x Abu Dhabi, UAETuesday 23 January 2018

Saad and Al Gosaibi: a manageable shock

Gulf banks' exposure to the two conglomerates will put pressure on the banking system, but financial institutions will manage.


The recent announcements that the Saad and Al Gosaibi groups, two major Saudi conglomerates, would undergo massive debt restructuring sent shockwaves through the Gulf's financial industry. As the groups have subsequently become embroiled in legal battles with other parties, and as banks assess their levels of exposure, the full impact that this news will have on the financial sector in the region is yet to be seen.

Standard & Poor's has conducted a survey on 30 commercial banks that it rates in GCC countries to determine the direct exposure of this sample set to the Saad and Al Gosaibi groups. Results related to individual banks remain confidential, but a collective look at the affected banks has yielded some useful insights. The most important finding is that while total exposure net of collateral to the Saad and Al Gosaibi groups is significant and will put additional pressure on ratings, banks in general should be able to manage any fallout.

As would be expected, banks from Saudi Arabia, home to the two troubled groups, and the UAE, the region's financial centre, have been the most exposed to these groups. Rated banks in the two countries represent almost two thirds of total net exposure of the sample group. There was a significant variation in total debt exposure among banks within the sample. Only two banks appeared to have no exposure, while three banks showed net exposure above 20 per cent of their adjusted total equity (ATE). Most fell somewhere in the middle, with 12 banks having less than 5 per cent exposure of ATE, and 10 having net exposure to the troubled companies represent more than 10 per cent of their ATE. Fortunately, some GCC banks included in the survey had taken significant levels of collateral against these exposures in the form of cash and listed shares, roughly 30 per cent excluding personal guarantees. Syndicated loans, sukuk and working capital loans, borrowed predominantly by non-financial arms of the two companies, accounted for a large portion of the debt owed to these banks.

There are high levels of debt concentration within loan portfolios of some GCC banks which have created significant credit risks for these banks. Concentration risk is considered a key structural weakness that is given due consideration in S&P's rating methodology. While this exposure in itself is not expected to trigger ratings actions, it is likely to contribute to negative rating pressure. The current trend for GCC banks in the sample set is negative; almost 40 per cent of these ratings currently have negative outlooks.

There are certain key factors that S&P believes will help GCC's commercial banks to weather these difficult times. For example, GCC banks generally have a high earnings capacity. This helps provide a generous cushion for potential losses. In addition, GCC banks have a tendency to set aside a considerable amount for loan loss reserves. The ratio of these reserves to total non-performing loans stood at 140 per cent at the end of last year. Finally, most GCC banks are well capitalised.

There are also certain traits related to the GCC that makes the impact of corporate failings of this nature particularly difficult to assess. The region should not miss out on some of the lessons learnt from this episode. Public communications after the discovery of the problems at the Saad and Al Gosaibi groups has been minimal, including from the regulators. Corporate governance, transparency and public reporting procedures in the regions have historically been relatively poor and need to be brought up to international standards to help restore public confidence levels.

Additionally, the prevalence of family ownership of GCC banks and businesses creates extra risk factors that are difficult to establish, such as succession risk, key man risk, related party exposure and contagion risk. Overall, these family ownership structures tend to be a negative credit factor. Improvements in these areas could help the region manage similar events in the future. Emmanuel Volland and Goeksenin Karagoez are credit analysts at Standard & Poor's