Defaults prompt rethink of Saudi creditworthiness

ONE MORNING TOWARDS the end of May, creditors from around the world gathered in a Bahraini hotel with representatives of the central bank and TIBC, a local lender believed to be in default on some of its debt. Was this the day the world’s banking industry lost patience with the Middle East?

Inside the hotel, confusion reigned. To some of the creditors it seemed the Central Bank of Bahrain and TIBC gave hardly any assurances and scant idea why the bank had missed payments. It was four hours of frustration and anger. For many, it made matters worse that they had flown in to work on a Sunday, their day off.

Word in the market was that Deutsche Bank threatened to block Bahraini banks’ access to its foreign exchange platform. To have had this added to TIBC’s problems could have been a disaster for an economy whose oil reserves were depleted and whose population’s hopes were pinned on its troubled status as an offshore financial centre. Deutsche Bank declined to comment when contacted by Euromoney. Its foreign exchange platform continued to do business with Bahraini banks. But reports from Reuters and Bloomberg said the German lender had also filed a lawsuit against TIBC in New York, alleging that TIBC failed to honour its side of a foreign exchange transaction.

On May 12 Standard & Poor’s said it understood, from conversations with TIBC’s chief executive and Al Gosaibi employees, that the bank’s missed payments were ahead of a likely group-wide restructuring at Ahmed Hamad Al Gosaibi and Brothers (Ahab), the family business that owned and backed TIBC. S&P said the payments could be honoured. But according to the ratings agency, the Al Gosaibi group considered TIBC’s default to be "aggressive defensive protection measures" – part of a defensive strategy. The Al Gosaibi group and TIBC did not comment on this when asked.

How could this happen? The Al Gosaibis were supposed to be one of the richest families in Saudi Arabia, a kingdom reputed to be full of fantastically rich families. The veneer of invincibility some of the globe’s biggest banks had attached to family-owned Gulf corporates was already beginning to crack.

It was not long before things got worse. Reuters reported that the Saad group, another private Saudi conglomerate, had announced a debt restructuring. Standard & Poor’s downgraded the group to default status. Citing Saad’s management, the agency said Saad was entering into a standstill agreement with its creditors, thereby suspending its debt payments.

Then Bahrain’s central bank announced that it had been told by the management of Awal Bank, a Saad entity, that Awal was seeking to renegotiate debt with its creditors. Ratings agency Capital Intelligence reiterated this and downgraded the Bahraini bank to default status before withdrawing coverage.

A family dispute

Saad initially said the cause of its restructuring was "the failure of companies owned by a prominent family business and the unexpected and unprecedented regional reaction to that failure", according to Reuters.

Both the Saad and Al Gosaibi groups are based in Saudi Arabia’s Eastern Province. Maan Al Sanea, chairman of Saad, is related to the Al Gosaibis through various marriage links, and the assumption in the market was that the prominent family business Saad had referred to was the Al Gosaibi group. A further development came in July, when a law firm acting for the Al Gosaibis filed a suit in New York in which Al Sanea was referred to as a senior executive of the Money Exchange, part of the Al Gosaibis’ financial services division.

The Al Gosaibis’ suit claimed the directors and principals of Ahab only became aware of a $150 million foreign exchange transaction after Dubai-based Mashreq Bank sued the Al Gosaibis in New York in late May for not honouring their side of this deal. The foreign exchange transaction referred to by Mashreq was one in a series that had been occurring since 2005, according to the lawsuit. Similar transactions between Mashreq and the Money Exchange totalled $4.7 billion in the first four months of this year alone, the lawsuit said.

The Al Gosaibis’ lawyers alleged that Al Sanea "organized a massive fraud in which he entered into transactions largely through the Money Exchange and purportedly in Ahab’s name with third parties including, allegedly, Mashreq".

The lawsuit also said: "Al Sanea obtained loans frequently using forged or falsified documents and then diverted the funds received to his own use. Inter alia, he wrote cheques drawn on Ahab accounts in favour of companies under his control. Ahab presently estimates that Al Sanea misappropriated approximately $10 billion as a result of his frauds." These allegations are vehemently denied by Al Sanea’s connections.

At the end of August Saad said: "The claims filed in New York have yet to be served formally against Maan Al Sanea/Saad/Awal, which is odd and [this] indicates they are more part of a media campaign than a proper legal strategy. However, if we are served, we will of course respond confident in both the actual facts and the judicial process."

