The European Central Bank (ECB) has just published the final version of its guide to mergers and acquisitions. In this document, it states that it is prepared to recognize the amount of badwill presented to it. Badwill corresponds to negative goodwill arising from a bank reconciliation. This technical announcement could have significant financial consequences. For further information.
What is "badwill"?
Badwill allows an acquirer to book a profit if it pays its target less than its book value. Normally, this situation is rare, as buyers usually pay more than book value. However, it could become commonplace, as the banking sector has suffered particularly badly on the stock market. At the end of October 2020, Société Générale's valuation was down 64%. Similarly, the stock market index including British banks such as HSBC had reached its lowest level since 1991. Since January 2020, it had fallen by 43%, far more than the Euro Stoxx 50 (-14%).
As a result, the Covid-19 crisis has had a definite impact on bank valuations, creating uncertainty about earnings and asset quality. A balance sheet worth 1 can be bought for 0.5. From now on, the buyer is entitled to pocket the 0.5 difference, corresponding to badwill. This profit can be used to finance the operation, cover restructuring costs or strengthen shareholders' equity.
Facilitating bank mergers
In the final version of its January 12, 2021 guide to consolidation, the result of a consultation initiated last October, the ECB sets out its expectations of banks with regard to mergers and acquisitions. Its position is clear: the institution intends to "facilitate sustainable consolidation projects".
Two main aspects are designed to reassure banks.
- Firstly, merging institutions that are already supervised should not see their capital requirements increase in the first financial year following the merger.
- Secondly, badwill, now recognized by the ECB, can be used to "improve the sustainability" of the new entity, to cover integration costs or bad deb ts, for example.
A rise in bank mergers in Europe?
It remains to be seen whether this major change will trigger a wave of consolidation in Europe. It has to be said that the trend has already accelerated in 2020. Among the symbolic operations that marked the year were: the marriage in Italy ofIntesa San Paolo with UBI Banca, and that of CaixaBank with Bankia. In both cases, the merger created a new national champion.
If the number of mergers & acquisitions is still limited, it's mainly because of the regulatory hurdles still to be overcome. Indeed, banks still come up against penalizing prudential rules.