Mergers to meet changing economic environment

The recent spate of mergers and news of intended mergers among financial institutions in the six-nation Gulf Cooperation Council (GCC) bloc is being welcomed by analysts as a move that needed to happen yesterday. The mergers are also being embraced with a whew of relief by the banking industry, long-suffering from having too many banks and too few customers.

Over the years, the GCC states have witnessed a swell in the number of new banks opening up, and their branches sprouting all over the region. There are an estimated 73 listed banks and their innumerable branches now serving the 54 million population of the GCC.

Qatar has the highest ratio of banks to citizens (1:150,000) in the region, with 18 local and international lenders serving 2.7 million people; Kuwait is a close second (1:190,000) with 23 banks for a population of 4.4 million. In contrast, the United Kingdom with a population of 66 million, has only about a dozen listed bank.

The superfluity of banks has led to increasing inter-bank rivalry and unhealthy competition for an ever-shrinking market-share. Banks in the region have also had to cope with the high costs arising from the need to comply with new accounting standards and keep abreast of the latest technological changes taking place in the sector. In addition, the value added tax implemented in Saudi Arabia and the United Arab Emirates, and the job-nationalization drive by most GCC states, have further raised operational costs for banks in the region.

In addition, global oil price — the pivot on which much of the GCC economy spins — has a strong bearing on the performance of banks. Every dollar increase in price of oil on the international market is closely correlated to GDP growth in the six-nation bloc, which then trickles down and translates into growth in assets for banks. It is a different story when oil prices go the other way, as liquidity is wrung out from the banking sector and pressure is piled on bank profitability.

With most banks in the region overly reliant on government deposits, many have yet to recover from the mid-2014 oil price crash that saw GCC states axing expenditures, pruning spending and dipping into state reserves to fund budgets. The nearly two-year-long sustained low oil price scenario since June 2014, led to dwindling government deposits and slashed government spending that had a bearing on the poor loan performances.

Suddenly left without the government assets that they had relied on to keep their books in balance, and faced with damped demand for credit, several banks were forced to rethink their policy of standing alone. While the precipitous fall in oil prices in 2014 did not immediately trigger any major merger drive among banks in the region, it did compel bank boards to do a reassessment of their spending and profitability, and to seriously contemplate being acquired by market leaders in order to provide value to shareholders.

Governments in the region, which have more than a large say on the boards of most banks, have been prodding financial institutions to look into the long-term benefits of merging with or acquiring other entities. Mergers or acquisitions would give the joint entity a stronger presence and competitive edge in the market, and would allow them to compete for deposits and seek new growth opportunities. The restructuring is part of the GCC strategy to create a robust and innovative financial sector, as it gradually attempts to wean the economy from its over dependence on hydrocarbon resources.

Behind-the-scene goading by governments seem to be working. The year 2019 began with news of  Kuwait Finance House (KFH), the country’s biggest Islamic lender deciding to acquire Ahli United Bank (AUB) of Bahrain. Speaking on the occasion, the Chairman of Kuwait Finance House, Hamad Abdulmohsen Al-Marzouq, said the purchase of AUB will boost consolidated profit for the group.

The merger of KFH with AUB, the first cross-border merger of banks in the region, will create one of the largest Islamic banks in the world with assets of more than $94 billion and equities exceeding of $10 billion. The joint entity will also become the largest bank in Kuwait and the sixth largest bank in the Gulf region, where a spew of bank mergers are in the offing.

The first bank merger in UAE, way back in 2007, brought together Emirates Bank International and National Bank of Dubai to create Emirates NBD. The joint entity has more than trebled its profit from 2008 to 2018, while net income has increased at a compound annual rate of 11 percent over the same period. In 2017, authorities in Abu Dhabi brought together its largest lenders, First Gulf Bank and National Bank of Abu Dhabi to create First Abu Dhabi Bank, the second-largest bank in the GCC. This merger set the tone for talks among competitors in the region.

In 2018 the merger trend moved to Saudi Arabia, where the boards of Saudi British Bank (Sabb) and Alawwal Bank, subsidiaries of the HSBC and Royal Bank of Scotland, respectively, agreed to come together in $5 billion stock deal to create a financial entity worth $73 billion in combined assets.  Meanwhile, the kingdom’s biggest lender, National Commercial Bank, is reportedly in talks with Riyad Bank for a merger that would create a financial institution worth $182 billion in assets and make the joint entity the second largest bank in the GCC.

In January of this year, the boards of Abu Dhabi Commercial Bank and Union National Bank , where the Abu Dhabi government has the majority stake, agreed to a merger to create a ADCB, an entity that will take over Al Hilal Bank, also owned by the government, to become the third largest lender in the UAE with nearly $115 billion in assets. Plans are also believed to be underway in Qatar and Oman to merge banking institutions so they emerge as viable entities capable of overcoming challenges and thriving.

Other financial institutions with non-banking charter are also following in the steps of banks with their own mergers and acquisitions (M&A). Last year, Mubadala and the Abu Dhabi Investment Council both owned by the Abu Dhabi government combined to create a wealth fund with about $230 billion in assets. A year earlier Mubdala had merged with International Petroleum Investment Co., another government-backed investment firm.

In Saudi Arabia, after postponing its much-hyped initial public offering to 2021, Saudi Aramco agreed last month to buy 70 percent of petrochemical giant Sabic from the country’s sovereign wealth fund, the Public Investment Fund (PIF), in a deal worth about $70 billion. Analysts believe that it would give PIF the financial firepower it needs to carry out ambitious investment plans at home and abroad.

In Kuwait, there has also been some consolidation activity among Kuwaiti investment companies. In early March of this year, KAMCO Investment Company and Global Investment House, two leading firms in the asset management and investment banking industry, agreed to cement the merger talks and commence the regulatory process.

Shareholder attitudes toward M&A are also changing. With each successful deal, governments and companies are becoming more comfortable with the idea of consolidation, and begin to see it as an efficient tool to improve performance in a more challenging economic environment.