As the largest bank merger since 2008, the combination of NBAD and FGB could mean big changes for the Middle East financial sector. Sarah Rundell investigates.


In July 2016, the same month that Abu Dhabi announced plans to merge its two largest sovereign investment funds (the International Petroleum Investment Company and Mubadala Development Company), two of the country’s biggest banks also announced plans to team up.

Against a backdrop of weak oil prices, a slowdown in growth and pressure on banks’ earnings, the tie-up between National Bank of Abu Dhabi (NBAD) and First Gulf Bank (FGB) will shape a leaner institution with reduced costs that is able to respond to today’s more challenging environment. It will also create one of the region’s largest lenders from two banks known for their keen expansionary ambitions.

As the biggest merger since the 2008 financial crisis, this could herald the beginning of a new phase of consolidation in the UAE’s crowded banking market, with no less than 50 banks in constant competition. And as European and American banks continue their retreat to home markets, such consolidation could help position UAE banks to take advantage.

“The new, well-balanced bank will be an engine of UAE growth, driving further investment and economic diversification, and advancing the ambitions of entrepreneurs and the people they employ. The bank will have the strength and expertise to support the development of the UAE’s private sector, from SMEs to large companies gathering strength to expand beyond their national borders,” says Sheikh Tahnoon Bin Zayed Al Nahyan, chairman of FGB, in a statement.

The new bank, which will trade under the NBAD name, will have a combined market capitalisation of US$29bn and some US$175bn of assets. Dwarfing any regional banking rival in Bahrain and on par with Qatar National Bank (QNB), the largest bank in the region, it will put the UAE out in front when it comes to regional acquisition opportunities, believes Redmond Ramsdale, senior director, financial institutions at ratings agency Fitch. “This merger creates a diversified national champion and one of the largest banks in the GCC with a substantial balance sheet. As international banks continue to retreat to their home markets to improve their capital ratios, more opportunities will open up for local banks,” he says.


Combined ambitions

The two banks have made no secret of their desire to expand. NBAD has been positioning itself to benefit from economic growth along the so-called west-east corridor that stretches from Lagos to Shanghai and includes many of the world’s next mega cities. FGB has also targeted expansion in North Asia, mainland China and India in a bid to benefit from trade and finance flows between the UAE and these regions. Now both these strategies will be pooled into one ambition, with the combined bank operating an international network of branches and offices that already spans 19 countries.

“Expansion across fast-growing emerging markets presents a vast business opportunity for our customers and for us, as a larger, stronger, combined bank. We will have the capital, expertise and international networks to be the preferred financial partner for anyone doing business along the west-east corridor,” Nasser Ahmed Alsowaidi, chairman of NBAD, explains in a statement.

Expansion could include the purchase of banking entities previously owned by western players, the most recent example being UK-based Barclays’ sale of its Egyptian operations, which include 56 branches that serve around 127,000 customers. Interested parties so far include Dubai’s largest bank Emirates NBD, which bought BNP Paribas’ Egyptian subsidiary in 2013, but the new NBAD will undeniably be in a strong position to bid for this or similar takeovers.

It will also be big enough to win business from multinational corporations which rarely consider working with small regional banks, allowing it to play in the big league. “It will allow the bank to reach further and to compete more with the likes of HSBC,” argues Ramsdale.

The bank will benefit from following local companies into foreign markets. “Better capitalised UAE banks will be able to support larger transactions for local corporations. Banks will be able to attract more liquidity that will allow them to scale and invest in technology and distribution,” says Sanjay Uppal, CEO of Singapore-based consultancy StraitsBridge Advisors and former chief financial officer at Emirates NBD, which was created after the merger of Emirates Bank International and National Bank of Dubai in 2007.

He observes that the recent rise of the banking sector in the country, which has seen the combined balance sheet of UAE banks grow from US$100bn in 2003 to US$700bn today, clearly underscores the growth that lies ahead.


Government loan expansion

The combined bank should have the capital strength and core liquidity to increase investment in the non-oil economy, particularly in sectors such as tourism, construction, chemicals and strategic infrastructure. Abu Dhabi’s development of its ports and airports illustrate its ambitions here, for example, the new Midfield Terminal building, a prestige project for government-owned Adac and a linchpin in Abu Dhabi’s broader plans to increase tourist traffic as part of the Vision 2030 strategy to diversify the economy.

