GCC lenders are coming up with ways to resist geopolitical tensions and unstable oil prices through partnerships with fintechs and increasing their presence in the international market through synergies.
Wednesday 30, January 2019 BY MUZORIWA KUDAKWASHE
The GCC, home to some of the fastest growing economies in the MENA region, is seeing a booming banking sector attracting some of the world’s heavyweights in the industry over the past few years since the recovery from the oil crisis of 2014. In its Global Banks 2019 Outlook, S&P Global has predicted that the financial profiles of GCC banks financial profiles should remain stable in 2019, absent of any unexpected geopolitical shocks.
However, the volatile oil prices, existing geopolitical tensions and the slump in real estate sector threaten the financial profile of banking sectors in the region. GCC lenders are coming up with ways to resist external shocks ranging from partnerships with fintechs, increasing their presence on the international market and reduce a glut of banks in the region through synergies.
Mergers and Acquisitions
There has been an increase of bank synergies across the region between GCC-based lenders and international banks operating in the region. The region is heavily over-banked, and lenders are being forced to merge as they seek to stay competitive in an era of lower oil prices. Regional banks are heavily reliant on government deposits, customer spending, as well as the real estate sector, and these have been dwindling in sync with crude oil prices.
According to Bloomberg, there are more than 73 listed banks in the GCC, catering to a population of around 51 million. The formation of First Abu Dhabi Bank in the UAE in 2016 triggered a wave of consolidation across the region, resulting in more than a dozen banks in the region exploring possible mergers to increase the lenders’ capital base, improve operational efficiency and to comply with requirements of the countries from where they are operating.
Source: S&P Global
Abu Dhabi Commercial Bank (ADCB) and Union National Bank (UNB) are in talks with Al Hilal Bank for a possible tie-up that would create a regional powerhouse with assets of about $110 billion. The trio share the same majority owner in Mubadala Investment Company, which analysts are saying it is likely to increase the chances of a smooth consolidation.
Similarly, Sharjah-based Invest Bank has secured support from the Central Bank of the UAE and the Sharjah government after it was hit by recent high levels of bad loans, partly due to its exposure to the troubled GCC real estate and construction market, which threatened its capital base. The Government of Sharjah has pledged to acquire 1.59 billion shares for AED 1.12 billion or 50.07 per cent of the total issued share capital of the bank as well as to subscribe in full to the shares offered to it as part of a rights issue to be undertaken by Invest Bank in 2019 and any new shares offered to other shareholders, which remain unsubscribed.
S&P Global expects profitability to stabilise with a return on assets at about 1.6 per cent and a net interest margin at three per cent in 2019, benefitting from the higher interest rates and significant non-interest-bearing deposits. The Saudi banking industry is also witnessing a number of successful tieups following the confirmation by Saudi British Bank (SABB) and Alawwal that they have entered into a binding merger agreement in October having started discussions on a potential merger in April 2017.
Under the merger agreement, all of the assets and liabilities of Alawwal Bank will be transferred to SABB—the tie-up will create the Kingdom’s third-largest bank, a top-tier retail and corporate bank with SAR 271 billion in assets. Upon completion of the merger, SABB will continue to exist; Alawwal bank will cease to exist as a legal entity and its shares will be cancelled and new shares in SABB will be issued to shareholders of Alawwal Bank.
There is an increase in bank mergers in Saudi Arabia, as profit margins have been squeezed by lower government and consumer spending due to recent economic transformation programmes such as the introduction of Value Added Tax (VAT) in January 2018. National Commercial Bank (NCB) and Riyad Bank have announced that they have begun preliminary discussions for a potential merger in December. As the Kingdom’s Public Investment Fund (PIF) and the Government are major shareholders in both banks, the consolidation is also expected to run smoothly.
According to Bloomberg, the PIF owns stakes in some of the biggest lenders and is weighing which banks could be merged to increase scale and competition. Al Rajhi Bank’s subsidiary in Malaysia is exploring a potential merger with Malaysian Industrial Development Finance (MIDF), after receiving preliminary approvals from the Saudi Arabian Monetary Authority (SAMA) and Bank Negara Malaysia (Malaysian Central Bank).
The second quarter of 2018 saw an increase in banks exploring potential tieups in the region as a whole. Kuwait Finance House (KFH) invited Bahrain’s Ahli United Bank to begin a due diligence process for a potential merger in July 2018. The duo announced that the scope of the agreement includes valuation studies and work to assess the feasibility of establishing a new banking entity and it would disclose any matters related to the possible merger in a sequential and timely manner. Three-quarters of the 24 GCC banks rated by S&P carry a stable outlook and the average GCC bank rating is ‘BBB+’.
