Who is next?

The question ricocheted around global securities markets last week as investors identified vulnerable banks -- the usual suspects as well as a few surprises -- and tried to handicap their chances of survival. Although no European bank exactly matches the "pure" investment bank model that defined the fallen Lehman Brothers Holdings Inc., it is equally true that no lender can escape the powerful forces that have seized up credit markets.

Short sellers immediately targeted HBOS plc, the U.K.'s biggest mortgage lender, and on Sept. 18 the bank agreed to sell out to its much smaller rival Lloyds TSB Group plc for a fire-sale price of £12.2 billion ($21.8 billion) in stock. Hedge funds had exacerbated a heavy selloff in the bank's stock last week -- 17% on Monday, 21.7% on Tuesday, 19% on Wednesday -- that ultimately drove the lender into merger talks.

Bankers, regulators and government officials raced to cobble together an agreement. Above all, the government of Prime Minister Gordon Brown looked to avoid another nationalization along the lines of Northern Rock plc earlier this year. The government took over Northern Rock after the mortgage lender suffered the first run on a U.K. bank since the 1860s.

In a rare intervention last week, Secretary of State for Business and Enterprise John Hutton said the government would override antitrust concerns about the HBOS deal, changing competition law to extend its "public interest" powers beyond media and national security. The banking fusion, which will create an entity with 28% of the U.K. mortgage market, might otherwise have been blocked by antitrust regulators.

Lloyds has been much more conservative in its approach to investing in subprime-related products and, as a result, its stock has held up better than many of its competitors.

UBS, the European bank that has suffered most from its exposure to toxic U.S. mortgages, was another obvious candidate for short sellers. On Sept. 15, the day Lehman filed for bankruptcy protection, UBS shares fell 14.5%, forcing the bank to make a statement insisting it had sufficiently strengthened its capital position earlier this year, having raised $15.6 billion in a rights issue. Many investors believe the Swiss group will not be able to sell its investment bank. Some reports suggest the bank would have to write down a further $5 billion of investments after having already written down $42 billion in recent months. But subsequent share price declines have not been as severe, and most observers believe UBS will prevail.

Barclays plc, which had to write down £2.8 billion of investments in the first half of the year, has so far avoided the worst of the turmoil of recent days, partly thanks to its deal to acquire Lehman's North American investment banking unit out of bankruptcy. (The acquisition requires court approval.) Barclays' share price rose on the news.

Some hardy European banks will certainly consider acquisitions -- especially if they are at bargain prices. Several of the relatively stronger banks could be in a position to bail out their weaker rivals. Banking analysts at Keefe, Bruyette & Woods Inc. identified HSBC plc, Banco Santander SA, ING Groep NV and perhaps BNP Paribas SA as "too big to fail" and as "likely to outperform" as investors see them as "short-term
safety plays."

Before Morgan Stanley confirmed it was in talks with Wachovia Corp., HSBC was named as a possible bidder for the New York-based investment bank.

Surveying the terrain of European banks, Ian Gordon, an analyst at Exane BNP Pariba says, "Any bank with toxic assets or a reliance on wholesale funding will suffer."

As a group, French and German bank shares have held up relatively well as investors seem to bet that the lenders will be able to survive the credit crunch. In the wake of the American International Group Inc. bailout, one statistic got their attention, though: Of the $441 billion in credit default swaps listed by the insurer in June, more than 75% were held by European banks.