Middle East: Arab banks lay regional plans

Bahrain: diversifying away from oil

Saudi Arabia and Kuwait: closed-economy cousins

Oil lows hit UAE, Oman and Qatar

Results for the top 20 Arab banks in 1998 were mixed and clearly reflect both regional and general emerging-market difficulties. The operating environment throughout the Gulf Cooperation Council (GCC) states – Bahrain, Saudi Arabia, Kuwait, Oman, Qatar, and the United Arab Emirates – was difficult on account of the weak oil price. Despite the recent price increase providing some respite, growth will remain subdued this year in most Middle East countries although slightly more robust in Egypt, Morocco and Tunisia.

The subdued growth prospects may precipitate banks to promote strategic corporate activity through consolidation and alliances. Already there has been action in this respect, most notably the proposed merger of Saudi American Bank (Samba) and United Saudi Bank, which, if successful, will create the fourth-largest bank in the Arab world.

Further intra-country activity is necessary in markets such as the UAE. However, the often intransigent nature of regional shareholders will continue to be one barrier. And although cross-border consolidation is a logical progression, there are significant ideological and cultural differences between markets, even in the GCC states so it will take some time.

The Bahrain-based Arab Banking Corporation (ABC), the second-largest bank by capital and the biggest by assets, was hit severely by its exposure to Asia and Latin America. Following a big jump in the provision charge, ABC’s net profit fell by some 87% in 1998 to $25 million. Provisions largely related to south-east Asia – mainly Indonesia – and China. ABC’s performance at the operating level fell by only 5% to $322 million.

New direction

ABC’s experience last year may mean that its management rationalizes some of its broad-based but poorly connected asset interests. The bank has embarked on a new strategic direction, focusing closely on the Arab markets and aiming to become a capital-market leader with a strong presence in the Middle East. Deals made by the bank in 1998 emphasized this new strategy, establishing a wholly owned subsidiary, ABC Islamic Bank, to develop Islamic financing, and another subsidiary in Algeria. ABC Islamic Bank reported profits of $3.8 million in its first year of operations.

ABC also raised its stake in ABC (Jordan). Imminent plans envisage the conversion of its Tunisian offshore business to a domestic-licensed subsidiary and the establishment of an investment bank in Egypt, which will undertake asset management and equity underwriting. Corporate restructuring over the past year means that the bank is now organized on functional lines rather than the previous geographical emphasis.

ABC’s close neighbour, Gulf International Bank (GIB), recorded a reasonable performance last year considering the tough conditions. The bank’s margin tightened after a rise in its funding cost. Provisions have been raised against Asian and Russian exposure and the bank now has in place a comfortable general provisioning level.

GIB’s acquisition of Saudi Investment Bank (SIB) was concluded in early April 1999. GIB is predominantly a product-limited commercial bank with a particular focus on the Middle East. The bank needed to widen its products and services, especially linked to capital markets. Management could have either built up its capital-markets expertise internally or through acquisition, ultimately deciding on the latter course. SIB’s activities are centred on corporate finance and capital markets. However, its problem was the lack of a customer base, which GIB can provide. GIB will now market asset-management and capital-market activities in the GCC. Pro forma balance sheet as at end December 1998 was $14.9 billion with equity of just over $1 billion, which would have boosted its ranking to eighth in terms of capital and sixth in terms of assets. The year-end 1999 balance sheet should be around $13.5 billion. The deal, which involved capital restructuring and the issue of new shares in GIB, will involve the Saudi Arabian Monetary Agency (Sama) taking a 22.2% share of GIB and JP Morgan a 5.3% stake (JP Morgan previously held 20% of SIB and Sama 50%).

Saudi opening

A major step for both GIB and the GCC was the recent approval granted to GIB to open a commercial banking branch in Saudi Arabia, which should be opened by the end of the year. GIB was the first bank to receive such approval and follows the late 1997 decision of the GCC to allow banks from one member state to operate in another. GIB expects to have three Saudi branches over the medium term and will open branches in other GCC countries. The acquisition of SIB will aid GIB’s move into Saudi though the former’s strong local connections.

Investcorp maintained its impressive track record last year, with net income up 5% to $114 million in challenging global market conditions. Return on equity was 18.1%. In spite of the tough conditions in Gulf markets, Investcorp comfortably placed $900 million with Gulf clients last year. Investcorp has a strong business model with diversified streams of income. It has an unrivalled franchise in the Gulf with strengths in private equity, asset management and placement ability.

The downturn in the Saudi economy and the squeeze in liquidity put pressure on domestic banks and other Gulf banks with exposure to Saudi Arabia. Saudi banks generally focused on government exposure on the lending side in 1998 with many corporates looking abroad for funds. Arab National Bank’s earnings slipped a hefty 39%, again through a rise in bad debt and a 77% increase in the provision charge. In December 1998 the bank adopted stricter criteria for provisioning for non-performing loans. Arab National Bank’s retail franchise has been developed aggressively over the past five years, backed by a high level of technology. The bank intends to focus increasingly on its strength in retail banking.

