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Shares in National Bank of Abu Dhabi (NBAD) and First Gulf Bank (FGB) soared on Sunday after they confirmed discussing a possible merger to create what would be one of the largest banks in the Middle East and Africa.
Both banks have close links to the Abu Dhabi government, which has been cutting costs and restructuring its assets to increase efficiency as low oil prices slash its revenues.
Analysts said an NBAD-FGB tie-up could mark the start of a wave of consolidation in the United Arab Emirates banking sector, which is crowded with more than 50 banks and squeezed by lower government spending and tougher global capital rules.
Reuters, quoting sources aware of the matter, had reported on Thursday that the two banks were in preliminary talks on a merger.
In Sunday's statement, the banks, Abu Dhabi's largest and third largest lenders by assets, said each had formed a working group to "review the commercial potential along with any legal and structural aspects of a merger or combination." The groups would provide recommendations to their respective boards of directors.
Many analysts said that in the absence of details of how and when the merger might take place, buying the stocks in response to the merger news was risky.
"Shareholders have nothing to gain, in our view," wrote analysts at HSBC, adding that any share swap to pay for a merger could dilute the value of holdings in both banks.
But local investors welcomed the idea of an Abu Dhabi mega bank, pushing NBAD shares up their 15 percent daily limit on Sunday while FGB rocketed 11.5 percent. Shares in other Abu Dhabi banks also climbed on speculation that they might eventually be involved in an M&A wave.
NBAD is 70 percent owned by the Abu Dhabi Investment Council, and FGB is controlled by members of the emirate's royal family. That means that if there is political will to complete the merger, it will be easily accomplished, said an Abu Dhabi-based investment banker with a foreign institution.
"Size does matter in banking, be it for lending or deposits, future expansion, limits on exposure to single borrowers...as well as to support the economy," he said.
A larger bank would help Abu Dhabi's aspiration to become a major financial center, said a government source. The emirate is launching a financial free zone, Abu Dhabi Global Market, to attract foreign investment.
A merger between NBAD and FGB would create a bank with assets worth around 627 billion dirhams ($171 billion), according to figures they gave for the first quarter of 2016.
That would exceed the first-quarter assets of the region's current largest bank by assets, Qatar National Bank (QNB) , which had 550 billion riyals ($150 billion) at the end of the first quarter. Still, last week QNB completed acquisition of Turkey's Finansbank, which could keep it ahead.
Due diligence for a merger could take six months and full integration a further 12 to 18 months, EFG Hermes said in a research note.
It said FGB would probably be absorbed into NBAD which had a larger asset base, or the two might become subsidiaries of a new holding company -- a model used in neighboring Dubai in 2007 when Emirates Bank International and National Bank of Dubai combined to form Emirates NBD, Dubai's biggest bank.
NBAD, known for its strong wholesale banking operations, reported a 10.7 percent year-on-year fall in net profit to 1.27 billion dirhams in the three months to March 31, while FGB, which is strong in consumer lending, reported a 6 percent fall to 1.33 billion dirhams.
NBAD had a Tier 1 capital ratio of 15.1 percent on March 31 with FGB's ratio at 16.9 percent - both well above the UAE regulator's requirement of 8 percent.
Chiradeep Ghosh, senior analyst at SICO in Bahrain, said news of the merger talks was surprising. "The two banks have contrasting business models and different operating styles, strategy and philosophy," he said.