Assessment of mergers and acquisitions in GCC banking. Said Gattoufi and Saeed Al-Muharrami*

Transcription

1 358 Int. J. Accounting and Finance, Vol. 4, No. 4, 2014 Assessment of mergers and acquisitions in GCC banking Said Gattoufi and Saeed Al-Muharrami* College of Economics and Political Science, Sultan Qaboos University, P.O. Box 20, Muscat, 123 Sultanate of Oman *Corresponding author Ghanim Shamas Salalah College of Technology, Salalah, 211, Sultanate of Oman Abstract: This study analyses the impact of mergers and acquisitions (M&A) on the performance of commercial banking in GCC countries through analysing a set of ratios. It contributes to the debate about whether mergers and acquisitions improve the performance of the GCC commercial banks. Seven financial ratios were used to investigate the impact of M&A on the operational performance of the merging banks. The sample consists of 42 commercial banks in the GCC countries. The results of financial ratios are mixed; where acquiring banks, target banks and banks that went through joint ventures show mixed results. It was not easy to establish a strong link between banks involved in M&A and the impact of mergers on their operating performance. However, the findings suggest that, on average, M&A activity did not have significant impact on operational performance of banks involved in this type of consolidation. Keywords: mergers and acquisitions; M&A; financial ratios; GCC banks. Reference to this paper should be made as follows: Gattoufi, S., Al-Muharrami, S. and Shamas, G. (2014) Assessment of mergers and acquisitions in GCC banking, Int. J. Accounting and Finance, Vol. 4, No. 4, pp Biographical notes: Said Gattoufi received his PhD in Management from Sabanci University in Turkey in He obtained his Diplôme de Troisième Cycle de Gestion and Bachelor in Mathematics from Tunisia. He is currently an Associate Professor at Sultan Qaboos University in the Sultanate of Oman. His publications appeared in reputed journals including The Journal of Operational Research Society and Journal of Risk Finance. His areas of research are in performance assessment using data envelopment analysis with applications of inverse DEA in mergers and acquisitions in banking. Copyright 2014 Inderscience Enterprises Ltd.

2 Assessment of mergers and acquisitions in GCC banking 359 Saeed Al-Muharrami is an Associate Professor of Banking and Finance at Sultan Qaboos University. He received his BSc in 1988 from University of Arizona, USA, his MBA in 1994 from Oregon State University, USA, and his PhD in 2005 from Cardiff University, UK. Beside his teaching and research duties, he is the Director of Humanities Research Center. His areas of interest are banking market structure, competitiveness, efficiency, productivity, performance, commercial and Islamic banks, monetary policy, and feasibility studies. He has written three books and has published several scientific papers and publications. Ghanim Shamas is a Lecturer in the Department of Business Studies, Salalah College of Technology in Oman since June He received his Master in International Accounting and Financial Management from University of Glasgow in Scotland in He received his Bachelor in Accounting with minor in finance from University of Sharjah, UAE, in He has held the position of head of accounting section over the period His current research interests are mergers and acquisition, performance management, and efficiency of financial institutions, particularly Islamic institutions. 1 Introduction Founded in 1981, the Gulf Cooperation Council (GCC) includes six countries bordering the Gulf. These countries are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates (UAE). The ultimate goal of the GCC creation is to ensure prosperity and economic development for its members. There is a strong belief among the region s decision makers and authorities that facilitating the cross-border economic activities within the region has a crucial impact on the ongoing economic development efforts. Thanks to the recent increase in oil and gas revenues, the GCC members accumulated high liquidity with limited opportunities for investment. The authorities strive to create opportunities for investment to create jobs in order to lighten the social unrest generated by an increasing unemployment rate. The contribution of the financial sector, particularly the banking sectors as the main channel of fund circulation, is the main driver for such development. The relatively small size of the banks in the region constitutes, in the eve financial services liberalisation, a major weakness that generate high vulnerability of banking units in the region facing international giants of banking. Public authorities and financial regulation authorities, aware of the matter, are encouraging consolidation in the sector locally and regionally. Multiple consolidations happened in the region and some are ongoing in-borders and cross-borders, among them two initiated major ones in Oman. The general trend toward consolidation witnessed in the region is being fastened and encouraged by regulators, a consolidation that is considered and advised as the main mean to overcome and mitigate the current global financial crisis, reduce the vulnerability of the financial system and boost the development through the creation of banking units able to finance ambitious mega-projects planned in the region. This was in fact the prerequisite condition for any support in rescuing troubled banks in Kuwait lately. In UAE, though it was not that much explicit, the banks are under pressure to merge to be eligible for a government rescue plan. A significant development in the institutional framework of Oman banking industry was the merger of HSBC Bank Middle

