As European banking consolidation boldens, new challenges emerge – Moody’s

A new trend is emerging in the European banking landscape as evidenced by the recent flurry of cross-border consolidation in Europe, the size of the deals — the acquisition of ABN Amro, if successful, will be the biggest in history — and the increased assertiveness of shareholders, says Moody’s Investors Service in a new Special Comment on banking consolidation in Europe.

The creation of the Euro has not led to as much cross-border banking consolidation as initially anticipated, although there has been much more consolidation in Europe than generally perceived — and a notable recent acceleration in such activity.

“Indeed, Europe now has one of the highest levels of foreign banking ownership in the world compared with other large regions,” says Cailleteau, Senior Vice President and co-author of the new report.

Many of the forces driving this development are not Europe-specific — nor are they specific to the banking world — but it seems that the obstacles to large cross-border transactions in Europe are fading away.

“As with other sectors, the ‘urge to merge’ has delivered uncertain benefits, with ‘in-market’ consolidation proving to be generally more successful than cross-border operations,” says Cailleteau. However, Moody’s notes that M&As are gradually becoming better managed.

According to Moody’s, the main question raised by the accelerated reconfiguration of national banking industries in Europe is whether consolidation is credit-positive and specifically whether — and to what extent — size matters in determining a bank’s financial strength.

Moody’s professes some agnosticism in this regard. On the one hand, consolidation can bring with it risks and challenges; on the other, smaller but well-focused and disciplined banking franchises can attain very high ratings.

“In sum, a key issue is whether consolidation is based on sound economic rationale or simply reflects a circular strategic game — where banks become predators simply because they do not want to become the prey,” explains Cailleteau.

“The rating outcome of banking consolidation is generally positive for the acquired entities and neutral to mildly positive for the acquirers,” says Henry MacNevin, General Manager of Moody’s Milan office and  co-author of the report. Overall, in-market consolidation in particular is viewed more positively from a longer-term perspective, adds MacNevin. From a rating management standpoint, Moody’s believes that the immediate financial impact must be weighed against this positive long-term potential, especially in cases where consolidation is backed by strong management and strategy.

The complex relationship between consolidation, stability and competition leaves ample room for regulatory interpretation, say Moody’s new report.

Although Moody’s believes that the intervention of regulators in cross-border deals has in general — albeit not always — reflected reasonable concerns, the rating agency notes a strong trend towards limiting this room for interpretation. “Regulatory reluctance is going to be increasingly ineffectual,” notes Cailleteau.

“Looking ahead, more consolidation in Europe is likely in future, both domestically and across borders, and it is also likely to become bolder in scope,” predicts Cailleteau. Moody’s notes that this may generally be credit-positive, despite the now obvious diminishing returns in terms of creditworthiness.

The report also concludes that a trend towards re-segmentation may emerge in the European banking industry, along the lines of a dominant consolidation model, and would bring with it new challenges, such as execution risk.