The Case for Consolidation

The banking system in the Middle East region remains highly fragmented making competition intense, creating perfect conditions for merger and acquisitions as banks positions themselves for improved economic conditions post-pandemic

The landmark merger between the National Bank of Abu Dhabi and First Gulf Bank to create First Abu Dhabi Bank (FAB) in July 2016 sparked a deluge of consolidation in the banking sector across the Middle East. The structural characteristics of banks and financial institutions in the region are a diverse mix of conventional and Islamic entities, as well as being both retail-focused and corporate-aligned in their stance, which from a potential future merger perspective will offer value-added consolidations. depositors, borrowers and shareholders in the Middle East’s banking system.

Two years into the pandemic, 2021 closed with a wave of deal-making some of which have been in the making for some time as banks positions themselves for improved economic conditions postpandemic. While it is still difficult to decipher how the merger and acquisition (M&A) market may evolve in 2022, there are signs of life.

The second wave of deal-making could begin when the full impact of the current challenging operating environment becomes visible. Fitch Ratings said that the fragmentation in the Middle East region banking system is greater compared to other emerging markets with many banks, resulting in strong competition and weak pricing power.

It is worth noting that growth in the Middle East banking assets is linked to regional GDP, which moves largely in tandem with oil prices. Despite the uncertainties surrounding the trajectory of COVID-19, regional economies are on the recovery path, driven by a recovery in oil prices, supportive government spending and comprehensive economic diversification initiatives.

Last November, Moody’s said that stronger government finances benefit banks’ solvency, funding and liquidity due to the governments’ dominant role as key

Driving synergies

The Middle East region’s banking system remains highly fragmented making competition intense, and the situation is expected to intensify due to the shrinking

population in some countries after expatriates departed for their countries amid massive job losses in the past two years.

If the creation of FAB paved the way for a wave of mergers across the Middle East, Emirates NBD’s takeover of Turkey’s Denizbank in 2019 triggered a wave of acquisitions as regional banks are increasingly expanding their operations to sustain growth. FAB offered to acquire a majority stake of “no less than 51%” in EFG Hermes Holding in February, a deal that values the Egyptian investment bank at $1.2 billion.

However, industry players are saying FAB’s bid may be too low, and the Abu Dhabi-based lender may have to raise its bid given EFG Hermes’ immense influence over Egypt’s financial markets and supercharged growth of its fintech businesses.

The potential deal is expected to be FAB’s second major transaction in the country after last April’s acquisition of Bank Audi Egypt. EFG Hermes is being advised by Goldman Sachs on the bid.

The Bahraini banking system, in particular, is ripe for dealmaking and the authorities are reportedly supportive of consolidations, but sound profitability and a lack of common shareholders prevent obvious tie-ups. “Nevertheless, asset quality, profitability and capital pressures at some banks could result in more tie-ups in 2022,” said Fitch Ratings. Last year, Bank ABC agreed to buy Blom Bank Egypt in a deal valued at $427 million and the takeover, which is subject to regulatory approvals in Bahrain, Egypt, and Lebanon, is expected to close in Q1 2022.

Jordan’s Capital Bank agreed to acquire 100% of Societe Generale Bank Jordan (SGBJ) in February, in its second foray within a year to expand its foothold regionally and domestically. The acquisition of SGBJ, which is 87.7% owned by Societe Generale de Banque au Liban, came 12 months after Capital Bank completed its takeover of Lebanese Bank Audi’s businesses in Iraq and Jordan.

The call by Lebanon’s central bank for local lenders to recapitalise by the first quarter of last year and repatriate part of deposits transferred overseas saw banks such as Bank Audi SGBJ and Blom Bank putting their units in other parts of the Middle East region up for grabs.

Meanwhile, Oman’s Sohar International Bank received approval from the central bank to go ahead with the due diligence process for a potential merger with Islamic lender Bank Nizwa earlier in January 2022.

Success stories

Banks in the Middle East region are facing the pressure of tighter liquidity and increasing competition amidst a more challenging macroeconomic backdrop and past mergers have demonstrated the merits of tie-ups.

Last April, Saudi Arabia completed the tie-up between National Commercial Bank

(NCB) and Samba Financial Group (Samba) into Saudi National Bank (SNB), a banking giant with $244 billion (SAR 914 billion) assets in 2021. SNB is expected to be on equal footing with regional rivals Qatar National Bank and First Abu Dhabi Bank.

Qatari lender Masraf Al Rayan (Al Rayan) completed its $50 billion (QAR 182 billion) consolidation with Al Khalij Commercial Bank (Al Khalij) in November last year. The tie-up created the Gulf state’s second-largest bank by assets and one of the largest Shari’ah-compliant banks in the region.

Meanwhile, Egypt’s EFG Hermes also completed its takeover of stateowned Arab Investment Bank (aiBANK), transforming itself into an Egyptian universal bank, last November. EFG Hermes, which agreed to buy a 51% stake in aiBANK in May 2021, said the deal will make it an investment bank, a commercial bank and a platform for nonbank financial institutions.