3 360 S. Gattoufi et al. East Limited s Oman branches with Oman International Bank in June The registered name of the bank is now HSBC Bank Oman. Do banks mergers and acquisitions (M&As) in Gulf countries enhance bank performance? In other words, do M&A add value to shareholders? How do M&A affect the financial as well as the economic performance (efficiency) of these banks? How do micro and the macroeconomic indicators reflect the impact of M&A on the commercial banking sector performance in the GCC countries? The research investigates the answers to these questions using banks annual reports. The rest of this study has the following structure: Section 2 describes M&As in GCC banking. Section 3 presents the literature review. Section 4 describes the methodology. Section 5 presents the empirical results. The final section concludes the study. 2 Commercial banking and consolidation in GCC countries The high liquidity of the financial sectors boosted by the sharp increases in oil and gas revenues has created a major element favouring the development of a strong commercial banking sector. However, the banking sector in the region remained classical in the nature of its activity and formed by relatively small units, compared to their international counterparts, that are unable to support the ambitious development programmes intended by the governments in the region to boost the employment and reduce the possible social unrest that can be generated by the increasing unemployment rate particularly among university degree holders. Hence, GCC banks have been considering consolidation through M&A, as a means for boosting their performance and improve their investment capabilities, since the early nineties. Managers of commercial banks in GCC countries realised the need to expand beyond the usual operations and boundaries through utilising their high liquidity which would enhance their competitive position. Moreover, being a member of the World Trade Organization (WTO) obligates all members to open up their market s doors including banking sectors to permit foreign rivals to compete with domestic companies. The current policies in the region are very strict toward foreign banks licensing, despite their explicit intention to join the WTO. The UAE had in fact stopped granting licences to foreign banks long time ago, and restricted the number of branches of these foreign banks to a very limited number. Saudi Arabia didn t allow foreign banks to open branches in the country and in the 1980 s existing foreign banks had to comply with the Saudi regulators and turned into joint-ventures with a minimum of 60% Saudi ownership. Dubai International Financial Centre (DIFC), where 100% foreign ownership is allowed is a unique exception in GCC region. Oman sustains parallel stringent requirements with regard to ownership. Over the GCC banking history, 40 years, not many GCC banks have succeeded to build regional platforms. This is not in line with the general aim of GCC that heralded since its inception, that the development of cross-borders economic activities in the region as its major raison-d être. However, there are two exceptions to that, namely the Ahli United Bank (AUB) located in Bahrain and to a slighter degree the National Bank of Kuwait (NBK). Surprisingly, Saudi banks, though they are active in the giant economy in the region, are unable to develop significant cross-borders activities in terms of commercial banking or investment.

4 Assessment of mergers and acquisitions in GCC banking 361 The resolution passed at the 18th summit meeting attended by the leaders of GCC countries, held in Kuwait in December 1997, allowed national banks in these countries to open branches in other members countries. This represented a major turning point supporting the efforts towards financial integration among GCC countries, in preparation for a higher degree of integration at the monetary level and a preparatory step toward the implementation of WTO Agreement on the liberalisation of the financial services under the General Agreement on Trade in Services (GATS). Accordingly, many national banks opened branches and representative offices in other GCC countries. For example, locally incorporated commercial banks operated in Oman with a network of 479 branches in 2012, an increase of 18 branches from Locally incorporated commercial banks, in addition, had 10 branches and two representative offices abroad. Most of these branches and representative offices are in the other five GCC countries. Up to date, bulk of banking mergers occurred in the Gulf is different in scale and financial strength, failing to realise that joining banks could reap the benefits from amplified balance sheet assets and economies of scale. Instead, hostile mergers have been the dominant way of integration, where a troubled bank forced to go through merger with financially healthier one. For instance, NBO had a bad record of loans profile going back to the late 1990s. Although AHB was regarded as a great and well managed bank, it was also encountering competitive difficulties. The bank was facing difficulty in its mortgages finance division when it realised that that profit had been shared by other local banks that provide housing finance too. Though inactive regionally despite the public authorities declared wishes and explicit calls for consolidation regionally and locally, large GCC commercial banks preferred to develop their cross-borders activities outside the GCC. These banks may have realised that that the economic booming growth is implausible to run forever, hence expanding their activities abroad will be a wise choice to anticipate the possible saturation of their home market. Hence, the search for lucrative targets at home, has been more proactive and they are expanding further into different sectors and regions. For the flourishing commercial Islamic banks, the South East of Asia is proving fertile hunting grounds. Kuwait Finance House and Al-Rajhi Bank established extensive operations in Malaysia, and Qatar International Islamic Bank setting up shop in Pakistan, Commercial Bank of Kuwait has bid for banks in Egypt and Turkey and Qatar National Bank is expanding its activities to several countries (Iraq, Yemen, Libya and Tunisia). Also, Commercial Bank of Kuwait has attempted to seriously consider a worthy bid for control of Turkiye Finans with Saudi Arabia s National Commercial Bank as well as stretched its arms to cross border markets such as Iraq and Syria. The previous analysis of the commercial banking activity in GCC countries identifies awareness about the importance and the need for increasing the size of banking units. This created an ongoing trend of consolidation that took mainly the forms of M&A to create bigger banks within each country and within the GCC through cross-borders activities. This trend is encouraged by the regulating authorities to anticipate any future liberalisation in the banking sector that can be dictated by the possible WTO membership. Moreover, there are no indicators that the mutation in the sector is about to end. Contrarily, and as claimed in Gattoufi and Al-Hatmi (2009), it is expected that the trend will last and possibly with higher pace.

