July – August 2009
Is the Middle East overbanked and what is the case for and against for mergers? Will any banks merge this year and if so, who, when, where, why and what? Mike Gallagher goes looking for answers There is always a rumour going around somewhere that certain Middle East banks might be about to merge. One conference after another has banking heads and consultants giving their views on what makes for the perfect banking marriage and which countries' regulations offer the best prospects for wedded bliss.
The first and most recent example of a Middle Eastern mega-merger was in early 2007 when Emirates Bank and National Bank of Dubai (NBD) combined to become Emirates NBD which now has over 120 branches and over 650 ATMs.
After that came about, the merger of Industrial Development Bank of Egypt (IDBE) and the Egyptian Workers Bank went ahead in November 2008 which became Industrial Development & Workers Bank of Egypt (IDWBE) and now has 19 branches.
Around the same time, Egypt's EFG-Hermes and Bank Audi from Lebanon (in which EFG has a 28 per cent stake) decided to put their plans to merge on hold, due to inclement market conditions. There has been no word since of any further developments.
Then in July 2009, Actis, an emerging markets private equity specialist, said that it had executed an agreement to invest $244 million to acquire 50 per cent of the stake held by the consortium led by Ripplewood Holdings in Commercial International Bank in Egypt.
Lebanese banks have been amongst the most active in moving into new territories and Saad Azhari, the Chairman and General Manager of BLOM Bank (which has been busy setting up shop in Saudi Arabia and Qatar), in the October 2008 edition of Banker Middle East explained their motivations for going abroad.
"We prefer to apply for licences and then grow the business that way. That has been our model in almost every case except for Egypt, where we bought a bank. The reason we bought Misr Romanian Bank was because the Egyptian government was not giving any new licences so we had to buy a bank."
Non performing loans
However, the rumour mill about possible mergers has started to go into overdrive as the effects of the global economic slowdown have started to hit home. Middle Eastern banks which were exposed to the subprime market in the US, the troubled real estate market in certain parts of the GCC (as well as Europe and the US), toxic derivatives, struggling family businesses, significant credit card defaults and large numbers of non-performing loans, will be feeling the effect on their balance sheets and the urge to merge may become hard to ignore.
Upcoming second and third quarter results will have merger-watchers crunching their own numbers to see which banks are most likely to become the targets of takeovers or decide to join forces with other banks which have complementary products, services and potential.
"Over the past decade, numerous local and regional investment banks and companies - both conventional and Islamic - were established, but the majority were 'mono-line', particularly real estate, and they now find themselves under severe pressure as their business models have been unable to withstand the market shocks over the past year. There is a strong case for consolidation in this particular segment of the banking sector, and we are likely to see some M&A activity over the coming months," said Frederick Stonehouse, Managing Director, Head of Strategic M&A at Unicorn Investment Bank in Bahrain.
Kuwait and Bahrain
Most of the merger rumours in recent months have come out Bahrain, as well as the UAE and Kuwait, but little if any from Qatar or Oman. In Bahrain, Islamic investment bank Gulf Finance House flatly denied reports that it was planning to merge with First Investment Bank from Kuwait.
"All the rumours in this regard are erroneous and completely without foundation," the bank said in response to reports in Al Watan, a Kuwaiti newspaper. "Gulf Finance House would like to assure its shareholders, investors and clients that it has no plans to merge with any bank or financial institution and continues to operate as a stand-alone Islamic investment bank."
The same newspaper reported that Stehwaz Holding from Kuwait was thinking about merging with Al Madar Finance and Investment. Stehwaz already owns 69 per cent of Al Madar. In 2008, Kuwait's Burgan Bank bought Jordan Kuwait Bank, Algeria Gulf Bank, Bank of Baghdad and Tunis International Bank from United Gulf Bank (UGB).
There was also plenty of speculation about what might happen to Kuwait's Gulf Bank, which was hit by $1.4 billion in derivatives losses in late 2008 with the Kuwait Times reporting that Gulf Bank Chairman Qutaiba Al-Ghanim said his bank was open to discussions about a merger with NBK.
Persistent rumours about Abu Dhabi Commercial Bank and another unnamed Abu Dhabi bank have been going around for ages, but thus far they have been just rumours. However, a research report from Prime Holding said that a merger between National Bank of Abu Dhabi (NBAD) and ADCB "will create the largest local bank with assets worth AED 312 billion ($84.9 billion).
Rumour mill
Banks around the region have been assessing their exposure to the troubled Saad and Algosaibi groups in Saudi Arabia which may have losses totalling $10 billion. Some banks have come forward and admitted their losses, but others have been less forthcoming on their exposure, something that is keeping the merger rumour mill humming away merrily.
