Four merger announcements toward the end of 2020 marked the beginning of a wave of consolidation in the Danish banking sector that analysts believe will continue in 2021. Future deals may, however, not offer the same opportunities for value creation due to recent share price gains.
Bank deal-making picked up across Europe in 2020, and Denmark was no exception. Sparekassen Vendsyssel's agreement to acquire Salling Bank A/S at the end of September was followed by three more deals in as many months. They included Sydbank A/S buying Alm. Brand A/S' banking arm, Vestjysk Bank A/S purchasing Den Jyske Sparekasse A/S and Spar Nord Bank A/S taking over P/F BankNordik's Danish business.
More M&A activity has followed this year, with Arbejdernes Landsbank A/S announcing March 24 that it will take a majority stake in Vestjysk Bank. While the two banks will continue to operate independently, Mads Thinggaard, equity analyst at ABG Sundal Collier, considers it likely that Arbejdernes Landsbank will carry out a full merger at a later stage.
The surge in deal-making comes after years of declining profitability in the Danish banking sector, with return on average equity dropping to 4.99% in 2020, from 11.17% in 2017, according to S&P Global Market Intelligence data. The average cost-to-income ratio increased to 61.48% from 50.00% over the same period.
Rising capital requirements, tighter regulation and growing IT costs are making it too costly for Danish small and medium-sized banks in particular to operate, said Sydbank equity analyst Mikkel Emil Jensen in an interview. Add those factors to a fairly fragmented Danish banking market that has long faced pressure on margins in light of years of negative interest rates, and you get a market ripe for consolidation.
"The motivation to consolidate is certainly no less in 2021," Jensen said.
The transactions toward the end of 2020 were "an eye-opener to the fact that it is possible to create really large shareholder value by doing these mergers," Thinggaard told S&P Global Market Intelligence.
Vestjysk Bank's acquisition of Den Jyske Sparekasse, for example, led to a 40% bid-upside for shareholders in the acquired party, Thinggaard said. He expects EPS for the buyer to grow 30% because of the deal — an "enormous reward" for shareholders of both banks. Meanwhile, Thinggaard estimates that Sydbank's EPS will grow 15%-20% after its "relatively small deal" to acquire Alm. Brand Bank.
A common characteristic among the deals at the end of 2020 was that they were driven by desire rather than financial distress, said Nicholas Rohde, owner of BankResearch, a provider of data and analysis on financial institutions in Denmark. Despite Danish banks having taken significant coronavirus-related loan loss provisions, they performed reasonably well in 2020 and have faced very few real loan losses so far, he said in an interview.
Rather, banks have sought to boost profitability and take advantage of cost synergies, said Rohde, who expects the same factors to drive more mergers in 2021. He foresees that group two banks in particular — which includes lenders such as Ringkjøbing Landbobank A/S, Sparekassen Sjælland-Fyn A/S and Jutlander Bank A/S — will be considering potential targets primarily among smaller, group three banks.
Banks in Denmark are categorized by the country's financial regulator, with institutions in group one to four being classified according to the size of their working capital. The regulator's recently released list of groups, based on 2020 third-quarter reports, counted a total of 90 Danish banks or branches of foreign banks.
Jensen agreed that most future deals are likely to be made among small and medium-sized banks, adding that such mergers typically face fewer barriers in gaining approval from competition authorities. But recent activity suggests that there is also an appetite among the larger players if an opportunity presents itself, he said.
Excess capital
While the drivers of recent deal-making are not directly linked to the COVID-19 pandemic, regulators' restrictions on dividends throughout the crisis have left many banks in Denmark with significant excess capital that they are now looking to put to work elsewhere, said Thinggaard.
The Danish financial regulator has asked banks to suspend dividend payments for 2019 and requested restraint on payments for 2020. Despite these restrictions, Alm. Brand's sale of its banking business to Sydbank shows that institutions are permitted to distribute capital freed up from a sale, said Thinggaard.
A growing focus on M&A has boosted the valuations of Danish bank shares, said Thinggaard. This, together with a positive global sentiment around bank stocks and business model improvements among Danish financial institutions, has driven significant share price gains in the Danish banking sector in recent months, he added.
In the six months since the Sparekassen Vendsyssel-Salling Bank deal was announced, the S&P Denmark BMI Banks Industry Index has increased 44%, according to S&P Dow Jones Indices data.
As a result, future deals are unlikely to drive as much value creation as those announced in 2020, Thinggaard said, although he still foresees deal opportunities that will "make good sense and bring value to shareholders" and believes that the Danish banking sector is likely to see more mergers this year.
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