UAE economy: Dubai debt crisis update

FROM THE ECONOMIST INTELLIGENCE UNIT

Creditors of Dubai World have had their first round of talks about how to deal with the company’s statement that it needs at least six months grace from some of its most onerous debt repayments. There is a reasonable chance that a deal can be reached that would avoid the need to test whether creditors will be able to obtain satisfaction through the courts (in Dubai, the special jurisdiction of the Dubai International Finance Centre or England). However, Dubai still faces a long and painful period of adjustment to a world in which it will be much harder for it to secure financing for its ongoing operations and new projects.

The warning signs have been there for anyone to see for several years. Viewswire first indicated serious concern about the risk of Dubai overreaching itself in May 2006, when we pointed to flaws in the way the ruler and his inner circle were directing the economy, and observed that the Dubai development model may be slipping out of control. In one of analyses from this period we concluded that, “distracted by its own hype, Dubai [may be] pursuing too much too soon, committing mistakes and making miscalculations that will come back to haunt it.” And how.

More recently, there was dismissal in May this year of Nasser al-Sheikh, who, as director of the Department of Finance, had put together the Dubai financial support fund, but had fallen foul of powerful interests-widely assumed to include the head of the stricken Dubai World. In our report on the Dubai government’s end-October borrowing foray, we drew attention to the clause in the prospectus that stated baldly that the government had no legal obligation with respect to the debts of government-related entities (GREs) and that it was not even prepared to hazard a guess as to the size of these debts.

Debts in the woodwork

It has since become clear that the debts of just one of the business arms of the Dubai government, Dubai World, are considerably larger than previously thought. Having asked for a six month “standstill” on debt repayments-barely two working weeks before US$4bn was due to be repaid by Nakheel, its principal real estate affiliate-Dubai World has indicated that it is seeking to restructure US$26bn in debts owed by the parent company, Nakheel and Limitless (see box). This is about double the amount estimated by Deutsche Bank in a note issued late last for this part of the company’s debt-it identified a further US$10.5bn owed by DP World and other affiliates not included in the restructuring.

The scale of the problem provides some explanation for the mystery as to why the government and Dubai World behaved they way they did: they could have admitted earlier that they wished to restructure these debts, having concluded that it was not possible to settle them through the Dubai Financial Support Fund. This fund secured US$10bn from the UAE Central Bank in February, and was given the mandate to lend to strategically important GREs, based on commercial criteria. The government signaled its intention to raise a second US$10bn tranche for the support fund from the private debt market, thereby affirming a degree of independence from Abu Dhabi and the federal government. The Dubai government itself tested the waters with its own US$1.93bn sukuk issue in October, but was obliged to pay a relatively stiff price despite making clear in the prospectus that it was not liable for any of the GRE debt. The support fund would have been obliged to provide much more detail about the true state of GREs in any prospectus taken to the private debt markets. The Dubai government finally admitted defeat at the end of November. The first step was the dismissal of Omar bin Suleiman as governor of the Dubai International Financial Centre; no reason was given, but it is probable that he was blamed in some way for the failure of the second tranche of the support fund. At the same time, the ruler sent out another message of disapproval for GRE leaders by pushing three of them (Emaar’s Mohammed Ali Alabbar, Dubai World’s Sultan Ahmed bin Sulayem and Dubai Holding’s Mohammed al-Gergawi) off the board of Investment Corporation of Dubai. On November 25th, two days after these changes were announced (and on the eve of the Eid al-Adha holidays), the government briefly excited the markets by saying that it had raised US$5bn for the support fund from two Abu Dhabi banks on highly favourable terms, but then deflated investor sentiment by saying that the funds would not be used to prop up Dubai World and that the company was seeking a standstill on its debt repayments until at least May 2010.

Talks have now started between Dubai World and its creditors. It seems that either the creditors would reject the standstill, and declare Nakheel to be in default, setting in train a long and painful legal process, or a deal can be reached providing for a partial payment of Nakheel’s sukuk and a refinancing. Either outcome would only deal with the initial Nakheel payment due on December 14th; there would then have to be further discussions about the remaining US$22bn.

Local banks take the biggest hit

As markets absorbed the implications of Dubai’s debt troubles, it appears that western banks’ exposure to the emirate’s troubled conglomerates is not material. It is a different story for local lenders, although a newly unveiled liquidity support facility from the UAE’s central bank will lessen the impact. The damage done to investor sentiment in the region will take much longer to recover.