Sultan bin Saud Al Qassemi, writing in his blog on Zawya, said, "In Kuwait, the problems that Gulf Bank faced last autumn have been resolved by large amounts of cash being injected into the bank by the Kuwaiti Government. Gulf Bank, whose losses reached $1.4 billion, is probably better off being merged with, say, National Bank of Kuwait, if only to give it a more competent management team."
Just how overbanked is the Middle East? Or is it overbanked at all?
"I think it varies from country to country, but I think we are certainly at a juncture where we could see some consolidation movements," said Jean-Christophe Durand, the Regional Director for BNP Paribas - GCC. "Saudi Arabia with a population of 30 million is not overbanked, but for the other smaller countries there are a lot of players for the size of the stake."
The numbers seem to bear this out. The GCC has an estimated population of 40 million, while the Middle East and North Africa has a population of 432 million.
Saturation
Dr. Alexander von Pock, Senior Manager of the Financial Institutions Group at A.T. Kearney Middle East believes the Middle East banking market as a whole is far from being consolidated and claims that the top three players in the GCC account for only 16 per cent of market share, while top three players in consolidated markets would account for more than 50 per cent.
Breaking it down by country, the UAE has 52 banks and a population of approximately 4.7 million, while Lebanon has 65 banks and a population of 3.9 million.
In Saudi Arabia there are 12 local banks and about as many foreign banks with a population of nearly 30 million. In Bahrain the conventional segment includes 19 retail banks, 69 wholesale banks, two specialised banks as well as 36 representative offices of overseas banks and 29 Islamic banks. The island Kingdom has a population of 718,000.
Qatar's population is 824,000 and Oman's is 3.3 million, while Jordan has 6.1 million and Syria has nearly 20 million. Those looking for opportunities in Morocco need to know that it has 34 million people, while Libya and Tunisia have populations of 6.1 million and 10.3 million respectively. Algeria's population is about the same as Morocco's.
Iran, which many banks consider to be a goldmine, has, after Egypt, the largest population in the region, at 65 million, while Iraq's head count is estimated to be roughly the same as Saudi Arabia's.
Favourable demographics
According to the Kuwait Central Bank's website, there are 17 banks and 101 investment companies (catering to a population of nearly 2.6 million), while in Egypt the population is a whopping 81 million with 40 banks (there used to be over 60 a few years ago) of various sizes battling away for market share.
A number of banks from across the region have been eyeing the North African powerhouse for some time and Islamic banks such as Abu Dhabi Islamic Bank have been reinforcing their presence in the country, while First Gulf Bank from Abu Dhabi has a presence in Libya.
"Based on fundamental measures (deposits and loans as a percentage of GDP, branches per capita) Saudi Arabia and the wider Middle East are not overbanked. Growing penetration and favourable demographics provide substantial growth opportunities for many years to come," said Abdulkareem Abu Alnasr, the CEO of National Commercial Bank (NCB) in Saudi Arabia.
Some countries like Iran, Iraq, Saudi Arabia, Egypt, Morocco, Algeria, Libya (and not forgetting Turkey, with a population of 72 million) have the kinds of demographics that thrill the forward planning departments in some retail and investment banks and insurance companies, both conventional and Islamic. Most of the aforementioned countries have large, educated, under-banked and comparatively young populations.
"However, in general, the Middle East national banking markets are comparatively small and some of them are highly fragmented. The fact that most banks operate exclusively within their national boundaries constrains severely their abilities to capture economies of scale," Alnasr added.
Some industry analysts believe it is almost certain that regulation and supervision standards for the banking industry will be tightened in the aftermath of the global and regional economic slowdown, making it necessary for banks to maintain higher liquidity and capitalisation levels, and perhaps become less profitable.
Michael Miebach, Managing Director of Barclays Global Retail and Commercial Banking in the Middle East and North Africa agreed. "Banking consolidation in the Middle East has been talked about for a long time, but never truly materialised during the boom years where consistent growth prevailed across the industry. However, the economic downturn presents a different set of challenges where declining margins, lower yields, balance sheet and capital pressure force institutions to consider all opportunities to maximise shareholder return and ensure their longevity."
Field of growth
But not all mergers take place in tough economic climates, as the Emirates NBD cases shows. It took place as the region was booming. But mergers in any situation, even boom times, are not easy and can face (sometimes significant) opposition from shareholders and employees.
"When you are doing M&A in a field of growth, you can manage the negative aspects of that," said Sanjay Uppal, Group Chief Financial Officer at Emirates NBD. "We significantly slowed down our hiring process during the transaction. Our balance sheet in 2007 had grown 40 per cent, therefore when we consolidated the organisations, the redundancies that came out automatically filled in the gaps that we had carried for many months."
