• Abu Dhabi gov’t considers merger of ADCB & UNB, and ADIB & Al Hilal Bloomberg reported that the Abu Dhabi gov’t is mulling mergers between i) ADCB and UNB; and ii) ADIB and Al Hilal Bank (unlisted), as it seeks further consolidation in banking; if they decide to go ahead with the above mergers it will only go ahead after the closure of FGB-NBAD’s merger (end-1Q17e). We believe these mergers are likely to happen given the sector’s subdued medium-term revenue growth outlook (liquidity constraints and modest economic growth) and potential cost synergies, which would support operating profit growth. These potential mergers would also help ease competitive pressure by reducing the number of banks. We have a Buy on ADCB and Neutral calls on ADIB and UNB. We expect any merger with ADCB to be advantageous for UNB’s shareholders as i) ADCB’s profitability, deposit structure, and market positioning is superior to UNB’s; and ii) there is scope for synergies (c9% of combined 9M16 earnings).
• Factors supporting the case for these potential mergers We flagged in June 2016 that ADCB and UNB are strong merger candidates as they are conventional banks and have a common majority shareholder (ADIC owns a majority stake in both banks). UNB as a standalone entity lacks the scale – loan and deposit market share of 5% - to compete effectively against the large players. Meanwhile ADIB, majority owned by EIIC (the UAE’s sovereign wealth fund), is an Islamic bank, so it makes sense that it would merge with another Abu Dhabi based Islamic bank (Al Hilal). In addition, ADIB is closed to foreign investors which limits the number of banks it can merge with (within our coverage, only Dubai-based CBD is completely closed to foreign investors).
• Key source of synergies: elimination of duplicate costs Cost synergies are the tangible upside of these proposed combinations. The banks can close overlapping branches and ATMs, eliminate duplicate administrative costs, and save on audit, marketing and compliance costs. FGB & NBAD’s mgmt. projects cost synergies amounting to c8% of the combined expense base and c5% of combined net profit. These cost savings however would likely take two to three years to completely materialise, and are likely to be initially offset by one-time integration costs. Revenue synergies would be more challenging to extract, in our view, as they typically are not as tangible as cost synergies. Moreover, ADCB and UNB are relatively stretched in terms of liquidity, as reflected in their high LDRs (ADCB: 105%; UNB98%), which lessens the scope for spread improvement by letting go of expensive funding.

Shabbir Malik
Murad Ansari