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Middle EastSeptember 2 2007

Birth of a UAE champion

Stephen Timewell in Dubai reports on the mould-breaking merger plans of the UAE’s first and fourth largest banks.
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It is always hot in the Gulf in August but the release of detailed plans of the recommended mega-merger between Emirates Bank International (EBI) and National Bank of Dubai (NBD) has raised the temperature in banking circles even higher. But it is not just that the Dubai government has decided to create a national and regional champion, it is that the expected emergence of Emirates NBD, as the new bank will be called, with a combined market capitalisation of $11.3bn and the region’s largest asset base, is likely to become a catalyst for more mergers in the region and a major redrawing of the banking landscape.

The realisation that UAE banks and others in the region are just too small to compete for the huge opportunities in the Gulf has finally struck home. In The Banker’s latest Top 1000 World Banks ranking, the UAE’s largest bank, Abu Dhabi Commercial Bank, was ranked only 194th. And while all UAE banks have shown strong organic growth, it has not been enough to catapult them into the big leagues. While the pre-tax profits of the 94 Middle East banks in the Top 1000, including 16 UAE banks, grew by more than 30% last year, together the profits of the 94 did not match those of Citigroup.

Size matters, and earlier this year the Dubai government, which owns 76% of EBI and 14% of NBD, decided to act. While previous attempts to merge the two banks failed in 2001, this time the government was determined to build an institution with the size and scale to better compete with major Gulf banks and the international institutions flooding in to take a slice of the current hydrocarbons boom.

Although shareholders of both banks still need to approve the offer, the boards of both banks and the government have given their acceptance to the merger of the first and fourth largest banks in Dubai. Shareholders are expected to give their approval in special meetings in the first week of September.

A regional leader

Underlining his critical role in the process, Sheikh Mohammed Bin Rashid Al Maktoum, UAE vice-president, prime minister and ruler of Dubai, says: “The integration of two of the UAE’s firmly established and best-known financial institutions will create a UAE champion and a regional leader. This merger reinforces Dubai’s position as a world-class financial centre.”

The objectives of the merger to create a UAE champion highlight not only Sheikh Mohammed’s ambitions but also how far Dubai has come. Rick Pudner, chief executive of EBI and the designated new chief executive of Emirates NBD, explained to The Banker the merger process where Goldman Sachs acts as exclusive joint adviser to both banks with Lehman Brothers acting exclusively as “fairness opinion” adviser to EBI and Morgan Stanley acting similarly for NBD.

These three world-renowned investment banks have joined the Dubai International Financial Centre only recently and represent clear efforts not only to seek the best advice, now delivered locally, but also to raise the quality of transparency.

Emirates NBD, which is to be 56% owned by the government of Dubai, is expected to become the market leader in the UAE with total asset combined market share of approximately 19.2% ($45bn) and total loan combined market share of 21.7% ($29.7bn). This puts the new entity well ahead of the UAE’s current largest bank in asset terms, National Bank of Abu Dhabi, whose total assets at end-2006 were $27.5bn. The combined Tier 1 capital of the two Dubai banks at the end of 2006 was $3.9bn, making it, in effect, the third largest bank in the Gulf.

The merged entity is also expected to become the leading retail banking franchise in the UAE with a combined network of 99 branches and 429 automated teller machines (ATMs), with Mr Pudner relishing a stronger retail presence in Abu Dhabi. In corporate banking, Emirates NBD will become a major player, accounting for one-fifth of corporate loans. And in asset management it will be the leading provider in Dubai, with assets under management of Dh8.5bn ($2.3bn). EBI also has a strong Islamic subsidiary, Emirates Islamic Bank, which will encompass NBD’s small Islamic activities and provide strong growth potential.

Emirates NBD’s strategy is to leverage its financial strength, scale and market positioning to capture opportunities in both domestic and regional markets and to become a leading regional financial institution with an increasing international presence. The new entity will have full branches in Saudi Arabia, Qatar, the UK and Jersey and representative offices in India, Iran and Singapore.

