Parent support of little comfort

18 July 2013

Large parent companies leaning on banks to fund subsidiaries with no guarantee of the debt is a practice the region’s banking sector would be better off avoiding

A key feature of the Middle East banking arena has always been relationships. How much business does a bank get from a client? Who is the client’s parent company? How much can the parent be relied upon to support its subsidiaries? How damaging would it be to the borrower, or the borrower’s parent company, if it had problems paying off its debts? These are all questions banks ask when committing to a deal.

Often the pressure of relationships, particularly where large entities or state-owned firms are concerned, makes banks commit to deals that based on the fundamentals of a transaction alone they would never normally do.

Name-lending became a dirty word in Saudi Arabia in 2009 following the defaults on billions of dollars of debt racked up by two firms based almost entirely on reputation. Events such as this encouraged banks to start looking for more binding guarantees.

When state-owned Saudi Telecom Company started trying to lean on its local relationship banks in 2010 to fund its Indonesian operation, Axis, it looked to offer the minimum form of support possible: a comfort letter. Typically used when a parent company does not want to explicitly guarantee the debt of a subsidiary, most banks saw through it and walked away from the deal; a brave move for a transaction being marketed by a key part of the Saudi establishment.

There are many other examples of strong parent companies leaning on their banks to fund subsidiary operations with no real guarantee. It is reminiscent of the debate around implicit state support for state-owned entities. Ultimately, the chances of lenders being bailed out rely on the willingness of the parent.

Regional banks would be better off getting proper guarantees from parent companies, or abandoning parental support. Everyone would know where they stand and banks would have to properly price the risk of a transaction.

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