5 362 S. Gattoufi et al. 3 Literature review The topic of M&A is rich and popular academic area. US and European studies are the big contributions to this topic. However, in the GCC region, the topic is very rare which makes it hard since there is no any relevant background. Different papers have been published with regard to GCC covering different topics within the area of banking industry, but not in the field of bank M&As. Al-Muharrami (2008) examined technical, pure technical and scale efficiencies in GCC banking using DEA for the period His findings highlighted first that smaller banks exhibited superior performance in terms of technical efficiency than did larger ones. Second, big banks proved to be more successful in adopting the best available technology, while medium banks proved to be more successful in choosing optimal levels of output. Al-Obaidan (2008) tried to analyse the optimal bank size in GCC states. He concluded that non-large banks have technical efficiency approximately 35% as large banks. Furthermore, scale efficiency of non-large banks is approximately 50% as large banks. Therefore, economic efficiency of non-large banks is roughly 18% as large banks. There are, in fact, substantial numbers of studies that have been published trying to assess the argument of achieving positive gains through M&A. The efficiencies, economies of scale, and improved management are the main motivations (Madura and Wiant, 1994). However, studies in this area have shown conflicting findings. Healy et al. (1992) documented that there is a clear positive link between abnormal stock gains at merger announcements and the after-merger rises in operating cash flows (OCF). Houston and Ryngaert (1994) find that, on average, bank M&As do not impact the overall wealth of all shareholders in the transaction. Managers expect on most occasions that mergers can reduce costs by excess capacity reduction instead of profit efficiency enhancement (Houston et al., 2001). Rhoades (1994) summarised the previous studies over the period from 1980 to His general conclusion indicated that mergers in banking did not enhance performance. Shaffer (1993) argued that it s possible to achieve X-efficiency gains when efficient banks merge with banks that have lower efficiency. Moreover, findings by some scholars like Altunbas et al. (1995) and Pilloff and Santomero (1998) reported that acquiring banks are more efficient than the target banks before the merger. In addition, it s been reported that when acquiring banks believe that they can make substantial diversification gains they are likely to bid for target; which is consistent with the motivation to enhance to the return of the expected risk tradeoff and profit efficiency increase (Benston et al., 1995; Amihud et al., 2002). Despite the fact that the reported findings based the last decade (1990s) showed mixed results, however, occasionally, they have reported that gains in cost efficiency were achieved, according to Berger and Humphrey (1992, 1997). The effects of efficiency were specifically studied by Rhoades in 1998 using nine banks that went through M&A. He suggested motives behind the mergers along with consolidation process could influence the cost efficiency effects. Also, Al-Sharkas et al. (2008) investigated the impacts of both efficiencies (cost and profit) of bank consolidation on the American banking sector reporting that M&As have enhanced the banks cost and profit efficiencies. Rezitis (2008) mentioned that studies in Europe showed support for economies of scale in both very small banks and average size banks according to Altunbas et al. (2001) and Vennet (1996) reported that because of economies of scale there could be potential efficiency gains in mergers among small and medium-sized European credit

6 Assessment of mergers and acquisitions in GCC banking 363 firms. Rezitis (2008) studied the impact of M&As activity on the efficiency and total factor productivity of Greek banks. His findings suggested that there is a negative effect of M&As on technical efficiency and total factor productivity growth of Greek banks. 4 Methodology There are two major approaches used to judge and evaluate the impact of mergers on the performance. These two approaches are operating performance methodology and market methodology. This study uses operating performance approach. The operating performance approach mainly uses accounting data. The central idea is to compares the performance of merging firms before and after the merger by using accounting data to determine whether consolidation actually leads to changes in the reported financial numbers like cost reduction and profit increase. The financial ratios have been used since the early 1990s in assessing the performance of banking M&As by several authors. However, there is no common agreement on a single set of ratios which has been agreed upon. Cornett and Tehranian (1992) and Linder and Crane (1992) are among the first people to use this approach to evaluate the performance in bank mergers. Cornett and Tehranian (1992) included financial ratios in evaluating the impact of M&A on banks. One of their first papers using financial ratios was in 1992 when they studied the after-merger performance of USA banks over the period They used mainly OCF; defined as earnings before depreciation, goodwill, interest on long-term debt, and taxes divided by the market value of assets. Also, Healy et al. (1992) used financial ratios to assess the performance of large American banks after the acquisitions. Their study covered mergers between 1979 and mid They defined OCF as revenues less cost of goods sold to the customers, less overhead expenses, plus depreciation. Campa and Hernando (2006) used seven financial ratios for the acquirers and the targets prior to the merger and for the acquirer after the mergers. Their sample included a selected M&A which occurred in the financial industry of European Union between 1998 and This study adopts a similar approach that has been used by Campa and Hernando (2006). Selected studies based on the existing literature where financial ratios were used in assessing the impact of M&A in commercial banks are presented in Appendix Financial ratios Financial ratios are often used by market participants like creditors and investors in their decisions to gauge the performance of firm and its financial health. Financial ratios provide a comparative view among similar banks as well as trends over time for individual bank. This study includes five categories of seven ratios namely: 1 Profitability: reflects the firm s capacity to make profits and earnings from its main business activities. The two ratios are: return on equity (ROE), and net financial margin (NFM). 2 Solvency: shows to which degree the bank can take up a reasonable level of losses before becoming bankrupt. This ratio measures the amount of a bank s capital expressed as a percentage of capital to assets; the ratio used is Capitalisation ratio.

