• Prefer NBAD on potential re-rating and lower foreign ownership Bloomberg reported that FGB and NBAD are exploring a potential merger, however while the negotiations are ongoing the two may decide against pursuing the merger. The UAE’s banking space is quite crowded with c50 banks, credit penetration is high at c100% of GDP, while the credit and macro growth outlook is soft. We believe the solution to these challenges is consolidation and the economies of scale and synergies that come with this. We would play a merger via NBAD as i) it is relatively undervalued (2016e P/B NBAD: 1.1x versus FGB: 1.8x) and ii) it is under-owned by foreign institutions. Moreover, NBAD is likely to become part of an entity that offers i) wider spreads (2015: FGB: 3.0%, NBAD: 1.8%), ii) superior cost efficiency (FGB: 21%, NBAD: 39%), iii) better capitalisation (CET1 - FGB: 14.2%, NBAD: 13.2%) and iv) dynamic management (FGB>NBAD).
• Scale & balance sheet compatibility likely drivers of merger The merger would create the largest bank in the region by assets with estimated total assets of USD173bn versus USD148bn for QNB, currently the largest bank by assets in the MENA region. The combined bank would represent nearly a quarter of the system’s loans and deposits. Their balance sheets are complementary as FGB is stretched in terms of LDR, and NBAD’s liabilities can be potentially used to fund FGB. In terms of lending FGB is a retail oriented bank, while NBAD is corporate focused. The branch overlap would be moderate, in our view, as FGB has a small branch network thus potential cost savings in this area would be limited. This merger could also pave the way for more consolidation in the sector – ADCB, UNB and ADIB. That said, the willingness of key shareholders is likely to be the deciding factor on further consolidation.
• Post-merger structure: two likely templates The due-diligence process could take six months following which the integration of the two banks may take another 12-18 months. We believe there are two likely templates for the post-merger structure of the bank: i) FGB is absorbed into NBAD as the latter has a larger asset base and it is strategically important to the Abu Dhabi government; and ii) FGB and NBAD become subsidiaries of a newly created holding company as was the case in 2007 when Emirates NBD was formed by merging EBI and NBD.
• Merger could attract passive inflows of cUSD220mn Assuming a 25% float is used for the merged entity’s index market cap, a merger could lead to fresh passive inflows of cUSD220mn (MSCI cUSD140mn, and FTSE cUSD77mn) from MSCI & FTSE trackers (for a more detailed analysis please see section II). Foreign ownership at NBAD is 4%, but 13% at FGB - a difference of USD1.4bn. The average foreign ownership for MSCI EM/FTSE EM members for UAE banks is 10%.

Shabbir Malik
Murad Ansari
Mohamed Al Hajj