The CaixaBank-Bankia merger in Spain is an example of domestic activity driving the M&A market in the banking and payments sector. (Photo by Pablo Blazquez Dominguez/Getty Images)

M &A activity in the banking and payments sector started to reheat in late 2020 following a collapse in the number of deals as a result of the Covid-19 pandemic. However, it is the domestic consolidation that is driving this increase in deals, with cross-border investment deals still relatively small, partly due to their complexity and the numerous regulations involved.

Indeed, figures from GlobalData reveal that cross-border activity accounted for only 26% of the deals that took place over the third quarter of 2020. The data shows that there were 153 deals, worth $10bn, in the third quarter, up from 141 ($7.4bn) in the second quarter and 165 ($8.9bn) in the first.

The potential impact of the EU’s banking union

Credit rating agency Scope states that prospects for cross-border M&A in general are improving, although it “continues to be sceptical in terms of the cross-border bank mergers, but sees the possibility at least on paper of more attractive financial rationales”.

Progress on banking union in Europe, which would see barriers to cross-border M&A lifted, could mean the banking landscape will look very different in a few years from what we see today. EY

However, Scope adds that “the completion of the banking union [within the EU], including a functioning deposit guarantee scheme that would support the logic of such deals and encourage more cross-border risk sharing, seems to be moving glacially”.

Indeed, EY seems to share the same view about the positive influence of the banking union on cross-border deals. It says: “Progress on banking union in Europe, which would see barriers to cross-border M&A lifted, could mean the banking landscape will look very different in a few years from what we see today.”

However, the head of Germany’s Federal Financial Supervisory Authority, Felix Hufeld, told business newspaper Handelsblatt that the completion of a banking union in Europe along with the establishment of a joint deposit protection scheme is not a precondition for cross-border bank mergers. Nevertheless, he added that high levels of complexity is a key reason behind the current low number of M&A deals.

Eyes on domestic bank consolidation

Despite the uptick in cross-border M&A on a global level in both value and volume during the third quarter of 2020, it still compares poorly when compared with domestic M&A, and it is this activity that has driven the recovery in the banking and payments M&A market.

Figures from GlobalData show that there were 588 deals in banking and payments at a global level during the third quarter of 2020, up from 540 in the second quarter, but down from 651 deals in quarter one. In terms of the deal value, it amounted to $61.6bn in the third quarter, up from $47.6bn in quarter two.

The Investment Monitor analysis shows that 74% of the deals that took place in the third quarter were domestic, amounting to 83.8% of the deal value that was invested over the three months. This demonstrates that domestic M&A activity and consolidation has become something of a trend amid the pandemic for investors looking to reduce costs and generate economies of scale.

“We think the drive to consolidate domestically is supportive for credit,” said Marco Troiano, analyst for Italian and Spanish banks at Scope, in a press release. “It improves the banks’ market positions and pricing power and allows a faster reduction of costs. It also allows greater economies of scale in IT investment and innovation.”

On top of that, GlobalData reports that within banking and payments M&A activity, “domestic consolidation remains an agenda for regulators for reducing costs, with the CaixaBank-Bankia merger in Spain being a notable example of that. Reduced operational expenditures will also help in weathering the Covid-19 impact. Meanwhile, this challenging period offers opportunities for cash-rich buyers to benefit from distressed valuation”. Other examples of domestic takeovers include Intesa Sanpaolo acquiring UBI Banca in Italy in the early months of 2020.

Southern European banks’ rise on the radar

Rating agency Scope states that the current focus on banking M&A activity in Europe falls on Spain and Italy, which are “countries with fragmented banking markets and large branch networks, where the cost benefits and the strategic sense of consummating domestic tie-ups have sparked a frenzy of activity and speculation about how the long-overdue process of consolidation will play out”.

On top of that, EY finds that another factor behind this consolidation is a concern over profitability, particularly among the weaker banks in Europe. “This has been exacerbated by the rise of non-performing loans as a result of Covid-19 and a recognition that investments in digitisation and a more fundamental transformation need somehow to be funded and accelerated,” says the EY website.

Figures from GlobalData highlight that Europe was second in terms of deal activity in the banking and payments sector in the third quarter of 2020, recording 158 deals with a value of $13.9bn, with North America experiencing the highest M&A activity in the sector. Indeed, North America recorded 253 deals worth $33.7bn in this period, with Asia-Pacific in third with 137 deals worth $12.5bn. There were 27 deals in the Middle East and Africa, and 16 deals in South and Central America.

With financial services investors looking to waterproof their investments amid the Covid-19 pandemic, it would seem that M&A activity is being used to cut costs, transform distressed assets and increase operational efficiency. However, delays to any banking union in Europe as well as the complexity of cross-border deals explain the dominance of domestic deals as the appetite for consolidation gets larger.