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By Rochelle Toplensky 

For the first time in years, European bank mergers look to be more than a tantalizing mirage on the horizon.

Last week, Turin-headquartered lender Intesa Sanpaolo secured the investor support needed to buy local rival Unione di Banche Italiane, or UBI. The hostile deal was announced just before Covid-19 went global and was hashed out through the lockdowns. The merger will create the eurozone's second-largest bank by market value, after BNP Paribas, even though Intesa agreed to sell over 500 branches to midsize rival BPER Banca to satisfy competition authorities.

Investors and top bankers have long wanted industry consolidation in Europe -- particularly cross-border tie-ups -- to help diversify risk, build scale, boost profitability and compete with better-funded Wall Street players. But deals have proved elusive, running up against a patchwork of national rules, increased capital requirements for bigger banks and domestic politicians' interest in having a local lender to foster homegrown companies.

That just might be changing. Intesa-UBI, though an all-Italian affair, is the region's first big acquisition not borne out of financial distress in many years. If it proves successful, other lenders might consider similar moves. The European Central Bank has made clear its support for tie-ups and even laid out its supervisory approach.

That still leaves plenty of national banking rules to complicate cross-border deals and sap potential cost savings. While European Union members' finance ministers have made some progress toward creating a banking union, they are now focused on the pandemic.

Historically, though, it is in times of crisis that the EU changes. Its unexpected agreement last month to issue EU-level bonds is a case in point. These are a "game-changer," says Nicolas Veron of the Peterson Institute for International Economics. With the EU now willing to raise its own financial firepower -- even if it insists the Covid-19 recovery package is a one-off -- markets are more confident that the eurozone is here to stay. That EU-level debt also muddies the link between banks and their country, the so-called bank-sovereign nexus, which made it hard to create a true pan-eurozone lender.

There is no shortage of potential targets. European bank stocks are cheap: The Stoxx Europe 600 bank index trades for less than half of book value, and eight constituents for less than a third. Some lenders will also become distressed following large loan losses because of the Covid-19 pandemic -- British, Norwegian and EU banks face a combined hit of up to EUR830 billion, according to consultant Oliver Wyman. Some governments are still trying to figure out how to get rid of the bank shares they acquired in the global financial crisis.

There may also be willing buyers. European lenders have plenty of capital, for now, and mergers are an obvious answer to the pressing question of how they will boost profits in a world of ever lower interest rates. Private equity could emerge as a left-field consolidator. Regulators have allowed it to buy up some smaller regional banks -- Blackstone bought Baltic Luminor Bank in 2018 and Lone Star acquired Portuguese Novo Banco in 2017.

To be sure, the consolidation wave might not appear. Lenders have helped their home-market governments out in this year's crisis and politicians may want to keep them local. It remains difficult to assess the value of a bank and its loan book until government support programs roll back to reveal customers' true creditworthiness. And finding the right match is always tricky.

Still, Intesa's successful bid is a sign that deals can happen even in unlikely circumstances. BPER Banca's purchase of UBI branches hints at an appetite for deals, and UBI management's unsuccessful defense against the takeover prompted other Italian banks to seriously talk about tie-ups.

Banking consolidation is clearly feasible within Italy and other European countries. Cross-border deals are far less certain, but at least some stars seem to be aligning.

Write to Rochelle Toplensky at rochelle.toplensky@wsj.com

(END) Dow Jones Newswires

August 07, 2020 07:45 ET (11:45 GMT)

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