The scale achieved from these mergers is leading to improved liquidity management, enhanced profitability and reduced inefficiencies with better cost to income ratios. Similarly, the tie-ups also afforded these financial institutions wider international reach and are better placed to serve regional corporates with international ambitions, as well as international companies operating locally.

SNB has been studying potential purchases of financial institutions in Europe and Asia as Saudi Arabia wants the lender to boost its presence outside the kingdom as part of Crown Prince

Mohammed bin Salman’s Vision 2030 economic diversification initiative.

“In today’s era of significant economic change, companies continue to look for partners that can leverage their abilities for cross-selling, accessing new markets and customers and other synergies to enhance financial performance and gain competitive advantage, boosting the combined market share,” said KPMG.

However, COVID-19 stalled the negotiations on the region’s only crossborder tie-up between Kuwait Finance House and Bahrain’s Ahli United Bank, which was postponed until further notice. The challenging operating environment

THE FRAGMENTATION IN THE MIDDLE EAST REGION BANKING SYSTEM IS GREATER COMPARED TO OTHER EMERGING MARKETS, WITH MANY BANKS RESULTING IN STRONG COMPETITION AND WEAK PRICING POWER

– Fitch Ratings

might push some banks in the Gulf region to find a stronger shareholder or join forces with peers to enhance their resilience.

Catalyst for change

The coronavirus crisis has created perfect conditions for dealmaking activity across the Middle East region. A surge in domestic consolidation, divestiture of non-core businesses and scope deals are likely to shape mergers and acquisitions in the future as banks seek to create larger entities that are financially more robust and efficient, capitalising on economies of scale to better diversify the concentration of risks that prevail in the sector.

Common shareholders

Bank consolidations in the GCC region have so far largely involved common shareholders (normally the government and related entities) reorganising bank assets under a single entity in a bid to achieve a leaner cost structure and increase profits in a highly competitive and overcrowded banking market.

S&P Global said that the first wave of M&A was driven by shareholders’ desire to reorganize their assets, including the tie-up between NCB and Samba, a deal that involved a common shareholder, the Saudi Arabian government through the Public Investment Fund (PIF). The Saudi wealth fund held a 44.29% shareholding in NCB and a 22.91% stake in Samba.

The Qatari government was the ultimate shareholder in Al Rayan and Al Khalij, the country’s fourth and sixth largest banks, through the Qatar Investment Authority and other stateowned entities with stakes of 49% and 47% respectively, according to Moody’s.

Overbanked

With 0% interest rates and an overbanked population especially in the Gulf region, the emerging operating environment may necessitate a consideration to accelerate any potential merger plans to take advantage of economies of scale and solidify customer bases.

Qatar has 2.5 million people being served by about 20 local and international banks, leaving smaller lenders at a disadvantage unless they can find a niche or competitive edge. “With over 50 financial institutions set against a population of 11 million, both retail and commercial banking customers in the UAE have a wealth of choice, ranging from international and local lenders, specialist and commercial banks, and private banks.” Deloitte

Overall, the Middle East region had more than 160 banks serving a regional population of 58 million as of 2019 compared with a dozen commercial banks in the UK catering for a population of 66 million.

THE FIRST WAVE OF M&A WAS DRIVEN BY SHAREHOLDERS’ DESIRE TO REORGANIZE THEIR ASSETS, INCLUDING THE TIE-UP BETWEEN NCB AND SAMBA, A DEAL THAT INVOLVED A COMMON SHAREHOLDER, THE SAUDI ARABIAN GOVERNMENT THROUGH THE PUBLIC INVESTMENT FUND (PIF)

– S&P Global

Market dynamics

Banks in the Middle East are pro-innovation and industry experts see them continuing to dominate the emerging markets banking landscape as the sector goes more digital. The outbreak of the pandemic presented an opportunity for the global financial service sector to accelerate and strengthen the digitalisation of complex processes and end-to-end customer journeys across the front, middle and back offices, a trend that was already in full throttle in the Middle East.

Deloitte said that the digitisation of banking services is another spur for consolidation, as larger banks are better equipped to navigate and capitalise on these market changes. For smaller regional banks, operating expenses are expected to increase significantly due to requisite investments in the new technologies to bolster digital strategies and improve operational efficiency, tasks that can be made easier with stronger balance sheets.

Meanwhile, banks in the Middle East are still battling with problem loans owing to the property and retail slump, a crucial sector for regional economies which has been sluggish for years on the back of high supply vs a weaker demand.

Real estate assets in the Middle East continue to face downward pricing pressure despite a rebound in 2021 and banks with a heavy concentration in the sector are also likely to report increased impairments on their books. M&A in such instances may serve among other things to diversify such risks and provide access to new platforms of capital.

Last December, the UAE central bank said that it would use new criteria to supervise banks’ exposure to real estate by introducing an “enhanced framework” that covers all types of on-balance-sheet loans and investments, and off-balancesheet exposures to the sector.

The emergence of new strains of COVID-19 has increased growth risks and policymaking challenges globally. However, the general business and operating environment for banks in the Middle East are expected to remain broadly the same this year as in 2021. On the M&A front, a saturated banking market and sluggish economic growth are expected to push regional lenders to look for expansion abroad.