European banking M&A gathering pace

Yesterday lunchtime, BBVA announced that it had approached the management of Banco Sabadell, to explore a possible merger between both entities, with BBVA also appointing advisers for this purpose. For some context, BBVA is among the largest banks in Spain with a market cap of around €60bn and total assets of €802bn as at 31 March 2024. Sabadell is a mid-tier player in the Spanish market, with additional exposure in the UK, with a market cap of around €9.5bn (pre-headlines) and total assets of €236bn. A potential merger of both entities would strengthen BBVA’s SME franchise in the Spanish market and rebalance its reliance away from Mexico, towards Europe.

To be clear, a BBVA-Sabadell tie-up is still to be agreed and there are always lots of hoops to jump through before the deal is finalised. That said, the latest development follows similar transactions in the UK; Nationwide (total assets of £275bn) acquiring Virgin Money (£92bn), and Coventry Building Society (£62bn) pursuing acquisition of Co-op Bank (£28bn). Considering these transactions have come to fruition only in the last several months, we would risk a conclusion that we are seeing an accelerated trend of consolidation within the European banking space.

In our view, consolidation of the sector can only be seen in a positive light for bank creditors, with acquiring institutions enjoying increasingly strong profitability (and equity valuations – as we highlighted in our previous blog) in the higher rates environment, and looking to consolidate their market shares in their local jurisdictions. Indeed, none of the transactions that we have seen so far stretch the acquirers beyond their means or lead to banks venturing outside of the area of their expertise. We see this as a clear distinction to European bank consolidation in the past, which often happened across the national borders and/or where retail banks extended themselves into investment banking activities. In our view, execution risks associated with these current deals will be low.

We would also note that, all else being equal, higher concentrations within respective geographies should lead to stronger profitability of the remaining players. The exit of smaller institutions that still report profitability below their cost of equity (as evidenced by their equity valuations) reduces the number of vulnerabilities in each banking sector and further strengthens its stability.

Finally, we would note that the latest transactions have come from a position of strength, rather than weakness. This is a clear distinction to the deals we have seen in the aftermath of the Eurozone crisis, e.g. Intesa buying failed Veneto banks with government assistance or Santander acquiring resolved Banco Popular. European banks have been beneficiaries of recent higher base rates; following a period of single-digit returns under low base rates, return on equity for the European Bank Index stocks returned to 11.1% in 2023. It is expected to remain >10% over the next two years, which is the forecast horizon. Issuers therefore have strong capacity to support financing these transactions out of recurring profitability and existing excess capital.

Looking ahead, we would not rule out further transactions in the European banking space. We continue to believe that M&A within the borders carries low execution risks, reduces the number of competitors in the banking sector, and therefore structurally improves profitability of the remaining banks. These fundamental considerations should continue act as a tailwind to the sector valuations, including those of Additional Tier 1 instruments.