“Saudi is a key market for us going forward,” says Mr Pudner, emphasising the role of the Riyadh branch and the opportunities being a national champion has for acquisitions and organic growth. Stressing the initial focus on the UAE, Saudi Arabia and Qatar, he adds: “The GCC needs to have a larger bank. If you have oil wealth why should this wealth be farmed out to others?”

Worldwide presence

Outside the GCC, the strategy for Emirates NBD is expansion into selected strategic markets. EBI has had bitter experience of pulling out of Hong Kong in 1997 and Pakistan more recently, so the Asian strategy will be cautious. Nevertheless, the presence in Singapore and optimism over Islamic finance raises confidence.

Emirates NBD is expected to be up and running by year end with full integration expected to take 18 to 24 months. Cost saving synergies are said to amount to Dh350m per year recurring, and the chairman of EBI, Ahmed Humaid Al Tayer, the designated chairman of the merged bank, has stated that job cuts are unlikely as all resources will be necessary for expansion.

The deal has received strong market support and Peter Carvalho, senior analyst at Moody’s Middle East office, is quoted as saying: “Moody’s believes that Emirates NBD will benefit from a stronger franchise and capitalisation, an expanded product range, greater geographic reach and better positioning in the corporate and retail business. Going forward, the synergies expected will generate a better value proposition for the merged entity.”

But that is not all. The merger represents a watershed in banking in the Gulf and elsewhere in the Middle East as well as providing a model for many more mergers and acquisitions to come. For years, the UAE has been branded as over-banked, with 21 local and 25 foreign banks (excluding the Dubai International Financial Centre), but there has been no consolidation.

Many small, largely family-owned banks have soldiered on in the UAE and elsewhere in the Gulf but their lack of scale and resources has inhibited their ability to expand and compete in many areas. The recent increased cost of regulation, due to Basel II, Sarbanes-Oxley, anti-money laundering legislation and much more, has made it more difficult for smaller institutions to absorb these extra overheads and compete as a universal institution or even as a niche player.

The days of the smaller bank in the Gulf seem to be doomed as high costs, including added regulatory expense and high staffing costs, and the ability to provide the range of sophisticated products and services customers want, force banks to examine economies of scale. While there has also been a cultural aversion to mergers in the past, attitudes are changing and the big EBI-NBD merger represents a major breakthrough.

As the governor of the UAE Central Bank, Sultan Al Suwaidi, explains (see box): “When banks see what the new merged entity [Emirates NBD] will do, I think many other banks will see the benefits and advantages and ask questions about mergers.”

After years of ignoring the consolidation trend worldwide, in the past two years the Gulf has seen several smaller deals and efforts by a handful of banks, National Bank of Kuwait and Bahrain’s Ahli United Bank in particular, to genuinely establish a regional presence. This movement is expected to continue and while the process is often tortuous, the Gulf and Middle East consolidation machine is slowly but surely gathering momentum. The Dubai merger will certainly help.

National Bank of Kuwait, the largest bank in Kuwait, has been a pioneer in cross-border acquisitions and recent moves in Egypt and Turkey have given it a strong regional footprint. Last month, NBK won a competitive tender to buy Egypt’s Al Watany Bank for $516m.

NBK won the tender for the 22-branch bank after submitting a price of E£77.01 (€10) per share, equal to 4.16 times book value and 17 times earnings, beating the second bid, an alliance of Commercial Bank of Kuwait and Al Noor Financial Investment Company, by E£2 per share. The deal is expected to be finalised by the end of this year after obtaining both Egyptian and Kuwaiti relevant regulatory approvals and changing Al-Watany Bank’s current name to reflect its acquisition by NBK.

Commenting on winning the bid, NBK’s chief executive, Ibrahim Dabdoub, said that the deal constitutes a significant step within NBK’s expansion strategy in the region. He also expressed his great satisfaction in the opportunity to enter the Egyptian market as it is one of the most promising markets in the region. Stakes in 14 Egyptian banks have been sold since 2004.

NBK also acquired recently a 40% stake in Istanbul-based Turkish Bank, a 20-branch operation in the attractive and expanding Turkish market. This purchase, the first by a GCC bank in Turkey, represents another milestone in regional expansion.

