JEDDAH —

Consolidation has been an ongoing theme over the past two to three years for GCC banks, particularly amongst state-owned enterprises, as the Abu Dhabi authorities continue to reshape their economy due to lower oil prices, Indosuez Wealth Management said in a report released Sunday.

The merger of First Gulf Bank and National Bank of Abu Dhabi in 2017 created the UAE’s largest bank, First Abu Dhabi Bank, with $188 billion in assets as at H1 2018. The potential merger between Abu Dhabi Commercial Bank, Union National Bank, and Al Hilal Bank will create an entity with approximately $113 billion of assets (using H1 2018 figures), making it the fifth largest lender in the GCC and third biggest in the UAE. Abu Dhabi has also merged several state investment funds, including Mubadala and Abu Dhabi Investment Council – the latter holding majority stakes in Abu Dhabi Commercial Bank and Union National Bank, potentially easing the progress of any merger.

The benefits of potential mergers among banks in the UAE and GCC are clear – pricing power, less pressure on funding costs, increasing banks’ scale and revenue base. However, sizeable single name and sector concentrations as well as high levels of related-party lending will continue to constrain many banks stand-alone credit profiles.

Consolidation among UAE banks is continuing as the country looks to reshape its economy and consolidate state-owned companies to deal with lower oil prices. Earlier in September 2018, three Abu Dhabi banks (Abu Dhabi Commercial Bank, Union National Bank, and Al Hilal Bank) announced merger talks. Last week, three other Abu Dhabi listed Sharjah banks (Bank of Sharjah, Invest Bank, and United Arab Bank) publicly denied media reports of another three-way merger. Taking into account the UAE market, the consolidation trend is fundamentally positive and will improve banks’ franchises through increased pricing power as well lowering funding costs for banks. However, existing weaknesses, namely sizeable single name and sector concentrations, high levels of related-party lending, and asset-quality issues are still characteristics of banking in the Middle East and remain key features for creditors to look out for.

The UAE banking system is arguably over-banked with approximately 50 banks operating in a country with a population of 9 million.

With regards to the operating environment, GDP growth has been weak in recent years due to the lower oil prices. While crude oil prices are currently rising, they have experienced a sustained fall since 2014 (WTI $111/barrel in May 2014), having a material impact on GCC economies and resulting in lower economic growth and rising public debt-to-GDP ratios (see chart below). Lower economic and credit growth has increased competition for lending opportunities as the pool of high quality customers and deposit sources shrinks. Both these dynamics have put pressure on UAE banks’ net interest margins (see chart below) which have trended downwards, supporting the case for mergers. — SG