7 364 S. Gattoufi et al. 3 Efficiency: an indicator of how well management and staff have been able to keep the growth of revenues and income ahead of rising operating costs. 4 Lending intensity: the ratio used is net loans to total assets. 5 Risk profile: bankers are concerned with six main types of risks: credit risk, liquidity risk, market risk, interest rate risk, earnings risk, and capital risk. Each of these forms of risk can threaten a bank s solvency and long-run survival. This study uses two ratios to measure the amount of a bank s credit risk expressed in loan loss provisions to total loans, and loan loss provisions to net interest revenue. These seven ratios, representing the five categories, considered for this study are listed in Table 1. These ratios are chosen based on Campa and Hernando (2006). The ratio analysis is used for the micro analysis to analyse the individual financial performance of those banks that went through M&A, before and after the event takes place. Table 1 List of ratios considered for the analysis Ratio 1 Return on equity (ROE): (net income / total equity)*100 2 Net financial margin (NFM): (net interest revenue / total earning assets )*100 3 Capitalisation ratio (CAP): (equity / total assets )*100 4 Cost to income ratio (EFF): (operating expenses / (net interest revenue + other income)*100 5 Lending activity (LOANS): (net loans / total assets)*100 6 Loan loss provisions to total loans (PROV): (loan loss provisions / total loans)*100 7 Loan loss provisions to net interest revenue (RISK): (loan loss provisions / net interest revenue)*100 Parameters Profitability Solvency Efficiency Lending intensity Risk profile The financial statements of GCC commercial banks are prepared in accordance with International Accounting Standards (IAS). Al-Shammari et al. (2007) reported that IAS become mandatory in Oman in 1986, Kuwait in 1991 and Bahrain in 1996; where UAE, Qatar and Saudi Arabia required their listed firms to apply IAS in1999, 1992 and 1999 respectively. This makes the comparison even easier and realistic to draw sound and logical conclusions about these banks performance before and after the consolidations. 4.2 Data description The study uses financial reports gathered from Bankscope database. The data covers the period This study is considering 10 M&A that occurred during the sample period and they are presented in Table 2. Within the subset of banks that went through

8 Assessment of mergers and acquisitions in GCC banking 365 M&A, one can distinguishes three types of banks, namely acquirers, the target banks and those that went into a joint venture (JV). Table 2 GCC Commercial banks involved in M&A over the period Year of M&A Bank role in M&A Country Bank name Code 2005 Acquirer Bahrain Ahli United Bank B Acquirer Oman Bank Dhofar SAOG B Acquirer Kuwait Bank of Kuwait and Middle East B Target Bahrain Bank of Bahrain and Kuwait B Acquirer Kuwait Commercial Bank of Kuwait SAK B Acquirer Qatar Commercial Bank of Qatar (QSC) B JV UAE Mashreq Bank B Target Oman National Bank of Oman (SAOG) B JV KSA Saudi Investment Bank B Acquirer UAE Union National Bank B041 5 Empirical results In this section we looked at the impact of M&As covering the ten banks involved in M&A. The averages of the seven ratios for the merging ten banks were calculated and tabulated in Appendix 2. 1 Ratio 1: ROE The average of the commercial banking sector experienced a smooth increase starting from 15.81% in 2003 and reached the highest to 24.7% in For merging banks, there were four banks out of 10 that improved their ROE. Three out of these four banks outperformed the sector. Although bank B023 witnessed a moderate drop from 30.1% in 2005 to 23.07% in 2007 but it still outperformed the sector. The only bank that encountered a significant drop is B038; it almost dropped by 50% starting from 23.88% in 2005 then plunged to 12.88% in 2007; this observation can be found in Appendix 2, Section 1. 2 Ratio 2: NFM As one can notice in Table 6 there have been moderate fluctuations in the ratio over the 5 years period. Banks involved in M&As didn t experienced significant change after mergers. There were just two banks that stayed above the average. Although these two banks witnessed a decline in their NFM; the two banks were operating in the same environment (Oman). None of the 10 banks has improved its NFM. Bank B023 seems to revert. Profitability indicators in terms of ROE and NFM experienced mixed results for banks involved in MA; there was no single bank which showed an improvement in both of these two ratios over the period of 5 years. 3 Ratio 3: capitalisation ratio (CAP) The average of the sector for this ratio experienced a gradual rise till 2005 where it started to slowly fall. There was only one bank (B038) which experienced an