After major markets re-opened on November 30th, a consensus is emerged that the financial implications of Dubai World’s actions were not as grave as initially feared. On the first day of trading in Dubai and Abu Dhabi following the initial announcements, the benchmark indexes closed down by 7.3% and 8.3%, respectively. Since then the markets have flattened out-although there could be more trouble if a formal default is declared.

On November 29th, the UAE central bank issued a statement pledging support to banks that do business in the federation. Lenders will be able to borrow from a “special additional liquidity facility” at 50 basis points above the three-month Emirates interbank offered rate (currently 1.94125%).

Estimates of the exposure of individual lenders to Dubai World vary widely. But based on patchy, often outdated information from the Emirates Banks Association, the Bank for International Settlements and other sources, analysts have triangulated forecasts on the potential financial impact at individual banks.

Most estimates of lenders’ exposure begin with data from the Emirates Banks Association (EBA) or the Bank for International Settlements. At the end of 2008, the foreign banks with the largest loan books in the UAE, by some distance, were HSBC (US$17bn) and Standard Chartered (US$7.7bn), according to the EBA. The Bank for International Settlements reports only total financial claims by country-at the end of June, foreign banks were owed US$113bn in the UAE, led by lenders in the UK (US$50bn).

Analysts are digging into underwriter tables to estimate foreign banks’ exposure to Dubai World. Over the past three years, Dubai World issued US$13bn of syndicated loans, according to Dealogic data cited by Morgan Stanley. RBS was a bookrunner for deals worth US$2.2bn, followed by Deutsche Bank and Credit Suisse, both involved with deals worth US$1.7bn. Bookrunners sometimes retain shares of deals, typically single-digit percentages of the total issue amount. Even if Dubai World’s top bookrunners retained 10% of the loans they helped place, exposures would not be material relative to the size of their balance sheets (especially considering that most exposures would be hedged).

Unsurprisingly, local lenders are more exposed to Dubai’s debt troubles than large western banks. To date, only a few banks in the UAE have detailed their exposure to Dubai World. The National Bank of Abu Dhabi said on November 30th that it held US$345m in Dubai World debt. First Gulf Bank, rumoured last week to have more than US$1bn exposure to Dubai World, issued a statement saying only that the numbers cited in the press were “incorrect and absolutely overstated”. Press reports identified Abu Dhabi Commercial Bank and Emirates NBD as carrying the biggest exposure among local banks, although neither bank was prepared to provide figures.

Tarnished aura

The unravelling of Dubai’s grandiose economic ambitions has left a long trail of damage in its wake. The victims range from holders of Dubai World debt to the hapless Indian construction workers whose services will no longer be needed. The crisis has also raised questions about the reputation of Dubai’s ruler, Sheikh Mohammed bin Rashid al-Maktoum, who was happy to take full credit for Dubai’s glittering achievements during the boom times, but who may now find it hard to evade responsibility for the slide in the emirate’s fortunes.

The market reaction to Dubai’s request to creditors to accept a standstill on payments due from Dubai World and its affiliates-notably including US$4bn in bond redemptions due from Nakheel on December 14th-was dramatic, with share prices in Europe and Asia falling sharply on fears about the exposure of international banks. This reaction may have been disproportionate, as the total amount of debt at risk is not huge by post-credit crunch standards, and government debt levels in the Gulf as a whole are relatively low.

Nevertheless, the damage to Dubai’s reputation has been considerable, and its aggressive quest for regional and even global leadership in a number of different sectors has been perhaps fatally compromised. The strategy for getting out of the crisis seems to involve making a distinction between sound and impaired assets. The first commentary from the government after its pre-Eid bombshell on the debt standstill was a statement by Sheikh Ahmed bin Saeed al-Maktoum, the uncle of the ruler and best known for his role as chairman of Emirates airline, which along with DP World, has been one of the most successful of Dubai’s global ventures. Sheikh Ahmed, speaking in his capacity as chairman of Supreme Fiscal Committee (which has oversight of the support fund), said that the intervention in Dubai World was “carefully planned” and was taken in full knowledge of how the markets would react. He said that there was a need to “take decisive action to address its particular debt burden”, and that more information on the restructuring plan would be made available after the Eid holidays. Not a lot has been forthcoming.

This is not the first time that restructuring Dubai World has been on the agenda. Nasser al-Sheikh, the head of Dubai’s finance department at the time, had suggested at the end of March that Dubai World could be merged with the Investment Corporation of Dubai (ICD), a government holding company whose assets include Emirates and Dubai Aluminium Company (Dubal; another of the emirate’s more strongly established businesses). However, this idea was quickly shot down, and Mr Sheikh (who had started the process of setting up the support fund) was later dismissed without explanation.