Regional deal making

Back in the Gulf, more cross-border deals are emerging. On August 17, Commercial Bank of Qatar announced a bid for a 34% stake in the small Sharjah-based United Arab Bank. The stake in the nine-branch bank was estimated to cost Dh1.8bn. CBQ took a similar stake in National Bank of Oman in 2005. UAE law prevents foreign lenders owning more than 49% of local banks.

As this hydrocarbons boom in the Gulf continues, banks from the region are realising that size matters and that the only realistic long-term strategy is through consolidation and a regional approach. It may take a long time, but the path towards the Gulf being led by a small number of larger, more sophisticated local banks has begun in earnest with the EBI-NBD merger. A new phase of Gulf banking is beginning.

INTERVIWE WITH SULTAN AL SUWAIDI, GOVERNOR OF THE UAE CENTRAL BANK

Sultan Al Suwaidi, governor of the Central Bank of the UAE, has not only been a long-time advocate of currency union in the Gulf, he also strongly supports consolidation and stronger, larger local banks. In an interview with The Banker, the governor fully backed the recommended merger of Emirates Bank International and National Bank of Dubai. “It is good for UAE banks, it is good for Dubai in particular, we need to create relatively large size banks.”

Stressing that consolidation will yield better value for shareholders, the governor added that domestic UAE banks are lacking in investment banking resources. “Larger banks can pursue bigger investment banking capabilities. The benefits of larger size banks is that they can provide additional value from investment banking, which we need in the UAE.”

Emphasising the great wealth in the country, he added: “We need larger institutions to create more meaningful investment banking capabilities and objectives to benefit the economy.”

He was also adamant that the merger of the two Dubai banks should not be the last. “We would like to have further mergers in Abu Dhabi. The next step should be in Abu Dhabi.”

Although there are no solid proposals on the table and the governor refused to speculate, the two biggest banks in the UAE (by Tier 1 capital), Abu Dhabi Commercial Bank and National Bank of Abu Dhabi, could produce another formidable national champion. With combined Tier 1 capital and total assets at the end of 2006 of $5.4bn and close to $50bn respectively, this theoretical Abu Dhabi merger would be significantly larger than the Dubai merger.

However, in discussing possible mergers the governor noted: “The maturity of shareholders is not there yet. At present shareholders do not dictate what they want, they are not the driving force behind change.

“Shareholders need to be the driving locomotive, but change is happening and I believe the current implementation of Basel II will help give shareholders enough transparency to drive further change.”

Examining the trends, Mr Al Suwaidi says that in the old days, Middle East and Gulf Cooperation Council (GCC) banks wanted to become international banks. “Now they are more realistic and are trying to become regional banks. They can do better in the region.”

He adds: “In the region there is plenty of money but limited expertise [in terms of human resources], so expansion of banks regionally [especially in Egypt, Yemen, Syria and north Africa] will add value to the region and to the banks.”

Talking about the region, the governor is very bullish on the benefits of GCC monetary union despite Oman’s reticence and Kuwait’s recent move away from the dollar. He favours a currency basket approach pegged to an undisclosed basket of currencies. “Monetary union is a good end result for the [six] economies of the GCC. We cannot add additional growth engines to our economies except through monetary union.”

Stressing that for growth engines to be fully effective “we need to harmonise economic and tax policies”, the governor believes two out of three key elements can be achieved by the 2010 monetary union timetable. First, free capital flows, and second, pegging to the same measure, whether it is the dollar, euro or a particular basket. “We have to maintain cross-rates at the same level.”

On the contentious issue of high inflation, which was estimated by the Ministry of Economy at 9.3% in 2006, the governor explained that 20% of the inflation rate can be explained by the weak dollar, making many imports more expensive, but 80% is explained by escalating rents. But while the adverse impact of high inflation is being felt throughout the economy, as so much is imported through Dubai, the governor is optimistic that inflation will decline in 2007 from 2006 rates, as more housing becomes available to meet the high demand, thereby taking pressure off prices.

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