Yesterday, the European Banking Authority published the results of its transparency exercise, with data updated as of June 30, 2024, covering banks from 26 countries in the European Union. The results allow for an analysis of risk-weighted assets (RWA), which are calculated using the internal credit risk models of each bank. These models estimate the credit risk of the portfolios and countries where each bank operates.

One key metric is the RWA density, obtained by dividing the RWA by the total credit risk exposure. A higher density may indicate that the bank has a riskier credit profile or that its internal models are more conservative in estimating risk.

Given this context, it is important to analyze the RWA density of Spanish banks that use internal models approved by the Supervisor. Table 1 shows the RWA density for each Spanish bank, for both the "Corporates" and "Retail" portfolios, over the last three years, considering only their credit activity in Spain to ensure the comparison among banks is as consistent as possible.
 

RWA Density, under internal models, for loans in Spain in the last three years.

The bank with the lowest density in Corporates portfolios is Banco Sabadell. This could be due to either a lower credit risk profile compared to the rest of the banking industry in Spain or slightly more optimistic estimations than its competitors. In either case, it is not problematic as it is subject to comprehensive supervision.

Given the context of BBVA's takeover of Sabadell, the regulatory capital impact on BBVA can be estimated if BBVA's densities are applied to Sabadell's portfolios. However, there are certain limitations since the exercise is subject to specific conditions, as the portfolio grouping is defined by the European Banking Authority and does not fully capture the heterogeneity of reality.

Impact of the Takeover on Regulatory Capital

According to the Capital IQ database, as of September 30, 2024, Banco Sabadell has a Core Tier 1 Capital of €11.03 billion and RWAs of €79.93 billion, resulting in a Core Tier 1 Capital Ratio of 13.8%. BBVA, on the other hand, has a Core Tier 1 Capital of €48.72 billion, RWAs of €379.52 billion, and a Core Tier 1 Capital Ratio of 12.8%.

If the takeover bid proceeds and BBVA's internal models and risk-weighted asset (RWA) densities are applied to Sabadell's portfolios-which takes time to implement-considering that the difference in density amounts to €11.01 billion, BBVA would need to increase its Core Tier 1 Capital by €1.41 billion (€11.01 billion x 0.128) to maintain its Capital Ratio.

It is clear that BBVA will have assessed the potential impact on its Regulatory Capital resulting from the transaction, as well as the contribution of synergies from the operation to capital generation. This is estimated at around €589.9 million, based on expected synergies of €850 million over three years and an effective tax rate of 30.6% (the latest estimate from Capital IQ). However, the ultimate decision lies with Sabadell's shareholders. It is essential to consider that, in any integration process, synergy estimates always involve a degree of uncertainty due to the challenges of operational integration and internal resistance from the acquired entity.

Lessons from Hostile Takeovers in Italy

Looking at the Italian banking market, there are two interesting cases. The hostile takeover launched by Intesa San Paolo (Intesa) on UBI Banca (UBI) on February 17, 2020, was accepted by 90.2% of UBI shareholders on July 30, 2020. Reviewing the latest RWA densities published (June 30, 2019) before the launch of the takeover for loan portfolios in Italy, both banks had very similar densities: 59.31% for Corporates at UBI and 54.01% at Intesa, and 21.03% for Retail at UBI compared to 20.00% at Intesa. Thus, the acquiring bank had densities very similar to those of the acquired bank, albeit slightly lower.

In the case of the takeover launched by Unicredit on November 25, a very different scenario emerges. The densities from the 2023 and 2024 transparency exercises, as announced yesterday, reveal significantly lower densities at BPM compared to Unicredit. Specifically, the densities published yesterday were 50.54% for Corporates at BPM versus 53.03% at Unicredit, and 20.15% for Retail at BPM compared to 38.39% at Unicredit.

Key Shareholders in the Takeover Scenario

On July 5, BBVA shareholders approved the capital increase necessary to undertake the takeover of Banco Sabadell, with 96.04% voting in favor. Considering that BBVA shareholders currently hold 29.947% of Sabadell's share capital, BBVA's advantage appears clear.

Furthermore, analyzing the shareholders who have increased their stakes in Sabadell since March 31 of this year, among the 104 institutional investors who increased their positions, BlackRock stands out with an increase of 168,448,000 shares, representing 3.12% of Sabadell's capital. Zurich increased by 164,549,000 shares (3.05%), and UBS by 97,791,655 shares (1.81%). Conversely, 67 institutional investors reduced their stakes, with AllianceBernstein being the largest seller, reducing its position by 0.57% of the capital. These movements indicate that major players are betting on the takeover, which has closely linked the stock price variations of Sabadell and BBVA. On the other hand, Millenium sold short 0.49% of Sabadell shares on August 30, essentially betting against the takeover, expecting Sabadell's share price to drop if the takeover does not go through.

The Takeover and Credit Supply for SMEs

On November 20, the Spain's National Authority for Markets and Competition (CNMC) published a brief note justifying the move to the second phase of the review process. One of the most important issues is how the operation would impact credit supply to SMEs in areas where the resulting entity would acquire a significant market position. This could be the main obstacle, potentially requiring BBVA to either divest market share in such areas or increase its long-term commitment to maintaining credit supply to SMEs without significant credit risk increases. The effect of banking consolidation on credit is generally negative, often reducing the supply of bank credit in the economy, which directly impacts companies' financing costs since non-bank financing alternatives are significantly more expensive. In the case of syndicated loans, the effect of a merger is evident as the resulting bank would have credit limits for syndicated financing, unable to fully replace the gap left by the acquired bank. However, SMEs typically do not participate in syndicated financing.

Additionally, it is crucial to consider that due to current regulation and supervision, startups and newly established SMEs cannot access bank financing, which is the most cost-efficient option. Credit institutions now primarily finance mature businesses, which can more easily secure financing from other banks. In other words, the Eurozone's biggest issue is that banks do not finance innovative, high-potential projects.

Value Creation for Shareholders

Regarding value creation, it is necessary to analyze the difference between Return on Equity (ROE) and the Cost of Equity (COE) required by shareholders in the event of a merger. As of Q3 2024, BBVA's annualized average ROE stands at 19.2%, compared to Sabadell's 14%. Consequently, ROE for Sabadell shareholders would likely increase, given that BBVA's ROE has consistently outperformed Sabadell's since 2001. Additionally, sophisticated investors may infer that a lower RWA density might imply a higher COE due to, among other factors, reduced capacity to absorb unexpected losses, potential regulatory demands for higher density, or future reassessments of internal model viability. Thus, the operation could generate value for Sabadell shareholders through higher ROE and lower COE.

The Foreseeable Outcome

The commendable work by César González-Bueno and Josep Oliu, along with the Board of Directors, in both management and communication, has enabled Sabadell to hold its ground. However, barring potential political interference, if an alternative value creation strategy for shareholders is not found, all indications point to the takeover proceeding, provided that any conditions imposed by the CNMC do not significantly affect the transaction's profitability. If BBVA obtains control of Sabadell, it is, in my opinion, only a matter of time before the merger is completed.