But is merging such a good idea when significant numbers of them fail and is there ever a good time? Studies on M&A activities show that failure rates range from 40 to 80 per cent.
A study by the Hay Group in 2007 claimed that just nine per cent of European mergers are "completely successful" in achieving their stated objectives.
The study found that the great majority (93 per cent) of business leaders made traditional financial due diligence a high priority, while over half (55 per cent) focused on IT systems integration. However 58 per cent confessed that over-prioritising systems integration resulted in insufficient focus on intangible assets and cultural integration.
"The conventional wisdom 'used' to be that they failed because of financial, legal or other reasons. Basically, there were agency issues and complexities that weren't teased out in the due diligence process, and those things caused the endeavour to fail," said Andy Barkett, writing in a blog called The Eclecticist.
"In the last few years, the conventional wisdom has changed. The new convention is that mergers fail due to a lack of cultural compatibility or a failure to adapt the cultures to mesh together. Yet, the story goes, they happen anyway because of the egos of executives and because of the interminable pressure to grow." However, Rad Madha at EFG-Hermes was reported as saying in Executive magazine that, "I am not a believer that current issues can be resolved by mergers, although a limited number of cross-border mergers may be appropriate. This is not the kind of market to be combining banks. The suspicion would be that any bank willing to be bought would have a loan portfolio not worth buying."
"Clearly there is safety factor associated with scale but there are also huge synergies on both the cost and revenue side. Whilst we haven't seen any major movement in the region yet, there have been sizable examples in Europe and America where consolidation has delivered safety, scale and synergies to banks that are able to engage from a position of strength, and where banks previously considered too big to fail have been all but swallowed up," said Barclay's Miebach.
But is the Middle Eastern banking environment really so diverse as to make potential mergers such a challenge?
"I would say that the best time to do consolidation activity is in a growth environment in order to be able to tap into the right levels of synergies and so on," said Uppal from Emirates NBD. "However we are in a different environment today and even in this environment there is room for activeness, as opposed to waiting for the inevitable."
Every cloud has a silver lining and many bankers, even as they wonder just how much exposure they have to a particular sector or large family business, may be looking for the kinds of growth opportunities that are too hard to ignore.
"The current global financial crisis has highlighted weaknesses in banks worldwide, and banks in the Middle East have not been immune. The mergers and takeovers of banks in the US and Europe will inevitably be mirrored in the Middle East, with the strong absorbing the weak - frequently with the explicit or implicit support and encouragement of the regulators, whose primary role is to preserve the stability of the banking system. With the share prices of banks languishing at historic lows, there are excellent opportunities for acquisitions in markets which remain attractive in the long term," said Stonehouse at Unicorn.
Financial muscle
Indeed, bank stocks have been pummeled on the regional bourses over the past year with wave after wave of bad news driving investors to dump financial stocks. ADCB's shares were selling for AED 5.15 on 21 July 2008 but were (at the time of writing) trading at around AED 1.70, while GFH was at BHD 3.267 on 31 July 2008 and is now around BHD 0.790.
Middle Eastern Warren Buffets, the proverbial 'value investors' believe that the current gloom should not be allowed to disguise the fact that the Middle East remains attractive for banks, with a generally low market penetration, good economic prospects and a strong population growth.
"In the past, the reluctance of bank shareholders in the region to agree to mergers and acquisitions has prevented the emergence of Middle Eastern banks which have the financial muscle, network and product range to compete with international banks. However, the current crisis is likely to act as a catalyst for banks to merge, and in the long run this will be beneficial for the banking sector and for the regional economies," said Stonehouse.
"Retail and commercial banks have also been adversely affected by the global economic downturn, and there will inevitably be consolidation in this sector also, which is long overdue," he added.
The falling price of oil, which hit $147 in July 2008 and at the time of going to press is around $60 will have done nothing for investor confidence and this has affected the appetite for mergers. The liquidity that everyone said was "sloshing about" in 2007 has evaporated like the price of oil in three figures and is now little more than a case study in economists' textbooks, alongside irrational exuberance and survival of the fittest.
In the first six months of 2009, mergers and acquisitions activity in the Middle East continued to fall back from the high results reported in the first half of 2008, according to data from ZEPHYR/ BvDEP.
The data showed that values slumped to a new low in records dating back to 2006, deteriorating by 70 per cent to $6.2 billion from $21 billion in the second half of 2008 and plunging by 81 per cent from $32.4 billion in the first half of 2008.
Volume performed better but was still down by a fifth over the six months at 122 and was 49 per cent lower from the high of 241 recorded in the first half of 2008.
