The merger of National Commercial Bank with smaller rival Samba Financial Group will establish a national champion that will be better able to fund Saudi Arabia's vast infrastructure projects, in a deal that could trigger further consolidation in a reshaped banking sector, analysts said.

NCB is the largest bank in the country by assets and its acquisition of Samba, which is provisionally agreed, will put it on a more equal footing with regional rivals Qatar National Bank (QPSC) and First Abu Dhabi Bank PJSC.

The NCB-Samba merger will have far-reaching effects on the financial landscape within the kingdom. The new entity would have a 30% market share of Saudi's banking assets, double that of its nearest challenger, Al Rajhi Banking & Investment Corp., CI Capital estimates. It will also give NCB a larger foothold in corporate banking and might prompt further mergers in that space as lenders need scale to compete.

The deal will be the eighth bank merger in the Gulf Cooperation Council, or GCC, agreed since 2014. Of these, six have involved common shareholders — usually government-controlled entities — and this latest merger is no different, with the state-run Public Investment Fund of Saudi Arabia, or PIF, the top stakeholder in both NCB and Samba.

An S&P Global Market Intelligence analysis shows that PIF has stakes in four of the top nine Saudi banks by assets. Other state entities, including the General Organization for Social Insurance and Public Pension Agency, are shareholders in many of the Saudi banks in the sample. All three hold stakes in both NCB and Samba.

PIF's chairman is Crown Prince Mohammed bin Salman, whose economic development plan, Vision 2030, requires hundreds of billions of dollars of investments.

Financing such spending is trickier following the plunge in oil prices, reduced crude output and a domestic economic malaise exacerbated by the coronavirus pandemic. That makes this latest merger all the more important.

The deal will result in a combined entity with total assets of $213.12 billion, according to S&P Global Market Intelligence data, and it will create the third-largest bank in the GCC by assets.

"It could make the largest bank in Saudi Arabia even bigger, which would help the government implement Vision 2030," said Mohamed Damak, senior director of financial services and global head of Islamic finance at S&P Global Ratings in Dubai.

"A bigger bank means a bigger capacity to finance the economy, to underwrite bigger loans."

2nd wave?

NCB and Riyad Bank had previously discussed a merger, but talks collapsed in December. The Saudi government could push for further banking consolidation after the NCB-Samba deal, according to Sara Boutros, a senior analyst at CI Capital in Cairo.

"It wouldn't be a surprise to see Riyad Bank joining NCB in two to three years," she said.

"Banque Saudi Fransi could also merge with another entity because competing in corporate lending will be more difficult following the NCB-Samba merger. Corporate-oriented banks will look to merge with rivals in order to achieve the scale that will enable them to compete."

In its first-quarter results presentation, Samba warned that the plunge in oil prices, interest rate cuts and subdued consumer demand would hurt Saudi's banking sector, while a GCC-wide earnings slump due to the pandemic could cause banks' owners to rethink their determination to remain independent, said Damak.

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"We might see a second wave of mergers that won't be driven by common shareholders reorganizing their assets but instead based on a purely economic rationale," he said.

"Some boards and management teams will probably come to the conclusion that it makes sense to join forces with the bank next door to become bigger and more efficient."

NCB alone had a 19.9% share of Saudi banking sector assets, 14.0% of corporate banking and 22.2% of retail banking. Samba specializes in corporate banking and would boost NCB's share of this segment by 9 percentage points, according to CI Capital calculations.

Samba's first-quarter loan-to-deposit ratio jumped to 79.7% from 67.6% a year earlier as the bank awoke from a relative slumber that had baffled analysts.

"Apart from the past six months, Samba's management has been very cautious over the past six years — it was puzzling why they were doing so little despite having a good client base, strong brand in corporate banking and decent liquidity," said Boutros.

"Until the second half of 2019, Samba was unwilling to lend aggressively. Under NCB, there's much more potential to be unleashed."

Size matters

Ahead of the mooted merger, NCB was ranked fourth among GCC banks in terms of loans, deposits, assets, market capitalization and net interest income. Should the merger go ahead, the new entity would become the region's leading lender by earnings, operating income, equity and net interest income, and be among the top two or three by the other metrics.

"The prime advantage is that the merged entity will be better able to serve Saudi's large corporates likes Aramco and SABIC, with a bigger equity book. Previously, they'd have to be part of a lending syndicate for bigger projects," said Chiro Ghosh, vice president for financial institutions at Bahrain's SICO Bank.

"The merger provides good diversification as well as a bigger book potential."

Regulations limit the percentage of a bank's loan book that can be lent to a particular borrower, so the larger the bank the more it can lend to large corporates.

"The bigger banks will always have an advantage in that respect, while their size also allows them to be more diversified in their lending," said Ghosh. "A downside is that it's much harder to grow quickly when you're a big bank. In consumer banking, being big is less of an advantage — size matters more in corporate banking."

NCB's sole international subsidiary is Türkiye Finans Katılım Bankası AŞ, which is seen as a risky, underperforming unit, in part due to the lira's slump and Turkey's economic malaise, and the merger with Samba will dilute Turkish exposure, according to S&P Ratings.

Failed merger

Yet for all the benefits, the fact remains NCB only targeted Samba after the Riyad Bank deal fell through.

"Merging with Riyad Bank makes much more sense for NCB from a strategy perspective because Riyad would have given NCB more market share within retail and would have been an entity to compete more aggressively with [top retail lender] Al Rajhi," said Boutros.

NCB will acquire Samba at a price-to-book ratio of 1.3 to 1.4, which offers a 30% upside to Samba's closing share price on June 30, according to CI Capital.

"This is a reasonable premium," said Boutros, noting Samba had traded as high as 1.8x book value.

"Historically, Saudi's market is priced at a premium, with high valuations versus the rest of the Gulf. The failure of the Riyad Bank merger was down to pricing. Samba is plan B."