Bad debts in the Middle East have damaged reputations, and made banks increasingly nervous about the region’s risks, writes Kevin Godier.


Just a year after the global downturn derailed Dubai’s explosive growth, the emirate is now struggling with mountains of debt and a severely dented reputation.

Its largest corporate entity, Dubai World, which owns the troubled real estate developer Nakheel, announced in November 2009 that it was suspending payments on some US$26bn of its US$59bn or so of outstanding obligations.

Beyond Dubai, the reputations of two large Saudi family conglomerates are also taking a battering an on-going US$20bn-plus debt scandal. As the debt piles high and reputations worsen, the international banking world’s faith in the economic strength of the region has been clearly shaken, but as yet not completely shattered.

Dubai woes
Companies in Dubai have borrowed massively to transform the emirate into a trade and tourism hub for the region, tapping credit on what appears to have been an understanding that this would be backstopped by the central government of the United Arab Emirates, whose sovereign wealth fund is by far the largest as a share of GDP on the planet. Hence, when Dubai’s government said that its assets, including Emirates airlines, would not be involved in any sale aimed at plugging Dubai World’s debt, this triggered credit downgrades for all government-linked companies amid fears of a domino effect.

After almost three weeks of brinkmanship, Abu Dhabi rode to the rescue on December 14 with a US$10bn injection, of which US$4.1bn was allocated to Dubai World to pay immediate obligations on an Islamic bond.

Dubai’s circumstances “have led to a general reconsideration of risk, and short-term reticence was palpable”, says Peter Hall, vice-president and chief economist at Export Development Canada (EDC). The events at Dubai World “were a huge wave to navigate, and the jury is still out on its lasting effects”, he says, highlighting that “sizable Western institutions, many with exposure to Dubai, have capitalisation concerns and are vulnerable to shocks”.

Nevertheless the adjacency of Abu Dhabi, whose royal family has strong marriage ties to Dubai, can be seen as a strong comfort, believes Bernard de Haldevang, head of financial and political risks, Aspen Insurance UK. “It is hard to see Abu Dhabi allowing Dubai to fail, particularly as there is such a strong concept of debt honouring in the Middle East,” he contends.

Saudi family scandal
Whereas Dubai’s financial difficulties were broadly known well ahead of the debt default, banks were mostly taken by surprise in late July, when the Central Bank of Bahrain (CBB) seized two banks belonging to the major Saudi groups. The CBB said an investigation at both banks – the Awal Bank, owned by Saad Group and The International Banking Corporation (TIBC), a unit of the Ahmad Hamad Algosaibi and Brothers conglomerate – had shown a substantial shortfall in assets compared with their liabilities.

As the story broke, it transpired that the total debt, now defaulted upon, owed by the two family-owned companies to around 120 local and international banks probably exceeds US$20bn. In one of the largest financial scandals in Middle East history, Saad’s chairman Maan al-Sanea is also alleged to have fraudulently siphoned just under US$10bn out of the Algosaibi family company – one of whose daughters he married – into his own business.

Worse, the Saudi Arabian Monetary Authority (SAMA) is widely reported to have overseen a restructuring deal for seven local banks holding syndicated and bilateral debt exposures worth SR9bn (US$2.4bn), at a rumoured 15% discount. SAMA has largely remained silent on the restructuring, and the Saad group has denied the existence of the agreement, which has left international bank creditors fuming on grounds of unfair treatment.

“It has been very difficult for us to ascertain any precise details, but it seems that local banks have been able to cut a deal with the Saad group, and take repayment, with a haircut,” says a banker based in Belgium, who focuses on letters of credit (LC) issued by GCC-based banks.

“Regionally and internationally, the view is that it is irregular and unfair for any authority to favour local over international creditors. Trade financiers and other bankers dealing with the Gulf states have always had to focus upon their counterparties’ credit risk and reputation risk – but now there is a third risk to assess, which is the willingness to repay,” he points out.

Illustrating the grimness of the situation, an underwriter in the London political and credit risk market holding trade finance exposure to both afflicted Bahraini banks indicates that the risk has nearly reached write-off status already. “We have downgraded our recovery expectations from 50% to 10%,” he says.

The notion of recovery may be problematical “because of the way that the assets in question are structured, and their seemingly opaque nature”, says Nick Robson, head of credit and political risk, JLT. “Are they Bahraini, or are they Saudi assets? It has been reported that the funding that the Bahraini banks were raising was apparently being used for business in Saudi Arabia, so one should be able to ‘see through’ in theory. However, even if they have security tied directly to Saudi Arabia, the linkage through the Bahrain entities may mean that in practice they have a lower priority in the queue than you would expect given the security.”

The Saudi developments “have raised concerns among international creditors and have demonstrated that transparency issues continue to weigh on the business environment”, says Inge Lambrechts, country analyst at Belgium’s Office National du Ducroire. Other observers, most of whom prefer to remain off-record, claim that the clarity of GCC legal systems and their treatment of foreign creditors has now become a major concern. “There is very little comfort in the Saudi legal system,” another underwriter points out.
“The GCC has now been tested in a similar way to the rest of the world, but there is no full picture on the scale and scope of the impact, and there could still be consequences that are yet to come through,” said a London-based trade financier. “The area has been very progressive in recent years, but this shows that it is still a very opaque region – I want to see regulation and governance issues addressed,” he added.