The banking sector dominated the top four places in the first half of 2009 with Dubai Islamic Bank's decision to raise $817 million over a five year period leading the way, almost double that of its nearest rival, the $441 million purchase of a five per cent stake in the Saudi Arabian institution Samba Financial by the Public Pension Agency, ZEPHYR/ BvDEP figures show.
What is stalling M&A activity by banks in the Middle East? Is it down to inadequate cross border regulation and too much protectionism? Would a GCC single currency or new set of rules by a GCC Central Bank make any difference?
Monetary union
"A monetary union, as we saw in Europe, [would] make it a lot easier for people to think about cross-border mergers," said Michael Helou, the co-Head of Investment Banking at Rothschild's in Dubai in an article in Finance Asia magazine. "A GCC monetary union can only be a positive but I'm not convinced it could be a catalyst."
Most bankers seem to agree that one obstacle to mergers is the influence of families, given that a not insignificant number of banks are still family owned and that may be as much of a hindrance as poor regulation.
"A high proportion of banks in the region are niche players that have limited reach and do not enjoy a viable customer franchise," said Abdulkareem Abu Alnasr from NCB. "Many are controlled by individuals or family groups, have low levels of institutionalisation and may not practice good standards of governance. Even the largest banks in the region are small compared to their counterparts in OECD countries."
Competitive disadvantage
Alnasr believes that the national focus and small scale of regional banks puts them at a significant competitive disadvantage: High concentrations of loans and deposits; high vulnerability to the economic cycles in their national markets; limited access to capital markets and top notch talent with a limited capacity to invest in distribution, IT and risk management capabilities.
"To overcome these structural weaknesses and to close the competitive gap vis-à-vis international banks, it is necessary for the banking sector to consolidate - certainly in highly fragmented domestic markets, but more critically, across national boundaries so that the benefits of scale and risk diversification can be effectively captured," Alnasr said.
Entering new markets, either through strategic stakes, by acquiring banks or getting a licence can be a time consuming and in the short term, costly exercise especially when margins are feeling pressurised.
"We got the licence to move into Saudi Arabia at the end of January [2008] and it took around a year and a half before we got the licence to operate there," said Azhari from BLOM Bank.
"It took around a year to get the licence for Qatar, which we received in April [2008]. It takes time because a lot of documentation is required before the approval is given and that can be delayed if some document or other is missing. Then, when you get the approval you have to scout around for a location, find the staff and so on, so it can take as long as a year after getting a licence to be up and running."
Mardig Haladjian, General Manager, Moody's (Cyprus) and head of Moody's regional banking team believes that there are several small Middle Eastern banks that may not be able to develop economies of scale and survive over the long term. Some of these may need to consider merging. However, he admits that most Middle Eastern countries have large, underbanked populations and substantial needs for infrastructure investment and these could provide banks with the needed business to grow in the years ahead.
There is also the issue of a pan-Arab megabank, something that would rival the likes of Citi, JP Morgan, Goldman Sachs and HSBC and many (including Central Banks) are in favour of the idea, although the vast majority agree it is a long way off.
"There could be three, four or more of them," said Uppal from Emirates NBD. "As we move towards more intra GCC trade flows, that will be aided by such pan regional banks. I do believe that these are developing markets and a strong banking system will be a key cornerstone for the GCC to achieve its ambitions. We believe that M&As are going to be essential for creating that environment."
But the big question remains. Will there be any mergers in the region in 2009 and what will they look like?
Prudent
Jean-Christophe Durand from BNP Paribas said, "What we could see is a conventional bank taking a stake in an Islamic bank which is able to compliment its activities, but in terms of consolidation, I see it more among all these new Islamic banks which emerged over the past five or six years with family capital or government most of the time which had similar types of vision and investment banking, real estate activities and so on and given the crisis will be more inclined to work together to join forces and even merge."
Sultan bin Saud Al Qassemi said, "There is the special case of Dubai Holding, which owns two competing Islamic banks. It would be prudent to either merge Dubai Bank and Noor Islamic Bank into a stronger and more liquid entity or sell Dubai Bank off to an interested party - maybe even back to Emaar Properties," in his blog on Zawya.
The general opinion is that it is very difficult for a foreign bank to have, for instance, a retail network unless they have been established in the region for a long time like HSBC or Standard Chartered. However, as Durand points out, "There might be newcomers to the region which might be interested in taking stakes in banks in the region which could help them to increase their wealth management, investment banking or retail banking presence. Consolidation is not just about within the region. It could also involve outside players," he said.
Banking consolidation in the Middle East has been talked about for a long time, but never truly materialised during the boom years where consistent growth prevailed across the industry.
