Large bank M&A across Europe is now inevitable

Euromoney asks the chief executive of one large European bank for an outlook on the economy, likely credit losses and potential mitigants.

He expects the European economy to contract maybe 8% in 2020 – although his own economists are regularly updating their estimates in one worrying direction. The worst quarter will be the second, but social distancing will continue to hurt many businesses into the third and fourth quarters of 2020.

He hopes for a recovery starting in the first quarter of 2021.

Credit losses will be large over the next three quarters. Bank accounting and regulation have proved highly pro-cyclical, thanks to IFRS 9 in Europe and the FASB current expected credit losses model in the US. His bank’s balance sheet has not shifted but credit and market risk-weighted assets have seen huge increases, testing capital.

Consumers in Europe may not have come into this as highly indebted as those in the US, where unemployment will be much worse, but the biggest mitigant he sees against crippling hits to banks from corporate failures is government support and nationalization, starting with airlines.

How bad is it likely to get?

“There is a risk that some banks will be hit by far higher than expected losses in corporate and consumer credit. This is not a financial crisis yet. But it just takes one big bank suddenly to get into trouble,” the chief executive says.

That’s why bank stocks are trading around 0.3 to 0.4 of tangible book value. Robbed of dividends and with buybacks suspended, investors now worry about being tapped for yet more cash when common equity tier-1 ratios fall closer towards regulatory minimums.

Restructuring

Inevitably, thoughts are turning once again to what has always been the logical outcome for this industry. 

“In the short term, I cannot imagine any large bank mergers given that they involve redundancies to achieve cost savings and require regulatory approval,” the chief executive tells us, “But in 2021 and 2022 you could see a lot. It is overdue anyway. The debate will be around the involvement of those banks that by then have actual state shareholdings or de facto guarantees.”

The pandemic has changed customer behaviour. Banks that have 50% of employees in large branch networks are going to have to restructure and cut costs. Cutting costs requires raising capital. Raising capital is next to impossible at 0.3 times tangible book. Such deals will happen as part of mergers.

Many European countries still have room for domestic banking consolidation – Germany, Italy, Spain, Poland – where cost synergies might be 25% to 30%. Those deals will come first, then cross-border ones where cost synergies might be 10%. 

Governments may blanche at the brutal impact on unemployment, but it is the only way for the industry to survive.