Contagion fears
The inevitable question is whether similar troubles have been stored up at any other Saudi families, a theme played down by most observers. At rating agency Standard & Poor’s (S&P), Farouk Soussa, Dubai-based head of Middle East ratings, notes that Saudi companies are more leveraged than before, and thus financial problems will be greater in a counter-cyclical downturn. “But there is no evidence or even rumours of systemic shock afflicting other Saudi corporates – S&P has looked into that area very thoroughly,” he says. And although S&P has downgraded some bank ratings, Saudi corporate gradings have not been affected, he adds.

Saudi, however, remains firmly within the focus of most international banks. The majority have no doubt moved away from name-lending and placing too much reliance on the perceived strength of corporate relations. As one Dubai-based banker remarks: “There may be slightly less lending than before these troubles arose, but the lending opportunities to what is still by far the Arab world’s strongest and largest economy are so good that there will be no significant drop in the financing flows,” he predicts.

Indeed “the risk premium for Saudi Arabia has not gone up by as much as you might expect”, says the London-based banker. “We believe that people are under-pricing the risk still in the Middle East, as they try to build up their banking books again. We think it needs to go up to reflect the real risk, which of course varies between institutions and countries.”

In the whole turnover credit insurance market, “our pricing for credit risks in Saudi has been in line with that of the global credit insurance market and we have not seen a marked increase in business failures compared to the global market”, says Anil Berry, regional manager (Middle East) at Euler Hermes’ Dubai office.

He continues: “In general we have increased rates in the region of 20%. However, premium rates are still competitive and have been accepted by the market.” Berry emphasises that Euler Hermes is also witnessing greater financial transparency in the Kingdom, having set up a local team in the region last year.

“We undertake buyer visits in Saudi Arabia on a weekly basis and once the local businesses understand the role we play in the credit market we find they are willing to share with us financial data on their company,” he says.

The safety factor in most Saudi risks is underscored by the national wealth accumulated during the commodity price boom. Foreign exchange reserves managed by SAMA exceeded US$438bn at the end of 2008 and covers more than one year of all import costs. “External liquidity is still excellent,” says ONDD’s Lambrechts, who argues that “there is little risk of debt distress at the country level as the external debt ratio is expected to vary around 20% of GDP in 2010 and to represent less than 40% of current account receipts, which predominantly come from oil exports”.

She nevertheless concludes that “the political risk outlook is favourable but complacency is out of place as Saudi Arabia is not immune to the problems of the global economy and commercial risks cannot be neglected”.

Abu Dhabi’s helping hand
ONDD’s Lambrechts also contends that despite the damage to investor confidence and the reduced creditworthiness of a number of Dubai’s high-profile government-related entities, “the political risks of the emirate are mitigated at country level since the transfer risk is the responsibility of the UAE’s Central Bank”. But although Abu Dhabi still has a very strong net foreign asset position, “the lack of a clear bailout strategy for public companies and individual emirates in financial distress is a cause for concern”, she says.

From the banking perspective, exposure to Dubai World is reportedly quite significant, as shown by the rise in shares at institutions such as HSBC and Royal Bank of Scotland immediately after the December 14 cash injection. “Since Dubai World we would look for a higher premium on Dubai banks,” says an LC confirmation specialist based in Paris, also noting there is very little business available as overseas exporters have become warier over the market.

Looking at the political and structured credit insurance markets, “I don’t think that there is a huge amount of fallout from Dubai for most insurance players”, says Robson. “Dubai World is a small shock after a lot of big ones, and there are no significant direct losses that I know of. Of course many Dubai World projects and companies remain good, although I expect that some of the whole turnover credit insurance players may experience some loss arising from suppliers that have worked on those of the company’s projects that will be delayed or cancelled.”

Adds a political risk underwriter: “Our desire to provide cover on Dubai is very low, given that many risks in the emirate are linked to property and all the associated services. We were approached on Nakheel in April 2007, but declined, as we considered that it was a house of cards. From a credit perspective, there is also the question of whether credit legislation applies to foreigners.”

According to de Haldevang, “people have until recently had their heads in the sand” regarding Dubai. “It cannot be compared with any of the other GCC economies, given that in terms of revenue generation – property excepted – there is little more than a modicum of manufacturing and IT industry and some small pockets of oil and gas production.”

Dubai market trends tighten, highlights banker

Dubai’s trade finance markets have tightened in line with the global recession and the slow-down in the emirate’s troubled real estate market, according to Ali Raza Dharamsey, head of trade, UAE & GCC, at Barclays Bank. Trends witnessed by Barclays include letters of credit (LC) increasingly being issued by project developers in favour of contractors seeking payment security, as well as a rising interest in credit insurance, he highlights.

“During the last 12 months, we have also noted an increase in beneficiaries based outside of the GCC countries, especially Europe, who have requested LC confirmations for instruments issued from Dubai. We have particularly seen this for local banks in Dubai where they opine that the market risk has enhanced during this period with a significant level of focus being placed on the ratings as a reflection of the risk profile.”

Barclays estimates risk pricing to have increased by approximately 50-100 basis points (bp) for the larger banks in Dubai and between 100 and 200bp for medium-sized banks. “We have also seen an increase in risk pricing for corporates and as a result corporates are open to structured or out-of-the-box transactions to secure financing at acceptable pricing,” says Iain MacDonald, head of trade product, Barclays.