© Banker Middle East 2009
Is the Middle East overbanked and what is the case for and against for mergers? Will any banks merge this year and if so, who, when, where, why and what? Mike Gallagher goes looking for answers There is always a rumour going around somewhere that certain Middle East banks might be about to merge. One conference after another has banking heads and consultants giving their views on what makes for the perfect banking marriage and which countries' regulations offer the best prospects for wedded bliss.
The first and most recent example of a Middle Eastern mega-merger was in early 2007 when Emirates Bank and National Bank of Dubai (NBD) combined to become Emirates NBD which now has over 120 branches and over 650 ATMs.
After that came about, the merger of Industrial Development Bank of Egypt (IDBE) and the Egyptian Workers Bank went ahead in November 2008 which became Industrial Development & Workers Bank of Egypt (IDWBE) and now has 19 branches.
Around the same time, Egypt's EFG-Hermes and Bank Audi from Lebanon (in which EFG has a 28 per cent stake) decided to put their plans to merge on hold, due to inclement market conditions. There has been no word since of any further developments.
Then in July 2009, Actis, an emerging markets private equity specialist, said that it had executed an agreement to invest $244 million to acquire 50 per cent of the stake held by the consortium led by Ripplewood Holdings in Commercial International Bank in Egypt.
Lebanese banks have been amongst the most active in moving into new territories and Saad Azhari, the Chairman and General Manager of BLOM Bank (which has been busy setting up shop in Saudi Arabia and Qatar), in the October 2008 edition of Banker Middle East explained their motivations for going abroad.
"We prefer to apply for licences and then grow the business that way. That has been our model in almost every case except for Egypt, where we bought a bank. The reason we bought Misr Romanian Bank was because the Egyptian government was not giving any new licences so we had to buy a bank."
Non performing loans
However, the rumour mill about possible mergers has started to go into overdrive as the effects of the global economic slowdown have started to hit home. Middle Eastern banks which were exposed to the subprime market in the US, the troubled real estate market in certain parts of the GCC (as well as Europe and the US), toxic derivatives, struggling family businesses, significant credit card defaults and large numbers of non-performing loans, will be feeling the effect on their balance sheets and the urge to merge may become hard to ignore.
Upcoming second and third quarter results will have merger-watchers crunching their own numbers to see which banks are most likely to become the targets of takeovers or decide to join forces with other banks which have complementary products, services and potential.
"Over the past decade, numerous local and regional investment banks and companies - both conventional and Islamic - were established, but the majority were 'mono-line', particularly real estate, and they now find themselves under severe pressure as their business models have been unable to withstand the market shocks over the past year. There is a strong case for consolidation in this particular segment of the banking sector, and we are likely to see some M&A activity over the coming months," said Frederick Stonehouse, Managing Director, Head of Strategic M&A at Unicorn Investment Bank in Bahrain.
Kuwait and Bahrain
Most of the merger rumours in recent months have come out Bahrain, as well as the UAE and Kuwait, but little if any from Qatar or Oman. In Bahrain, Islamic investment bank Gulf Finance House flatly denied reports that it was planning to merge with First Investment Bank from Kuwait.
"All the rumours in this regard are erroneous and completely without foundation," the bank said in response to reports in Al Watan, a Kuwaiti newspaper. "Gulf Finance House would like to assure its shareholders, investors and clients that it has no plans to merge with any bank or financial institution and continues to operate as a stand-alone Islamic investment bank."
The same newspaper reported that Stehwaz Holding from Kuwait was thinking about merging with Al Madar Finance and Investment. Stehwaz already owns 69 per cent of Al Madar. In 2008, Kuwait's Burgan Bank bought Jordan Kuwait Bank, Algeria Gulf Bank, Bank of Baghdad and Tunis International Bank from United Gulf Bank (UGB).
There was also plenty of speculation about what might happen to Kuwait's Gulf Bank, which was hit by $1.4 billion in derivatives losses in late 2008 with the Kuwait Times reporting that Gulf Bank Chairman Qutaiba Al-Ghanim said his bank was open to discussions about a merger with NBK.
Persistent rumours about Abu Dhabi Commercial Bank and another unnamed Abu Dhabi bank have been going around for ages, but thus far they have been just rumours. However, a research report from Prime Holding said that a merger between National Bank of Abu Dhabi (NBAD) and ADCB "will create the largest local bank with assets worth AED 312 billion ($84.9 billion).
Rumour mill
Banks around the region have been assessing their exposure to the troubled Saad and Algosaibi groups in Saudi Arabia which may have losses totalling $10 billion. Some banks have come forward and admitted their losses, but others have been less forthcoming on their exposure, something that is keeping the merger rumour mill humming away merrily.
