Friday, November 27, 2009

The New Normal in Dubai, Fallout from the Standstill Agreement

The recent news that Dubai World has asked for a standstill agreement with its debtholders, including the holders of the Nakheel sukuk which matures on December 14th, is undoubtedly bad news for those issuers. However, it is not necessarily the end of the world for the Dubai, Inc. entities or for their sukuk. The announcement about the standstill agreement has not yet been fully described, so it is unclear whether it will constitute a technical default on the debt of the Nakheel sukuk.

It has been clear for quite a while that Dubai's government related entities (GREs) like Nakheel have had more debt than they will be able to service out of the revenue they can generate with property prices down more than 50% since their peak. The Dubai World companies are legally distinct from the government of Dubai, one of the seven Emirates within the UAE. This has led to considerable uncertainty about what the eventual outcome of the debt when it matures. There was optimism in early November when Dubai's Department of Finance repaid the Dubai Civil Aviation Authority sukuk of $1 billion following the issuance of $1.93 billion in sukuk at the end of August.

Optimism was the first reaction a couple days ago when Dubai raised an additional $5 billion in debt from two government-owned banks, National Bank of Abu Dhabi and Al Hilal Islamic bank, in Abu Dhabi. The optimism soon turned to pessimism after Dubai World, the ultimate guarantor of the sukuk, said they would need a 6 month standstill agreement from creditors, including the Nakheel sukuk. The result was a fall in the price of Nakheel's sukuk (story includes graphic of the price chart for the sukuk) from 110 prior to the announcement to close to 50. At the same time, the credit default swaps on Dubai's debt (the cost of insurance) rose from around 300 basis points to 541.2 basis points on Friday. ThomsonReuters had a chart showing the increase (not including the rise on Friday):

This summary of the latest events seems to confirm the negativity surrounding the Nakheel sukuk and the other debts owed by Dubai World and its related companies. However, it could be the start of a much needed restructuring and a realization that things have changed, the much mentioned "New Normal" (originally coined, I believe, by PIMCO's Mohamed El-Erian).

The new normal for Dubai is a recognition that it cannot continue the breakneck speed of development that it had embarked upon, fuelled in large part by debts like that of Nakheel. It has recognized that the world today is a more risk averse, less leveraged place. In order for Dubai to realign itself within the New Normal will probably include some form of bail-out from its wealthy neighbor of Abu Dhabi, which has far more oil revenue that continues to flow in, as well as the sovereign wealth fund, Abu Dhabi Investment Authority, which has assets estimated at $627 billion.

This will be a profoundly humbling experience for Dubai, which has been able to raise debt on its own and on behalf of the companies located there. However, with a much longer timetable for the development of sufficient resources to repay the bonds and sukuk issued, it may be the best alternative, especially prepared to a straight default by Nakheel or Dubai World. The announcement that a chief restructuring officer has been appointed to work with the Dubai Financial Support Fund which is managing the so-far-raised $15 billion may signal that the Emirate has started on the road to the New Normal. Only time will tell whether a default (which would likely be followed by others) can be avoided.

The turmoil created by the Nakheel sukuk being the first shoe to drop, however, may have spillover effects in the Islamic finance indsutry, particularly the sukuk markets. Until this point in what had been a recovery in the sukuk markets, only high-grade corporate and sovereign issuers had tapped the markets. Dubai's Department of Finance was one of these issuers and it will be telling how the prices of these new issues fares in the market with the developments in the Nakheel sukuk resolution. The spillover will probably be mitigated the better the resolution goes, but there will still be fallout. Investors bid up the Nakheel sukuk from the low 60s earlier to 110 and they have seen the value of these sukuk fall precipitously. This could make investors hesitant in the future to invest in sukuk. We shall see.

1 comment:

Stephen said...

Well I guess the recession is still not over yet. I think more problem will start to surface