Dubai, from dream to nightmare

Dubai shook investor confidence across the Persian Gulf after its proposal to delay debt payments risked triggering the biggest sovereign default since Argentina in 2001.

The cost of protecting government notes from Abu Dhabi to Bahrain rose, extending the steepest increase since February as Dubai World, with $59 billion of liabilities, sought a “standstill” agreement from creditors. Its debt includes $3.52 billion of bonds due Dec. 14 from property unit Nakheel PJSC. Dubai credit-default swaps climbed 90 basis points to 530 after yesterday increasing the most since they began trading in January, CMA Datavision prices showed.

“There is nothing investors dislike more than this kind of event,” said Norval Loftus, the head of convertible bonds and Islamic debt at Matrix Group Ltd. in London, which manages $2.5 billion of assets including Dubai credits. “The worst-case scenario will, of course, be involuntary restructuring on the Nakheel security that brings into question the entire nature of the sovereign support for various borrowers in the region.”

Dubai World’s assets range from stakes in Las Vegas casino company MGM Mirage to London-traded bank Standard Chartered Plc and luxury retailer Barneys New York through asset-management firm Istithmar PJSC. The Dubai government’s attempt to reschedule debt triggered declines in stocks worldwide that had been rebounding from the worst financial crisis since the Great Depression.

‘Debt Burden’

“We understand the concerns of the market and the creditors in particular,” said Sheikh Ahmed Bin Saeed Al- Maktoum, who chairs the Supreme Fiscal Committee in charge of apportioning financial support to ailing companies, in the first statement to come out of the Dubai government since the announcement about debt rescheduling. “However, we have had to intervene because of the need to take decisive action to address its particular debt burden.”

The MSCI Emerging Markets Index of stocks had the biggest decline in four weeks, falling 2.2 percent, led by Russia and China. Europe’s Dow Jones Stoxx 600 Index lost 3.3 percent in London, the biggest decline since April 20. South Africa’s rand and the Turkish lira weakened 2.1 percent against the dollar. Hungary’s forint lost 1.7 percent per euro. Credit-default swaps on Russia increased to 205 basis points from 192.

The MSCI World Index of 23 developed markets has risen 26 percent this year after banks worldwide recorded more than $1.7 trillion in writedowns and losses and governments committed about $12 trillion to shore up economies.

‘Shock’ Announcement

“The announcement was a shock,” said Beat Siegenthaler, chief emerging-market strategist at TD Securities Ltd. in London. “It is strongly affecting European markets.”

Dubai, ruled by Sheikh Mohammed Bin Rashid Al Maktoum, borrowed $80 billion in a four-year construction boom to transform the economy into a regional tourism and financial hub. The emirate suffered the world’s steepest property slump in the global recession, with home prices dropping 50 percent from their 2008 peak, according to Deutsche Bank AG.

Moody’s Investors Service and Standard & Poor’s cut the ratings on Dubai state companies yesterday, saying they may consider Dubai World’s plan to delay debt payments a default.

Gulf region default swaps jumped, with contracts linked to Bahrain adding 29 basis points today to 223.5, the biggest increase since Feb. 18. Contracts linked to Abu Dhabi added the most since February yesterday, climbing 36 basis points to 136.5 and were another 23 basis points higher at 159.5 today, according to London-based CMA. Qatar default swaps rose 13 basis points to 117, adding to yesterday’s 11 basis-point increase.

‘Further Defaults’

“Dubai is the most indicative of the huge global liquidity boom and now in the aftermath there will be further defaults to come in emerging markets and globally,” said Nick Chamie, head of emerging-market research at Toronto-based RBC Capital Markets.

Saudi Arabia default swaps climbed the most since February, adding 18 basis points to 108. The British Bankers’ Association asked the U.K. government to intervene with Saudi authorities over debts of at least $20 billion owed to as many as 100 banks by Saad Group and Ahmad Hamad Algosaibi & Brothers Co., two family holding companies based in the oil city of Al-Khobar, according to a letter dated Nov. 20.

Default swaps on Dubai World unit DP World Ltd., the Middle East’s biggest port operator, jumped by a record 181 basis points to 540.5 yesterday and were priced another 72 basis points higher today at 612, according to CMA data.

‘Restructuring Process’

Dubai World had $59.3 billion in liabilities and $99.6 billion in total assets at the end of 2008, subsidiary Nakheel Development Ltd. said in an August statement. Dubai owes $4.3 billion next month and $4.9 billion in the first quarter of 2010 through government and corporate debt, Deutsche Bank AG data show.

“DP World and its debt are not included in the restructuring process for Dubai World,” the government said in a statement to Nasdaq Dubai today.

The price of Nakheel’s bonds fell to 70.5 cents on the dollar from 84 yesterday and 110.5 a week ago, according to Citigroup Inc. prices on Bloomberg.

