Sounding the alarm

Debt freeze leaves global markets howling

by Sami Halabi and Emma Cosgrove

Duabi's man-made islands were just one of the many projects that Duabi World borrowed a still unspecified amount to build (AFP)

Common sense is the currency of rational minds — in this respect Dubai may be short on change. On November 25, Dubai World, the wholly owned subsidiary of the Dubai government, announced that it would request a 6-month standstill on all payments and debt servicing of some $11 billion due to creditors in December — effectively giving notice that the further $49 billion the company has outstanding may also be beyond its means.

The announcement came after the markets closed for the four-day Eid al Adha holiday, during which time the company maintained complete silence while the news shook the financial world, prompting panicked investors to line up at the doors of Gulf markets to dump exposed portfolios when bourses reopened on November 30. As they waited in the Gulf, financial markets from London to Beijing shed share value in fear of their own exposure.

Dubai and Abu Dhabi markets dropped instantly at the opening bell, followed closely by other regional markets. The next day, Dubai World released a statement confirming it was in talks with United Arab Emirates banks to restructure $26 billion in debt. The company said restructuring could consist of “deleveraging options,” “asset sales,” and “formulation of restructuring proposals.”

“We would expect a decision to come out of [the discussions]  on what assets underlay the liabilities, and what the plan is for liquidizing those assets so that bondholders get some partial repayments,” said Raj Madha, director of equity research at EFG-Hermes.

As executives and Dubai authorities prioritize Dubai World’s obligations behind locked doors, the rest of the financial world can do nothing but wait and watch the markets.

The markets react
By the middle of November 2009, the financial world seemed optimistic — and with some justification. The Morgan Stanley Capital International (MSCI) index had recovered 48.9 percent of losses incurred during the downturn, while the MSCI Emerging Markets index had fared even better, recovering 58.13 percent. The MSCI Arabian Markets index — Gulf Cooperation Council, Egypt, Jordan, Morocco, Tunisia and Lebanon — also followed suit, albeit with a little less vigor, recovering 30.89 percent of their losses.

After the announcement that Dubai World could effectively not pay its debt on time, that recovery quickly went into regression. In just two days of trading the Dubai Financial Market (DFM) dropped 12.5 percent and the Abu Dhabi Stock Exchange fell by 11.6 percent. Dubai’s indices for real estate, as well as investment and finance, saw some of the worse losses, down 18.1 percent and 15.5 percent respectively.
The fallout from the Dubai World announcement is expected to send foreign investors’ capital looking for economies with lower risk factors. This will almost certainly have an adverse effect not only on public markets, but other financial institutions as well.

One Abu Dhabi-based private equity (PE) executive commented that the “huge interest we have seen from foreign investors in the region will subside considerably over the next few quarters.”

This is seen as a harbinger of public sector encroachment on the private sector’s lending space.
“Banks will be less keen to lend to the private sector, and governments will prefer to tap into local resources. What is left over for the private sector will be reduced significantly,” said the executive.

While the immediate impact of the Dubai World announcement was felt worldwide, expectations are that outside the region the negative repercussions are temporary, as many markets are already bouncing back from their initial fall.
“This crisis will not find roots on the international level. It will stay regional,” predicted Fadi Khalaf, secretary general of the Union of Arab Stock Exchanges and former chairman of the Beirut Stock Exchange. “No one has any interest in pushing Dubai too much to make it pay at any price. We have to wait until they liquidate some assets at a reasonable price, but I think we will find a solution. We will pass through a difficult period but it will not be as long and as deep as the international crisis.”

Khalaf’s only fear is that the latest announcement could imply that the curve of the financial recovery will be “W-shaped” rather than “V-shaped.”

“With a ‘W’ we will need more support and have to test the bottom before going up again, and that takes more time,” he said, citing the United States financial crisis of 1972 that took on a W-shape and lasted until 1982.