Sultan bin Saud Al Qassemi, writing in his blog on Zawya, said, "In Kuwait, the problems that Gulf Bank faced last autumn have been resolved by large amounts of cash being injected into the bank by the Kuwaiti Government. Gulf Bank, whose losses reached $1.4 billion, is probably better off being merged with, say, National Bank of Kuwait, if only to give it a more competent management team."
Just how overbanked is the Middle East? Or is it overbanked at all?
"I think it varies from country to country, but I think we are certainly at a juncture where we could see some consolidation movements," said Jean-Christophe Durand, the Regional Director for BNP Paribas - GCC. "Saudi Arabia with a population of 30 million is not overbanked, but for the other smaller countries there are a lot of players for the size of the stake."
The numbers seem to bear this out. The GCC has an estimated population of 40 million, while the Middle East and North Africa has a population of 432 million.
Saturation
Dr. Alexander von Pock, Senior Manager of the Financial Institutions Group at A.T. Kearney Middle East believes the Middle East banking market as a whole is far from being consolidated and claims that the top three players in the GCC account for only 16 per cent of market share, while top three players in consolidated markets would account for more than 50 per cent.
Breaking it down by country, the UAE has 52 banks and a population of approximately 4.7 million, while Lebanon has 65 banks and a population of 3.9 million.
In Saudi Arabia there are 12 local banks and about as many foreign banks with a population of nearly 30 million. In Bahrain the conventional segment includes 19 retail banks, 69 wholesale banks, two specialised banks as well as 36 representative offices of overseas banks and 29 Islamic banks. The island Kingdom has a population of 718,000.
Qatar's population is 824,000 and Oman's is 3.3 million, while Jordan has 6.1 million and Syria has nearly 20 million. Those looking for opportunities in Morocco need to know that it has 34 million people, while Libya and Tunisia have populations of 6.1 million and 10.3 million respectively. Algeria's population is about the same as Morocco's.
Iran, which many banks consider to be a goldmine, has, after Egypt, the largest population in the region, at 65 million, while Iraq's head count is estimated to be roughly the same as Saudi Arabia's.
Favourable demographics
According to the Kuwait Central Bank's website, there are 17 banks and 101 investment companies (catering to a population of nearly 2.6 million), while in Egypt the population is a whopping 81 million with 40 banks (there used to be over 60 a few years ago) of various sizes battling away for market share.
A number of banks from across the region have been eyeing the North African powerhouse for some time and Islamic banks such as Abu Dhabi Islamic Bank have been reinforcing their presence in the country, while First Gulf Bank from Abu Dhabi has a presence in Libya.
"Based on fundamental measures (deposits and loans as a percentage of GDP, branches per capita) Saudi Arabia and the wider Middle East are not overbanked. Growing penetration and favourable demographics provide substantial growth opportunities for many years to come," said Abdulkareem Abu Alnasr, the CEO of National Commercial Bank (NCB) in Saudi Arabia.
Some countries like Iran, Iraq, Saudi Arabia, Egypt, Morocco, Algeria, Libya (and not forgetting Turkey, with a population of 72 million) have the kinds of demographics that thrill the forward planning departments in some retail and investment banks and insurance companies, both conventional and Islamic. Most of the aforementioned countries have large, educated, under-banked and comparatively young populations.
"However, in general, the Middle East national banking markets are comparatively small and some of them are highly fragmented. The fact that most banks operate exclusively within their national boundaries constrains severely their abilities to capture economies of scale," Alnasr added.
Some industry analysts believe it is almost certain that regulation and supervision standards for the banking industry will be tightened in the aftermath of the global and regional economic slowdown, making it necessary for banks to maintain higher liquidity and capitalisation levels, and perhaps become less profitable.
Michael Miebach, Managing Director of Barclays Global Retail and Commercial Banking in the Middle East and North Africa agreed. "Banking consolidation in the Middle East has been talked about for a long time, but never truly materialised during the boom years where consistent growth prevailed across the industry. However, the economic downturn presents a different set of challenges where declining margins, lower yields, balance sheet and capital pressure force institutions to consider all opportunities to maximise shareholder return and ensure their longevity."
Field of growth
But not all mergers take place in tough economic climates, as the Emirates NBD cases shows. It took place as the region was booming. But mergers in any situation, even boom times, are not easy and can face (sometimes significant) opposition from shareholders and employees.
"When you are doing M&A in a field of growth, you can manage the negative aspects of that," said Sanjay Uppal, Group Chief Financial Officer at Emirates NBD. "We significantly slowed down our hiring process during the transaction. Our balance sheet in 2007 had grown 40 per cent, therefore when we consolidated the organisations, the redundancies that came out automatically filled in the gaps that we had carried for many months."
