche Bank, or they might band together for scale. A similar series of mergers between some of the small Swiss private banks is also likely.
In the UK, some relatively small retail banks such as Alliance & Leicester, Bradford & Bingley and Abbey National, have all been mentioned as potential takeover targets. Belgian firms Fortis and Dexia are also frequently mentioned as possible merger targets, as are Bankinter and BNL. But no-one expects any big deals soon.
National rules
Further in-market, or domestic, deals would create national champions in Europe, but they are unlikely to happen because of the competition regulations governing consumer banking in each country. In Europe, market share limits still apply at the national rather than the continental level. "In Spain, it is difficult to see how the banks can move other than to move significantly forward in another market," says one senior FIG banker. "Some of them already have north of 25% market share." Cross-border mergers in Europe offer limited cost-cutting opportunities to sell to bank shareholders and carry abundant execution risk. Alternatively, given Spanish banks' sound management and strong links to Latin America, some of them are juicy targets for US firms.
Domestic consolidation would not necessarily provide a solution to banking systems' or individual banks' ills. HVB and Commerzbank are rumoured to have been in merger talks for months, but they appear no nearer to a deal. "One is predominantly a retail bank, and one is predominantly a wholesale investment bank," continues the FIG banker. "Yes, they are both German, so they could destroy one of the head offices, but they are both in restructuring. By merging, they might add to the complexity... integration would take five years." And even if in-market mergers were approved by national competition regulators, they would be likely to be mergers of equals, which are difficult to pull off.