According to Saad: "Although Mr Al Sanea has long had personal relations with the partners of Ahab, neither Maan Al Sanea, nor any related business entity, is a partner or has any ownership interest whatsoever in Ahab or in any of its related entities, nor do they have any business ties except on an arm’s-length commercial basis. Likewise, Ahab has no interest in the Saad Group company or in any business owned or controlled by Maan Al Sanea.

"Although Mr Al Sanea was at one time named as a managing director of Ahmad Hamad Al Gosaibi and Brothers Co (Ahab) he has not acted in such capacity for many years, is not involved in the operations of Ahab in any way, nor is he chairman of The International Banking Corporation [TIBC]."

After hearing a complaint from Ahab, at the end of July, a court in the Cayman Islands ordered assets of Al Sanea and Saad worth $9.2 billion to be frozen. The order, as well as the allegations in New York, "are based on spurious and scurrilous accusations", according to Saad.

Saad said: "Ahab’s involvement of Saad in defending itself in court [at the beginning of September] represents a continuation of the baseless, yet public, campaign it has chosen to wage, utilizing the media to circulate false claims about Saad Group and its chairman. Saad will respond fully to all of these claims through the proper judicial process and definitively demonstrate their lack of any foundation. The claims have been made before a full investigation has taken place and rely on partial and incomplete information."

Meanwhile, Bahrain’s central bank has also been investigating whether there was any fraud in relation to an asset shortfall suggested by a report into Awal and TIBC that it commissioned.

"There are grounds for doubting the existence of some of the banks’ reported assets. Other assets may be worth substantially less than have been reported by the banks," the central bank told Euromoney after TIBC and Awal had been brought under its administration in July.

The central bank appointed as external administrators UK law firms Trowers & Hamlins for TIBC, and Charles Russell for Awal Bank. But neither Awal, TIBC, nor Charles Russell responded to requests for comment. Trowers & Hamlins simply said it was preparing an inventory of the assets and liabilities of TIBC but would not be making any public statements about the bank until this report was completed.

The case continues

These events have already caused a shift in the global financial community’s attitude to Middle Eastern risk. The two groups and their banks owe money to well over 100 banks from countries as diverse as Indonesia, China and Korea. They were regarded as stable, blue-chip companies.

The Al Gosaibis’ activities, for example, encompassed not only banking and financial services but also bottling and distribution of soft drinks, real estate development, and shipping. Al Sanea was better known for investing outside Saudi Arabia, and aside from a contracting business and real estate in the kingdom, Saad had a portfolio of global blue-chip assets that included a 3.1% stake in HSBC, as well as a 29% stake in UK housebuilder Berkeley. Some of these stakes have been reduced this year but Saad had some $30 billion of assets at the end of 2008, including $10 billion in investment securities, according to Standard & Poor’s.

One big problem has been the delay in knowing for sure why the groups were unable to pay their debt, the level of banks’ exposures, and when and even whether there would be a resolution to the dispute.

International fraud cases are not usually resolved in a quick and easy manner. But these groups are especially complex. After the Cayman ruling, for example, more than 40 entities pertaining to Saad and Al Sanea had assets frozen. The allegations are also of an especially large fraud.

As a result of the uncertainty, creditors and their lawyers have employed their own strategies to try to redeem assets. The Financial Times and others report that Germany’s Commerzbank and British Arab Commercial Bank have launched lawsuits in London against Al Gosaibi companies, and that Bahrain’s Arab Banking Corporation is claiming $30 million from Saad in London.

Independent creditor actions might make it more difficult for lenders to act together and apply pressure on debtors. But in this instance pressure has been less effective anyway as bankruptcy law in Saudi Arabia is in its infancy.

Forensic accountants have been trawling through financial statements to try to prove what money went where, and how, so lawyers can present their cases. But whatever accountants find, and whatever judgements are made in New York or elsewhere, might have little bearing on what is decided in Saudi Arabia, which is not a party to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. The Kingdom also has its own Islamic-style systems of judging such disputes, and while these might result in a greater degree of reconciliation between antagonists, they can take longer than western methods.

The king of Saudi Arabia has created a committee, which includes various government ministers, to adjudicate on the matter. In early June, the Al Gosaibi group also announced that it was requesting its creditors to appoint steering committees. A formal creditors’ group has been created for the Al Gosaibi restructuring.