The push for consolidation and the acknowledgement of the need to create bigger, stronger banks in the region was exemplified by the announcement in early January 1999 of the proposed merger of Samba – 30% owned by Citigroup – and United Saudi Bank (USB). USB was itself the product of a merger between United Saudi Commercial Bank and Saudi Cairo Bank in 1997. USB’s profit was up by 50% in 1998, reflecting the merged institution. If the Samba-USB deal goes ahead, it will create an institution with combined assets of around $20 billion. At least part of the rationale for the merger is the weak growth prospects for the Saudi economy over the next two years, following on from the fall in GDP in 1998.

Islamic specialist

Al Rajhi Bank continues to be the most profitable bank in the Middle East in terms of actual profits ($376 million net profit in 1998), generating very high returns. The Islamic bank’s high profits reflect its substantial pool of cheap, stable deposits drawn from the largest branch network in Saudi Arabia. It was one of the first banks to exploit fully the potential of Islamic banking, and many banks, both western and Arab, throughout the region are dedicating resources to this rapidly growing market segment.

Al Rajhi’s retail services and asset activities have been narrowly focused but the bank is addressing this and is diversifying its operations. Riyad Bank produced a steady result in 1998. The bank, with a new general manager, has been going through a restructuring programme in order to make it more customer driven and market oriented in the light of a more competitive domestic banking sector. Riyad Bank has a long-standing role of financing the country’s most important industrial projects and is closely involved in financing the needs of the public sector.

As Saudi Arabia has one of the most developed banking sectors in the region, with generally strong and sophisticated banks, much of any cross-border banking consolidation activity is likely to involve Saudi banks, especially in the light of the significant foreign shareholdings that some banks there have.

National Bank of Egypt (NBE) performed strongly in fiscal year 1998 and rose in the ranking of both capital and assets, reflecting the improved operating environment in Egypt over recent time. Profit rose significantly, up by 50%, but from a low base, and profitability ratios remain weak. The bank is fully government owned and, combined with the other three large public-sector banks, control around 70% of the market.

Many banks have highlighted Egypt as offering potential, especially in investment banking, and have entered the market. The main issue for the Egyptian banking sector remains the timing of a government sell-off of some of its interests in the big-four banks. Competition will intensify in Egypt as more foreign banks enter the market. NBE has a large network of 340 branches with solid retail banking operations. NBE has recently invested heavily in technology and has diversified its business activities to include merchant banking, leasing and project finance. NBE was the first Egyptian bank to undertake capital-market activities and in September 1998 it acquired a 10% stake in Egypt’s leading investment bank, Commercial International Investment Company. The bank intends to develop further its capital-market operations.

Kuwait experienced lower economic growth and commercial-sector weakness in 1998. National Bank of Kuwait’s (NBK’s) operating profit fell by 7% to $268 million although the net result was up because of a lower provision charge. The bank’s bad debt ratio fell to 6% from 9% at end-1997. NBK controls around 33% of the domestic market and remains in a strong position. Management aims to widen its business operations in a steady manner and in recent years has focused more on the markets of the Levant regions, particularly Lebanon and Egypt.

Gulf Bank, the second-largest bank in Kuwait, and ranked 20 in the Arab world, suffered earnings pressure in 1998, with net profit falling by 11%, because of higher provisions linked to its personal lending operations and a poor non-interest income performance. Internal management machinations and shareholding movements continue to unsettle the bank. Recently Al-Ghanim Industries and Kuwait International Investment Company purchased large stakes in the bank, possibly around 20% each. If both parties have support of a number of smaller shareholders, they may have built up a controlling stake. The bank has been long vulnerable to a takeover.

The National Bank of Dubai (NBD) and Emirates Bank International (EBI), two of the UAE’s strongest financial institutions, are currently negotiating a merger. If it proceeds, it will create the largest bank in the UAE and place it in the top five in the Middle East in terms of total capital. In the UAE there are a large number of small banks, many with indifferent financial profiles, so consolidation is needed. Both NBD’s and EBI’s results in 1998 were steady, indicating the greater diversification in the Emirates economy and less reliance on oil-related activity than in some other GCC states. However, NBD’s results were held back by a 59% increase in provisions.

EBI is the flagship institution of the emirate of Dubai and has been at the forefront of banking development activities in the country. EBI’s operations are centred mainly on trade and project finance, especially trade linked to Dubai. The bank has diversified its product range over recent years to include such things as credit cards and asset management, and has moved into merchant banking activities. Investment-banking operations for the UAE are currently fairly weak and most of the upper-tier banks will focus on this area.

Abu Dhabi Commercial Bank (ADCB) performed well in 1998, with net profits rising 12% to $138 million. ADCB has a strong retail customer base backed by a large branch network and has also benefited from increased merchant banking activity in the UAE.

Looking ahead, as margins remain under pressure, banks will need to concentrate more on fee-driven income, in both retail and investment banking. Islamic banking looks as if it will enter a period of rapid growth and non-Islamic institutions will develop more services based on Islamic principles on both sides of the balance sheet.

Although moves towards harmonization of banking within the GCC are slowly taking place, it will be some time before an open playing field is created as currently rules and regulations vary significantly between states. Nevertheless, small steps have been taken towards economic liberalization across the GCC and reducing regulatory barriers to competition. More needs to be done, especially towards opening up and making stock markets across the region more transparent. When more common ground is established, we will see a higher rate of consolidation and cross-border activity.

Darren Stubing is a senior analyst at Capital Intelligence, an international rating agency