But is merging such a good idea when significant numbers of them fail and is there ever a good time? Studies on M&A activities show that failure rates range from 40 to 80 per cent.
A study by the Hay Group in 2007 claimed that just nine per cent of European mergers are "completely successful" in achieving their stated objectives.
The study found that the great majority (93 per cent) of business leaders made traditional financial due diligence a high priority, while over half (55 per cent) focused on IT systems integration. However 58 per cent confessed that over-prioritising systems integration resulted in insufficient focus on intangible assets and cultural integration.
"The conventional wisdom 'used' to be that they failed because of financial, legal or other reasons. Basically, there were agency issues and complexities that weren't teased out in the due diligence process, and those things caused the endeavour to fail," said Andy Barkett, writing in a blog called The Eclecticist.
"In the last few years, the conventional wisdom has changed. The new convention is that mergers fail due to a lack of cultural compatibility or a failure to adapt the cultures to mesh together. Yet, the story goes, they happen anyway because of the egos of executives and because of the interminable pressure to grow." However, Rad Madha at EFG-Hermes was reported as saying in Executive magazine that, "I am not a believer that current issues can be resolved by mergers, although a limited number of cross-border mergers may be appropriate. This is not the kind of market to be combining banks. The suspicion would be that any bank willing to be bought would have a loan portfolio not worth buying."
"Clearly there is safety factor associated with scale but there are also huge synergies on both the cost and revenue side. Whilst we haven't seen any major movement in the region yet, there have been sizable examples in Europe and America where consolidation has delivered safety, scale and synergies to banks that are able to engage from a position of strength, and where banks previously considered too big to fail have been all but swallowed up," said Barclay's Miebach.
But is the Middle Eastern banking environment really so diverse as to make potential mergers such a challenge?
"I would say that the best time to do consolidation activity is in a growth environment in order to be able to tap into the right levels of synergies and so on," said Uppal from Emirates NBD. "However we are in a different environment today and even in this environment there is room for activeness, as opposed to waiting for the inevitable."
Every cloud has a silver lining and many bankers, even as they wonder just how much exposure they have to a particular sector or large family business, may be looking for the kinds of growth opportunities that are too hard to ignore.
"The current global financial crisis has highlighted weaknesses in banks worldwide, and banks in the Middle East have not been immune. The mergers and takeovers of banks in the US and Europe will inevitably be mirrored in the Middle East, with the strong absorbing the weak - frequently with the explicit or implicit support and encouragement of the regulators, whose primary role is to preserve the stability of the banking system. With the share prices of banks languishing at historic lows, there are excellent opportunities for acquisitions in markets which remain attractive in the long term," said Stonehouse at Unicorn.
Financial muscle
Indeed, bank stocks have been pummeled on the regional bourses over the past year with wave after wave of bad news driving investors to dump financial stocks. ADCB's shares were selling for AED 5.15 on 21 July 2008 but were (at the time of writing) trading at around AED 1.70, while GFH was at BHD 3.267 on 31 July 2008 and is now around BHD 0.790.
Middle Eastern Warren Buffets, the proverbial 'value investors' believe that the current gloom should not be allowed to disguise the fact that the Middle East remains attractive for banks, with a generally low market penetration, good economic prospects and a strong population growth.
"In the past, the reluctance of bank shareholders in the region to agree to mergers and acquisitions has prevented the emergence of Middle Eastern banks which have the financial muscle, network and product range to compete with international banks. However, the current crisis is likely to act as a catalyst for banks to merge, and in the long run this will be beneficial for the banking sector and for the regional economies," said Stonehouse.
"Retail and commercial banks have also been adversely affected by the global economic downturn, and there will inevitably be consolidation in this sector also, which is long overdue," he added.
The falling price of oil, which hit $147 in July 2008 and at the time of going to press is around $60 will have done nothing for investor confidence and this has affected the appetite for mergers. The liquidity that everyone said was "sloshing about" in 2007 has evaporated like the price of oil in three figures and is now little more than a case study in economists' textbooks, alongside irrational exuberance and survival of the fittest.
In the first six months of 2009, mergers and acquisitions activity in the Middle East continued to fall back from the high results reported in the first half of 2008, according to data from ZEPHYR/ BvDEP.
The data showed that values slumped to a new low in records dating back to 2006, deteriorating by 70 per cent to $6.2 billion from $21 billion in the second half of 2008 and plunging by 81 per cent from $32.4 billion in the first half of 2008.
Volume performed better but was still down by a fifth over the six months at 122 and was 49 per cent lower from the high of 241 recorded in the first half of 2008.
