The economic narrative of Dubai has shifted in recent years, from passage through its first financial crisis as a major player in the global economy to a more forward-looking version of itself.
Investors are increasingly focused on the future. That means thinking about opportunities related to Dubai’s plans to host World Expo 2020, its expected resilience to low oil prices and its move to add more innovation-based activity to its diversified economy. In the background, however, Dubai’s government, banks and government-related entities (GREs) are working through remaining legacy debts from the 2007-08 financial crisis. The bulk of these are scheduled for repayment by the end of the decade.
As of August 2015 the combined debt of Dubai’s government and GREs amounted to 136% of the emirate’s GDP, according to the IMF’s 2015 Article IV consultation for the UAE. Restructurings have shifted some payments further into the future, and annual debt service loads will range between $2.8bn in 2015 and $31.5bn in 2018. In total, Dubai and its GREs are scheduled to make $73.2bn in debt repayments by the end of 2020, according to IMF data, equal to 69.9% of current GDP. “Stronger financial positions and lengthened maturity profiles have further reduced debt-related risks,” the IMF said in its Article IV consultation. The concern for the future is ensuring that GREs in particular can still access funds at low relative costs, according to the IMF.
“It has been a long process, but when you look at the impact on the banking system of Dubai World’s restructuring it has been manageable,’’ Khalid Howladar, head of global Islamic finance at ratings agency Moody’s, told OBG. Dubai has largely put debt sustainability concerns behind it, without defaulting on any obligations, but memories remain fresh and are contributing to a climate of caution among lenders. “The banks have not had time to forget the last crisis, so they have been more cautious,” Howladar said.
One of the key indicators monitored in Dubai is credit default swaps, which provide insight on the risk perceptions of debt issuers. The Central Bank of the UAE (CBU) noted in its 2014 annual report that the risk premiums demanded by the market are far lower now: 226 basis points at the end of 2014, compared to 470 in December 2008. The spread had tightened to as little at 155 basis points in June 2014, but widened again in the second half of the year, concurrent with the slump in oil prices. For Dubai World, one of the GREs with the heaviest debt load, risk premiums were 72% lower at the end of 2014 than at the end of 2008. For Dubai Holding, another key GRE, the drop was nearly 62%.
Troubles began in the emirate in late 2009. The direct impact of the global financial crisis was minimal, but Dubai was still affected along with the rest of the world by indirect consequences, as many foreign investors had to liquidate their investments to redirect funds to home markets. The highest-profile struggle in Dubai was revealed in November 2009, when Dubai World announced a debt standstill and triggered a restructuring of $25bn in debts. That process was concluded in June 2011. Non-performing loans in the system rose to 10.5% in 2011, but had fallen to 7% by the end of 2014, according to the IMF.
Significant progress at Dubai World was made in January 2015, when it finalised an agreement with most of its creditors on a second restructuring. In this new arrangement an immediate payment of $2.96bn was made on a tranche of the loan due in 2015. The $11.7bn payment due in 2018 was extended to 2022 and structured differently – instead of a lump sum due at maturity, repayment will take place in smaller amounts over time. In exchange for these new terms, Dubai World agreed to concessions, including a higher interest rate. The new deal brought Dubai World up to date on its repayments, and as a result its debts were reclassified on banks’ balance sheets as a “performing loan” instead of a default, Moody’s said in February 2015. The agency added that the new terms of the restructuring are credit positive for the exposed banks, as they considerably reduce the risks that remained following the first restructuring in 2011.
One of the main beneficiaries of this development was Emirates NBD, Dubai’s biggest bank by assets, which reached Dh406.6bn ($110.7bn) by the end of 2015, according to a January 2016 press release. It is 56% owned by the government’s Investment Corporation of Dubai and is a leading lender to Dubai World and the emirate’s government. As of September 2015 its government exposure accounted for more than 40% of gross loans, according to a report from Arabian Business. In September 2015 Dubai-based daily Gulf News reported that the Investment Corporation of Dubai, which also owns stakes in highly visible GREs such as Emirates and Emaar Properties, had arranged a $500m loan from Emirates NBD and Dubai Islamic Bank (DIB), one the emirate’s largest sharia-compliant lenders. The Investment Corporation of Dubai is also an investor in DIB.
In addition, the UAE passed a law in March 2016 that ensures SMEs that are facing challenges in repaying their debts will be given up to three months before facing legal actions. The UAE Banks Federations (UBF), which represents 49 banks in the UAE, described it as a “mini-insolvency law” that would prevent spikes in defaults. Companies that borrowed Dh50m ($13.6m) or more from several banks and are showing signs of financial stress will be eligible for UBF support under the new law. Borrowers with exposure of less than Dh50m ($13.6m) will be allowed to approach the lending banks directly to mediate a resolution. The new plan will allow no pre-emptive action for 90 days after the signing of a standstill agreement and the UBF process is limited to 15 days after the first meeting with lenders.
Rules For Next Time
For foreign investors, a key question about Dubai is whether a debt crisis could happen again. Demand for credit is unlikely to drop. With World Expo 2020 upcoming, mega-projects are set to be built and Dubai’s overall debt could rise to $168.5bn in that year from $142bn in 2012, according to the Institute of International Finance.
The CBU, which regulates banks across the UAE, has put in place a solution. It instituted caps on lending that, under the current plan, will be enforced in 2018. The caps forbid banks to lend more than 25% of available capital to any one borrower. GREs are singled out for even more restrictive treatment under these new rules, and no more than a quarter of a bank’s capital can be lent to them as a group under this rule. The rule has two exceptions, both designed to improve credit quality. The first is that GREs which are profitable – rated at least “BBB-” or the equivalent by the three main global ratings agencies – and can service their debts on their own do not have to be grouped with other GREs. They can be considered a separate entity and banks can lend up to a quarter of their capital to them. The second exception addresses banks’ investments in GREs’ bonds and sukuk, or sharia-compliant bonds. These will not count against the cap if the specific security invested in is rated “AA-” or higher.
One of the key indicators of trends in public sector debt in the future will be banks’ ability to comply with these new rules. The IMF added that it expected compliance to be challenging. Economic research from Bank of America Merrill Lynch pegged overall bank exposure to the public sector in the UAE at 128% of capital in May 2015, the highest since the late 1970s. The figure was also up from 104% in 2013.
Dubai’s GREs and other public entities are certainly not likely to be starved of capital. The end result is likely to be a different funding mix than in the past, in which a handful of large lenders, also typically government owned, were the primary source of capital. New models emerging include mid-sized banks stepping in to provide credit in syndications. Foreign banks are also interested. Société Générale, France’s second-largest publicly traded lender, has been expanding its Dubai-based staff to finance public sector infrastructure projects across the region, according to Richad Soundardjee, Société Générale’s chief executive for the Middle East.
Another opportunity for foreign or local investors could be to buy some of the existing loan portfolios of banks looking to get under the cap. However, as of late 2015 no such transactions had been completed, according to Arabian Business. The exemption of highly rated debt securities from the lending caps also may serve as an incentive for GREs to sell sukuk, instead of relying on different forms of bank financing. That would diversify government lending away from banks and serve another goal, which is to develop a deeper and broader capital market, in particular for sharia-compliant financial instruments.
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