Saad Group and related entities outlook to negative on increased real estate exposure; 'BBB+' long-term rating affirmed

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Standard & Poor's Ratings Services said today that it revised to negative from stable its outlook on Saudi Arabia-based Saad Group and related entities, owing to our view of its increased real estate exposure resulting in the reduced liquidity and geographic diversity of its portfolio. At the same time, the 'BBB+/A-2' corporate credit ratings were affirmed.

The outlook revision reflects our view of Saad Group's reduced portfolio liquidity and diversity, with real estate holdings in Saudi Arabia constituting a substantially larger portion of Saad Group's asset base than previously. Due in part to current economic conditions, we are applying more conservative metrics for Saad Group's ratings, by altering our previous treatment of some of Saad Group's assets and liabilities. We also lowered our loan-to-value (LTV) threshold for the rating to 25% from 30%.

In 2008, Saad Group's reported real estate holdings roughly doubled, reaching $8.4 billion from $4.3 billion in 2007. This was largely due to increased investment property acquisitions and partly due to unrealized fair-value gains of $737 million during the year. Despite the substantial appreciation in the value of Saad Group's real estate holdings over recent years, the increase in real estate holdings has, in our view, adversely affected the liquidity of Saad Group's portfolio. It has also increased the concentration of Saad Group's assets in Saudi Arabia. Changes in portfolio liquidity and diversity, as well as the quality of holdings, are major rating drivers in our assessment of holding companies (see article titled "Rating GCC Holding Companies: Striking A Balance Between Operations And Investments" published April 3, 2007, on RatingsDirect).

We consider Saad Group's overall investment performance to be strong relative to that of the sector. This is partly as a result of Saad Group avoiding most of the worst-performing individual investments, despite its bias toward the global banking sector, a U.K. housebuilder, and various alternative investments. Despite net losses of about $4.4 billion on financial investments ($6.5 billion excluding shareholders' protective options), the Saad Group's overall asset base increased to $30.6 billion by year-end 2008, from $28.8 billion in 2007. This was mostly due to shareholder contributions of protective equity put options, worth about $2.4 billion at year-end 2008 and $1.2 billion in cash, among other contributions. Saad Group also benefitted from the $737 million of unrealized fair value gains on its real estate portfolio during 2008.

We revised our LTV calculation to include Saad Group's fixed-income securities, along with the associated liabilities incurred from Saad Group's repurchase agreements. Although we recognize the value of the protective equity options held by Saad Group, we choose to exclude the options from our ratio calculation as we already factor ownership support into the current ratings. According to our revised calculation, Saad Group's LTV ratio stood at 29% at year-end 2008, which was in line with our historical threshold of 30%. We believe, however, that in light of recent changes in the economic environment and in the composition of Saad Group's portfolio, an LTV ratio of less than 25% would be commensurate with the current ratings.

The ratings on Saad Group continue to reflect our view of its substantial liquid securities holdings and the proven support it enjoys from shareholders. The ratings are constrained by the high concentration of securities holdings in the global financial services sector, the volatility of Saad Group's portfolio, the active use of debt to expand Saad Group's asset base, and the relatively low liquidity of real estate holdings, which represent an increasing portion of Saad Group's portfolio.

The negative outlook reflects our view that Saad Group currently has an LTV ratio of above our revised threshold for the rating. We believe that an LTV ratio of less than 25% would be commensurate with the current rating, taking into account changes in the economic environment as well as recent changes in the composition of Saad Group's portfolio.

Any adverse changes in the group's portfolio characteristics or failure to reduce leverage in line with the threshold would likely result in a downgrade. Conversely, the outlook could be revised to stable if Saad Group's leverage declined to less than the 25% threshold and there were no further adverse changes in its portfolio characteristics.