"Ever since the well-publicized issues concerning the Saad Group and the Al Gosaibi family arose, Saad has been working hard with its creditors to determine a solution to all current difficulties," says the company. "It has been engaged in an orderly restructuring of the debt of its affected companies in cooperation with counterparties and international advisers. Saad’s overriding concern is to arrive at a fair resolution for all."

However, according to one creditor, even by the end of July Saad’s creditors had still established only an informal working group, partly because of the lack of responses from Saad.

Some banks appear to have been hoping for a government-led resolution but restructurings can allow banks to delay declaring loans as non-performing. Government action has been delayed. So market anxiety about Gulf banks’ exposures has continued into the autumn.

Wake-up call

In February 2009 Sulaiman Al Gosaibi, chairman of Ahab, uncle of Al Sanea’s wife, and last surviving son of the company’s founder, died in Geneva. Creditors have been wondering if and how the late chairman’s demise might have influenced events, reminding local and international banks that succession is an ever-present issue for family businesses, and a potential hazard for some.

For certain banks, moreover, the Al Gosaibis’ allegations have also brought up the issue of the general difficulties large family businesses face with maintaining internal transparency and cohesion.

Partly because foreign firms often look to the same handful of creditworthy partners when they enter these countries, many Gulf groups have extremely diverse activities, often in a small region or country. Family members are often numerous too. For example, just two of the four brothers who built up the Al Rajhi banking group in Saudi Arabia are thought to have more than 80 children between them, according to Forbes.

Most of all, the Saad and Al Gosaibi restructurings have highlighted the damage inflicted on Gulf family groups by the credit crunch. Many of these businesses were not unforthcoming about exploiting international banks’ eagerness to lend to reputable Middle Eastern groups. Nor did these groups have much trouble accessing credit from banks that were cash-rich thanks to the commodities bubble. One regional investor who knew Al Sanea, for example, told the Financial Times in 2007 that Al Sanea himself was known as "the king of leverage".

According to a statement given by Arab Bank to the Jordanian Securities Commission, the two groups had assets of $40 billion at the end of 2008. Yet at the end of 2008, Saad had $5.5 billion in revolving medium-term credit facilities close to fully drawn, according to Standard & Poor’s. Together, syndicated loans owed by the Saad and Al Gosaibi groups amount to about $6.3 billion, according to Bloomberg.

In addition (according to HSBC calculations) Awal Bank had net debt (the difference between its wholesale debt and liquid assets) of $3.4 billion at the end of 2008. TIBC had a net liquidity gap of $1.3 billion at the end of 2008 according to its annual report.

With bilateral loans, outstanding trade finance facilities and other liabilities harder to quantify because of their more private nature, estimates for the total exposure to the groups have ranged from about $15 billion to about $25 billion. Neither group gave a figure to Euromoney when asked.

In the past five years, according to Bloomberg, banks have advanced at least $64 billion to borrowers in Saudi Arabia, the biggest economy in the region. Lending to small- and medium-sized enterprises is almost non-existent in the Kingdom. The Saudi authorities restricted consumer lending after the 2006 stock market crash. Consequently, the corporate sector, which is dominated by family businesses, has been the biggest beneficiary of Saudi bank growth. But only 22% of total borrowing in Saudi Arabia has a maturity of more than three years, according to research from Saudi investment firm Jadwa. So after Lehman Brothers went bankrupt, some families were crippled by a sudden curtailment in the availability of credit that coincided with a collapse in the values of their equity and real estate portfolios.

The Saudi stock market fell by about 60% last year. And HSBC shares (for example) lost over 40% of their value in the first quarter of 2009. They fell to less than half of their lowest price in 2007, when Al Sanea purchased his stake. Al Sanea had invested in hedge funds and private equity, and almost a quarter of TIBC’s assets consisted of Saudi equity.

Family retailers have been damaged by shrinking regional consumer markets. Other groups saw the value of their raw materials inventories collapse thanks to the commodities crash last year. Al Ittefaq Steel Products Company, also based in Saudi Arabia’s Eastern Province, has defaulted on around $1 billion of debt, because its inventory is now worth less than its loans, according to Middle East Economic Digest. The group did not give a comment before Euromoney went to press.