Were this limited to a local phenomenon, Dubai could merely pay for what it had done, literally and figuratively, and the issue would be somewhat resolved. However, given the nature of financial institutions, the shockwave that started on the artificial islands off Dubai is having drastic consequences for the region. Markets from Qatar to Egypt have been dragged down and further fallout is expected.

Save the banks!
Though the lack of transparency of UAE banks makes it difficult to say for sure, general sentiment holds that the rising rate of non-performing loans has led banks to slow lending. The banks remain well capitalized, however, and appear to have the support of the authorities. Dubai World, on the other hand, does not, as the government refuses to guarantee its debts.

“Mixing up between the Dubai World Group and the government of Dubai is wrong,” said Dubai ruler Sheikh Mohamad bin Rashid al-Maktoum on December 1. The statement, issued by the state-run WAM news agency, cited Maktoum as saying that citizens should “roll up their sleeves.”

Still, local banks have seen immediate effects in their insurance costs. As the first news coverage broke of the requested standstill, the price of insuring Dubai’s debt shot up almost 28 percent.

Between November 24 and November 25, the cost of insuring $10 million of debt from default over five years jumped from $360,000 per year to $460,000. Abu Dhabi saw a similar effect with its corresponding prices going from $100,000 on the Tuesday to $157,500 the next day.

Two days after the Dubai World announcement, Fitch Ratings announced that it had downgraded three banks that are partially owned by Sheikh Mohamad’s Dubai Holding, stating, “The outlooks on Dubai Bank and TAIB Bank are negative. Tamweel remains on rating evolving watch.”

On November 29, the UAE Central Bank announced that it would “stand behind” its banks, making additional liquidity available to both domestic and foreign banks at 50 basis points above the three-month  Emirates Interbank Offered Rate (EIBOR), which fell from 1.941 percent on November 30 to 1.905 percent on December 1.
In an attempt to quell depositor panic the emirates’ central bank also stated that: “The UAE banking system is more liquid than a year ago.”

Emirates National Bank of Dubai has taken the lead as Dubai World’s largest creditor, according to the Financial Times, with an estimated $3 billion in exposure. Abu Dhabi Commercial Bank is likely to come in second, with a senior executive telling Reuters they were owed up to $2.45 billion, while another senior official at First Gulf Bank told the news agency their exposure is $1.36 billion, though First Gulf Bank later refuted this statement.
What exactly is on Dubai World’s books is unclear, as the company is not in the habit of issuing complete and transparent disclosures, but most financial experts estimate it’s total tab at near $60 billion.

European banks are quickly tallying their own exposure to Dubai World, and reports thus far point to a number in the range of $40 billion, with approximately $5 billion owed to banks in the United Kingdom.
The Financial Times estimates that HSBC, Standard Chartered and Lloyd’s Banking Group hold around $1 billion in exposure each. Royal Bank of Scotland is expected to be the most exposed with estimates of between $1 billion and $2 billion. Other European Banks heavily affected include the ING Group, BNP Paribas, Societe General and Calyon, who saw their shares plummet in early trading after the scandal broke.

Major banks across Europe saw share prices drop  following the announcement of the debt standstill, with HSBC Holdings down by 4.8 percent, BNP Paribas down 5.1 percent and Deutsche Bank shares down 6.4 percent.
Asian banks are also sharing in the woe. According to Reuters, Japanese banks have $1.16 billion in exposure to Dubai World, while South Korea’s Financial Supervisory Service stated that the country’s banks were exposed to approximately $32 million.

Despite the fact that Moody’s global credit rating agency maintains the current crisis would not alter the UAE’s sovereign credit rating, the debt problems of Dubai World have many looking farther up the food chain, and worrying about the solvency of the emirate itself. The Wall Street Journal estimates that the total exposure of European Banks to Dubai is $83.7 billion.