“Nakheel is now standing on the brink of failure given the astonishing amount of cash Dubai would have to inject on it in order to see the enterprise survive,” said Luis Costa, emerging-market debt strategist at Commerzbank AG in London. “Events like this are a perfect storm.”

Dubai credit-default swaps now rank as the fifth most expensive worldwide, exceeding Iceland’s and Latvia’s.

Preventing a Default

The contracts, which increase as perceptions of credit quality deteriorate, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A basis point is 0.01 percentage point and is equivalent to $1,000 a year on a contract protecting $10 million of debt.

UBS AG, Switzerland’s largest bank, said it expects the U.A.E. will prevent a default by Nakheel. Owners of bonds sold by Nakheel scheduled a conference call today, said an investor and a trader who received the details.

Dubai is one of seven sheikhdoms in the U.A.E. that includes Abu Dhabi, which holds 8 percent of the world’s oil reserves and bought $5 billion of bonds sold by Dubai yesterday through state-controlled banks.

Sheikh Mohammed turned to Abu Dhabi’s central bank on Feb. 23 to raise $10 billion by selling debt. The emirate’s credit default swaps dropped 178 basis points that day, after trading for a record 976 basis points.

Bond Sale

Unlike Argentina, which stopped payments on $95 billion of debt eight years ago after yields on benchmark bonds more than doubled in four months to more than 40 percent, Dubai’s announcement yesterday “was a surprise,” said Alia Moubayed, a London-based economist at Barclays Plc.

The government raised $1.93 billion last month in its first sale of Islamic bonds, attracting more than $6.3 billion of orders. The dollar-denominated securities due 2014, which are governed by Shariah laws barring investors from profiting from the exchange of money, dropped to 5.5 percent today to 92 cents, lifting the yield to 8.4 percent from 6.2 percent on Nov. 24, according to ING Groep NV prices on Bloomberg.

Gulf International Bank BSC, a Bahrain-based lender owned by the governments of six Gulf Arab states, postponed a planned sale of bonds in a $4 billion debt program, citing the “unexpected announcement” from Dubai, according to an e-mailed statement today.

‘Standstill’ Agreement

Dubai World will ask creditors for a “standstill” agreement as it negotiates to extend maturities, including $3.52 billion of Islamic bonds due Dec. 14 from Nakheel, Dubai’s Department of Finance said in an e-mailed statement yesterday.

Dubai World’s more than 70 creditors face the prospect of writedowns on as much as $60 billion of debt if they haven’t unloaded their holdings and the state-owned company fails to win additional support from Abu Dhabi.

The biggest creditors are Abu Dhabi Commercial Bank and Emirate NBD PJSC. Other lenders include Credit Suisse Group AG, HSBC Holdings Plc, Barclays, Lloyds Banking Group Plc and Royal Bank of Scotland Group Plc, according to a person familiar with the situation. Barclays slumped as much as 6.9 percent, the biggest intraday loss in a month, while RBS sank as much as 8.3 percent. Lloyds and Credit Suisse dropped more than 3 percent.

“Our exposure is immaterial,” said Credit Suisse spokesman Marc Dosch. HSBC, Lloyds and RBS declined to comment when contacted by Bloomberg. Simon Eaton, a spokesman for Barclays Capital in London, also declined to comment.

Default Criteria

Emaar Properties PJSC, the United Arab Emirates’ biggest developer, was cut by four levels by Moody’s to Ba2, two steps below investment grade. Jebel Ali Free Zone, an operator of business parks, and DIFC Investments were also lowered to speculative-grade by Moody’s yesterday. DP World and Dubai Electricity & Water Authority were downgraded two levels to Baa2, the second rank above junk. Moody’s and S&P said they may cut ratings further.

The debt “restructuring may be considered a default under our default criteria,” S&P said in a statement.

Borrowing from Abu Dhabi state banks accounted for half the $10 billion Dubai ruler Sheikh Mohammed said he planned to raise by yearend. He said Nov. 9 the program will be “well received,” and those who doubt the unity of Dubai and Abu Dhabi should “shut up.”

Sheikh Mohammed removed the chairman of Dubai World from the board of Dubai’s main holding company, the Investment Corporation of Dubai, last week.

Contracts on Abu Dhabi National Energy Co., the state- controlled energy producer known as Taqa, jumped 70 basis points to 250, the highest since August. Swaps linked to Mubadala Development Co., a government-backed investor that announced an $8 billion joint venture with General Electric Co. last year, rose 111 basis points to 247, according to CMA. Mashreqbank PSC, the U.A.E.-based lender owned by billionaire Abdul Aziz al- Ghurair, jumped by a record 254 basis points to 639.

“It’s very important to resolve this in a way that will minimize contagion across the region,” Matrix Group’s Loftus said.

To contact the reporter on this story: Laura Cochrane send me e-mail