Al Ittefaq, the flagship subsidiary of the Al Tuwairqi family group, was something of a champion of Saudi manufacturing. However, other restructurings of family businesses are taking place out of the public eye.

Crisis of confidence

After the Gulf property bubble burst, and much of the financial sector in Kuwait became inviable, people were relying on Saudi Arabia, Qatar and Abu Dhabi to use their foreign currency reserves to keep the Gulf boom humming. But families dominate political and cultural life in the Gulf, and family businesses, above all in Saudi Arabia, form the backbone of the region’s economy. The debt problems at the Al Gosaibi and Saad groups have therefore caused a general crisis in confidence, not only in Arabian family businesses but by extension in Arabia as a whole.

The two groups have been related in investors’ minds primarily because their problems emerged at the same time, and because of the similarities between the two groups (both are large family businesses based in the east of Saudi Arabia, and both own banks in Bahrain). Whether or not the two groups are completely independent, and whether or not the Al Gosaibis’ allegations have any foundation, their problems have become even more intertwined in investors’ minds because of the legal action. It is easy to see how the global credit crunch might have contributed to cashflow problems at Saad and Al Gosaibi, and how more of the region’s groups and banks could be further affected now that international banks are less eager to roll over debt.

Dow Jones says about two-thirds of the syndicated loans owed by the Al Gosaibi and Saad groups came from outside the Gulf. Similarly, in May last year, just under 40% of TIBC’s bank deposits came from Europe, with only 26% from the Gulf, according to Standard & Poor’s. Bankers estimate that banks from outside the Middle East provided roughly half of outstanding debt to the Saad and Al Gosaibi groups.

The Al Gosaibis assisted King Abdul-Aziz Al Saud financially during the birth of Saudi Arabia at the beginning of the last century; some observers therefore assumed that the Al Gosaibis’ business would be saved. But the longer the government delays compensation for creditors, the more foreign lenders have begun to think they might have overestimated the extent of government guarantees in the region – a worry already brought up thanks to delays in government intervention in Kuwait’s investment company crisis. These disputes might also have caused foreign investors to be more conscious of the inapplicability of western legal methods in Saudi Arabia. This is serious, as unlike in the UK (for example) creditors in Saudi Arabia need court rulings to get their hands on collateral.

For banks less familiar with the Middle East, just as there was a tendency before to bag the region together and greedily imagine that all Arabian businessmen had bottomless pockets, now there might be more of a tendency to fear that all Gulf businesses either have skeletons in their cupboards or have effectively gone bust because of speculation in equity and property markets. Banks are trying their best just to stay afloat in their core markets. Understanding the complexity of Middle Eastern risk is lower on their agendas. For some the answer might be to pull out of the Middle East and concentrate on home markets – which is precisely what their governments might be demanding.

Local banks might recognize better the opportunities that still exist. But as international banks withdraw, and family groups become weaker as a result, even local banks have reason to cut back lending to family groups. With few alternatives, Saudi banks are still eager to finance family groups’ core businesses, which generally remain healthy. Saudi banks, however, might be owed between $4 billion and $7 billion by Saad and Al Gosaibi, according to HSBC. Since last autumn, Saudi bank credit to the private sector has been shrinking, and as concerns about family groups grow, at least one economist in Saudi Arabia has argued that the local recession would be deeper than previously predicted.

Ratings audit

Banks rarely admit that they should have carried out better due diligence on their loans. The Al Gosaibi and Saad groups were audited by members of the big four global accounting groups, it is argued: the Saad group was even rated by Standard & Poor’s and reaffirmed as BBB+ less than two weeks before it suspended its debt payments.

"As a result of the adverse market conditions and the problems facing some of the major business corporations such as the Al Gosaibi and Saad groups, we have been more closely monitoring our portfolios and have been reviewing the level of exposures to our clients," says Ali Rahimi, head of commercial banking at Gulf International Bank, a relatively large regional lender based in Bahrain.

"We don’t do name lending," he says.

But everyone gained comfort from the reputation of such groups. In the latest full report for TIBC, Standard & Poor’s says: "The bank can [...] rely on the Al Gosaibi group in case of a sudden need for liquidity." Similarly, when ratings agency Capital Intelligence assigned ratings to Awal Bank in 2007, it noted that the bank "enjoys very strong ownership".

