Moody’s decision to downgrade 26 Italian banks on Monday should set off a wave of mergers and acquisitions (M&A) activity, as soaring mid-tier banks’ funding costs heap on the pressure to consolidate, according to analysts at Nomura.
The ratings agency’s downward revision of the country’s banking system saw UniCredit’s long-term debt rating fall by one notch to A3 and Intesa Sanpaolo’s rating cut to A3 from A2, in addition to 24 downgrades, including mid-cap financials.
Moody’s cited “adverse operating conditions, which are likely to cause further asset quality deterioration, earnings pressure and restricted market funding access”. It added: “These risks are exacerbated by investor concerns over the sustainability of the Italian government’s debt burden, which has contributed to the difficult wholesale funding conditions faced by Italian banks.”
The move was largely in line with market expectations, hot on the heels of Moody’s downgrade of the sovereign on February 13. The average (un-weighted) deposit rating (Ba1) for Italian banks and the average stand-alone credit assessment (Ba2) are now at the lower end of the ratings spectrum compared with other large western European banking systems.
In a report penned on May 1, analysts at Nomura argued credit downgrades could prove a catalyst for a consolidation of Italy’s popolari, or cooperative, banking sector. Historically, a one-person one-vote system combined with the need for central bank approval for the transformation of popolari banks into joint-stock companies have shielded these institutions from hostile bids. However, market forces – specifically rising funding costs, poor capital generation and increased reliance on the European Central Bank – have reinforced the logic of business mergers, the bank argued.
New banking landscape
The report painted two merger scenarios – more as a case study rather than a baseline projection. In the first case, a merger between mid-sized financials UBI Banca and BAPO would be value-accretive for shareholders, with a projected 9% return on tangible equity (ROTE) for the merged entity in its second year compared with 7.4% for UBI on a stand-alone basis.
In the second scenario, an all-share merger between Banca Popolare di Milano (BPM) and Banca popolare dell''Emilia Romagna (BPER) – which was proposed in 2007 and then rejected by the BPM board, citing corporate governance concerns – would deliver an 8.2% ROTE for the new institution in its second year compared with 7.6% for BPER.
It’s not clear if in-sector consolidation will kick in given corporate governance laws, whether large caps will drive this consolidation and if – as has been the case in Italy, historically speaking – any M&A premium will exceed the net present value of synergies arising from the associated merger.
However, one thing is clear: the gulf in profitability between the largest and smallest banks is growing with as much as a 420-basis-points gap in the ROTE in favour of the larger institutions, according to Nomura calculations.
