The Wide Angle

MAY - JUNE  ISSUE NO. 6 |  Debt Business Magazine

By: Sam Theodore

Scope Insights​, UK

The case for European banks' cross-border M&As remains weak

The current story of European banks lacks drama. No surprise, then, that the market is looking for more immediate actionable narratives to create news and trading flows. Building up expectations for transformational M&A, especially in the more image-seductive, cross-border space, ticks the box nicely.

Aside from the occasional investment banking fiasco or the unveiling of yet another moneylaundering event, the European banking story is far less dramatic than in the post-GFC decade. This should be good news for credit investors: the forthcoming Q2 results are about to attest to that. Troubled-loan levels may go up when publicsector support is gradually trimmed – probably next year– but not to crisis levels. Provisions and capital will cover them in most cases. For the larger groups, resolution worries are remote. To nobody’s surprise, returns will remain subpar, but the market is getting used to this.

 

The ECB will allow bank dividends to resume later this year. In brief, for banks the pandemic crisis narrative turned out to be wrong. To be sure, banks badly need to keep reinventing themselves in the digital age and the sustainable-finance space, as well as to massively cut legacy costs including physical branches and back offices.

 

These remain uphill challenges. However, following such trends on a quarter-byquarter basis is a little like watching paint dry. Hence the market’s need for something new. Like a big cross-border M&A story. “Now that things are being sorted out and a new crisis has been avoided maybe it’s time for meaningful crossborder consolidation to resume,” reads the typical statement – from market dealers and analysts, consultants, or financial media. More than two years ago, in April 2019, the first issue of The Wide Angle expressed scepticism about the rationales for cross-border bank mergers in Europe1 . If anything, since that time those rationales have become more doubtful, and the case for value-creating cross-border M&A more implausible. Especially as the 17 months since the start of the pandemic have accelerated both the need for banks’ digital transformation and pressure from all angles to migrate to more sustainable lending and investment.

Limited cost synergies for cross-border M&A

 

The key argument for transformational crossborder M&A in Europe – put forward not only by eager market participants but also by ECB regulators – is that it would create more efficient and profitable groups. The backdrop presented is one of stubbornly weak bank profitability, especially when compared to large US counterparts. More crossborder integration, goes the argument, would lead to larger, more globally competitive, and financially stronger players. But the end-result of merging cross-border two modestly performing banks is another modestly performing bank, just bigger and plausibly more complex. Unlike in-market mergers such as CaixaBank with Bankia or Intesa with UBI Banca, effective cost synergies are more difficult to achieve cross-border.

 

There are social, political, cultural, and regulatory hurdles which would make the case for vigorous excess capacity reductions in branches and back offices – notably staff – almost impossible to achieve under normal conditions. A 20% staff reduction resulting from an in-market merger, as difficult as it is to implement in parts of Europe (like France or Germany), is nevertheless more palatable than the same reduction being the consequence of a cross-border merger. Besides, a large-scale transaction like a crossborder M&A sucks up enormous management time, effort, and resources in pursuing a move which could also be unwelcome to equity investors. It is no surprise that there are no takers for the siren song of cross-border M&A so far. 

 

The appeal of mega-transactions will likely not strengthen in the future. Because the real competitive frontier in European banking, as The Wide Angle has highlighted several times in the past, is in the increasingly open digital ecosystem. The digital advance has been driving – and is in turn being driven by – changes in customer behaviour. Short of a colossal earthquake in the digital space, it is highly unlikely that in the post-pandemic age bank customers will migrate back to branch banking on a big scale.

 

The financial landscape in which banks compete is increasingly defined by open payment platforms and channels, financial information and transaction APIs, open banking and finance, and cloud-based data storage and back offices. Which means that rather than contemplating buying or merging with the distribution and backoffice infrastructure of another large legacy bank in a different country, banks should be focusing on their own digital transformation – which invariably comes at a steep price. Not only systems and infrastructures, but also the intellectual capital to steer and improve them. It is here that senior management time, effort, and resources should be primarily concentrating. The complexity of a large cross-border transaction would be an inexcusable distraction at the wrong time.

Non-financial risks should be increasingly central for bank valuations

 

Although not yet properly reflected in the market valuation of banks (which mainly reflects financial metrics) non-financial risks are becoming key in defining the sector: digital disruption, cybersecurity, climate and other ESG, money laundering and other misconduct. This is the new reality for the banking industry, one that is not going back.

 

In this new context, the true valuation of a bank merger or takeover cannot be purely financial. Which creates very significant challenges, as non-parametric risks are not easily ascertained independently. Due diligence on a loan book is different from due diligence on the bank’s sustainable finance dynamics, cyber risks, or misconduct aspects. The former can be easier performed by audit and loan experts; the latter less so. The potential for nasty surprises on a large scale, such as a latent money-laundering situation, increases the complexity of any future large M&A deal.

Wholesale and investment banking: a candidate for cross-border partnerships

 

Within the business models of the large banking groups, there is a widening bifurcation between retail and commercial banking on the one hand, and wholesale and investment banking on the other. If there is a case to be made for crossborder consolidation, it is for the latter.

 

But bolt-on consolidation of the investment banking franchises of large universal banks is unlikely and would be highly difficult to implement. More likely in tomorrow’s world it is investment-banking partnerships that will be the avenue of choice. And because wholesale and investment banking by its nature tends to be more global, partnerships could be envisioned either within national markets, for example among large French or large Swiss banks, or cross-border.

 

Such partnerships, potentially on a division-oflabour basis taking account of specific areas of expertise for each bank, could solve the problem of critical scale in global markets. Which remains a criticism of European banks versus the larger US groups, and, probably in the future, the large Chinese banks.

About Scope Group

Scope is the leading European provider of independent credit ratings, ESG analyses, fund analyses, creating a greater diversity of opinion for institutional investors. We also offer bespoke solutions for assessing and monitoring risk.

We have approximately 250 employees across offices in Berlin, Paris, London, Milan, Madrid, Oslo and Frankfurt. Our growth strategy is focused on ensuring institutional investors have fast and easy access to accurate, comprehensive and timely financial and non-financial analysis through our innovative platforms and products.


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