At a a Ramadan gathering in early September at Zabeel Palace in Dubai, the emirate’s ruler Sheikh Mohammed bin Rashid al-Maktoum said he was “not worried” about the ability of one of Dubai’s largest property developers, the government-controlled Nakheel, to deal with its debts of $4.5bn.
The comment reassured the credit markets, and traders quickly pushed up the price of the main part of that debt: a $3.5bn sukuk (Islamic bond) that matures in December.
The sukuk had been trading in the secondary market at 60-80 per cent of its face value since February, a sign that investors thought the company would struggle to repay the money.
Following Sheikh Mohammed’s comment, the bond’s price quickly rose to slightly above its face value, highlighting a renewed confidence that Nakheel will be able to repay the sukuk in full at maturity.
The Nakheel sukuk had been seen as a litmus test for the Dubai government’s ability and willingness to support the companies it owns or controls. But while it seems to have passed that test, Dubai’s debt problems are far from over.
This year alone, Dubai has had $10bn in debts to repay, and although most of the money has either been repaid or refinanced, the emirate has climbed one peak only to find itself at the foot of another. In 2010, it must refinance $13.1bn of debt, and in 2011 a further $19.5bn, according to Egyptian investment bank EFG-Hermes (see graph).
“Dubai’s debts need to be looked at more broadly,” says Fahd Iqbal, GCC strategist at EFG Hermes. “It is not just an issue of the Nakheel sukuk. There is still a tremendous amount of debt to be rolled over in 2010 and 2011, even if credit markets do improve.”
Most economists surveyed by MEED estimate that Dubai’s total debt obligations stand at $75-85bn, or about 100 per cent of its gross domestic product, which was AED301bn ($82bn) in 2008, according to the UAE’s Economy Ministry.
However, some bankers say that its total debts could be more than $100bn.“The $80bn figure that is often mentioned is only bonds and syndicated loans,” says one banker at a large Dubai bank.
“If you include direct loans between banks and companies [which are often not made public] then the figure would go well over $100bn.”
The size of the debt is not the problem, though, according to Michael Helou, co-head of investment banking for the Middle East at UK investment bank Rothschild, which has been advising the Dubai government on the restructuring of some companies and debts.
“For an economy that is developing as rapidly as Dubai, debt of $80bn is not that big a number,” he says.
“The issue is the profile of the debt and the fact that a lot of it is due over a short period, while the credit markets and the equity markets are both closed.”
Dubai’s ability to cope with its debt burden received a boost in February when the Central Bank of the UAE bought the first $10bn of a $20bn bond issue from the Dubai government.
The second $10bn tranche is expected before the end of the year, with the central bank again the most likely buyer.
In July, Dubai set up the Dubai Financial Support Fund to distribute the money from the bonds and invited local companies to apply for assistance.
“The business plans have been submitted and they are waiting for some clarity on what support they will get, when it will be available and what form it will take,” says one source close to the Dubai government.
“The best-case scenario is that banks are persuaded to accept some kind of delay in repayment”
Source involved in restructuring Dubai companies
“Then the discussions with banks and creditors can start. My feeling is that investors will get all their money back, but it will take some time for that to happen.”
However, although many companies are still waiting for a response to their applications, the majority of the first tranche has already been spent, according to sources close to the fund.
Another source involved in restructuring several Dubai companies says some creditors will have to accept that they are unlikely to be repaid in full on time.
“The best-case scenario is that banks are persuaded to accept some kind of delay in repayment for a period of time,” he says.
“If people start demanding that they get repaid on schedule, then they either have to accept a haircut [reduced payment] or the government may just say the money is not there, here are the assets, it is up to you to try and work it out now.”
The worst-case scenario is that some companies default, although most observers say this is now unlikely to happen, at least for the largest firms.
“I would be very surprised if any strategic assets default,” says Iqbal.
“But there may have to be some kind of rollover agreements that involve less than 100 per cent repayment. For smaller, non-core entities, it is more difficult.”
Alongside this guarded confidence about Dubai’s ability to cope with its debts, concerns about whether any defaults would lead investors to abandon Dubai for good have also subsided.
“If there was a default, there would be some negative publicity and market impact in the short term, but once there is clarity and growth starts again that will fall by the wayside,” says Helou.
“The GCC will be one of the fastest-growing economies in the world and people will not be able to afford not do business here.”
The actions of Dubai entities that refinanced debts this year has added to the cautious optimism.
Most companies, including stock market operator Borse Dubai and the Depasrtment of Civil Aviation, offered banks better terms than the original loans to refinance their debts, and repaid any banks that did not want to extend the loans.
However, pressure is growing for Dubai to take a more comprehensive approach.
“The time has passed for a piecemeal approach and the bigger borrowers are now expected to present the banks with a wholesale solution,” says the source involved in restructuring several Dubai entities.
One answer could be asking banks to extend all the loans by three to five years, he suggests. But that would not be straightforward, and would be impossible without greater clarity on what the Dubai Financial Support Fund is doing.
“They [Dubai companies] cannot start those sort of negotiations until the government has outlined who is being supported and how much they are getting,” says the source.
Even if the government can persuade its creditors to do this, it will only partially address another major issue: Dubai’s reliance on short-term financing.
According to Iqbal, in 2007, most Dubai companies switched from raising finance with a five-to-eight-year maturity to raising loans with a term of just three to five years.
When credit was easy to obtain, raising short-term funding and refinancing it every few years was an attractive option. Now that the credit markets have soured and refinancing is far harder, the flaws in this strategy have become apparent.
Dubai’s difficulties mean it is likely to again embrace the longer-term financing model favoured by its neighbours such as Abu Dhabi and Saudi Arabia.
The effort to get the emirate’s economy back on track will undoubtedly be painful, and many creditors will complain along the way, but ending its addiction to cheap, short-term debt would at least mean that Dubai has learned some lessons from this crisis.
But the first step remains ensuring the Nakheel sukuk is repaid or refinanced on schedule. One adviser to Nakheel’s parent company, Dubai World, says the property developer had been exploring the possibility of buying out the bond holders when bonds were trading below their face value earlier this year.
If it had done so, it could have offered investors slightly more than the secondary market value but far less than the face value of the bonds, potentially saving hundreds of millions of dollars in the process.
Sheikh Mohammed’s comment that there would be no problem repaying the bond at maturity effectively brought that planning to an end – when the price rebounded, there was no longer any economic rationale for doing so.
But the cost of restoring confidence to the market is one worth paying for Dubai, even if it means forgoing a short-term gain.
As it moves ahead with its financial rescue plan, Dubai is likely to find many other occasions when it has to pay a high price to ensure confidence returns to the market.