Across Europe you’ve seen the starting gun fired for consolidation within its banking sector. In Spain we have already seen two major deals, with more likely to occur, which should be positive for the sector.
Similarly, for their Italian neighbours, consolidation will undoubtedly accelerate given that it remains home to almost 500 different lenders. However, it’s a case of sequencing. Banks have been focused on their own balance sheet transformation and improvement and while there is still work to be done there, we are starting to make the natural move onto consolidation.
It feels like 2020 was the year where regulators acted with pragmatism over theory and the turnaround has perhaps been greatest in the regulatory approach now taken towards M&A within the European banking sector.
While we had long been sceptics of M&A within Europe, despite the clear structural rationale, towards the end of 2019 there appears to have been a shift in tone. With banks suffering from the low interest-rate environment, increasing digitalisation costs and rising regulatory costs, there appears to have been a real push from the industry for regulators to start thinking about competition for European banks on a global basis.
Regulatory costs to M&A had always been an impediment to consolidation and in hindsight have been detrimental to the health of the whole sector, in our view. While it would be disingenuous to say it was not already on the regulatory radar, the current pandemic has accelerated the need for action on this front as the focus and need for a healthy banking system has intensified.
Structural declines in profitability driven by the interest rate environment, significant overcapacity and rising costs related to digitalisation are inherent. While the rates market remains beyond the control of management teams, removing excess capacity and unhealthy pricing dynamics, as well as harvesting cost synergies in areas such as digitalisation – which is now on average greater than 10% of banks’ cost base – is an obvious lever to pull.
Over the course of 2020, the rhetoric towards M&A in policymaker speeches moved from lukewarm to outright constructive with a willingness to facilitate consolidation from a prudential perspective. To add fuel to the fire, in July 2020 the European Central Bank (ECB) released a special consultation on M&A clarifying the ability for accounting bad will to be utilised within the capital calculation. There was also clarity around the use of internal models and Pillar 2 capital requirements, which opened the door for transactions that perhaps would have been considered uneconomic in the past.
The coming together of strategic rationale and regulatory stance for consolidation should clearly play out over 2021. In 2020 we already saw opportunistic management teams move quickly with several large transactions in Italy and Spain.
It feels like the most likely outcome will be that such consolidation is undertaken on a domestic basis where the synergies remain most obvious. That said, we would not completely discount cross-border activity. Structural impediments remain in place for cross-border M&A, making this more challenging, but in certain business lines the rationale is not completely absent, in particular with digitalisation making up an increasing proportion of the cost base.
Either way, we anticipate this M&A trend accelerating in 2021, which should prove a positive dynamic for the sector and those invested in it.