Roubini On Dubai Debt Crisis

As usual, Nouriel Roubini’s RGE Monitor does a great job of summarizing issues, in this case the Dubai debt crisis:

• Dubai World’s request for a standstill on interest payments contributed to market corrections November 26-27 as investors worried that it implied a broader default on the debt of Dubai’s government linked institutions. While local markets were closed for the Eid holiday, global markets suffered significant losses as risk aversion returned given uncertainty about the treatment of Dubai Debt. However, by November 28, reports suggested that Abu Dhabi, Dubai’s richer neighbor, would provide a capital injection to avoid a default and facilitate a restructuring of Dubai World, particularly its cash-strapped property development vehicles. This has yet to be confirmed by Abu Dhabi officials.

• The request to freeze payments for 6 months was viewed as a technical default. Although the debt was not sovereign, the fact that it was issued by a majority government owned company meant it benefited from an implicit guarantee that helped it get favorable terms. State-owned Dubai World, has US$59 billion in liabilities, most of the estimated US$80-100 billion in Dubai liabilities.

• The Times (and other news sources) report that a rescue package is being pieced together in Abu Dhabi which will have significant conditions including the implementation of the restructuring of Dubai world, which could include asset sales of foreign holdings. Abu Dhabi banks and the central bank of the UAE previously bought Dubai bonds (the central bank did so in February, Abu Dhabi banks in November) to avoid defaults. Supporting Dubai, helps strengthen the UAE federation, ensure stability, limit exposure to Abu Dhabi investors and avoid a surge in borrowing costs.

• In 2009, all the maturing Dubai government-linked debt was been paid off in full or rolled over with government funds making up any shortfall in private funds. Yet, given the vulnerabilities of the property sector, Nakheel seemed be a different story given the government’s desire to support only viable companies. In RGE’s view, the lack of transparency about corporate and national finances and which debt might be honored added to uncertainty and credit risk.

• Local markets are closed until November 30 2009 but global markets, particularly those in Europe reacted negatively to the standstill announcement and the cost to insure Dubai debt more than doubled. CDS spreads on Dubai’s 5 year bonds soared above 600 basis points, driven up by a narrow market. CDS spreads of Abu Dhabi and other GCC countries also rose and European markets, some of which were already worried about debt defaults suffered. Dubai-exposed banks which are mostly in the EU and EMEA FX assets were most affected.

• The ratings agencies which previously worried that the State-linked company debt might not be paid in full, responded to the debt standstill request by sharply downgrading many state-linked companies. On November 2009, Moody’s cut the ratings on Dubai Ports World, Dubai Electricity and Water to Baa2 (junk status) from A3 and downgraded 4 other government linked companies as it reduced the assumption of government support to these companies, bringing ratings closer to the ratings indicated by the fundamental credit position of the companies rather than an expectation of government support. The agency noted that the debt restructuring plan “highlights the government’s intention to strictly adhere to its stated policy of supporting only those companies with viable long-term business prospects, which implies that support for distressed or weaker companies may be less forthcoming.”

• Although the US$3.5 billion Nakheel sukuk is backed by collateral, the value of the underlying assets has been eroded. Moreover, the bankruptcy and default regulations are still relatively untested meaning that the leverage of creditors making this in many ways a test case.

• UAE’s total external borrowing remains much lower than Abu Dhabi governments assets but even the assets of Abu Dhabi’s sovereign funds may be smaller and less liquid than some public reports suggest.

• Central bank of the UAE had $25 billion in fx reserves in June (most recent data) including include some of the Dubai currency bonds. Abu Dhabi has the ability to channel funds to federal government institutions but it might be only willing to grant funds to viable operations.

Uncertain Government Support

• The government of Dubai did not back Dubai World or Nakheel’s debt but it benefited from implicit support. Given the role of the company within the Dubai economy, its restructuring has been difficult. When Dubai floated a (sub)sovereign Sukuk in October 2009, the prospectus argued that the emirate had no legal obligation to settle state company debt, adding to creditor concern that there would be different classes of Dubai government-linked debt.

