If this year is to bring clarity and resolution to one of the Middle East’s most damaging corporate disputes, it has not got off to a particularly auspicious start. On 6 January, a judge in the New York Supreme Court ordered a halt to evidence-gathering in a -dispute between Ahmad Hamad al-Gosaibi & Brothers and the Saudi billionaire Maan al‑Sanea, head of the Saad Group, relating to debt repayment problems that first came to light in May 2009.

In May last year, Al-Gosaibi defaulted on three types of financial instruments: foreign exchange transactions, trade finance loans and swap agreements. Up to $1bn of debt was affected. In the same month, following a downgrade by ratings agencies Moody’s Investors Service and Standard & Poor’s to non-investment level, Saad Group became technically in default on at least two loans, of $2.7bn and $2.8bn respectively.

At this month’s court hearing, New York state judge Richard Lowe expressed concern that the case did not belong in a US court – a view shared by Al-Sanea, who wants Saudi judicial authorities to hear the proceedings. Banks from an estimated 110 countries have exposure to the defaults on corporate loans incurred by the Saad and Al-Gosaibi groups, which are estimated at about $20bn.

Public airing

A decision is awaited from the New York Supreme Court on whether it will actually hear the case, initially brought by Dubai’s Mashreq-bank against Al-Gosaibi, alleging it defaulted on currency exchange transactions worth $150m and that its Bahrain-based subsidiary, International Banking Corporation, defaulted on another $75m transaction. Mashreqbank’s reason for filing the case in New York was that the transactions involved US banks.

Al-Gosaibi, itself claiming to be the victim of an alleged $10bn fraud perpetrated by Al-Sanea, has also filed lawsuits in New York.

Many Saudi private sector firms are rightly wary that a bitter legal battle, potentially exposing corporate malfeasance between two of the kingdom’s largest family conglomerates, might tar the whole kingdom’s business sector and stymie their attempts to secure much-needed credit from both local and international financial institutions.

Local banks have already suffered collateral damage in the affair. High provisioning levels bear witness to their exposure, evidenced in some Saudi banks’ fourth-quarter earnings. For example, for the final quarter of 2009, Banque Saudi Fransi reported a 43 per cent fall in profits to SR324m, while Saudi Hollandi recorded a SR439m loss, compared with a profit of SR309m in the same period in 2008.

Key fact

The volume of credit extended to Saudi businesses shrank by 5.4 per cent in 2009

Source: Banque Saudi Fransi

Efforts by Saudi authorities to draw a line under the crisis have so far failed to convince the international banking community. In early September 2009, the Saudi Arabian Monetary Agency (Sama), the central bank, reportedly struck a deal resolving the level of Saad’s debt to Saudi bankers. This was seemingly confirmed by Sama governor Mohammed al-Jasser, on 28 September. Initial reports of the deal, which suggested the possibility of Saad and Al-Gosaibi eventually meeting their debt obligations, brought about the largest rally in two years on the Saudi Stock Exchange (Tadawul) in late September, when bank stocks led an index gain of more than 12 per cent.  

But in December that year, Sama denied any such deal had been reached. Sources in the kingdom say Sama was eager to underscore in its denial the fact that the September discussions between Saad and the Saudi banks did not amount to a formal settlement.

Al-Jasser described the September deal as a “set-off transaction”. While Sama has sought to distance itself  from the reports of a formal deal, the existence of any deal at all has been denied by the Saad Group. In a letter to creditors sent in mid November, Saad said it was not a party to any settlement or agreement.

Settlement fears

The fact that non-Saudi banks were apparently excluded from the settlement has caused resentment among foreign lenders, who fear that a two-tier process, where local banks’ concerns were fast-tracked, would leave them last in line in when it came to compensation.

International bankers have also expressed concerns about the ability of the Saudi judicial system to hear complex commercial cases. In a letter sent to UK Trade, Investment & Business Minister Mervyn Davies on 20 November, Thomas Harris, chairman of the British Bankers’ Association’s trade policy committee, expressed his fears that the confusion shrouding the case would tarnish the reputations of Saudi firms abroad. “Unless there is an early resolution, the current gridlock and despair among foreign banks can only lead to an increase in litigation, adverse media attention and damage to the ability of Saudi family businesses to obtain credit overseas,” he said in the letter.

Analysts confirm that the two groups’ exposure goes well beyond the kingdom’s borders. “These are families that are at least as exposed to the global market as they are to Saudi Arabia,” says Anouar Hassoune, vice-president of Moody’s Middle East banking team.

The partial settlement has helped, says Paul Gamble, an analyst at Saudi Arabian investment bank Jadwa, because at least banks now know how much they need to write off.

If a deal with the local and international banks is finally worked out, it would help to draw some of the poison that has seeped into the kingdom’s financial system. While Saudi banks have taken big provisions this year against possible loan losses related to these and other firms, more than eight months on defaults are still working their way through the system. Bank lending remains subdued and the effect of the Saad and Al-Gosaibi sagas is widely considered to be the main driver behind the liquidity lockdown. While banks began curtailing lending months before these troubles emerged, in line with the global crisis starting in September 2008, the domestic difficulties have compounded lenders’ risk-aversion with regard to Saudi Arabia.

“The current gridlock can only damage the ability of Saudi family businesses to obtain credit overseas”

Thomas Harris, British Bankers’ Association

“Commercial bank lending to the private sector is only up by 1.5 per cent over the first 11 months of 2009, compared with growth in 2008 of 28 per cent,” says Gamble.

Banks have been parking their cash in large quantities at Saudi Arabia’s central bank and investing in foreign assets, Banque Saudi Fransi states in a research note, entitled Slow But Sure, issued on 13 January. Bank surplus funds deposited with Sama stood at SR89.85bn at the end of November 2009 – more than double their level at the end of 2008. This rise in money held at the central bank is an indication that levels of lending to the private sector are weak.

