Holders of Nakheel’s latest sukuk (Islamic bond) issue are selling off the debt after discovering that the security on the deal is some land in the Dubai Waterfront project that is yet to be fully reclaimed.

The Dubai government-owned property developer started to issue the sukuk to its trade creditors in late August as the final part of paying off outstanding bills to them for work done before the company hit a cashflow crisis in late 2009. Unlike normal bond issues, the company only issued the final terms of the deal after it had started handing out the bonds.

The final terms were delivered to trade creditors in mid-September, which revealed that the security for the sukuk was some land in the offshore islands project Dubai Waterfront, near the Palm Jebel Ali, that had yet to be fully reclaimed. Nakheel had also failed to supply an independent assessment of the value of the security, which had been promised to creditors.

Nakheel creditor sukuk, which matures in 2016, had already come under selling pressure as contractors and other holders accepted over 20 per cent discounts on the face value of the bond in favour of getting some cash now.

“Once the terms were issued, even some of the people who had intended to hold the sukuk were so spooked they have decided to sell,” says one bond trader in the region.

One London-based bond analyst says the fact that the security does not yet exist should not cause the sukuk holders too much concern. “The sukuk holders should have recourse to other Nakheel assets if the value of the security is not enough to settle any outstanding amount of the sukuk,” he says.

That has not stopped holders trying to offload their Nakheel bonds though. An auction of around $87m was scheduled to begin on 20 September, which is expected to result in the price falling further. On that day traders quoted the price as around 76 cents on the dollar.

So far the company has issued AED3.8bn in bonds to its creditors, and another AED1bn is expected to follow over the next few weeks. As creditors have sought to offload the sukuk in the secondary market, bond traders have been surprised at the level of interest in buying the bonds. A UK-based bond trader says some buyers with an appetite for risk are attracted by the sukuk’s more than 10 per cent yield.

Nakheel did not respond to requests to comment on the security on the sukuk.