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Higher interest rates have boosted Spanish retail banks’ profits, attracting buyers to their shares in the past year. But investors aren’t the only ones who have taken a shine to these lenders; so have other bank executives.
On Tuesday afternoon, BBVA confirmed reports that it was preparing an offer for local rival Banco Sabadell. While the industrial logic makes sense for BBVA, for the deal to add to the pro forma group’s earnings per share will require significant cost cutting.
BBVA can add scale to its Spanish business, especially in lending to smaller corporates. Nearly three-quarters of the larger lender’s revenues come from outside Spain, mostly Mexico and Turkey, according to Visible Alpha estimates.
A previous effort to put the two together fell apart in 2020. Today a combination would create the country’s second-largest bank, worth almost €70bn. BBVA may have been spurred to act by rumours that Sabadell might itself move on smaller peer Unicaja.
Southern European banks have been big winners in the sector this year. Slower than expected European Central Bank interest rate cuts combined with subdued deposit account outflows improve the outlook for net interest income. Sabadell shares are up by more than two-thirds year to date, including a 5 per cent bump on Tuesday.
But the rise in Sabadell’s valuation makes this combination harder for BBVA to justify. Assuming BBVA pursues an all-share deal, to avoid reducing its capital buffers, any obvious valuation arbitrage between the two has dissipated. Both banks now command the same valuation at just over seven times forward earnings, according to Bloomberg data.
Cost cutting is thus critical to any deal. BBVA’s expected return on tangible equity is 15.5 per cent this year or 4 points higher than Sabadell’s. The latter has a cost-to-income ratio of some 51 per cent, well above BBVA’s 42 per cent.
Regulators are likely to be supportive. In-country consolidation should improve scale leading to better profitability. This is predicated on the large overlap between the two’s domestic branch networks, estimated at about 1,200 by Barclays at the time of the last merger attempt. BBVA will need to extract cost savings equal to 15 per cent of Sabadell’s operating overheads, after tax, about €312mn this year.
Should BBVA pay much more than Sabadell’s closing price Tuesday, the deal could be dilutive to earnings. That explains why shareholders sold BBVA shares down 6 per cent. Regardless of logic, BBVA investors should carefully scrutinise any proposed price for Sabadell.
