By Craig Mellow

A barbarian is at the gate of European banking, which remains locked within national borders despite the European Union's supposed common market. The gate is stoutly defended, though.

Andrea Orcel, CEO of Italy's second-largest bank, UniCredit, lately revealed a 9% stake in German No. 2 Commerzbank, setting the stage for a pathbreaking cross-border takeover. Maybe. "If this goes through, it could be a game changer for the whole sector," says Jennifer Cook, European bank analyst at T. Rowe Price.

Adding Commerzbank to its existing HypoVereinsbank subsidiary would also make Milan-based UniCredit Germany's top financial dog, surpassing iconic Deutsche Bank.

Investors love the idea, bidding up Commerzbank's shares by a quarter since Orcel's Sept. 10 announcement, and with good reason. UniCredit's stock has nearly quadrupled over the past two years under Orcel's stewardship. Commerzbank has merely doubled.

Other targets could follow across the continent if Orcel's campaign succeeds, including France's Société Générale and ABN AMRO in the Netherlands, says J.P. Morgan analyst Kian Abouhossein.

It's a big "if." Commerzbank's unions are resisting a tie-up, reasonably fearing cost cuts. That alone could kill the deal with Social Democratic Chancellor Olaf Scholz, presiding over a deeply unpopular coalition government, says Eoin Drea, senior researcher at the Wilfried Martens Centre for European Studies. "The chancellor needs to shore up whatever is left of his trade union support," he says.

Less parochial concerns are also at play. Commerzbank is a mainstay in financing Germany's critical "mittelstand" of midsize, privately owned companies, says Johann Scholtz, European bank analyst at Morningstar. "Commerzbank plays a very specialized role in the German economy," he says.

A structural obstacle to banking mergers across the EU is lack of a unified deposit insurance scheme. "This has been under discussion for at least 10 years, with very little movement," Drea says. That leaves national treasuries on the hook to bail out savers, and inclined to oversee banks on their own turf.

European bank stocks could be worth buying anyway, even as the interest-rate hikes that drove the recent rerating reverse, says Andrew Stimpson, head of European bank research at Keefe, Bruyette & Woods. Banks' "Goldilocks range" for rates could go as low as 2%, he argues; the European Central Bank recently cut its deposit rate by 0.25%, to 3.5%. Rumors of a European recession that would tarnish asset quality are proving exaggerated.

"Customer debt-to-GDP [gross domestic product] is in many cases substantially lower than 10 years ago," Stimpson says. His picks in the sector, aside from UniCredit, include Spain's CaixaBank and Allied Irish Banks.

European banks still trade much more cheaply than U.S. peers, at about seven times earnings on average, T. Rowe's Cook adds. Orcel and his competitors are lavishing cash on shareholders. Dividends plus share buybacks are yielding double-digit percentages of share value. "Compared with U.S. banks, your starting point is much cheaper and you're getting a much more attractive yield," she concludes.

Morningstar's Scholtz isn't so sure. Valuations are structurally constrained by the "quasinationalized state of European banks," he argues. "Stocks are starting to look fairly valued," he says.

One exception is BNP Paribas, which Scholtz sees as unfairly punished by France's political stalemate. Shares are flat year to date, while peers have kept surging.

Orcel may just still win in Germany, too. Either way, European banks have woken up.

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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September 20, 2024 03:00 ET (07:00 GMT)

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