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Europe Banking-Union Dream Sparks Dealmakers’ Animal Spirits

Europe Banking-Union Dream Rekindles Dealmakers’ Animal Spirits

(Bloomberg) -- With European banking mergers at their lowest on record -- and profits slumping -- politicians are finally getting more serious about the need for consolidation.

German finance minister Olaf Scholz is seeking to persuade European colleagues of the need for a banking union. He called publicly last month for a deposit insurance system that works across the region, a necessity for cross-border deals because it would make it easier for banks to take deposits from one market and lend in another. He’s now lobbying fellow ministers on its merits, and while his proposal has run into opposition, the bare facts are by now so bad policymakers find them hard to ignore.

The volume of European bank acquisitions has slumped even as top executives acknowledge the need for fewer players across the continent’s fragmented banking landscape and governments seek healthier lenders to boost growth. Profitability is a fraction of that at Wall Street rivals, and even with stock markets near records, shares of many large lenders are languishing. Add to that the fact that several European governments are still stuck with big holdings in their banks that they want to sell.

“The attempt by Scholz to break the deadlock and move the project forward is certainly a welcome development,” said Andreas Lindh, co-head of JPMorgan Chase & Co.’s financial institutions group for Europe, the Middle East and Africa. “There’s clearly a degree of frustration around the lack of progress on the banking union.”

While moving deposits across borders is only one of the outstanding hurdles to make deals more feasible, a move toward a common deposit insurance plan would be a clear first major step at stimulating deals. European countries have different rules for money laundering and financial products, and banks can’t consolidate capital or treasury functions at the holding level.

Europe Banking-Union Dream Sparks Dealmakers’ Animal Spirits

Unlike the U.S., Europe’s banking sector didn’t see large-scale consolidation after the 2008 financial meltdown. Post-crisis regulation was designed to prevent lenders from becoming too big, so European lenders cut back their investment-banking operations and exited businesses that consumed too much capital.

Fast forward ten years, and European bank CEOs still find themselves under pressure -- now not because of capital, but due to profitability. Ultra-low interest rates, regulatory costs, ongoing restructurings and the need to replace aging technology systems are all weighing on earnings. Deutsche Bank AG is cutting 18,000 jobs and has said achieving some of its targets will be challenging. Italian rival UniCredit SpA plans to cut about 8,000 positions.

Weak Returns

“Given negative interest rates and subdued growth, it will be difficult for banks to remain profitable through traditional banking activities,” said Giorgio Cocini, Bank of America Corp.’s co-head of financial institutions advisory in EMEA. “Regulatory constraints have so far been an obstacle to pan-European consolidation, which would be in theory a most natural outcome.”

Any move toward consolidation could benefit ailing German lenders, which are among the region’s weakest. European banks’ return on equity was 6.1% in 2018, lower than their pre-crisis levels and worse than the double-digit figures boasted by their U.S. rivals. German banks’ return on equity is only 2.4% -- just ahead of Greek lenders, which posted negative returns. Deutsche Bank earlier this year ended merger talks with domestic rival Commerzbank AG.

In theory, consolidation could help banks to diversify funding and boost scale while cutting costs and becoming more efficient through combining technology systems. Hurdles include the higher capital requirements that larger banks have, as well as investors’ reluctance to pour more money into banks after their share prices have already fallen so much.

ING Groep NV and UniCredit both looked at potential bids for Commerzbank after the talks with Deutsche Bank broke down in April, Bloomberg News has reported. Another deal that’s been mooted is a combination of Societe Generale SA and UniCredit, which have both improved their capital buffers, reduced non-performing loans and exited businesses across Europe.

French Strength

BNP Paribas SA -- one of the strongest European banks to emerge unscathed from the convulsions of the past decade -- could also eye expansion. It has already benefited from Deutsche Bank’s weakness, taking on about 1,000 of the German lender’s employees who cater to hedge funds.

“We see the French banks as possible consolidators as they have strong capital bases and are looking for geographical and product reach,” said Patrick Sarch, a partner handling financial-services M&A at law firm White & Case LLP. “Merging a strong and a weak bank would make the weak one stronger.”

There have been flirtations with large-scale M&A before. Sweden’s Nordea Bank Abp wanted to buy state-owned ABN Amro Group NV in 2016, though the idea was nixed by the Dutch government. Earlier this year, UBS Group AG briefly explored the idea of a merger with Deutsche Bank.

Most of the deals currently being pursued are less ambitious, focusing on areas like custody services and joint ventures in investment banking or asset management. On Thursday, Nordea announced it will buy SocGen’s Nordic leasing business for 575 million euros ($639 million).

Analysts have also flagged the possibility of domestic consolidation between mid-market lenders in countries including Italy and Spain.

Seeking Scale

Instead of megadeals between the biggest European lenders, a more likely scenario is a large bank from one country taking over a domestically-focused national champion in another market, said Basil Geoghegan, a partner at PJT Partners who advises financial institutions on strategy.

“It’s already hard to keep up with current regulation. Doing large-scale M&A would make things even more difficult,” Geoghegan said. “What I see is a deal where, say, a French bank buys a big position in, say, Spain and then keeps on adding to this platform.”

Domestic consolidation is already starting in many major European markets and could be a key driver of M&A volumes in 2020, according to at least half a dozen dealmakers. Bankers expect more mergers in the U.K. among challenger banks, which saw the last big deal in 2018 when CYBG Plc bought Virgin Money.

In Germany, DekaBank -- the asset manager of German savings banks -- and Helaba, the Landesbank for the states of Hessen and Thuringia, have initiated merger talks.

Big Catalyst

Any transactions that happen could finally allow European governments to exit their holdings in the banking sector. Spain owns a stake in Bankia SA, while the German government holds more than 15% of Commerzbank. ABN Amro is partly owned by the Dutch government and Royal Bank of Scotland Group Plc by the U.K.

Still, there’s a lot of work to do before the investment bankers and CEOs get their way. The idea of joint deposit insurance is seeing pusback from northern European countries concerned they’d have to prop up struggling banks in the south. Scholz’s proposal for stricter rules on sovereign debt holdings, which would hit Italian lenders particularly hard, is also facing resistance.

A move forward on the banking union could be a big catalyst for the sector, making it easier to retain talent, fund transactions and build operational scale in areas like consumer finance, according to BNP’s Jean-Sebastien Dietsch.

“It’s a matter of size. European banks are very small on a global basis,” said Dietsch, who heads BNP’s financial institutions corporate finance practice in EMEA. “Once capital is fungible across Europe, it gives you economies of scale, and that gives you more options.”

--With assistance from Alexander Weber, Birgit Jennen and Marion Dakers.

To contact the reporter on this story: Jan-Henrik Förster in London at jforster20@bloomberg.net

To contact the editors responsible for this story: Dinesh Nair at dnair5@bloomberg.net, Ben Scent, Dale Crofts

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