Definition of Madness: Spain Needs Bigger Banks, Apparently

Yves here. Don Quijones’ skepticism about Spain’s proposed bank mergers has sound foundations. I’d love readers to chime in with foreign market data, but in the US, the evidence is consistent that bigger banks are not more efficient than smaller banks. The real driver for bulking up is that executive pay is highly correlated with bank size and operational complexity. “Too big to manage” is CEO’s financial wet dream.

Yet banks have sold politicians on the ideas that bigger banks are desirable for competitive reasons. That’s false too. First, big multinationals are not very attractive customers from a profit perspective. They demand fine prices and operate as quasi-competitors, for instance, running their Treasury operations as profit centers. Second, they don’t believe in one-stop shopping, and deal with national banks in national markets that are important to them, because those banks are politically more plugged in than foreign banks.

But when banks get wobbly, the most expedient course of action is for regulators to merge them rather than deal with hassle and potential political embarrassment of resolving them and perhaps owning them for a long time. When the US took over then then number four bank in the US, Continental Illinois, in 1984, it was seven years before the government got out of owning it. And the banking business was a lot less concentrated then than now.

But at best, the logic of merging weak banks is like taking two sick dogs and expecting somehow to wind up with one healthy cat. And that’s before you get to factors that prevent mergers of healthy banks, such as computer system incompatibility.

Admittedly, Spain does have a lot of small banks, so some consolidation might be beneficial. But most of what is expected to happen is driven by desperation, not opportunity.

By Don Quijones, Spain & Mexico, editor at Wolf Street. Originally published at Wolf Street 

Spain’s banking sector is about to be hit by a new wave of mergers and acquisitions, according to US rating agency Standard & Poor’s. The new phase of industry consolidation will begin with the stealth merger of largely state-owned Bankia with wholly state-owned Banco Mare Nostrum (BMN).

The two banks, each the product of two madcap mergers of Spain’s most insolvent savings banks, will be merged into one entity that is expected to become Spain’s fourth biggest bank by assets. The merger is more or less a done deal, for the simple reason that besides Bankia, BMN has no other suitors and its IPO last year was a complete dud. No private sector player seems willing to even touch its assets with a barge pole, let alone buy them at a “discount”.

“Zero Synergies”

Two renowned Spanish economists, Daniel Lacalle and Javier Santacruz Cano, have already expressed serious reservations about the proposed operation. Most importantly, there are no synergies to be had, they argue, since Bankia already enjoys a strong presence in virtually all the regions where BMN is present.

“This type of operation between banks normally creates no value,” says Lacalle.

Santacruz is no less emphatic, warning that we’re likely to see a repeat of the 1999 merger between Banco Bilbao Vizcaya and Argentaria to form Spain’s biggest bank, BBVA, in which the public bank (Argentaría) was gifted on a platter to the private bank (BBV). There’s also a “very big risk” of “destroying value for shareholders.” In the case of Bankia and BMN, the majority shareholder is the Spanish taxpayer, which by now is wearily accustomed to seeing the value of its holdings destroyed as it keeps being left holding the tab for bankrupt banks’ impaired balance sheets.

Despite only being in the “study stage,” the merger has already received the blessing of Spain’s caretaker government, Spain’s central bank, and Standard & Poor’s, which has promised not to downgrade Bankia’s credit rating after it has absorbed BNM’s assets and liabilities. Now, S&P is forecasting that the tie-up will herald a whole new wave of banking consolidation in Spain, with mid-size banks mostly on the menu.

“There are a number of medium-size entities that are going to struggle to reach levels of capital returns that will be sustainable in time and in line with shareholder expectations,” said S&P’s director of financial institutions, Elena Iparraguirre. “These (mid-size) entities will need to find a solution to the problem.” That solution, one assumes, will involve finding bigger banks to be rolled into.

The financial consultancy Baker & Mackenzie has forecast 54% growth in M&A activity in Spain for 2017, much of which will be concentrated in the banking sector. Besides the Bankia-BMN tie up and the flurry of takeovers of mid-size entities forecast by S&P, there’s also the prospect of a merger between one of Spain’s four biggest banks, Santander, BBVA or CaixaBank, and its sixth biggest — and “most Italian” — bank, Banco Popular, which is fast running out of options.

Just today, the new president of Banco Popular, Emilio Saracho, an ex-JP Morgan VP, has announced that he’s preparing the bank for a merger, most likely with one of Spain’s four biggest banks, Santander, BBVA, CaixaBank or Banc de Sabadell. The inevitable result will be much greater concentration and much less competition.

The Ultimate Goal

Banking concentration was always one of the crowning goals of Europe’s banking union. The banking union legislation, passed in November 2014, included a rather innocuous-sounding proposal called the “sales of business tool,” which made it much easier for big banks to grow even bigger, by gobbling up smaller, weaker ones.

In a speech in July last year, ECB President Mario Draghi blamed much of Europe’s banking crisis on competition from the thousands of smaller banks that are crowding out the profits for the big banks, while completely overlooking factors such as the excessive complexity and interconnectedness of the banking system, the failure of the universal banking model, the zombifying banks at the top of the financial food chain, and, of course, the ECB’s negative rate policy. No, it’s all the fault of the small banks.

“Over-capacity in some national banking sectors, and the ensuing intensity of competition, exacerbates the squeeze on margins,” he said.

