Spain's caja overhaul will spark further bank mergers

MADRID (Reuters) - Spain's banking sector is headed for more consolidation as an overhaul of savings banks toughens competition, forcing smaller commercial banks into mergers to defend their flagging business and return to profitability.

Smaller banks will also be seeking increased scale as they fight to regain access to money markets for funding, seen as crucial to unblocking seized-up domestic lending and help revive Spain's recession-hit economy.

Stress tests of the health of Europe's banks has boosted market confidence in Spain's top names Santander and BBVA, which have both successfully sold bonds, but many smaller players remain cut off from market funding.

"The new challenge for smaller commercial banks is how to defend their territory against some of the revamped cajas, many of which will be healthier and more aggressively competitive," said BPI bank analyst Carlos Peixoto.

Mid-sized listed bank Sabadell (SABE.MC) and smaller rival Guipuzcoano GUI.MC have pooled resources in a deal valued at some 730 million euros (598 million pounds). Pastor bank PAS.MC, from the region of Galicia, declined an invitation to join.

But the merger of two Galician cajas, Caixa Galicia and Caixanova, could create too strong a competitor for Pastor on its home turf and force it to seek partners, Peixoto said.

In the past, the market was roughly divided up between the two top-tier banks, some small-to-mid-size banks and 45 cajas, which account for around 50 percent of the financial system. The cajas have an extensive branch network but got in over their heads through over-lending during a decade-long property boom.

Through mergers and takeovers the savings banks branches have shrunk by about two-thirds at a cost of around 11.2 billion euros from the government-backed restructuring fund FROB.L.

Cajas that got public funding for mergers are expected to close between 10 percent and 30 percent of branches and cut staff by 11 percent to 27 percent.

"In the end, the consolidation is about dividing up a market between fewer, more efficient institutions to ensure a return to pre-financial crisis profitability," said Santiago Carbo Valverde, professor at the University of Granada.

One formidable new player on the scene is the tie-up between Caja Madrid, formerly Spain's second biggest savings bank, and six smaller regional cajas to create a deposit leader, ahead of Santander (SAN.MC), BBVA (BBVA.MC) and former top savings bank La Caixa, with a market share of around 12 percent.

CAJAS GO PRIVATE

Apart from downsizing and weeding out weaker players, the cajas shake-up also changed their legal status, which will be a catalyst for further consolidation.

A law passed in July allows the cajas to offer up to 50 percent of capital to private investors, a move designed to curb powerful political influence over their boards and to bring them into line with listed rivals.

"There will be a second wave of mergers when the cajas open up to investors. Spanish as well as foreign banks can buy stakes, which was not allowed before," a banking source said.

The law also allows the cajas to create a new bank to manage their banking business, separating this from their charitable works, or to become a foundation, transferring their retail banking activities to a new bank in which they hold a stake.

"Our estimate is that more than 80 percent of savings banks will opt to become banks. It's a no-brainer. They need to be able to raise capital," Carlos Trascasa, director and partner at McKinsey and Co. in Madrid said at a conference last month.

This additional restructuring will ensure a return to "double digit" profits, he said.

FODDER FOR PREDATORS?

Last month, JC Flowers, a U.S. buyout fund specialising in distressed banks, agreed to subscribe to a convertible bond issue by Banca Civica, one of five Spanish cajas that failed the stress tests.

This ground-breaking deal -- the first time a foreign institution has invested in a caja -- does not mean the savings banks will become merely fodder for speculators, analysts say.

Spain's listed banks have been waiting in the wings to pick up cheap assets from the cajas, their long-time fierce competitors, particularly in the smaller regions.

"The leading banks are grabbing small and mid-sized firms' lending at fat margins as the loans roll off the cajas, which do not have the funding to hold on to them," a U.S. bank analyst said.

Last month, BBVA (BBVA.MC) said it hopes to grab between 2 and 3 percentage points in market share from the cajas in two-three years.

Mid-sized lender Popular (POP.MC) has set up a new bank with France's Credit Mutuel-CIC to participate in the consolidation, focusing on cajas' branch networks or loan portfolios.

"A rough estimate could be around 300 million euros for a 300-branch network," the banking source said, although noted this depends on the size and location of the branches.

(Additional reporting by Jesus Aguado; editing by Sitaraman Shankar)