LONDON  - Emirates NBD is making a virtue out of Turkish turbulence. The United Arab Emirates lender has agreed to pay Russia’s Sberbank 14.6 billion lira ($3.2 billion) for Istanbul-based Denizbank. In the long term, NBD should benefit from diversification and increased trade between Turkey and the Arab world. Right now, erratic politics and economic decline mean it is by no means a bargain.

Sberbank, Russia’s largest bank by assets, bought Turkey’s fifth-largest bank by assets in 2012 signaling intentions to expand abroad. Western sanctions have halted all that. Morgan Stanley reckons Sberbank breaks even, but can also reallocate capital to Russia, where it makes a return on equity exceeding 20 percent.

NBD is paying a small premium to Denizbank’s 2017 book value. That looks cheap given Denizbank made a 15 percent and 13 percent return on equity over the last two years respectively, and acquisitions of fast-growing emerging markets lenders are often done at multiples of book. NBD also advances its strategy – roughly 30 percent of group revenue will now be overseas – and can link local clients doing business in Turkey into a network stretching via Dubai into Saudi Arabia, Egypt and India.

Still, a high valuation would have been hard to justify. Denizbank’s cost of capital is over 15 percent. And Turkish risks have been rising in the wake of the failed coup d’état against President Tayyip Erdogan nearly two years ago. Economic growth has declined from last year’s 7 percent GDP expansion to 4 percent this year and 3 percent over the medium term, according to IMF estimates.

The risk is local lenders are “encouraged” by their government to keep growing their balance sheets: Denizbank’s loans expanded by 21 percent year-on-year during 2017. Inflation running at 11 percent may force the central bank to raise rates, prompting a rise in defaults. Erdogan, a self-described “enemy of interest rates”, has announced plans to pump-prime the economy, which could send inflation higher still.

To top it off, Turkey and the UAE have been at odds over the former’s support for Qatar – accused of supporting terrorism by other Gulf states. NBD expects trade between Turkey and Middle East to grow. If it doesn’t, a superficially cheap deal will end up looking costly.

CONTEXT NEWS

- Emirates NBD has agreed to buy Turkish lender Denizbank for 14.6 billion lira ($3.19 billion) from Russia's Sberbank.

- Dubai-based Emirates NBD said in January it had started initial strategic talks with Sberbank about a possible purchase of the Russian lender's stake in Denizbank, the fifth-largest private bank in Turkey.

- The deal will help Emirates NBD establish itself as a leading bank in the Middle East, North Africa and Turkey, said Hesham Abdulla Al Qassim, vice chairman of Emirates NBD in a statement.

- Emirates NBD, Dubai's biggest lender, will pay interest on the consideration for the period between Oct. 31, 2017 and the transaction's closing date, expected later in the year, the two banks said in a joint statement.

- Denizbank has assets of 169.4 billion lira and operates 751 branches including 43 outside Turkey.

(Editing by George Hay, Bob Cervi and Karen Kwok)

© Reuters News 2018