Bank M&A makes sense – except to the owners

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: CHUNT@EUROMONEY.COM

By:
Published on:

If everyone else is keen on consolidation, why aren’t shareholders?

merge-road-sign-300
Banking is different. Any normal industry stuck between weak revenues (banks have been hit by negative interest rates and subdued loan demand) and rising costs (complying with all those new regulations, overhauling legacy IT systems and building new digital capabilities) would be consolidating like crazy by now. 

Scale is the answer. 

But the provision of financial services is fragmenting as new fintechs and other challenger banks continue to appear. 

The nominal annual value of global M&A across all industry sectors peaked in 2007 at $4.5 trillion and then ran at half that level from 2009 to 2013 before recovering to its former peak in 2015 –albeit still below the 2007 level as a percentage of global GDP. But banking missed the invite to this party. 

Global banking M&A values peaked in 2007 at $300 billion, with cross-border deals counting for more than half that. In 2017, banking M&A deals amounted to just $45 billion, according to Dealogic, with most of those being purely domestic transactions.

Even in-market deals are few and small. Germany still has 1,643 banks and credit institutions. Italy has 569, France 422 and Spain 207, according to the ECB.

With returns on equity generally below cost of equity and cost-to-income ratios high, banks should be merging to secure cost synergies. They haven’t, partly because management teams at potential acquirers have been distrustful of the true state of non-performing loans they might be taking on at weaker targets whose lower share price to nominal book value ratios might be warning signals rather than invitations to bid. 

Could this be about to change, however?

The ECB and the Single Supervisory Mechanism have been pressing banks to quickly recognize and fully provision new NPLs emerging from the start of this year, partly to remove one big obstacle to industry consolidation. 

Before Christmas, the ECB published an interview in Público with Danièle Nouy, chair of the supervisory board of the ECB, in which Nouy seemed to be urging bank management teams to take on the complexity and risk of doing M&A deals, saying: “I think that with growth returning and with the huge amount of work that is being done in relation to non-performing loans, we are going to see a number of mergers taking place within countries and across borders.” 

Nouy waved away national protectionist instincts. “I think that the euro area has to be and has to see itself as a single jurisdiction. That is why, in my opinion, cross-border mergers within the euro area are the way forward, and I doubt that politicians would have a negative view of such developments.”

Potential targets

Rumours have swirled in recent months of BNP Paribas or UniCredit or Deutsche Bank making a play for Commerzbank. Standard Chartered is often mentioned as a potential target. ABN Amro is often talked of as a consolidator. KBC, Natixis and Mediobanca have all discussed reserving portions of excess capital for potential bolt-on acquisitions.

Analysts at UBS say they now expect consolidation among European banks to begin towards the end of 2018. 

Analysts at Citi agree, arguing that: “Improving fundamentals, macro strength and line of sight on capital requirements mean that it is time for European banks to consolidate in our view. We expect domestic consolidation first, followed by cross-border in the medium term.”

So, with regulators urging bank management teams into action and talking up Europe as a single market rather than a set of discrete national economies from a competition perspective, and analysts now hoping to tease a bid premium into valuations, there’s only one group left to convince. 

Euromoney suspects that shareholders will have little appetite to support new capital raises to finance M&A deals that might not be earnings accretive for two or three years. Aside from worrying about asset quality, investors are likely to focus on the difficulties for two big banks in integrating ageing IT infrastructures. 

Those investors who have stuck with banks through the tough times now want to see dividends or share buybacks – that’s the prospect now supporting bank share prices – not bold dashes for share by acquirers in new markets.

And here’s the final problem – history tells us that banks are not typically very good at managing large-scale M&A. Consider just about any of the potential consolidators today and you could point to its involvement in a previous acquisition or sale that never came close to delivering the synergies or benefits that its proponents claimed at the time. 

The last big rush to M&A in the banking industry was fuelled by low capital requirements and high leverage, and presaged the global financial crisis. The banking industry is in a very different place today. But it will be a brave chief executive that bets his future on a transformational acquisition, even if strategic logic dictates that would be the best move forward.