Geopolitical tension at work
News reports have indicated that the murder of a Saudi journalist, Jamal Khashoggi, in a consulate in Istanbul threatened a massive exodus by foreign investors and international lenders operating in the Kingdom. This has created a level of uncertainty due to the unknown long-term implications as the US Congress and Turkish Government continue to pursue the case.
However, despite some top executives from international lenders pulling out of the Future Investment Initiative (FII) Forum 2018 in Riyadh, senior investment bankers from HSBC Holdings, Societe Generale and Credit Suisse Group, amongst other banks, attended the event raising hope that the Khashoggi controversy may not undermine Saudi’s Vision 2030. Not all due diligence processes for potential mergers were successful in 2018, this is mainly due to geopolitical tension in the region.
Bank Dhofar and National Bank of Oman (NBO) announced plans for a potential merger in June 2018 and according to EFG Hermes the merged bank, with a combined asset of $20 billion (AED 74 billion) will be the second-largest financial institution in Oman after Bank Muscat. In a bourse filing, NBO said that it would consider the interests of all its shareholders in assessing the merits of a merger with Bank Dhofar following a statement by the Commercial Bank of Qatar (CBQ) discouraging the consolidation between the two lenders.
Source: S&P Global
CBQ is the majority shareholder in NBO, with a 34.9 per cent stake. GCC lenders reached a high tide of prudential regulation tightening with the finalisation of Basel III in December 2017, however now the risk lies in the delayed or uneven implementation of the agreed global standards across different operating environments in the region. This is threating to create tensions among sovereigns who once enjoyed a flawless and interconnected banking industry in the world owing to the GCC’s booming economies.
In November, Kuwait’s prosecutors appealed to their Dubai counterparts to ensure the release of $500 million in funds belonging to a Kuwaiti private equity fund that were frozen in Noor Bank as part of a money laundering investigation. According to a report by Reuters, the frozen funds, which Kuwait says are owed in part to two of its state entities are threatening a political and diplomatic fallout which will not be favourable to the lender caught in between.
S&P Global expects Brent oil price to average $55 per barrel in 2019, which is likely to increase the financing needs in the GCC given that the oil price is lower than last year. Analysts from different investment banks have projected oil price in 2019 to range from $61 to $73 per barrel. In its 2019 outlook report, the Kuwait Financial Centre stated that any possibility of an upward movement in oil prices beyond $80 per barrel remain bleak as long as the production continues to rise elsewhere.
In 2019, geopolitical tensions will also remain a key source of risk, as well as a catalyst for rising military-related fiscal spending, added Moody’s. Crude oil prices ended 2018 in free fall but reversed course on signs that the Organisation of Petroleum Exporting Countries (OPEC) and other major exporters will follow through on last month’s pledge to slash production. Progress in the US-China trade war talks also turned the economic outlook brighter, adding to oil’s momentum.
In an interview with Bloomberg, Mohammed Al-Rumhi, Oman’s Oil Minister said that the agreement between OPEC and partners including Russia as well as Oman will sustain prices at $60 a barrel. Bloomberg reported that OPEC and partners led by Saudi Arabia agreed to cut oil output this year to support prices. The group and its allies said they would start to trim 1.2 million barrels of daily production this month to stabilise the market— in December they reduced output by 600,000 barrels a day (bpd).
Low oil prices are likely to impact Sukuk issuance by GCC Islamic lenders—a complex operating environment that might push some issuers to relegate Sukuk issuance to second place. According to S&P, the volume of issuances from the GCC is likely to be flat in 2019. Oil prices can be extremely volatile like last year after reaching $86 per barrel in October 2018 the price retreated to close at $60 per barrel mark two months later representing upside and downside risks to S&P’s 2019 forecast.
The rating agency assumes oil prices will remain flat at $55 in 2019 and beyond. So far, the First Abu Dhabi Bank (FAB) has led Sukuk issuance in the Gulf by tapping the international market raising $850 million in Islamic bonds. Although GCC countries are diversifying their economies to reduce dependence on oil and gas exports, hydrocarbon revenues contribute greatly to their fiscal revenues and annual budget.
The sharp drop in oil prices in the fourth quarter of 2018 highlights the vulnerability of GCC sovereigns’ credit profiles to future oil price declines which will inevitably impact the capital base of banks. Should prices stay near $60, Oman’s budget deficits would be materially wider and debt likely higher.
The geopolitical tensions are the new way of doing business in the region, however the escalation of tension with Iran might prompt a closure of the Strait of Hormuz—which will have a sizeable impact on GCC sovereigns’ credit profiles. Expectations are high, more consolidations are expected among GCC banks. The UAE in particular, needs bigger and stronger institutions, too many small players— mostly family lenders will not be able to compete regionally and internationally as they will need to sustain their growth.