Robert Cronin is an Analyst at Carraighill

At Carraighill we have previously written about the need for consolidation in Spain (February 2019 and August 2019). For many years, its market has been over-banked with significant branch overlap amongst peers. RoEs are already too low and NII will be difficult to grow organically. The ten year Spanish sovereign currently yields <20bps and as we outlined in The Long View, banks in Spain retain over 80% of their overall securities balances in domestic issuances. Additionally, 12m Euribor has fallen by an additional 24bps since May. Positively, NPLs have substantially reduced in recent years. The scale of cost efficiencies from potential consolidation is significant. Owing to capital constraints we have long viewed share swaps as the most likely path, and Caixa Bankia gives credence to this. 

This theme of necessary consolidation is also relevant across Europe. Pressure on bank earnings from persistently low rates is reducing banking income across the region. In Spain, net income of the bank will fall by 20% to 71% over the medium term. Both organic cost takeout and in-market consolidation are required to limit RoE erosion. The former is now expensive (particularly in Germany for instance) while the latter remains politically difficult in the current environment. If neither happen and current rates persist, consensus earnings for all Spanish banks will fade each year. 

A landmark deal 

The proposed Caixa Bankia merger, announced on 3rd September, is a landmark deal which creates the new largest bank in Spain. It will overtake Santander in loan market share and whether it succeeds or not will influence the prospect of similarly large mergers across Europe. In announcing this so soon after COVID-19 struck, Caixa has established a first mover advantage. Completion of a deal removes Bankia from the list of potential acquisition targets for other large Spanish banks, leaving Sabadell, Unicaja and Liberbank as the primary options left. The pressure is now very much on banks like Sabadell and BBVA to address their structurally low/ unsustainable domestic returns and a combination of these two banks seems more probable in our view. 

In our report, we value the combined entity using our Carraighill Three Bank Analysis. We separately value the Banking & Insurance, Securities and Investment businesses and aggregate these to establish a fair value of the new entity. 

1.        A new dominant domestic playe

The combined Caixa Bankia entity will comprise one quarter of loans in Spain, overtaking Santander with the current largest market share of 17%. This topples Santander from its long-held number one position. The market cap of the entity following a combination will be >€16bn. We believe a merger is a necessary step in bolstering returns for both banks. This will be achieved primarily through cost takeout, which we address below. 

Analysts vary with regards to expectations of revenue accretion or attrition from the merger. We have assumed attrition for reasons outlined in the report. Further, we address the impact of the merger on Caixa’s overall loan mix along with it’s return profile. 

2.        Benefitting from cost takeout

Caixa and Bankia operate in similar regions within Spain, offering significant scope for branch and hence headcount reduction. Bankia has excess capital, particularly following the announcement of approval to credit risk models on its mortgage book. By carrying out the merger by way of a share swap, Caixa will free up this excess capital and use it in a number of ways. The majority will be deployed for cost takeout. We explore this alongside nuances associated with such a sizeable cost takeout. 

3.        And with reduced share overhang from the government (FROB/ BFA). 

Having owned >60% of Bankia, FROB (Fondo de Reestructuración Ordenada Bancaria)/ BFA (Banco Financiero y de Ahorros) will own <16% of the larger combined entity, This will significantly reduce the share overhang risk associated with government ownership. 

Caixa and Bankia are expecting the merger to be approved in early 2021 following on from their upcoming shareholder meeting in November and upon completion of due diligence and the necessary approvals from government. 

Interested in knowing more? 

Our detailed view on investment implications of the merger is available to Carraighill subscribers. If you would like to access this report, Carraighill Research Access enables you to access this and other thematic and sectoral research reports through our secure online portal. If you would like to speak to a partner or analyst on the topics raised in this piece, you can contact us here