Dubai World Restructuring?

• The property companies have been the most vulnerable, while others benefited from the bounce-back in tourism as well as global inventory restocking. the free zones, and Dubai Ports World have engaged in some significant cost-cutting also which has helped stem losses. However, the property development model has been challenged as prices have suffered sharp 40% declines in price before stabilizing at low levels in mid 2009.

• The quest for the standstill agreement came just a week after the leaders of Dubai World and several other state holding companies were replaced. There continues to be uncertainty about the way in which the restructuring might take place and if the standstill will be granted voluntarily or forced. Despite recent capital raising, Dubai has as much as US$9 billion in payments due by March 2010 and an estimated US$50 billion in the next three years.

• Una Galani of Breaking Views argues that Dubai “is biting the bullet… finally realising that it can’t pay off all its debts without a serious financial restructuring.” Although Creditors will resent making concessions, its necessary for the long-term. (11/25/09)

• On October 15, Dubai World announced a significant restructuring including job cuts of as much as 12,000 workers. It has consolidated several of its operations especially its overleveraged property vehicles. It has tried to avoid distressed sales of its assets to raise capital but may offer equity in several Dubai World subsidiaries to some of its creditors.

• Moreover, making the cuts may be a precondition from creditors, both private and public. Reports this fall suggested that Istithmar, one of Dubai’s sovereign funds might be liquidated or at least investments stopped. In September Dubai World transferred some staff and property to Istithmar World from property developer Nakheel.

• RGE’s Rachel Ziemba: Istithmar, the leveraged alternative investment arm of Dubai World has been under pressure for some time. Rather than a liquidation, what might transpire might be a reorganization within the holding company. (09/14/09)

The 2009 Debt Renewals

• Already several large refinancings have taken place (Borse Dubai, DEWA and Dubai Civil Aviation) with the government providing some funds to each. However, if the government may be rationing its capital despite a possible default.

• In September, Caroline Grady of Deutsche Bank suggested that Dubai needs the other US$10 billion bond issuance to help repay the debts coming due by the end of 2009 including US$3.52 billion sukuk (Islamic bond) of Nakheel and the US$1 billion global sukuk. Most of the debt holders are local which could increase their likelihood of rolling over the debt.

• Rating agencies have been worried that Nakheel’s debt would be restructured since at least April.

• US$14 billion in interest and principal payments came or comes due in 2009 (most has already been restructured). Dubai is slated to run a fiscal deficit in 2009 as revenues decline. The US$10 billion in instruments bought by the central bank of the UAE are five-year bonds that carry an annual interest rate of 4%, below the rate of Abu Dhabi government and government-linked corporations bonds issued in 2009. (EFG-Hermes)

• To ease its cash flow, Nakheel arranged to pay half the interest on the debt, 3.1725% , during the life of the bond and the rest at maturity. It backed up the sukuk with significant collateral: land and other assets worth more than twice the value of the sukuk but it now faces worse cash flow issues (National)

• April: DEWA, the Dubai utility which is a majority stakeholder in TAQA, the energy company making acquisitions abroad and Dubai Civil Aviation both raised funds to refinance debt. DCA’s loan includes a 1.7 billion UAE dirham tranche, US$100 million and 52 million euros. The facility will pay a profit rate of 300 basis points above benchmark interest rates. Dubai government will contribute US$365 million to bridge the shortfall. Dewa got US$2.2 billion loan at an interest rate of 300bps above the interbank offered rates and may also scale back capex plans

• February: US $1.2 billion of the US$2.5 billion loan for Borse Dubai was raised from international banks with another US$1.3 billion from state-owned Dubai banks after ICD, a state-owned investor deposited cash with them. Borse Dubai also received a US$1 billion equity injection from shareholders including the government.