9 366 S. Gattoufi et al. improvement in CAP ratio; also, the bank outperformed the sector average. Although the CAP ratios of rest of the nine banks have declined three banks still outperformed the sector; the banks are B012, B029 and B038. There was only one bank that encountered substantial drop; the bank was B017, CAP fell from 25.59% in 2005 to 13.72% in Ratio 4: efficiency The ratio (for the whole banking sector) has experienced fluctuations over the period from 2003 to Despite the theoretical belief that banks improve their efficiency through mergers, merging banks experienced mixed performance in their cost to income ratio (efficiency). There were only two banks that witnessed improvement in their efficiency after the mergers; namely bank B007 and B023. These two banks were operating in the same environment (Oman), though, the banks were still below the sector s averages in the period surrounding the M&A. While the efficiency ratios for five banks deteriorated they still outperformed the sector. There were three banks that encountered considerable deterioration in their efficiency ratios; B012 from 42.58% in 2005 (from Bahrain) to 67.16% in 2007, bank B023 from 25.35% in 2005 to 37.08% in 2007 and bank B041 from 17.77% in 2005 to 29.88% in The last two banks are from UAE. 5 Ratio 5: lending activity (LOANS) The sector has seen slight and gradual increase in the lending activity ratio as shown in Table 3. There were five banks out of the ten that improved their lending capacities; the banks are, B009, B012, B016, B017, and B041. However, one only bank out of these five outperformed the sector; B041 jumped from 59.27% in 2005 to 67.4% in Out of the other five banks that experienced decline in their lending activities, two were still above the sector s averages despite their decline; namely B007 and B023 (Omani Banks). 6 Ratio 6: loan loss provisions to total loans (PROV) The overall change in averages of sector s performance of loan loss provisions has improved (lower in value) of the period from as depicted in Table 4. There is a common improvement (lower in value) among all ten banks involved in M&A for the first time; all have improved their loan loss provisions. The (PROV) ratios performance can be found in Appendix 2, Section 6. However, the improvement wasn t significant except for four banks where there was remarkable improve in ratios; almost improved by 50%. These bank are B007 from 4.13% in 2004 to 1.49% in 2007, B016 dropped from 11.42% in 2005 to 6.94% in 2007, B029 improved from 12.18% to 5.54% a year after the merger and finally bank B041 lowered its risk profile from 3.85% (2005) to 1.32% (2007). This could mean that merging banks were able to establish good customer profiles by attracting more lucrative clients. 7 Ratio 7: loan loss provisions to net interest revenue (RISK) The overall trends for this ratio improved (lower in value) over the period of five years.

10 Assessment of mergers and acquisitions in GCC banking 367 For the banks involved in M&A there were seven banks out of ten that improved their risk profiles after the merger; six out of seven of these banks experienced significant improvement. There was just one bank which experienced almost no change in its risk profile; the bank was B012 where (RISK) was 6.33% in 2005 and 6.39% in Bank B016 was the only bank which has its risk profile improved and outperformed the sector s average. The bank that has its risk profile deteriorated after the merger were B017; from 2.87% in 2005 to 5.52% in 2007 and bank B007 (from 2.87% to 5.52%). These observations can be found in Appendix 2, Section 7. Table 3 Sector lending activity (LOANS) Average (sector) 55.42% 56.22% 56.91% 58.67% 58.2% Table 4 Loan loss provisions to total loans (PROV) Average (sector) 7.55% 5.28% 5.09% 4.04% 3.21% Table 5 Averages of loan loss provisions to net interest revenue (RISK) Average (sector) Comparison within the merged banks Within the subset of banks that went through M&A, one can distinguishes three types of banks, namely acquirers, the target banks and those that went into a JV. This section investigates the impact of M&A on each of these classes. Starting with acquiring banks, as reported in Table 6, all acquirer banks have experienced lower risk profile after merger except bank B007 the merger which is consistent with Campa and Hernando (2006) findings. This is also consistent with the findings of Benston et al. (1995) and Amihud et al. (2002) justifying it as a motive to improve risk expected return tradeoff and increase profit efficiency,. All acquiring banks experienced an improvement in their loan loss provisions ratios which could be a sign of the bank s ability to attract new customers. Efficiency ratio has improved over the period; from 39.27% in (2003) to 34.82% in (2007) for the whole sector, it can be seen in Table 6. For the acquiring banks, however, the efficiency has slightly worsened (except for bank B007) this is the opposite of Campa and Hernando (2006) findings. Nevertheless, since mergers in GCC banks are horizontal type then according to Berger and Humphrey (1992) and Rhoades (1993) when the acquiring banks are more efficient than the target banks, horizontal mergers produce no efficiency gains. CAP had deteriorated over the five years among all acquiring banks. However, the changes, in most banks, were moderate. As discussed in the section above, lending capacity of the sector has increased slowly. The acquirers have increased their lending capacity with exceptional performance for bank (B007); which is consistent with Campa and Hernando (2006) reported results.

11 368 S. Gattoufi et al. Table 6 Evaluating the performance of acquiring banks before and after the merger Ratios Loan loss provisions to net interest revenue (RISK) Loan loss provisions to total loans (PROV) Acquirers Bank B003 Bank B007 Bank B009 Bank B016 Bank B017 Bank B041 Change from 2004 to to 6 = significant improvement Change from 2004 to 2006 Change from 2005 to 2007 Change from 2005 to to 5 = worsen 13 to 11 = improved 15 to 3= significant improvement Change from 2005 to 2007 (0.38) to 5 = significant improvement Change from 2005 to to 5 = significant improvement 4 to 1 = improved 6 to 3 = improved 4 to 3 = improved 11 to 6 = improved 0.7 to 0.5 = improved 3 to 1 = improved Lending activity (LOANS) 35 to 42 = improved 76 to73 = worsen 47 to 55 = improved 50 to 51 = improved 49 to 55 = improved 59 to 67 = improved Cost to income ratio (EFF) 42 to 43 = worsen 44 to 38 = improved 30 to 33 = worsen 20 to 21 = worsen to 29.5 = worsen 17 to 29 = worsen (significant) Capitalisation ratio (CAP) 12 to 8 =worsen 12 to 11 =worsen 14 to 13 = worsen 16 to 12 = worsen 25 to 13=worsen 14 to 12 = worsen Net financial margin (NFM) 1.8 to 1.7 = worsen (very small change) 4 to 3 = worsen 2.5 to 2.3 = worsen (very small change) 3.7 to 2.7 = worsen 2.7 to 2.4 =worsen (very small change) 2.3 to 2.2 = worsen (very small change) Return on equity (ROE) 11 to 14 = improved 24 to 20 =worsen 21 to 20=worsen 24 to 23 = worsen 18 to 23 = improved 30 to 18 = worsen (significant drop) Notes: The merging years were ignored, 2005 for bank B007 and 2006 for the rest of the banks.

