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Gulf banks rated by Standard and Poor's are significantly exposed to the Saad and Algosaibi groups, which ran into severe and unexpected difficulties in recent months and have entered debt restructuring discussions with their respective creditors.
A survey undertaken by S&P on 30 commercial banks in the GCC shows that total gross exposure of the surveyed banks stands at about $9.6 billion. The banks included in the survey represent about two-thirds of the total assets of all GCC banks.
Exposure to the Saad (a conglomeration of international financial services companies, manufacturing facilities, investment companies, and health care, education, and real estate development activities) and Algosaibi (a group active in financial services, bottling and distribution, can manufacturing, real estate investment, hotels, shipping, and contracting) groups varies significantly among the sampled GCC rated banks.
Only two banks showed no exposure. Net exposure was less than five per cent of adjusted total equity (ATE) for 12 banks of the surveyed sample. Ten banks had net exposure representing more than 10 per cent of their ATE, and only three banks showed net exposure of more than 20 per cent of their ATE.
Surveyed banks in Saudi Arabia and the UAE have the largest exposures in the sample.
This was indeed anticipated, as Saad and Algosaibi are based in Saudi Arabia, while the UAE banking sector is the largest in the Gulf. Rated banks from these two countries represent almost two-thirds of the total net exposure of the sampled banks to Saad and Algosaibi.
GCC rated banks in the sample have taken what appears to be material levels of collateral against these loans.
S&P estimates the collateral level (in the form of cash or listed shares and without applying any haircut) at about 30 per cent, excluding personal guarantees. Again, the collateral levels vary widely among the banks.
Syndicated loans, sukuk and working capital loans accounted for a large portion of the debt owed to GCC rated banks.
From the data, these exposures appear to be mainly to nonbank entities of the groups. Noncash exposure (mainly through letters of credit) forms the rest of the exposure. Receivables arising from treasury-related business appear relatively negligible or covered by cash.
The Saad and Algosaibi restructuring discussions, according to S&P, suggest that high levels of concentration within loan portfolios of GCC banks create significant credit risks for these banks. Concentration risk is a key structural weakness that S&P regularly highlights and which it factors into its ratings.
While unexpected deterioration in the credit quality of large corporate groups occurs in all regions, S&P believes that there are features related to the Gulf that bear mentioning:
* Corporate transparency and public communication is, in general, limited. Public communication following the discovery of the problems at the Saad and Algosaibi groups has been minimal, including from the regulators.
While there are legitimate concerns with preserving truly proprietary information, lack of adequate information or signals from the affected parties tends, in our view, to weaken confidence. The governor of the Central Bank of the UAE recently stated that UAE banks will provide full disclosure of their individual exposure to Saad and Algosaibi.
* The family ownership of certain GCC banks and corporate groups creates, at least in theory, specific risks that may be difficult to assess, including succession risk, key man risk, related party exposure, and contagion risk.
Overall, these family ownership structures are a negative credit factor.
* Corporate governance and transparency in the Gulf is, in general, relatively poor and needs to be enhanced.
S&P says a lack of information since the discovery of problems at Saad and Algosaibi has deteriorated market confidence.
"While there are legitimate concerns with preserving truly proprietary information, lack of adequate information or signals from the affected parties tends, in our view, to weaken confidence," S&P says.
S&P believes that it is premature to assess the level of ultimate losses that creditors will face on their exposure to these two groups. It anticipates that only a few banks are going to allocate provisions against these exposures in the second quarter of 2009.
In this dismal scenario there are some mitigating factors that also need mention:
* GCC banks usually have high earnings capacity, providing a cushion for material potential losses.
* GCC banks are, on average, well capitalised.
* GCC banks usually maintain a high level of loan loss reserves. The ratio of loan loss reserves (including general reserves) to total nonperforming loans stood at a high 140 per cent on December 31, 2008, for the group of banks included in the survey, with some of them showing coverage ratios in excess of 200 per cent.
So total exposure net of tangible collateral to the two groups is significant but manageable for sampled rated GCC banks, says S&P credit analyst Goeksenin Karagoez.
Recently, HSBC had said that Saudi banks may have between $4 billion and $7 billion in lending exposure to troubled conglomerates.
A recent sell-off in Saudi banks suggests the domestic bad debt exposure to Saad and Algosaibi was around $15 billion, but those assumptions were "too pessimistic", HSBC analyst Aybek Islamov said. "Market concerns on Saudi banks' exposures to Saad and Algosaibi potential debt default (are) overblown," Islamov added.