When it comes to financing these kinds of projects, NBAD in particular will benefit from FGB’s much smaller government loan portfolio, which will allow it to meet central bank limits on government lending with little to no deleveraging of assets. Thresholds were put in place after the Dubai debt crisis to reduce banks’ vulnerability of lending to government entities, explains Alyssa Grzelak, an analyst at IHS Global Insight.

“By our estimates, NBAD’s exposure to the government was equivalent to 151% of shareholders’ equity at the end of the Q2 2016. In contrast, FGB’s total lending to the government and related entities was equivalent to just 46% of its shareholders’ equity in the same period. By combining operations, NBAD should have to do very little, if any, in the way of deleveraging on its government loan portfolio,” she says.

But it is worth noting that tourism is an area where Dubai has first-mover advantage, with its airport already serving 70 million travellers a year and capacity forecast to rise to 200 million, and its Jebel Ali port expected to become the world’s largest in the next 15 years, as Dubai becomes a logistical hub for the Middle East and Africa.

The architects behind the merger have also stated that the new bank’s boosted liquidity will increase its ability to lend to SMEs, an area the government wants to foster to create jobs and diversify the economy. In recent years, tighter liquidity within the UAE banking system has caused banks to lend less and restrict corporate credit lines. SME lending only accounts for 4% of UAE bank loans with 50-70% of SME requests for bank loans rejected, according to consultancy KPMG. Banks hit by defaults on loans made to SMEs include United Arab Bank – which reported losses in 2015 as a result of provisions mainly for bad loans to SMEs – and Abu Dhabi’s Shuaa Capital.


Overcoming tough competition

Trade and the availability of trade finance should also benefit from the merger, believes Saeeda Jaffar, managing director at consultancy Alvarez & Marsal’s Middle East office. “The banks under consideration have significant cost synergies. Transaction banking relies heavily on IT platforms and service operations. If managed correctly, this is a highly scalable business with significant economies of scale benefits,” she says.

IHS’s Grzelak adds: “Big banks can compete more on prices and will be able to snap up more business on the trade finance side.” A moot point in the current market, where demand for trade finance in the region has dropped along with the oil price, causing a jump in bank competition for deals.

Banks have seen “decimated volumes and shrinking trade finance portfolios” and “are trying to become more competitive to get the deals”, according to Emre Karter, head of treasury and trade solutions for Mena, Pakistan and Turkey, at Citi. He adds: “The credit ratings of corporations and the underlying asset is still quite good but the financing demand for trade has shrunk. It is definitely more competitive for banks and better for the users of trade finance out there at the moment,” he says.

A larger bank could also help Abu Dhabi’s ambitions to become a major offshore financial centre, another part of the kingdom’s long-term plan to diversify away from hydrocarbons. The quality of the UAE’s banks and the emergence of a national banking champion will boost a strategy that aims to capitalise on the UAE’s location between key financial markets in America, Europe and Asia, a recognised ease of doing business and investor-friendly policies.

Investor confidence in the region’s banks will help build the UAE’s ability to attract more overseas money, leading to more liquidity. “This merger suggests that the UAE will become a more attractive destination on the deposit side,” says Uppal.

However, here too Abu Dhabi will have a fight for dominance with its neighbour, where the Dubai International Financial Centre (DIFC) is established as the leading Middle East finance hub and gateway, with a regulatory framework modelled on those used in London and New York. Dubai’s success has already crimped the ability of Qatar’s Financial Centre, established in 2005, to attract any critical mass of financial companies because many are already settled in Dubai.

This merger could be a catalyst for others, in a region where a large number of banks compete in challenging market conditions, and in a global banking context where growing regulations around anti-money laundering, anti-bribery, corruption and KYC are forcing banks to invest in both human and IT resources.

Fitch’s Ramsdale, however, notes that the UAE is already a fairly consolidated market: “We expect consolidation as the market matures, but the UAE’s four largest banks between them have a 50% market share, so there has already been consolidation amongst the large players.”

“The Emirates NBD merger in 2007 was never followed by others, [though it was] widely expected at the time, because the financial crisis put a stop to it,” adds IHS’ Grzelak.
But even if no other mergers follow, the combination of NBAD and FGB shows Abu Dhabi’s determination – likely boosted by prolonged low oil prices – to finally press ahead with a rationalisation programme to improve efficiency.