Could Dubai Default?

On November 25, 2009, on the eve of the Eid holiday, Dubai World, the state-owned holding company asked creditors for a'standstill' or payment delay on outstanding debt until May 2010 for debt of Nakheel, the property developer subsidiary and Dubai world itself.

The move, coming, just ahead of the December 14 maturity date could if implemented be viewed as a technical default by many investors.

As a whole, state-owned Dubai World, has US$59 billion in liabilities, a significant amount of the total estimated US$80-100 billion in Dubai liabilities.

So far in 2009, all the maturing government-linked debt of Dubai has been paid off in full, with government funds making up any shortfall in private funds. Yet, given the vulnerabilities of the property sector and challenges of the economic model, Nakheel could be a different story given the government's desire to support only viable companies.

Yet, the costs in raising future funds may thus be even more costly. The lack of transparency about corporate and national finances and which debt might be honored, is adding to uncertainty and credit risk.

•Local markets are closed until November 2009 due to the Eid holiday. In addition to sending Dubai CDS spreads up 200 basis points, to levels higher than those of Iceland, the uncertainty has infected the CDS spreads of Abu Dhabi and other GCC countries (to a much lesser extent) and has been cited as an explanation in the 2%+ corrections in European asset markets, some of which were already worried about European debt defaults. Dubai-exposed banks were most affected as were EMEA FX assets.

•RGE's Rachel Ziemba argues that "Extending the maturity of Nakheel debt is feeding the market’s uncertainty on which debt Dubai will honor in full.” (via Bloomberg, 11/25/09)

•Dubai's total external debt, held mostly by government-linked corporations, is estimated at US$80-100 billion or 148-200% of 2007 GDP. Despite new capital, the vulnerabilities of Dubai World, the state holdings company, have reemerged in November 2009, with the company announcing a corporate restructuring and request by Nakheel, a property developer to delay payment on its debt.

•So far in 2009, all the maturing debt associated with Dubai-linked companies has been paid off in full, with government funds offsetting any shortfall in private funds, however, given the vulnerabilities of the property sector and challenges of its economic model, Nakheel could be a different story. The government suggested in the fall that it might ration scarce resources to companies that have viable business models, which might seem to exclude Nakheel. 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 to junk status.

•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.

•Rating agencies have been sharply downgrading Dubai government-owned corporations in the last year as the degree of government support has become less than clear. 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...confirmation of such policy could result in further reductions in support assumptions that would align ratings entirely with the companies' fundamental credit profile."

Uncertain Government Support

•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.

•The quest for the standstill agreement comes 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)

Dubai World Restructuring?

•The property companies have been the most vulnerable and while others benefitted 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.

•In late November 2009, Sheikh Mohammad replaced some of the head managers of Dubai World and Dubai Holding, the most credit-constrained parts of the Dubai Inc.

• On October 15, Dubai World, the government-owned corporation which has been seeking to restructure its debt, 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.

•This corporate restructuring could allow it to focus on core assets and consolidate some of the most vulnerable sections of the company. Moreover, making the cuts may be a precondition from creditors, both private and public. Reports suggested that Istithmar, one of dubai's sovereign funds might be liquidated or at least investments stopped. On Sep 17, Dubai World transfered 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

•RGE's Rachel Ziemba notes that the Nakheel debt expiry this fall will be a significant test case as it’s the largest debt coming due until next year (via Bloomberg 10/14/09).

•The Dubai government has been raising funds to provide financing for state-linked companies who might not be able to raise capital themselves. 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 (though the value has subsequently slumped but it now faces worse cash flow issues (National)

•The government insists that it has adequate funds to pay off any debts belonging to Dubai's quasi-sovereign companies (“Dubai Inc”) and its banks, especially as it will issue the next US$10 billion in bonds later this year.

•April: DEWA, the Dubai utility which is a majority stakeholder in TAQA, 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.

•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.

•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.