When Abu Dhabi funded a last-minute rescue package of state-owned Dubai World in mid-December 2009, it was well aware that the fallout from a default would have tarnished the whole region and put huge pressure on its own reputation in the capital markets.
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|Source: Moody’sInvestors Service|
So when Abu Dhabi helped Dubai World property subsidiary Nakheel avoid a $4.1bn default, policymakers in the larger emirate breathed a sign of relief.
But it was short-lived. On 4 March Moody’s Investor Service announced that all seven government-backed firms it rates in Abu Dhabi had been downgraded. The downgrade was not a surprise. Moody’s put the corporates on review for downgrade on 9 December, a week before the Nakheel bailout, as it questioned the worth of assumptions of state support elsewhere in the region following public statements from Dubai officials that said government support would not be given to Dubai World.
The uncompromising comments from Dubai prompted the question that governments may not always be willing to bailout state-owned firms, even if they have the resources to do so.
“After Dubai World, it has become increasingly important to distinguish between what an explicit guarantee of support and an implicit guarantee really means,” says Nish Popat, the Middle East head of fixed income at the Netherlands’ ING Investment Management.
Sources close to the emirate’s finance department say the Moody’s review played a major part in convincing Abu Dhabi to provide fresh financial support to Dubai. The hope was that it would limit the fallout of a wider re-rating of government corporates. But it was not enough.
After a three-month review, Moody’s announced that all seven government-backed companies it rates in Abu Dhabi had been downgraded. The most significant of which was putting Aldar Properties down two notches to Ba1, or non-investment grade status, more commonly known as junk. The rating is now below that of Greece, which is rated A2 despite concerns about a default on its E300bn ($407.5bn) of sovereign debt.
We obviously disagree with … Moody’s decisions, especially those concerning TDIC, Mubadala and IPIC
Hamad al-Hurr al-Suwaidi, Abu Dhabi Department of Finance
The downgrades also hit Mubadala Development Company, International Petroleum Investment Company (IPIC), Tourism Development & Investment Company (TDIC), Abu Dhabi National Energy Company (Taqa), Dolphin Energy and Etisalat. Although these all remained investment grade.
Moody’s says the downgrades reflected that “no formal explicit agreement exists between obligating the government to support them under all circumstances”.
The downgrades could make debt more expensive for Abu Dhabi. Aldar already faces a 1 per cent increase in the interest on its $1.25bn sukuk due in 2014, adding an extra AED45m ($12.3m) to its debt servicing costs. There are not thought to be any other covenants triggered by the downgrades, but if another ratings agency Standard & Poor’s (S&P) follows suit and downgrades Aldar, an additional 1 per cent could be added to the interest cost. S&P would not comment on its plans for the ratings of Abu Dhabi corporates.
Markets reacted quickly to the news of the Moody’s downgrade. After a huge sell-off of Abu Dhabi names, they quickly recovered the next day. One UAE-based fixed-income head at an international bank says, “There was so much uncertainty as investors waited for the outcome of the Moody’s review, that the removal of that uncertainty has actually helped stabilise the markets.”
Another Dubai-based bond trader says: “Everyone was expecting a one or two notch downgrade, and the extent to which investors have bought into the Abu Dhabi names since the downgrades shows that they have different opinions about the likelihood of support from the government.”
Like the bonds markets, Abu Dhabi was also quick to respond. The same day the Moody’s report was released, Hamad al-Hurr al-Suwaidi, undersecretary of the Abu Dhabi Department of Finance said: “We obviously disagree with the reasoning involved in a number of Moody’s decisions, especially those concerning TDIC, Mubadala and IPIC.”
However, Abu Dhabi has still not given any indication that it will solve the issue by providing an explicit guarantee on the firm’s debts.
Philipp Lotter, corporate analyst at Moody’s, says the government assured the agency that it “fully and unconditionally” stands behind the entities it has complete ownership of – Mubadala, TDIC, and IPIC. But it has stopped short of formalising that commitment. Lotter adds that in discussions with Abu Dhabi officials they said they were happy with the level of support they offer government companies, and had no plans to explicitly guarantee their debts. MEED tried to contact the Department of Finance on the issue, but it declined to respond.
Instead of explicit guarantees, the government may be considering a review of its relationship with its corporates, says one London-based banker who recently visited the Abu Dhabi Department of Finance. This would involve creating a top tier of companies, including the likes of Mubadala, TDIC and IPIC, which would have fastest access to government liquidity when required. The lower tiers would comprise the companies where the government is a minority shareholder, such as Aldar and Taqa, says the banker. These would still have access to government support, but as is already the case, it would probably take longer to be put in place.
Some bankers say this new system has already been adopted unofficially. The head of corporate banking at one bank in the UAE says, “We have already seen the government of Abu Dhabi providing substantial and prompt support to companies such as Mubadala and TDIC, whereas the speed with which support is offered to the companies it is not a 100 per cent shareholder in is much less.”
Despite the uncertainty of Abu Dhabi’s reaction to the downgrades, they may prove to be positive. As could Abu Dhabi imposing some greater distinction between its companies. Okan Akin, analyst at the UK’s Royal Bank of Scotland, says the news is actually pretty good for Abu Dhabi corporates. He points out that even Taqa is still rated four notches above its stand-alone credit rating, which would put it at Ba1, or below investment grade.
Akin says the fact that Abu Dhabi’s debt management office will have legal powers over debt issuance of government corporates is also goods news. “This risk management function could be a key differentiating factor for Abu Dhabi, allowing them to avoid the mistakes of Dubai,” adds Akin.
Lotter says Abu Dhabi can also benefit from the experience of mistakes made in Dubai. “Abu Dhabi is learning from the mistakes of Dubai and is putting a framework in place to give investors greater clarity. Anything that aids transparency is positive.”
In the shorter term, Abu Dhabi can take comfort that the majority of its borrowing was completed last year. The government and the companies it uses to implement development plans borrowed more than $12bn in highly successful capital market issues last year.
Mubadala and IPIC are currently both trying to refinance loans of $2.5bn each, but bankers say the downgrades will not impact those talks. “If anything, Mubadala and IPIC will be able to keep pushing their financing costs,” says the UAE-based head of corporate banking. “The issue will be for companies more exposed to real estate and tourism, such as Aldar and TDIC. But they are lucky to have done a lot of their borrowing already.”
There have also been suggestions that Abu Dhabi could now look to borrow on the government balance sheet, then distribute funds to companies it owns, to help keep borrowing costs low. This model has already been used successfully by Qatar, which borrowed $7bn in November last year.
But that seems unlikely in the immediate future. Mubadala already has an aggressive borrowing plan for the year ahead. In addition to the $2.5bn loan, it also has projects at Sowwah Square and the New York University to finance this year. Taqa will concentrate on deleveraging, and Aldar is receiving a government injection of cash from the sale of the Yas Island development back to the government.
While the downgrades may be good news for investors seeking greater clarity about how Abu Dhabi relates to its corporate sector, it still leaves questions unanswered. A prolonged slump in the local real-estate sector, for example, could test how much Abu Dhabi is prepared to use its sovereign wealth to bail out development firms not proving to be viable long-term businesses.
If the government’s support is limited, investors will once again face potential losses for failing to demand explicit statements of support.