Complex Made Simple

The GCC’s current wave of bank mergers is almost over

Banks in the region are going to let things settle for now- Here's why

We think the current wave of consolidation in the GCC banking sector is almost over 6 of the 8 mergers since 2014 have benefited from the presence of the same shareholders on both sides of the table--at acquiring and target banks The region's remaining major banks lack common ownership, meaning future deals will be more difficult, unless economic considerations force shareholders to the table

By: S&P Global

What's behind the renewed interest in mergers by banks in the Gulf Cooperation Council (GCC) over the past 24 months? Some market observers attribute this trend to the less supportive economic conditions since second-half 2014, when oil prices started to drop. However, the financial performance of the region's banks has deteriorated only slightly in the past few years, benefiting from structural supports such as large noninterest-bearing deposits and good efficiency.

S&P Global Ratings believes the reason for the current wave of bank mergers and acquisitions (M&A) in the region is the desire among banks with the same major shareholders to further enhance efficiency, strengthen franchises, and boost pricing power. Indeed, most mergers to date have involved banks with common major shareholders. As such, the pool of banks with similar ownership is smaller, which will mean fewer M&A from now on unless economic reasons force the issue. Given the overbanked nature of some GCC banking systems, we think that further consolidation could help improve banks' performance and financial stability.

A new wave of acquisitions motivated by purely economic reasons could follow, but we think it may take longer to be realized.

Financial Performance Is Healthy Despite Tougher Conditions

We believe Gulf banks are generating healthy earnings, underpinned by low funding costs. This performance is thanks to the significant amount of noninterest-bearing deposits in the funding profile, high efficiency, and manageable cost of risk (see chart 1). Most banks have shown relative resilience despite the significant shift in their operating environment after economic growth slowed following the decline in oil prices, with no substantial spike in the cost of risk or drop in profitability.

Chart 1

GCC banking systems are rather oligopolistic. They are also protected from external competition because local regulators rarely award new banking licenses or restrict the business that new banks can do. In Qatar, for example, most new licenses have been granted under the umbrella of the Qatar Financial Center, where licensed banks are not permitted to collect deposits from domestic customers. Similarly, in Saudi Arabia, the regulator has allowed 12 foreign players to operate locally but restricted the number of branches they can open.

The United Arab Emirates (UAE) and Oman are the two GCC banking systems where we have observed some overcapacity. In the former, there are 49 commercial banks serving a population of about 9 million. In the latter, 20 banks serve a population of about 4.7 million. The presence of a significant number of banks in these two countries means that smaller players typically have to differentiate by focusing on specific segments like Islamic banking, riskier clients rejected by larger lenders, or by competing on price. When the cycle turns, banks' shareholders are then typically encouraged to look at synergies more closely, with consolidation appearing a natural way out.

Based on our analysis of finalized or ongoing mergers in the past few years, it appears that the presence of the same shareholders at the acquiring and acquired banks were key to the deals (see table 1). For example, In the case of First Abu Dhabi Bank, the talks moved forward thanks to the presence of government entities on each side, along with some royal family shareholders.

Similarly, we understand the Qatari government and royal family members helped facilitate the merger between International Bank of Qatar (IBQ) and Barwa Bank. And we believe the presence of the same Saudi government-related entities on both sides of the table are likely to push ahead talks between National Commercial Bank and Riyad Bank.

That said, we see these operations akin to shareholders reorganizing their assets rather than genuine mergers, although the economic benefits are clear and reportedly significant. The one noticeable exception is the merger between Saudi British Bank and Alawwal Bank, where the two banks have no common shareholders except the marginal presence of a government-related entity. This transaction was primarily undertaken for economic reasons and due to the desire of some Alawwal Bank shareholders to reduce their presence in the Saudi market. We also note that of all the GCC mergers, only two involve both an Islamic and a conventional bank, namely Barwa and IBQ, and Kuwait Finance House and Ahli United Bank–although Ahli United has an Islamic subsidiary in Kuwait that accounts for about 50% of its assets. We see these as typically more challenging than mergers between two conventional or Islamic banks. This is because of their obvious operational differences and the necessity to convert the business of one bank to match the other. Typically, the conventional bank converts to Islamic banking. Another interesting observation is that there have been no cross-emirate mergers in the UAE.

Table 1

Bank Mergers Or Talks In The GCC 2017 To Date

The Merger Wave Ebbs

We still see a few M&A opportunities in the UAE, particularly in Sharjah, Dubai, and Abu Dhabi. However, we believe the ownership structures of the remaining banks (see chart 2), particularly in countries that we consider overbanked, mean there are limited opportunities for similar mergers to those seen in the past 24 months. This is because a merger involving assets held by private-sector shareholders and governments, or government-related entities, does not appear plausible for now. For example, in Saudi Arabia, we do not expect a large banking group with a subsidiary in the country to discuss joining forces with public or private sector shareholders of other banks.

Chart 2

Based on this, we think the current wave of mergers is likely over, but a new wave of acquisitions motivated by purely economic reasons could follow. This wave may involve consolidation across the different emirates, for example. However, any future M&A would require more aggressive moves by management than those seen in the past. The added hurdles of convincing boards and shareholders, who face the possibility of seeing their assets diluted or losing control, means the next wave of deals may take longer to build than the current one.