Saturday, May 15, 2010

Nakheel repays its sukuk, FT Special Report

The Nakheel restructuring discussions continue as Nakheel repays the Nakheel Development 3 sukuk for $980 million (Thursday) with assistance from the Dubai Financial Support Fund. The trade creditors of Nakheel are close to approving the deal which would pay them 40% in cash with the remainder in a "publicly traded security with a 10 percent per annum return". Previous reporting said the security would be a sukuk, which is not mentioned in the latest news. AFP reports that 50% of trade creditors have agreed to the plan; 65% approval is needed for it to be approved. One interesting piece of information contained in the article that I had not seen explicitly mentioned was that upon the approval of a restructuring plan, Nakheel would no longer be part of Dubai World and would instead be owned directly by the government of Dubai. The repayment of the Nakheel sukuk is described as a part of the debt restructuring plan for Dubai World.

The Dubai World debt restructuring is an extremely complex process with many different stakeholders with different goals. However, it appears that there has been differential treatment of various parties without regards to their seniority (excepting the initial Nakheel Development sukuk). The first Nakheel sukuk provided sukuk investors with a mortgage over the underlying (undeveloped) properties, but the trade creditors, investors in Nakheel Development 2 and 3 sukuk and the other debt holders are all unsecured creditors of either Dubai World or one of its subsidiaries. In general, a restructuring should (in my opinion) treat all unsecured creditors equally if the debt restructuring for all entities (with the exception of excluded business like DP World) is done at once. In the current deal, all investors are theoretically being repaid at par but sukuk holders receive their payment upon the scheduled maturity dates while trade creditors receive 40% cash payment with the remainder paid in the form of a tradable security and other creditors have maturities extended with a 1% interest rate being offered.

There are good reasons for some of these developments--the Dubai government recognizes that trade creditors receiving cash on their claims (at least on a portion) will help the local economy. Paying sukuk holders on the near-term maturity will avoid default. However, it is troubling for the Islamic finance industry as a whole because it could create a perception problem for the industry. In general, the products used in Islamic finance are created to mimic conventional bonds, but their robustness in cases of default is unproven. A default by Dubai World on sukuk could have ripple effects because it was viewed (incorrectly) as a quasi-sovereign issue. However, on-time repayment of the sukuk while other creditors see the maturity extended and the interest rate dropped could make companies less likely to consider sukuk.

The rationale is somewhat convoluted, but I will try to explain it. A company that uses both conventional and Islamic forms of debt finance brings a conventional unsecured, senior bond to the market. Before that bond matures, the company issues an unsecured, senior sukuk (equal in seniority with the conventional bond) to diversify its funding sources that makes up a relatively small share of the company's total debt. When the time comes to roll over the conventional bonds, the investors balk at the debt pointing to Dubai World and asking "If you run into trouble, will the sukuk certificateholders have de facto seniority over the bond holders? Will they be repaid while we wait for a debt resolution?". The prospects for the issuance of sukuk by a conventionally financed company to create investor concerns among conventional bondholders could make such a company think twice about issuing the sukuk in the first place. This would deprive the Islamic finance industry and sukuk markets of a large group of potential issuers and will slow the growth of a portion of the industry, but not just investment banks who work on the sukuk issuers. Takaful companies, for example, will see the shortage of sukuk accentuated if potential issuers do not issue sukuk for this reason.

The Financial Times has a special report on Islamic finance. Rather than try to summarize each article, I will just list the articles and recommend them all:

Other News

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