Abu Dhabi’s agenda

Ever since Dubai started to wobble when the global financial crisis erupted in September 2008, creditors have sought assurances that the emirate’s debt would ultimately be underwritten by Abu Dhabi, which, thanks to its oil wealth, has built up a reserve fund of several hundred billions of dollars. Abu Dhabi has provided support through various means, but has not publicly spelled out conditions. It is not clear whether the decision to withhold support for Nakheel and Dubai World was taken by the Dubai leadership alone, or whether they were acting in consultation with or under instruction from Abu Dhabi. Sheikh Mohammed’s recent remark that people talking of tensions between the two dominant emirates in the UAE federation should “shut up” indicated that this issue touches a raw nerve. Some have suggested that Abu Dhabi wants to strip away some of Dubai’s autonomy, for example through placing its customs department under federal authority. Whatever happens, Sheikh Mohammed, who has at times been portrayed in almost messianic terms, is a much diminished figure.

Who owns what in Dubai
The debt crisis has forced Dubai to make a distinction between assets that are owned by the government, and whose debt therefore is quasi-sovereign, and other assets that are defined as purely commercial, although ultimately they are part of the extended business empire of Dubai’s ruling Al Maktoum.
Dubai World adrift
One of the curious aspects of this distinction is that Dubai World has been classified as a government-related entity, even though it is 100% government owned. Dubai World’s principal affiliates are:
Nakheel-the property company behind the Palm developments, and the issuer of the US$3.52bn sukuk, which falls due (involving a total redemption payment of about US$4bn) on December 14th. The holders of the sukuk have recourse only to specified trust assets of Nakheel, principally land earmarked for the development of The Waterfront, billed as “an international community for 1.5 million people that is twice the size of Hong Kong island”.
Limitless-a global extension of Nakheel, with projects in Asia, Russia, Jordan and Saudi Arabia, Limitless is also involved in a number of major schemes in Dubai, including the Arabian Canal, a 75-km waterway looping round a stretch of land in the south of the emirate. Construction on the canal’s first phase started at the end of last year, but plans to award further contracts are on hold.
DP World-a global operator of container terminals that is 77% owned by the parent company, and is the only part of Dubai World to be listed (on the Nasdaq Dubai).
Dubai Multi Commodities Centre-a venture aiming to turn Dubai into a global centre for trading a wide range of commodities, including gold, diamonds, tea, coffee, petrochemicals and plastics.
Infinity World-the developer, in partnership with MGM Mirage, of the 67-acre, US$8.6bn, CityCenter in Las Vegas.
Economic Zones World-the flagship of this company is Jebel Ali Free Zone, which launched Dubai as a global trading and logistics hub in the 1980s.
Dubai World has indicated that it wishes to restructure US$26bn of the group’s debts. These debts are solely those of the parent company, Nakheel and Limitless. Previous estimates by banks such as Deutsche Bank and Barclays put Dubai World’s entire debt at between US$24bn-27bn, including about US$10bn owed by other part of the company. This suggests that Dubai World’s total debt may be in the region of US$40bn.
Investment Corporation of Dubai
The government has included the US$6bn in debts directly owed by ICD as part of its overall debt of Dh71.27bn (US$19.4bn) as of October 2009 (this figure has since been increased by US$5bn following the issue of US$5bn in bonds in November, subscribed to by two Abu Dhabi government-controlled banks). ICD owns 100% stakes in Emirates airline group, Dubai Aluminium Company, Emirates National Oil Company and Dubai World Trade Centre. It also owns 60% of Bourse Dubai, 55.6% of Emirates NBD (the largest bank in the UAE) and minority stakes in six other banks and 50% of Dubai Cable Company. It has significant exposure to the real estate market through its 29.4% holding in Emaar Properties, perhaps best known for being the developer of the Bourj Dubai, the tallest building in the world.
Dubai Holding
The ruler of Dubai, Sheikh Mohammed bin Rashid al-Maktoum, is thought to own 97.4% of Dubai Holding, which is split between commercial operations (hotels, real estate and telecoms) and investments, primarily Dubai International Capital and the Dubai Banking Group. It is chaired by Mohammed al-Gergawi, a federal cabinet minister and former secretary-general of the Dubai executive council. Dubai Holding’s real estate assets are currently being merged with those of Emaar (a development that is said to be causing some concern among the latter’s shareholders). According to Barclays Capital’s tally, Dubai Holding has debt of about US$13.4bn.