12 Assessment of mergers and acquisitions in GCC banking 369 NFM has deteriorated among all buying banks. We should be careful not to associate this to the impact of the merger activity rather than to the performance of the banking sector where it demonstrated gradual and slight decline associated with this ratio (net interest revenue divided by total earning assets). The profit of the acquiring banks measured by ROE has improved for two banks out of three banks. Bank B017 has increased its ROE by almost 5% which could be linked to the affect M&A since it outperformed all banks that involved in M&A as well as the whole banking sector as illustrated in Table 7. Table 7 Exceptional ROE for Bank B (ROE) Average(market) Average (Banks without M&A) Average (Banks with M&A) The second subset of banks that went through consolidations is those that were the target for a merger or an acquisition. Changes of the corresponding financial ratios before and after the merger action are reported in Table 8. Table 8 Ratios Changes in the financial ratios of target banks before and after the consolidation Loan loss provisions to net interest revenue (RISK) Loan loss provisions to total loans (PROV) Lending activity (LOANS) Bank B012 Targets Bank B029 Change from 2005 to 2007 Change from 2005 to to 6.6 = worsen (very small change) 54 to 19 = significant improvement 5 to 4 = improved 12 to 5 = improved to = improved (very small change) 64 to 61 = worsen Cost to income ratio (EFF) 42 to 67 = worsen 52 to 45 = improved Capitalisation ratio (CAP) to = worsen (very 20 to 15 = worsen small change) Net financial margin (NFM) 2.6 to 2.8 = improved (very 3.9 to 3.2 = worsen small change) Return on Equity (ROE) 17 to 14 = worsen 15 to 21 = improved Note: The merging year (2006) was ignored. Unlike the acquiring banks where they demonstrated consistency in their performance as a whole; there was inconsistent performance of those banks being a target. While target bank (B029) had its risk profile improved the other bank experienced the totally opposite; its risk profile improved significantly (from 54% to 19% a year after the merger). Similar to acquirer banks, the (PROV) for the target banks was improved over time. CAP has also dropped for the target banks. The target banks profitability showed an overall improvement; two target banks out of three have their profit increased measured by and just one target bank has NFM enhanced.

13 370 S. Gattoufi et al. Only one target bank had improved efficiency ratio (got lower in value); this is consistent with Campa and Hernando (2006) findings. On the other hand, this does not agree with Vennet (1996) when they reported that higher efficiency profitable banks are more likely to buy less efficient and profitable banks which are small in size. Comparing to acquiring banks, the lending capacities for these banks were mixed, one had improved where the other deteriorated which is opposite of acquirers (where all improved their lending activities. The third subset of banks that had a consolidation action is those that went into JV. Changes of the corresponding financial ratios between and after the consolidation action are reported in Table 9. Table 9 Ratios Changes in the financial ratios of JV banks before and after consolidation Loan loss provisions to net interest revenue (RISK) Loan loss provisions to total loans (PROV) Bank B023 Joint ventures (JV) Bank B038 Change from 2005 to 2007 Change from 2005 to to 17 = improved 12 to 8 = improved 3 to 2 = improved 3.36 to 3.03 = improved (very small change) Lending activity (LOANS) 47 to 43 = worsen 50 to 49 = worsen Cost to income ratio (EFF) 25 to 37 = worsen 2 to 34 = worsen Capitalisation ratio (CAP) 17 to 11 = worsen 13 to 14 = improved Net financial margin (NFM) 2.5 to 2.3 = worsen 2.3 to 2.5 = improved (very small change) Return on equity (ROE) 30 to 23 = improved 23 to 12 = worsen (significant) Note: The merging year was 2006 therefore ignored. The two banks involved in JV activities have improved their risk profile significantly. This is expected due to the diversification where risk can potentially be reduced; bank B023 joined operation with an investment bank where bank B038 joined with finance company. JV banks profitability measured in terms of ROE and NFM didn t improve after the consolidations. Similar behaviour was experienced for the JVs lending activities. Similar to other banks in the subsample, JV banks have enhanced their loan loss provisions. Efficiency of the two banks improved (ratio cost to income has dropped in value). 6 Concluding remarks This study provides an empirical assessment of banking consolidation of commercial banks in GCC countries. It addresses the question whether M&As improve the performance of the GCC commercial banks. Seven financial ratios were used to investigate the impact of M&A on the operational performance of the merging banks for the period from 2003 to The sample consists of 42 commercial banks in the GCC countries. The results of financial ratios are mixed; where acquiring banks, target and banks went through JV show mixed results and it wasn t easy to establish a strong like between bank involved in M&A and the impact of mergers on their operating