Investors have often incorrectly estimated the wealth of Gulf family businesses, partly because there has been an attitude on the part of some credit officers that certain financial information was not suitable for the eyes of a stranger. Details of wealth have been understood to be a personal and private matter pertaining to the family.

As a result, banking in the region has been more reliant on long-term relationships, personal trust, and reputation. One official from a bank in Bahrain, for example, tells Euromoney that western banks have been doing business with the Al Gosaibis for more than 50 years. The banker says it was normal for banks not to see the financial statements of companies such as the Al Gosaibi group.

Some banks will still want to do business with Gulf family groups, if only because of the lack of alternatives. But the restructuring of the Saad and Al Gosaibi groups’ debt as well as the surrounding rumours and legal action is causing a re-evaluation of the old methods. Banks have begun to wonder whether abuse of the old system could be widespread, with the possibility of more unexpected defaults. As elsewhere in the world, the centre of power in Gulf banks has already switched to the risk management departments.

It is not easy to change old habits, though. "You have to use your charm," says the head of corporate banking at another regional lender when talking about the demands on family borrowers for increased transparency. Nevertheless, the crisis in confidence caused by the problems of the Saad and Al Gosaibi groups has given much more impetus to the shift away from traditional modes of lending, just as it might give more impetus for jurisdictions such as Saudi Arabia to establish more formalized legal procedures for such matters as insolvency and liquidation.

New loans now require more collateral, and more stringent, better-documented guarantees. Instructions have come from the head offices of banks in Paris, London, and New York: financial statements must be received on time, and not just in the groups’ offices. Copies of the statements must be taken away. Details are also required of subsidiaries’ financial standing, including the mark-to-market value of subsidiaries’ investment portfolios.

End of an era

The crisis in confidence caused by the Saad and Al Gosaibi restructurings has, finally, put even more pressure on family groups to establish more formal and effective corporate governance structures.

The market has noted that Maan Al Sanea is the dominant personality behind Saad. He is the chairman of Saad, as well as the chairman of Awal. He established the company, and The Economist, the Financial Times and others have reported that he named the group after his eldest son. The question has therefore been asked whether stronger managerial checks and balances might have prevented some potential problems at the Saad group: for example, if it became over-leveraged.

This question could apply to other Gulf family firms in trouble. Moreover, the Al Gosaibis’ allegations could imply similar problems at that group, or at least in its financial services arm. "To conceal his fraud from Ahab’s board of directors and principals, Al Sanea controlled all information reported to the board and principals," according to the Al Gosaibis’ lawsuit (in particular, the claims allude to information reported from the Money Exchange). As noted, Saad says Al Sanea is not involved in Ahab’s operations in any way and that Ahab’s claims are false.

Nevertheless, secrecy and the involvement of owners in management are both common features of family businesses in the Gulf as they exist today. So the Saad and Al Gosaibi restructurings have caused more active discussion of the benefits, not only of opening up, but also of limiting the influence of individual businessmen by appointing stronger non-executive directors and having stricter divisions of responsibility between ownership and management, and chairmen and chief executives. These discussions are taking place, whether or not Al Sanea did in fact have too much control. Things had already begun to change. For a start, more family businesses are considering public listings. This helps, as in Saudi Arabia (for example) publicly listed firms require external directors, as well as audit committees and regular board meetings with minutes.

"Preparing for an IPO can stimulate the modernization of corporate governance at a firm," says Tim Gray, chief executive of HSBC Saudi Arabia. "Once the company is listed, asset values are clearer, and sale or transfer of assets is easier; so listing can help avoid potential conflict between heirs when the head of a group passes away." Gray says the bulk of Saudi IPOs in HSBC’s pipeline are for family businesses.

After the Saad and Al Gosaibi crises, going public will look to be more of a necessity. Some family firms have even started to recruit more executives from outside, especially for financial roles. The Saudi Bin Laden Group and Kuwait’s Al Shaya group both have chief financial officers from outside the family, while the chief executive of Dubai’s Majid Al Futtaim is from Sweden, and is a former chief executive of retailer Ikea.

Family-run firms can benefit from executives’ intimate knowledge and emotional attachment to their businesses. But for some less traditional companies, the recent crises underline the need for families to be seen and not heard. For them, it is one more reason for families to exist only in firms’ shareholding structures, and in their name.