Europe’s Embattled Banks Look to Mergers as Way Out of Malaise

By Nicholas Comfort, Jan-Henrik Foerster, Steven Arons and Demetrios Pogkas

December 22, 2020, 12:00 AM EST

Across Europe, the region’s biggest banks are coming around to a stark realization: they need a radical plan to break out of a prolonged slump.

Years of negative interest rates have eroded lenders’ bottom lines. European banks have shrunk their workforce by a fifth since the global financial crisis, jettisoned unprofitable units and exited riskier businesses—to no avail. The global pandemic has heightened their vulnerabilities, driving stock prices to record lows. And the gap between European banks and U.S. rivals such as JPMorgan Chase & Co. and Morgan Stanley has only grown since 2008.

Note: Data from end of Q3 2020.

Source: Bloomberg Intelligence

Now, bank boardrooms from Madrid to Frankfurt are abuzz with talk of mergers and acquisitions that could help them exit this painful loop and create a European behemoth that can survive—and perhaps even thrive—in the post-pandemic era. While the prospect of a pan-European champion has remained elusive so far, smaller domestic deals in Italy and Spain are potentially setting the stage for more ambitious plans to reshape the industry.

Europe’s bank leaders for years have emphasized the need for transformational deals to stand out in a fragmented market that’s glutted with thousands of smaller, regional lenders. The lack of common deposit protection across the European Union and cumbersome regulations have stymied such efforts across borders.

But the accelerating slump at Europe’s banks has spurred a renewed sense of urgency, with regulators and banking executives signaling a need for change. Deutsche Bank AG has said it wants to be part of Europe’s banking consolidation when it finally takes off. At UBS Group AG, Chairman Axel Weber drafted a wish list of possible partners earlier this year. Intesa Sanpaolo SpA head Carlo Messina in November called for European banks to seek cross-border mergers.

Bloomberg News has identified eight possible deal scenarios based on interviews with more than a dozen bank leaders, investment bankers and experts who follow Europe’s lenders. Smaller, less complex deals remain far more likely to occur but this octet offers up a selection of some of the more eye-popping and transformative deals the region’s powerbrokers may be weighing.

Spokespeople for the banks declined to comment for this story.

A sharp decline in share prices at some banks has made them potential targets in any takeover attempt. Rising provisions for soured loans and trading losses have eroded the strength of several lenders. That puts firms like Commerzbank AG or Societe Generale SA in a weaker position compared with peers such as BNP Paribas SA and UBS Group AG.

Domestic deals offer the prospect of cost savings, while cross-border deals provide a path to global scale, which could also drive the idea of a European banking union forward.

“European banking M&A is red hot,” says Hyder Jumabhoy, a partner specializing in financial services M&A at law firm White & Case. “The tone and nature of discussions between potential merger counter-parties has evolved from what they were four years ago—synergies and post-merger integration are front of mind. This approach very much points toward the seriousness of discussions.”

Possible Deals that Could Shake Up Europe’s Banking Industry👆

Explore the pros and cons of eight potential mega-deals below

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Note: Potential deals based on conversations with investment bankers and experts who follow European banking. Figures not originally in dollars were converted using the currency exchange rates for the period the data relates to. Credit Suisse uses U.S. accounting principles, all other banks report under IFRS.

Chronic Struggles

Ever since the global financial crisis more than a decade ago, European banks have struggled to recover their footing. Taxpayer bailouts ushered in an era of stringent financial regulation and banks were forced to retreat from some of their most lucrative activities. Unlike their counterparts in the U.S., they’ve also had to contend with the impact of negative interest rates that’s eroded their revenue from lending.

That’s translated into a bloated cost base for Europe’s lenders, with expenses swallowing up the majority of revenue at the region’s banks, according to data compiled by Bloomberg. The average cost to income ratio for 38 of Europe’s biggest banks stood at 60% last year. At Deutsche Bank, costs outstripped revenue in 2019. At UBS, they represented about 80% of revenue last year and more than 70% at Barclays.

Note: European average reflects 38 listed banks.

Source: Company filings, Bloomberg Intelligence

Banks have responded by firing staff and closing branches to focus more on digital offerings. They’ve also overhauled businesses and sold units, taking banking job cuts announced this year to almost 70,000, the highest since 2015.

That’s dominated by HSBC Holdings Plc, which said in February that it would reduce its workforce by 35,000 as part of a plan to cut $4.5 billion of costs at underperforming units in the U.S. and Europe. Deutsche Bank is in the midst of a plan to cut 18,000 staff by 2022. Banco Santander SA reached a deal with unions this month to cut more than 3,500 jobs in Spain.

Source: European Central Bank via Bloomberg Intelligence

But the job cuts haven’t gone deep enough, and the onset of the pandemic has delayed any prospect of higher interest rates while forcing banks to boost provisions for losses on loans.

There’s no guarantee that deals will fix these structural issues. Many mergers ultimately fail to add value and financial combinations are particularly complex. Banks would still need to spend billions of euros to upgrade technology systems.

“Many deals only work if no additional capital would have to be put up,” said Philippe Oddo, managing partner of Franco-German group Oddo BHF.

However, in a move that may ease deal-making, regulators are now highlighting flexibility in how banks can account for acquisitions: the European Central Bank says lenders can use paper gains from buying competitors at a discount to pay for the cost of restructuring and cleaning up their balance sheets. Intesa CEO Messina has gone so far as to call that numbers quirk a “magic shield” for contending with bad loans in the pandemic.

The ECB also says it won’t automatically increase capital requirements at banks after a merger, although regulators would probably order mega-banks to meet a higher bar if they get a lot bigger.

The fallout from the coronavirus is another driver as weaker banks run up losses and stronger ones see an opportunity to gain market share. In 2020, banking M&A emerged from a decade-long hiatus. Deal volumes among the region’s lenders rose 27% year-on-year to $37 billion since the start of July, data compiled by Bloomberg show.

For now, the deals taking place generally involve big banks buying smaller competitors in the same country or smaller lenders merging with each other. In Spain and Italy, such deals are already reshaping the industry. This year’s biggest domestic deal saw CaixaBank SA agree to buy Bankia SA for about $5 billion to create Spain’s largest domestic lender. Banco Bilbao Vizcaya Argentaria SA sold its U.S. unit for $11.6 billion, giving it the means to pursue acquisitions of its own, while Italy’s Intesa bought Unione di Banche Italiane SpA.

“At some point we may see three to four large groups in every country with 20% market share,” said Giorgio Cocini, co-head of financials dealmaking for Europe, the Middle East and Africa at Bank of America Corp.

Europe’s Embattled Banks Look to Mergers as Way Out of Malaise

Undervalued and Underachieving

Possible Deals that Could Shake Up Europe’s Banking Industry👆

Expensive Business

Dwindling Workforce