Dubacle: More Delusion

There's a commentary in The National on the relative negotiating positions of the banks and Dubai Inc which is to put it mildly a bit unbalanced.  It seems much of this is based on comments from the borrower.

It's unclear if this article is meant as propaganda to raise morale on the home front.  Or it reflects the  thinking of decision makers at Dubai Inc - that they really believe they are in the driver's seat.  If it does, a very dangerous delusion.

Certainly, Dubai Inc is not without leverage.  The sheer quantum of debt and the government connection give Dubai a good deal of negotiating power.  But that power is not unlimited.  It cannot serve up whatever dish it wants.  The Banks too have power.

Let's go through the article's contentions.

1. Unless The National is applying Gulf News' new reporting standards for the Dubacle or there is a relatively low local bar for competence, it's a bit of a stretch to think of Dubai's recent actions as being even remotely "shrewd".  Dubai's "clever" play here has caused a real setback not only in Dubai, but the wider world of the Emirates, the GCC and beyond.   A coach whose team has a propensity for "own goals"  should be very careful about imagining himself another Arsene Wenger, particularly if he's called those plays.   Equally such a team needs to be very careful, especially in front of its own "net".  There is a significant difference between the state of play at Emirates Stadium and in the Emirates.
   
2. The "set of incentives and penalties" is less the result of the work of "brilliant" advisors than the simple situation described above.  Dubai Inc owes the banks a shipload of money.  Many of them will be looking for a way to avoid taking a big hit (but note that incentive is not opened ended) and so will be inclined to "extend and pretend" on the loans if need be.  As well, since the borrower is government related, some of the banks (but not all) will want to maintain as good a relationship as possible on the presumption that there will be future profitable business.  
3. It's important to remember that lending is a very low margin business.  Gross interest margins are rarely over 2.5% - and that is before all other costs.  It doesn't take much of  loss of interest or a haircut on capital to undo many prior years' slim margins.  Thus, a "small loss" may be much larger than it appears.
   
4. The payment of interest is a major carrot, but the failure to pay interest also has four very negative impacts on Dubai.  First, it lessens the incentive of banks to play along.   Non accrual is  painful. Why play nice if you're going to take a hit?   Second, many local banks are significant lenders.  Non accrual will be at least as painful, if not more, for them.  Therefore, it is not just "foreign firms" who find interest "especially" important.  And many of the largest local lenders happen to be government owned banks in Abu Dhabi and Dubai.  So non payment of interest is not without some very direct and visible consequences.  Third, non payment of interest is not only going to set back efforts to repair the harm already done to the reputation/status of the DIFC, the local stock market, the good Shaykh himself, etc but also will aggravate it.  As well, it's likely to cause additional damage elsewhere in the region.  Fourth, non payment of interest is going to increase pricing on any new loans and dramatically diminish their volume  - not only to Dubai but to other regional borrowers.  Clearly, withholding interest is not without very serious risks for Dubai.
   
5. The imposition of the DIFC insolvency/reorganization law is a double edged sword.  Yes, it gives Dubai Inc a way to get a legally enforceable standstill in the UAE and probably other jurisdictions without bank agreement.  It also means that 100% creditor agreement isn't necessary to close a refinancing.  However, it takes the case out of the inadequate local legal system and gives the creditors important rights and a very visible "Western style" legal forum.   The borrower cannot hide behind local courts nor use the excuse that local law won't let it do something.  Or simply shrug its sholders and say "Well, that's the local court system for you".   With the case in the DIFC court and under the DIFC law, should Dubai Inc attempt to game this forum or ignore its decisions, then the very basis of the DIFC is profoundly undermined as is any pretension to a transparent fair system in the Emirate.  Thus, the banks can use or threaten to use this forum to upset those pretensions if Dubai does not play "nice".   If Dubai Inc fails to pay interest, the banks can make a case that the company is truly insolvent and should be wound up.  And filing such a case does not require that a majority of creditors agree.  Chapter 5 Paragraph 51 of the DIFC Insolvency Law states that one of the tests of insolvency is that a company be past due on an amount over US$2,000  for three weeks without agreement of creditors.  A standstill of course legally stays this route.  But how long could the DIFC Court allow a standstill to remain, if creditors cannot agree a rescheduling?  And at what point do creditors claim the court process is rigged if the court refuses to end the standstill? Could Shaykhly pride accept either of these two developments as both entail the very visible ending of the Dubai dream?  Wouldn't a disguised unwinding be more palatable just as an "extend and pretend" for the banks would be?  If, of course, such is needed.
   