The banking sector dominated the top four places in the first half of 2009 with Dubai Islamic Bank's decision to raise $817 million over a five year period leading the way, almost double that of its nearest rival, the $441 million purchase of a five per cent stake in the Saudi Arabian institution Samba Financial by the Public Pension Agency, ZEPHYR/ BvDEP figures show.
What is stalling M&A activity by banks in the Middle East? Is it down to inadequate cross border regulation and too much protectionism? Would a GCC single currency or new set of rules by a GCC Central Bank make any difference?
Monetary union
"A monetary union, as we saw in Europe, [would] make it a lot easier for people to think about cross-border mergers," said Michael Helou, the co-Head of Investment Banking at Rothschild's in Dubai in an article in Finance Asia magazine. "A GCC monetary union can only be a positive but I'm not convinced it could be a catalyst."
Most bankers seem to agree that one obstacle to mergers is the influence of families, given that a not insignificant number of banks are still family owned and that may be as much of a hindrance as poor regulation.
"A high proportion of banks in the region are niche players that have limited reach and do not enjoy a viable customer franchise," said Abdulkareem Abu Alnasr from NCB. "Many are controlled by individuals or family groups, have low levels of institutionalisation and may not practice good standards of governance. Even the largest banks in the region are small compared to their counterparts in OECD countries."
Competitive disadvantage
Alnasr believes that the national focus and small scale of regional banks puts them at a significant competitive disadvantage: High concentrations of loans and deposits; high vulnerability to the economic cycles in their national markets; limited access to capital markets and top notch talent with a limited capacity to invest in distribution, IT and risk management capabilities.
"To overcome these structural weaknesses and to close the competitive gap vis-à-vis international banks, it is necessary for the banking sector to consolidate - certainly in highly fragmented domestic markets, but more critically, across national boundaries so that the benefits of scale and risk diversification can be effectively captured," Alnasr said.
Entering new markets, either through strategic stakes, by acquiring banks or getting a licence can be a time consuming and in the short term, costly exercise especially when margins are feeling pressurised.
"We got the licence to move into Saudi Arabia at the end of January [2008] and it took around a year and a half before we got the licence to operate there," said Azhari from BLOM Bank.
"It took around a year to get the licence for Qatar, which we received in April [2008]. It takes time because a lot of documentation is required before the approval is given and that can be delayed if some document or other is missing. Then, when you get the approval you have to scout around for a location, find the staff and so on, so it can take as long as a year after getting a licence to be up and running."
Mardig Haladjian, General Manager, Moody's (Cyprus) and head of Moody's regional banking team believes that there are several small Middle Eastern banks that may not be able to develop economies of scale and survive over the long term. Some of these may need to consider merging. However, he admits that most Middle Eastern countries have large, underbanked populations and substantial needs for infrastructure investment and these could provide banks with the needed business to grow in the years ahead.
There is also the issue of a pan-Arab megabank, something that would rival the likes of Citi, JP Morgan, Goldman Sachs and HSBC and many (including Central Banks) are in favour of the idea, although the vast majority agree it is a long way off.
"There could be three, four or more of them," said Uppal from Emirates NBD. "As we move towards more intra GCC trade flows, that will be aided by such pan regional banks. I do believe that these are developing markets and a strong banking system will be a key cornerstone for the GCC to achieve its ambitions. We believe that M&As are going to be essential for creating that environment."
But the big question remains. Will there be any mergers in the region in 2009 and what will they look like?
Prudent
Jean-Christophe Durand from BNP Paribas said, "What we could see is a conventional bank taking a stake in an Islamic bank which is able to compliment its activities, but in terms of consolidation, I see it more among all these new Islamic banks which emerged over the past five or six years with family capital or government most of the time which had similar types of vision and investment banking, real estate activities and so on and given the crisis will be more inclined to work together to join forces and even merge."
Sultan bin Saud Al Qassemi said, "There is the special case of Dubai Holding, which owns two competing Islamic banks. It would be prudent to either merge Dubai Bank and Noor Islamic Bank into a stronger and more liquid entity or sell Dubai Bank off to an interested party - maybe even back to Emaar Properties," in his blog on Zawya.
The general opinion is that it is very difficult for a foreign bank to have, for instance, a retail network unless they have been established in the region for a long time like HSBC or Standard Chartered. However, as Durand points out, "There might be newcomers to the region which might be interested in taking stakes in banks in the region which could help them to increase their wealth management, investment banking or retail banking presence. Consolidation is not just about within the region. It could also involve outside players," he said.
Banking consolidation in the Middle East has been talked about for a long time, but never truly materialised during the boom years where consistent growth prevailed across the industry.
© Banker Middle East 2009
