HSBC, RBS Saudi Arabian Ventures in Talks to Merge

(Bloomberg) -- HSBC Holdings Plc and Royal Bank of Scotland Group Plc's Saudi Arabia ventures are exploring a potential merger to create the kingdom's third-largest lender with $78 billion in assets.

Alawwal Bank, which is 40 percent owned by RBS, plans to start initial talks with HSBC's Saudi British Bank, according to a statement on Saudi stock exchange website Tuesday. Both lenders are based in Riyadh, with HSBC owning 40 percent of SABB.

The negotiations come as banks grapple with how to approach the Middle East's biggest economy, which is embarking on an unprecedented diversification and privatization plan but still blocks foreign control of local banks. The combined entity would be the kingdom's biggest after National Commercial Bank and Al Rajhi Bank, and follows the merger of other regional lenders as they battle with sustained low oil prices, slower economic growth and a decline in asset quality.

“The current environment is ideal for mergers," Jaap Meijer, head of equity research at Arqaam Capital Ltd., said by telephone. “Growth opportunities are limited, and banks need to cut costs to still deliver returns for shareholders." The combination will also make it easier for RBS to exit Saudi Arabia “as it will hold a smaller stake in a bigger, stronger bank."

Shares in SABB climbed 6.2 percent on the Saudi stock exchange at 10:41 a.m. in Riyadh, while Alawwal jumped 9.7 percent.

RBS Sale

RBS has for years tried unsuccessfully to sell its Alawwal holding, which is worth about $1.3 billion, according to data compiled by Bloomberg. Any interest in the stake came from local or regional groups, according to analysts and people familiar with the transactions. Credit Agricole SA, which is also considering the sale of its 31 percent stake in Banque Saudi Fransi, has failed to attract big-name global banks, people familiar with the matter said.

Read More: If Saudi Future's So Bright, Why Can't These Banks Find Buyers?

A deal would mark Saudi Arabia's first banking industry merger for almost 20 years and could prompt other deals. Samba Financial Group merged with United Saudi Bank in 1999, creating one of the largest regional financial institutions at the time, of which Citigroup owned 23 percent, according to Samba's website. Saudi Arabia is currently home to about 33 million people and 26 banks -- 12 local and 14 foreign lenders.

“The history of mergers in the country is checkered as a few have tried and been unsuccessful,” said Muhammad Potrik, head of research at Riyad Capital. If this deal is successful it “could be a precursor to the start of a M&A trend in the banking and other sectors such as petrochemicals, insurance and retail.”

Elsewhere in the Gulf Cooperation Council, National Bank of Abu Dhabi PJSC and First Gulf Bank PJSC last month completed a merger to create the United Arab Emirates' largest bank with assets of $180 billion. Qatar's Masraf Al Rayan QSC, Barwa Bank QSC and International Bank of Qatar QSC announced plans for a three-way merger last year.

Bad Loans

Both Alawwal and SABB primarily lend to businesses, not consumers, and both reported that non-performing loans to the construction and building industry more than tripled in 2016. Lending by Saudi banks to the private sector was expanding rapidly as recently as last year, but has since stalled. In February, annual growth slowed to 0.3 percent, the lowest figure since 2009.

Alawwal and SABB also have large common shareholders, with the billionaire Olayan family holding about 22 percent in Alawwal and about 17 percent in SABB, according to data compiled by Bloomberg. State-controlled Public Institution for Social Security holds a 10.5 percent stake in Alawwal and 9.74 percent in SABB, according to the data.

Fee Bonanza

Some global banks are investing in Saudi Arabia in preparation for an expected fee bonanza. As part of efforts to repair state finances damaged by a slump in oil prices, the kingdom plans to create the world's largest sovereign fund and sell hundreds of state assets, including Saudi Arabian Oil Co. The IPO could value the company at $2 trillion and generate millions of dollars in fees.

Citigroup Inc. on Tuesday said it received an investment banking license from the kingdom's regulator after 13 years. The New York-based lender lost its license when it sold its stake in Samba Financial Group in 2004.

To contact the reporter on this story: Matthew Martin in Dubai at mmartin128@bloomberg.net.

To contact the editors responsible for this story: Stefania Bianchi at sbianchi10@bloomberg.net, Vernon Wessels