The Bank for International Settlements (BIS), a Swiss international organization for cooperation between central banks, estimates that as of June 2009, UK banks had claims of $50.2 billion across the entire UAE, followed by French institutions at $11.3 billion, and German banks with $10.64 billion on their books.
The US appears to have less at stake, with the BIS reporting that American banks held $10.62 billion in exposure (as of June 2009). Southeast Asia’s biggest bank, DBS Group Holdings, said it had $1.3 billion of exposure in Dubai, calling the situation was “manageable.”

Family feud
As Executive went to print, Dubai’s big brother, Abu Dhabi, had yet to signal a willingness to help its smaller headline-grabbing sibling pay off its debt, which Moody’s estimated at $100 billion. For the moment, it seems Abu Dhabi is more concerned with propping up the country’s banking sector, evidenced by its most recent acquisition of $5 billion of Dubai-government issued bonds to two Abu Dhabi banks in which the larger emirate holds stakes.

“There was a decision taken a year ago that Abu Dhabi would not let Dubai fall but if they intervened they would do so only in terms of buying assets that actually have value,” said the head of a regional financial association that spoke on condition of anonymity. “They are not going to throw money on the streets, because they are responsible in the eyes of their population, so they won’t buy up too many of the distressed assets.”

The possibility is that Abu Dhabi will want stakes in flagship companies that are doing well, such as Emirates Airlines, which economists from French bank Societe Generale described as potential “collateral” for a bailout.
Abu Dhabi’s most significant means of asset acquisition is through its giant sovereign wealth fund (SWF), the Abu Dhabi Investment Authority (ADIA). Sven Behrendt, visiting scholar at the Carnegie Middle East Center and a specialist on SWFs and political risk management, said he didn’t believe that injecting massive amounts of cash into Dubai’s firms would fit ADIA’s core strategy.

“The idea is to spread your risk and then you come up with a certain formula,” he said. “If you have to bail out your friends from Dubai then this will have an impact on your investment portfolio.”

How much Abu Dhabi can afford to spend picking up Dubai’s assets — ostensibly protecting its own sovereign risk factor and the economy of the UAE — is not certain. Although the ADIA is purported to be the largest in the world, there is little transparency; estimates as to how much it holds in cash reserves — or its losses sustained during the global financial crisis — vary wildly, with assets estimated anywhere between $330 billion to $900 billion.
“Should we just think that Abu Dhabi has ‘a lot’ and that is sufficient?” quips Behrendt. “We don’t know their holdings, how much they have, or their asset allocations. We don’t know anything about them.”

The bloom is off the rose
Dubai World has said its debt restructuring will include the liabilities held by its property development subsidiaries Nakheel and Limitless, but not other companies it owns which are “on a stable financial footing.”
Arbitration procedures look set to be the next step as auditing firm KPMG has been selected to represent Dubai’s creditors. “They have to negotiate, to sit together and find a solution. If they don’t do this they won’t get a cent,” said Khalaf.

Dubai took hits, this year and last, as the global financial downturn struck home, but now it seems the gloves have come off. “The global markets are going to punish Dubai in the long term, and they are going to have to pay for the risks,” said Behrendt. “Perhaps that will lead them to a point where they reform their system… It probably didn’t work well as a model for others when it went well, and it doesn’t work as a model when it falls.”
Marred by a lack of transparency, where investors can only guess at how much has been borrowed, Dubai’s track record regarding risk management leaves much room for improvement.

“If you have a government that is going to default on its debt, you [normally] also have the parliament, media, banks and all sorts of stakeholders that are going to push the government to get its house in order. Normally these would be the checks and balances, but in Dubai this doesn’t exist,” says Behrendt. “You can build the biggest building, bridge or airport but at some point you have to keep your clients. Who is going to put money into Dubai now? I certainly wouldn’t.”

First published in Executive Magazine’s December 2009 Middle East issue


Author: Sami Halabi

Sami Halabi is a policy consultant who covers a range of policy issues and analyses development programmes, particularly in the Middle East and North Africa. Sami specialises in analysing policies and programmes in order to provide evidence-based recommendations to policy-makers and international development agencies. Sami holds a Master of Public Policy with Distinction from The University of Edinburgh.

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