What European banks need before mergers can save them

European banks must revolutionise their business models – even the European Central Bank recognises this now.

In new draft guidance, the ECB signals it won’t stand in the way of mergers, including cross-border deals in the EU. This is at a time, moreover, when hope in Europe’s united future is surging, thanks to the €750 billion EU recovery fund.

One big merger is already under way: the continent’s biggest bank takeover for a decade. Intesa Sanpaolo’s €5 billion bid for local rival UBI Banca is raising hopes, at the very least, of more mergers in Italy’s fragmented banking market.

But are would-be M&A advisers and financial journalists getting ahead of themselves?

“I’m not quite sure Covid will speed up domestic M&A as well as cross-border M&A,” warns Jean Pierre Mustier, chief executive of UniCredit, and president of the European Banking Federation, during a Euromoney Livestream interview in July.

Weak confidence

The UBI deal might not trigger a wave of immediate mergers. Deals are unlikely to happen without a lot of government support – in part because of a lack of banks that are confident enough to take on the costs and risks of a takeover now.

As Mustier says: “If you have two banks which are weak, and you put them together, you create a weaker bank.”

The UBI deal, notably, involves two unusually strong Italian banks. That’s why it has caused controversy in Italy. It leaves weaker Italian mid-tier lenders without partners. And it was launched on the eve of the coronavirus crisis, not after it.

Strong European banks were rare enough before the coronavirus, and the sector is now facing a big and extremely unpredictable spike in bad debt. Oliver Wyman’s base case is for €400 billion in credit losses over the next two years, with the bad-debt ratio doubling to 8% in France, for example.

The consultancy’s guess is that another continent-wide lockdown would bring Europe’s banks credit losses to €800 billion.

Any European bank that might launch an attack at the moment would be doing so when it has precious little idea of the health of its own loan book, never mind that of its inevitably weaker target, which could be hiding all sorts of bad new and old credit decisions, and desperate investments, about to turn sour.

With Intesa now unable to do more deals due to competition-law barriers, and with UBI gone as a rival bidder, the tie-up could help French banks to get better deals on acquisitions in Italy. But it is even harder to be confident of a target’s balance sheet abroad, especially when the country is poorer than yours and with a worse governance reputation.

Domestic relevance

The ECB’s draft guidance, published earlier this month, is most relevant for domestic deals, as they’re more likely to result in cost-saving synergies.

It also seems like an attempt – at least partly – to undo the harm to M&A that was done by asking for a €1 billion capital raise before greenlighting the Banco Popolare and Banca Popolare di Milano merger in Italy in 2016.

As a European institution, the ECB is naturally keen to see the single market in banking made real via mergers. But neither this nor the EU’s new fiscal solidarity makes any difference to the nitty gritty of national regulatory differences in banking in the eurozone.

The ECB’s main message, in any case, is just that it won’t impede deals.

Supervisory board chair Andrea Enria is not encouraging mergers, but saying it is up to the market to decide. Bank CEOs may well decide mergers don’t make sense, and wisely so.

Any lender will certainly need government support to take the plunge on Italy’s fourth biggest lender, Banca Monte dei Paschi di Siena, which the Italian state needs to sell by next year. 

Bigger banks also have to worry about the Financial Stability Board’s capital add-ons for banks of global systemic importance.

Recent rumours in Italy of a tie-up between UniCredit and Banco BPM are “fantasy”, according to Mustier.

Perhaps more importantly, he’s been so insistent on a “no M&A” mantra that this must also rule out, at least for now, an acquisition of Germany’s Commerzbank. The German lender is the big European bank in most urgent need of fixing – ideally through a merger.

Investor concerns

UniCredit always comes up in European bank M&A discussions, as it is the only bank with big operations in more than one large economy (Italy and Germany). Yet things would need to change immensely for it to move on Commerzbank, for example.

Partly due to Covid-19, UniCredit is in no position to take on such an undertaking from a position of strength. It has much more work to do improving its own efficiency and valuation.

Diego de Giorgi spent many years trying to sell European bank M&A at Goldman Sachs, then Bank of America. 

Now non-executive director at UniCredit, he admitted in another recent online panel discussion just how little interest European bank investors have in ambitious long-term growth strategies like M&A, dominated as they are by value investors, hedge funds and index trackers.

This investor base has already nudged Mustier and others to focus more on capital returns. 

That may be for the best, but the ECB’s post-Covid dividend ban – presently of uncertain end date – makes it even harder for private shareholders to stand by European banks, especially in their riskier projects.