According to Moody’s, Saudi banks’ credit is concentrated in a few major companies because the domestic economy is dominated by a relatively small number of corporate groups. Saudi banks’ top 20 group exposures, including unfunded commitments, typically exceed 200 per cent of their Tier 1 capital – the core measure of a bank’s financial strength.

The agency regards such high concentrations as a negative ratings driver, partly because they include significant exposures to large, family-owned businesses. Although these firms are usually well resourced and have taken steps towards institutionalisation, for example by restructuring the company with a view to listing, corporate governance and transparency remain patchy.

This leads to ‘name-lending’ practices, whereby banks lend to family-owned businesses on the strength and reputation of the family name. This, says Moody’s, can give rise to a high level of credit problems during economic downturns, because proper credit checks are not carried out.

Although much of the Saudi credit slowdown can be laid at the door of the global -crisis, which made banks more concerned with preserving the health of their balance sheets than lending, Gamble argues that these tensions were largely resolved in the first -quarter of 2009.

“We would have anticipated bank lending to pick up again but, unfortunately, the Saad/Al-Gosaibi defaults occurred in the second quarter of 2009, so the sluggishness in credit growth since May/June is in large part due to that issue and the concerns that it raised within the banking sector,” says Gamble.

Risks reassessed

“If you look at Sama’s figures, the pick-up is nothing to write home about,” says Jarmo -Kotilaine, chief economist at investment services company NCB Capital, a subsidiary of the local National Commercial Bank.

“At the moment all we have seen is a relative stabilis-ation. By no means have banks rushed back to the marketplace. I do not see any significant changes.

“The big question for this year will be: who is going to blink first – the banks, or the companies? Are companies going to change their way of doing business, or will there be greater flexibility on the side of banks?”

As Banque Saudi Fransi argues, the Saad/Al-Gosaibi debt default story, while shaking the credibility of regional borrowers, did not bring lending to Saudi entities in general to a halt. Instead, it forced creditors to reassess the risks of lending to different entities and to -categorise them accordingly.

According to one Gulf banker, the only Saudi bank that is lending in higher volumes is Bank Al-Jazira. “That is because it is a small bank and heavily exposed to brokerage, whose revenues have come down, so it is looking for other sources of income,” he says.

Foreign banks’ reluctance to lend is likely to continue, so long as the name-lending issue is unresolved, thus depriving the Saudi private sector of a larger, longer-term capital pool. 

“I think the local banks will all start lending more,” says Gamble. “However, foreign banks did not like the way the Saad deal was handled and have been spooked by what happened in Dubai.”

Over the past decade, Western banks have become more exposed to the Gulf as they sought out business opportunities. The Gulf’s family firms were a logical place to go, as they were the main players in the corporate sphere and were seen as relatively good credit, despite their lack of transparency. Western banks have therefore emerged as an additional financing tier on top of the relationships that family firms enjoyed with local banks.

The freezing-up of international bank lending is a problem for Saudi private sector firms, though it is unlikely to prove a challenge for larger, state-backed entities.

“Many Saudi private sector firms are rightly wary that a bitter legal battle might tar the whole business sector”

“If you are a company that has a real top-tier ownership, with government participation, such as Saudi Basic Industries Corporation, you won’t find any problems raising money,” says Kotilaine. “If there are clear government guarantees on your borrowings, then it simply will not be an issue.”

Despite the lingering impact of name-lending, and the likely lengthy process of resolving the Saad and Al-Gosaibi debts issue, analysts believe that  the wider crisis of confidence will slowly ease this year.

Banque Saudi Fransi, for instance, anticipates advances in bank lending to the private sector this year, a primary reason being necessity. After all, if banks want to avoid a repeat of their lacklustre 2009 profit performance, they will have to energise the pace of credit expansion.

Banks will need to abide by prudential limits with some corporations. Nonetheless, there is enough pent-up demand from the private sector to unlock credit growth during this year, particularly in the second half.

The more intriguing long-term question is: what impact will the Saad/Al-Gosaibi fallout have on reshaping the kingdom’s corporate culture and ensuring that similar damaging crises do not recur?

Some believe the events will eventually prove to be a trigger for wide-ranging reform of the kingdom’s – and the Gulf’s – business culture. The extreme caution of Saudi banks essentially constitutes the first phase of a retreat from their old ways, says Kotilaine, but family businesses will be likely to take time to come to grips with the new situation.

“Banks have started demanding collateral, even ahead of more fundamentally revising their loan approval procedures,” says Kotilaine. “Many companies have yet to figure out how to adjust to these new circumstances.”

MEED has heard unconfirmed reports that Sama has exerted pressure on Saudi lenders not to make loans to family groups unless the borrowers are in the form of a joint stock company and planning an initial public offering on the Tadawul (Saudi Stock Exchange).

Some, however, dispute whether the central bank would apply this kind of pressure on Saudi family firms. “There are a lot of well-run Saudi family firms that would not have any interest – or need – to go public,” says Gamble.

Detailed statements

A lawyer in the kingdom tells MEED that, with the existence of the Capital Market Authority, more robust processes and greater corporate governance requirements are now in place, so lenders can take greater comfort from more detailed financial statements. 

For the Saudi authorities, there is a sense that lessons will be learned from last year. “There are positives to be drawn from the -crisis, as it will cause more people to pay -attention to proper corporate governance standards,” says the lawyer. “The affair can act as a catalyst for improvement and greater reliability on corporate governance.”

Perhaps more likely is a gradual transition to more formal, rule-documented procedures for borrowers and lenders than presently exist. For borrower and lender alike, one thing is clear – the status quo cannot continue.