6. The writer seems to presume that Aidan can decide "how big a haircut" he wants to give creditors, dictate the terms to them, and they will meekly accept.   Sadly, this is a typical regional debtor approach in many cases - to try to skin the banks for more than is needed.  But the writer's belief to the contrary, any haircut will have to be justified by economics.  A great deal of the incentive of the banks to play along is to minimize the amount of loss taken.  The first element is the  absolute amount.  Banks will not take whatever Aidan decides.  The second element is the timing.  Banks will want to minimize any immediate loss.  Many a rescheduling has shifted known problems into the future - hoping for a miracle.  And the personnel involved prefer that any serious damage occur on someone else's watch.  And even, if writer is correct and banks may have to sit still for Aidan's haircut, they do not have to come to the Dubai or UAE barbershop again. That is, they can withhold new loans.  Any haircut justified or not will have an impact on new extensions of credit.  A large  haircut or one that is seen as unjustified will act as a potent drug against bankers' anmesia (future loans and future pricing).  Since Dubai on its own cannot execute its economic plans without new loans., this seems a rather dangerous thought much less a strategy.  That is, unless Shaykh Khalifa is going to fund all new projects.
7. As well, while the old saying that it is easiest to forgive oneself is no doubt true.  A haircut for creditors also affects local banks.  Many of whom are owned by either Abu Dhabi or Dubai.  Both Emirates would have to provide additional capital to their banks.  One might argue that on a net basis Dubai would gain (the Emirate would benefit from a net reduction in loans), but that would be to ignore the very real negatives mentioned in Point #6.
   
8. It's likely that many original creditors have sold their positions.  The new creditors bought at a discount and are looking for a quick turn on their money.  They have no interest in a relationship with Dubai World, Dubai Inc, Dubai, the UAE, the GCC etc.  They will not go gentle into the night.  They are likely to play very hard ball as QVT did on the Nakheel Sukuk.
   
9. Failure to agree a debt rescheduling within an artificial deadline also harms Dubai and the region for the reasons mentioned above.   So Dubai has an incentive to work towards a deal as well.  Many a bank group has told a debtor that it has to make a concession because it's impossible to "herd the creditor cats".  In fact, that is a well known creditor strategy in a rescheduling.  There will numerous small "cats" among the creditors refusing to go along on the hopes that they can be bought out if they cause enough trouble.  The DIFC law requiring just over 75% of creditors' agreement to impose a refinancing is a bit of an antidote, but it's not a miracle cure.  QVT had no trouble assembling by some accounts 40% of the Nakheel bondholders to oppose any payment delay.
10. From a technical aspect, the creditor group involves a variety of diverse groups - traditional lenders, "Islamic" lenders, syndicated loans, bi-lateral loans, bonds, sukuks, etc.  All with different interests, legal positions, etc.  A large and very diverse group of cats to herd.  The thought that this will be all neatly packaged by April is a bit optimistic.  And the onus will be on Dubai to continue paying interest to avoid upsetting the banks.  And note that most syndicated loan agreements contain a clause that requires 100% creditor consent for an extension of maturity, change in interest rate or any serious change in creditor rights.   A "haircut" would certainly fall under these clauses.  And so one bank out of 100 in a syndicate can hold up the entire syndicate's agreement to a rescheduling as the DIFC law does not apply within syndicates.
    
11. Finally while it may come as a shock to the writer at The National, most rescheduling negotiations take place after a debtor has actually defaulted.  History would suggest that default does not convey any special power to the debtor.  It merely reflects the reality of the simple fact that the debtor cannot pay its debts.  The terms of the restructuring of Global Investment House and the failure of The Investment Dar to close its own restructuring should be ample caution to those who feel defaults place overwhelming power in the hands of borrowers.
    
12. Probably, the biggest omission in the article is the position of Abu Dhabi.  Abu Dhabi has "invested'' US$25 billion of its own funds in Dubai for debt support - US$10 billion through the Central Bank, US$5 billion through AlHilal and NBAD and US$10 billion itself.  Not to mention other charitable works it has undertaken in the Emirate.  A financial Armageddon in Dubai could cost it a pretty penny.  So it's unlikely that Shaykh Khalifa has given his "brother" Shaykh Mohammed a blank check to engage in silly power games with creditors - given the potential impact on those financial subventions as well as the larger interests of Abu Dhabi and the UAE.

While Dubai has a good hand in this card game, I think the creditors have a better hand.

For the foreign banks by and large Dubai is a samak saghir in the context of their overall business.  And regional titans of finance - both governmental and otherwise - should realize that in the context of these firms' global business, the region is no larger a fish.   A painful loss in Dubai will not be life threatening.

Local banks bear more risk though no doubt the government would lend a helping hand if need be. 

That is not the case for Dubai.  And Dubai has as well to deal with Shaykhly pride.  The Queen will not lose any face over a failure to resolve the Dubacle. The good Shaykh may. 

What is the critical issue now is that both sides put away any juvenile attitudes.  The rescheduling will require very hard work.  Both sides should approach it on that basis with decisions founded in economic reality.   This is not the time for bragging and schoolyard attitudes.  It is time for professionalism.