14 Assessment of mergers and acquisitions in GCC banking 371 performance. However, the findings suggest that, on average, M&A activity didn t have significant impact on operational performance of banks involved in M&As. The results could be important for bank shareholders and bank managers since M&As rarely add value or enhance performance. They may also help regulators and supervisory authorities in their definition of a coherent competition and merger policies; realising that M&As are not the real magic solution. They should enlighten the investors, the managers and the government regulators that M&As do not have a definite clear benefit for the stakeholders. Although if there are any gains or benefit they are still limited and insignificant. However, there could be some benefits that the bank might realise from the consolidation even if it doesn t accomplish operating efficiency gains. Rhoades (1998) reported that the benefits could include a more diversified deposit and loan base, a different strategic orientation and a good vehicle for growth. The industrialists insist on the benefits and advantages that can be brought by the M&A activities. On the other hand, vast number of academic studies reported no or limited positive impact for the M&A strategies. Could it be due to the models used to study the impact of M&A? Or could it be the managerial motives justified for the consolidations? The real explanations will take more efforts and deep investigations and it may be very long time before the research community as well as the industrialists can document solid conclusions; only the future can provide the ultimate findings. References Al-Muharrami, S. (2008) An examination of technical, pure technical, and scale efficiencies in GCC Banking, American Journal of Finance and Accounting, Vol. 1, No. 2, pp Al-Obaidan, A (2008) Bank management and portfolio selection: the case of the Gulf Cooperation Council Countries, European Journal of Economics, Finance and Administrative Science, Vol. 11, pp Al-Shammari, B., Brown, P. and Tarca, A. (2007) An Investigation of Compliance With International Accounting Standards by Listed Companies in the Gulf Co-Operation Council Member States, SSRN: or ssrn Al-Sharkas, A., Hassan, M. and Lawrence, S. (2008) the impact of mergers and acquisitions on the efficiency of the US banking industry: further evidence, Journal of Business Finance & Accounting, Vol. 35, Nos. 1 2, pp Altunbas, Y., Evans, L. and Molyneux, P. (2001) Bank ownership and efficiency, Journal of Money Credit and Banking, Vol. 33, No. 4, pp Altunbas, Y., Maude, D. and Molyneux, P. (1995) Efficiency and Merger in the UK (retail) Banking Market, Working Paper, England. Amihud, Y., DeLong, G. and Saunders, A. (2002) The effects of cross-border bank mergers on bank risk and value, Journal of International Money and Finance, Vol. 21, No. 6, pp Benjamin, L. and David, T. (2002) New Zealand bank mergers and efficiency gains, Journal of Asia - Pacific Business, Vol. 4, No. 4, p.61. Benston, G., Hunter, W. and Wall, L. (1995) Motivations for bank mergers and acquisitions: enhancing the deposit insurance post option versus earnings diversification, Journal of Money, Credit and Banking, Vol. 27, No. 3, pp

15 372 S. Gattoufi et al. Berger, A. and Humphrey, D. (1992) Measurement and efficiency issues in commercial banking, in Griliches, Z. (Ed.): Output Measurement in the Service Sectors, pp , The University of Chicago Press, Chicago. Berger, A. and Humphrey, D. (1997) Efficiency of financial institutions: international survey and directions for future research, European Journal of Operational Research, Vol. 98, No. 2, pp Campa, J. and Hernando, I. (2006) M&As performance in the European financial industry, Journal of Banking & Finance, Vol. 30, No. 12, pp Cornett, M. and Tehranian, H. (1992) Changes in corporate performance associated with bank acquisitions, Journal of Financial Economics, Vol. 31, No. 2, p.211. Fuentes, I. and Sastre, T. (1999) Mergers and acquisitions in the Spanish Banking industry: some empirical evidence, Banco de Espana, Internal Report, No Gattoufi, S. and Al-Hatmi, S., (2009) A productivity analysis of the Omani banking industry: a data envelopment analysis (DEA) approach to decompose and analyze its technical efficiency, International Journal of Accounting and Finance, Vol. 1, No. 4, pp Healy, P., Palepu, K. and Ruback, R. (1992) Does corporate performance improve after mergers, Journal of Financial Economics, Vol. 31, No. 2, pp Houston, J. and Ryngaert, M. (1994) The overall gains from large bank mergers, Journal of Banking and Finance, Vol. 18, No. 6, pp Houston, J., James, C. and Ryngaert, M. (2001) Where do mergers gains come from? Bank mergers from the perspective of insiders and outsiders, Journal of Financial Economics, Vol. 60, Nos. 2 3, p.285. Linder, J. and Crane, D. (1992) Bank mergers: integration and profitability, Journal of Financial Services Research, Vol. 7, No. 1, pp Madura, J. and Wiant, K. (1994) Long-term valuation effects of bank acquisitions, Journal of Banking and Finance, Vol. 18, No. 6, pp Marcia Millon, M., John, J. and Hassan, T. (2006) Performance changes around bank mergers: revenue enhancements versus cost reductions, Journal of Money, Credit, and Banking, Vol. 38, No. 4, p Megginson, W., Morgan, A. and Nail, L. (2004) The determinants of positive long-term performance in strategic mergers: corporate focus and cash, Journal of Banking & Finance, Vol. 28, No. 3, pp Pilloff, S. and Santomero, A. (1998) The value effects of bank mergers and acquisitions, in Amihud, Y. and Miller, G. (Eds.): Bank Mergers and Acquisitions, Kluwer Academic Publishers, Boston. Rezitis, A. (2008) Efficiency and productivity effects of bank mergers: evidence from the Greek banking industry, Economic Modeling, Vol. 25, No. 2, pp Rhoades, S. (1993) Efficiency effects of horizontal (in-market) bank mergers, Journal of Banking & Finance, Vol. 17, Nos. 2 3, pp Rhoades, S. (1994) A summary of merger performance studies in banking and an assessment of the operating performance and event study methodologies, Federal Reserve Bulletin, Vol. 80, No. 7, p.589. Rhoades, S. (1998) The efficiency effects of bank mergers: an overview of case studies of nine mergers, Journal of Banking & Finance, Vol. 22, No. 3, p.273. Shaffer, S. (1993) Can megamergers improve bank efficiency?, Journal of Banking and Finance, Vol. 17, Nos. 2 3, pp Vennet, R. (1996) The effect of mergers and acquisitions on the efficiency and profitability of EC credit institutions, Journal of Banking & Finance, Vol. 20, No. 9, pp