Since that speech, apart from the occasional shotgun marriage between struggling entities in Italy, M&A activity in Europe’s banking sector remains stagnant. Put simply, few banks want to buy or merge with other banks, for two obvious reasons:

One, they don’t have the disposable capital for such an operation. In Spain, Germany, and Italy the biggest banks (Santander, Deutsche and Unicredit) have enough on their hands trying to expand their own capital base this year to fill holes in their balances sheets.

And two, they also have no idea just how serious their rival institutions’ problems are. As the Bankia example showed, merging one insolvent institution with another (or others) often compounds their problems. Bankia was spawned in 2011 from the merger of seven insolvent savings banks, only to collapse in 2012. It’s not the only major bank to have failed after a big merger or acquisition; so, too, did the Royal Bank of Scotland after its suicidal purchase of ABN Amro, in 2007. And there’s Monte dei Paschi, which collapsed years (and multiple bailouts) after purchasing Antonveneta from Santander for an exorbitant €9 billion.

Now, Europe’s financial authorities want more of the same while ignoring the effects of further concentrating risk, power, and market share among the already too big to fail institutions at the top. By Don Quijones.

This time, the ECB is already doing “whatever it takes.” And still. Read…  Euro Breakup Rattles Investors Once Again

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  1. Hemang

    A Godsend opportunity for some to make a huge killing I guess. When they are not running stark naked straight from a 7 Star bathroom to a black hotel cleaning woman demanding copulation like Domnique Strauss Kahn, the International Monetary Fund (IMF) former head Rodrigo Rato , a Spanish banker was sentenced to four years and six months behind bars. You call it madness; they call it a kiss from the Goddess of Fortune. Banking mergers are elaborate gold winning stratagems. The earnest Catholic writer doesn’t realize that!

  2. Hemang

    And at least Rato is in jail. NOT ONE BANKER WAS SENT TO JAIL BY OBAMA. Welcome welcome President Trump. It is kind of really late sir but welcome at any rate!

      1. Hemang

        I sit in western India all covered with dust on 3 dollars a day. Did not know that about Rato. Also, Spain just does not come on the mental radar of the 9 percent growth Indian-China consciousness except as a background to Bilbao and Franck Ghery-No offence meant, it is just the distance I guess. But I wish Mr. Obama would have put some of those WASP and Non-WASP Thugs (and Thugesses) in jail in 2008-9. Which is why I have to say again:Sir It is kind of late but welcome ,welcome Donald J. Trump at any rate.

  3. Colonel Smithers

    Thank you, Yves for the post and Hemang for bringing up Rato. One wonders if the (real) reason for Rato’s abrupt departure from the IMF will ever come out.

  4. dontknowitall

    The neighboring Portuguese neoliberal prime minister Passos Coelho and his barely competent finance minister were pushing hard to hand over the troubled banking sector to Spanish banks for a trifle. During the past election concerns were raised of the effect on the country’s sovereignty of handing the entire finance industry to a neighboring nation. The new socialist prime minister Antonio Costa (first European prime minister of Indian descent) and his left coalition seem to have managed to stop the madness.

  5. Ignacio

    I believe that “competitivity” in EU-phrasing is the main driver. By competitivity, I mean reducing the number of branch offices and reducing the number of employees per branch as well. In this sense, the fact that Bankia is already present where BMN is, is a feature not a bug (you have good excuse to close more branches). The deal will also eliminate most if not all administrative positions in BMN (it is done integratively). This is done resorting to early retirements en masse (55yo) as has been done before.

    It seems to me this is another way to facilitate the transition to a cash-free world.

    STAGE1: relentlessly reduce bank branches

  6. tony

    The systems analysis community has a lot of lore about leverage points. Those of us who were trained by the great Jay Forrester at MIT have all absorbed one of his favorite stories. “People know intuitively where leverage points are,” he says. “Time after time I’ve done an analysis of a company, and I’ve figured out a leverage point — in inventory policy, maybe, or in the relationship between sales force and productive force, or in personnel policy. Then I’ve gone to the company and discovered that there’s already a lot of attention to that point. Everyone is trying very hard to push it IN THE WRONG DIRECTION!”

    Leverage Points: Places to Intervene in a System

    I think that applies to the entire Eurozone.

  7. Gman

    Aside from the obvious, I’m sure with many still unknown, legacy issues of the European banks, their biggest problem isn’t their size or numbers, but their continuing confused private/public status, all the baggage that entails and the obvious reluctance (or inability, in terms of some ‘autonomous’ EZ member states) to effectively tackle it.

    They are the bastard offspring, in both senses of the word, of the incestuous, dysfunctional relationship between the state and the private sector. The hideous outcome of which culminated in 2008 and still continues to haunt almost their every move and those of the economies they helped lay waste to with the aid of complicit, venal, expedient political establishments.

    In spite of numerous claims to the contrary, the supposed nemesis of the private sector (but ssshh, its secret lover really) the ‘dead hand of the state’ (or ECB if you’re a EZ second or third tier member), is the only thing keeping most of these apparently systemically linked ‘private businesses’ upright.

    The days of really, and when Isay ‘really’ I mean ‘shockingly embarrassingly’, easy money are mostly gone. When the golden goose stopped laying and died, these vultures just shrugged and set about the carcass.

    Nominally ‘private’ businesses acting primarily in their own selfish, shareholder interests, but under the auspices of the state and charged with the uniquely and vitally important task of money creation more or less at will for private profit, lending at little or no real personal risk to themselves, was never going to end well was it?

    Well not for most of us anyway.

  8. Edward

    This is still not as crazy as giving Wall Street $13 trillion for sinking the world economy through scams.

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