Bank predators go bargain-hunting

A well-capitalised Santander is looking to pick up Alliance & Leicester for a knock-down price. The Spanish bank's approach may presage a wave of corporate activity in the banking sectoras the credit crisis weeds out weaker players. By Sean Farrell

Emilio Botin, the chairman of Banco Santander, is a wily operator and a canny deal-doer. So when he let it be known that the Spanish bank had talks to buy Alliance & Leicester he focused a spotlight on the prospect for banking mergers this year.

Bank stocks slumped in 2007 as lenders in the US announced massive write-downs and investors worried that the worst was yet to come for the sector. A&L was the worst performing UK bank in the second half of the year after Northern Rock's near-collapse caused jitters about its rival mortgage lender's ability to raise funding.

But while most investors are sitting out the credit crunch until they have more clarity around banks' exposure to the credit crunch, trade buyers could seize their chance to pick up assets on the cheap.

"The fact that Santander was prepared to have a conversation with Alliance & Leicester suggests that some pretty big, smart bankers think valuations have got to a depressed level and are near the bottom," Simon Maughan, an analyst at MF Global Securities, said.

British bank stocks rose after news of the Santander-A&L talks but a deal would not necessarily augur more takeovers in the UK. Santander is in an unusual position because, after buying Abbey National in late 2004, it is already in the UK and could extract big cost-savings from putting the two banks together.

Most banks doing cross-border deals will be looking for growth as the easy profits of the debt boom disappear. The UK is a profitable market, but with clouds hanging over the economy, potential buyers such as the French banks may decide this is not the time to make an entrance.

Instead, big European banks such as Spain's BBVA, Unicredit and Intesa Sanpaolo of Italy and France's BNP Paribas are likely to look for international deals in fast-growing emerging markets.

Market watchers have spent years waiting for one of the US's big banks to buy a UK lender. Bank of America has courted Barclays on and off, and some thought it might pounce after Barclays lost out in its bid to buy ABN Amro. But the American giants have been worst-hit by the credit crunch and their shareholders could revolt against a big cross-border deal with no clear cost or revenue gains during a financial crisis.

Vasco Moreno, an analyst at Keefe Bruyette & Woods, said: "It is difficult to see the US banks doing international deals. They don't have a lot of capital, particularly the big ones. If the US goes through a difficult period in the next 12 months you will probably see domestic consolidation."

Last year saw the biggest ever banking takeover the Royal Bank of Scotland consortium's €71bn (53bn) acquisition of ABN Amro of the Netherlands. The battle for ABN started in the first half of the year when the debt markets were still booming and no one envisaged the liquidity crisis that has engulfed the banks.

Deals approaching the scale of ABN are unlikely in the current climate but even banks feeling the squeeze could take advantage of low valuations to pick up bargains.

Having missed out on ABN Amro, Barclays will be looking for other ways to achieve its goal of becoming more international. With RBS occupied with ABN Ambro and the US banks weakened, Barclays could revisit its long-held ambition to buy Standard Chartered. But Standard Chartered trades on a whopping price-earnings ratio of about 18 and would drive a hard bargain to give Barclays the keys to its booming Asian markets.

Standard Chartered is already digesting deals in Taiwan and Pakistan and has agreed to buy American Express Bank but will stay on the lookout for plum opportunities in its markets. A merger with DBS, the Singaporean bank controlled by Temasek, Standard Chartered's biggest shareholder, would give it greater scale in many key Asian markets.

HSBC is likely to be a seller and a buyer. Britain's biggest bank is refocusing on emerging markets and has said it will make acquisitions and sell off units that do not generate enough returns. Its US auto-finance business could be put up for sale. If HSBC were to sell off all or part of its French business, banks such as BNP Paribas and Socit G*rale could be eager to bid.

At the same time, HSBC has announced deals to buy banks in Taiwan and South Korea, both of which were gaps in its Asian network.

The credit crunch came close to producing a deal in September when Lloyds TSB was in talks to buy Northern Rock but the authorities balked at Lloyds' request for 30bn of loans at a commercial rate. Lloyds is in its strongest position for years and could take the opportunity to do a deal, though its options in the UK would be limited by competition restrictions.

Mr Moreno said: "Deals this year will be opportunistic and the banks doing the deals will be mostly large banks like Santander. Small banks and monoline financial services firms are most likely to sell out."

The big sticking point for these deals is valuation which scuppered the Santander-A&L talks. If targets believe they can wait for the credit crunch to ease, they could be unwilling to accept what looks like a hefty premium to their depressed share price.

Potential targets may be wary of selling out in the short term because inter-bank lending rates have been coming down since central banks announced coordinated action to inject liquidity in the system.

The rate for three-month sterling inter-bank loans has now dropped below 6 per cent for the first time since June, indicating that banks are finding it easier to fund their businesses.

Another driver of deals will be banks selling-off non-core assets to boost their capital or get out of businesses they no longer want. Both Barclays and HSBC sold off UK sub-prime assets last year and industry sources predict that other mainstream lenders will sell some of their riskier lending businesses to specialists in those markets if they can get a reasonable price.

Private equity firms are also said to be scanning the financial sector for bargains. It is harder for buyout houses to buy a bank than other companies because of the debt that the firms use to fund their deals. But the private equity houses are in the market for assets being sold off by banks in a hurry to shore up their balance sheets.

What many think has been an indiscriminate sell-off of debt securities could also produce hefty profits if assets bought at knock-down prices perform better than expected and markets unfreeze.

Mr Botin's interest in A&L may not be the start of a deal deluge, but it can only be a matter of time before the trade off between risk and reward starts to look too good to resist for the banks with big enough balance sheets.

Mr Maughan said: "People are thinking, 'We are getting close to the bottom in terms of pricing and close to the time when we want to expand'."

Santander's British ambitions

When Santander bought Abbey National just over three years ago, many thought Spain's biggest bank would make a second acquisition in the UK to extract the maximum benefit from the deal.

Alliance & Leicester was top of most people's list because it was big enough to give Santander scale and the scope for cost cuts. It would also give Santander an entry into UK business banking, which Abbey has been trying to build up for years but in which it remains a small player.

Abbey's chief executive, António Horta-Osório, said that Santander wanted to add about 300 branches to Abbey's network. A&L, with about 270 branches, would accelerate that plan.

A&L is best known as a mortgage bank but it also has a sizeable commercial banking operation. The deal would give Abbey 6.5bn of commercial lending balances, 76,300 business banking accounts and over 20 per cent of the market for supplying cash to UK high streets.

A&L has been viewed as a takeover candidate since the former building society demutualised in 1997. It has attracted interest from Credit Agricole but the French bank decided against taking its approach further. David Bennett, A&L's chief executive, took over the top job in July last year and might be loath to sell up so early in his tenure.

But A&L's business looks shaky after the credit crunch upped the cost of wholesale finance, which accounts for about half of its funding. A&L has arranged bank loans, including 4bn from Credit Suisse, that it says will take it through to the third quarter of this year. A sale to Santander, with its strong balance sheet, would eliminate those worries, but shareholders might feel aggrieved. At the time of the Credit Agricole approach, A&L shares were trading at over 1,100p compared with their 648p closing price on New Year's Eve.

Santander ended talks with Abbey early in 2004 but returned to claim its prize a few months later. Investors seem to think Emilio Botin, Santander's chairman, could yet get his deal. A&L shares rose over 16 per cent yesterday, closing at 754p.