16 Appendix 1 Assessment of mergers and acquisitions in GCC banking 373 Table A1 Selected references that used ratios in analysing the efficiency of banks Year Outlet Author Country Methodology Ratios/accounting data 1992 Journal of Financial Economics 1992 Journal of Financial Economics 1996 Journal of Banking and Finance 1998 Journal of Banking and Finance 1999 Journal of Banking and Finance Cornett and Tehranian USA Accounting ratios Operating cash flows (OCF) = (earnings before depreciation, goodwill, interest on long-term debt and taxes) / (market value assets) Paul Healy USA Accounting ratios Pretax operating cash flow return on assets: operating cash flows as sales minus COGS and selling administrative expenses plus depreciation and goodwill expenses, asset employed using market values, which represent the opportunity cost of the assets. Rudi Vander Vennet Stephen Rhoades Benjamin Esty et al Banco de España Fuentes and Sastre Europe Accounting ratios + stochastic cost frontier ROA, ROE, two cost ratios: the labour cost ratio, the operating expense ratio.for the stochastic cost frontier: two outputs (loans and investments) three inputs(cost of labour, capital and deposits) USA Financial ratios + translog cost function Five balance sheet ratios: ROA, no interest expense, total expenses, expenses to assets and other no interest expenses-to assets ratios are the components of no interest expenses revenue, net income(after taxes) to average assets USA Accounting ratios + interest-rate beta ROA, book equity/assets,non-performing assets /total assets, non-interest expense/average assets, purchase price/target book value, purchase price/target trailing EPS, premium to target core deposits Spain Financial ratios Profit generating capacity: Total income = interest income + commissions +result on financial operations, interest expenses, gross income = total income interest expenses operating expenses. Net income = total income interest expenses operating expenses, all these ratios are expressed as a percent age of average total assets. Efficiency and productivity: operating expenses/average total assets, operating expenses/ total income, operating expenses/gross income. Productivity per employee: average total assets / number of employees, productivity per office: average total assets / number of offices, number of employees and offices following merger. Indicators of market share and total assets growth: market share (in terms of total assets). Indicators of business structure: Lendingdeposit activity in pesetas, as a percentage of total assets. Indicator of capital adequacy: capital / total assets

17 374 S. Gattoufi et al. Table A1 Selected references that used ratios in analysing the efficiency of banks (continued) Year Outlet Author Country Methodology Ratios/accounting data 2001 Journal of Asia-Pacific Business 2004 Journal of Banking and Finance 2006 Journal of Banking and Finance 2006 Journal of Money, Credit and Banking Benjamin, L. and David, T. Megginson and Morgan Campa and Hernando Marcia Millon et al. New Zealand Accounting ratio + DEA Operating efficiency: cost to income ratio, operating expense / average total assets, employee s productivity: operating income / average employees, ROA. DEA Model (1) after 1990: inputs: interest expense, non-interest expense.outputs: net interest income, non-interest income. DEA Model (2) after 1990: inputs: interest expense, non-interest expense. Outputs: customer deposits, net loans and advances, operating income. DEA Model (3) before 1990: inputs: interest expense, non-interest expense. Outputs: deposits, loans and advances USA Accounting data + ordinary least square (OLS) European Union Market-to-book value ratios, operating cash flows = (Sales COGS-selling and administrative expenses + depreciation and will amortisation) / ( market value of common equity + the book value of preferred stock and debt) Accounting ratios + event study Measures of Profitability: ROE and net financial margin (NFM), Solvency: capitalisation ratio (CAP). Efficiency: cost to income ratio (EFF). Lending intensity: net loans to total assets (LOANS). Risk profile: loan loss provisions to total loans (PROV) and loan loss provisions to net interest revenue (RISK) USA Accounting ratio + regression model 40 Accounting ratio were used, e.g.,: liquidity risk indicators: loans to total assets, core deposits to total assets, total loans to total deposits, liquidity ratio. Growth indicators: asset growth rate, deposits growth. Profitability indicators: ROA, ROE, net interest margin. Capital adequacy indicators: Total capital to assets, loans to total capital, deposits to total capital.asset quality indicators: allowance for loan losses to loans, loan loss provision to loans. Operating efficiency indicators: non-interest expense to non-interest revenue, non-interest expenses to net operating income, non-interest to total assets (personal expenses to total assets, fixed assets to total assets, total assets to employees, net income to employees)

18 Appendix 2 Assessment of mergers and acquisitions in GCC banking 375 Table A2 Ratios of banks involved in M&A Bank code Section 1 ROE B B B B B B B B B B Section 2 Net financial margin (NFM) B B B B B B B B B B Section 3 Capitalisation ratio (CAP) B B B B B B B B B B