Dubai Five-Year Credit Default Spreads

Not surprisingly, after the announcement by Dubai World that it was seeking a six month payment standstill for certain of its subsidiaries, the market began re-rating those companies' risk. As well, the market also began taking a closer look at the risk of the Emirate itself.  And country risk in general.

Using four data points – two days just before the announcement and this Tuesday and Wednesday – we can see the impact. Data is from Markaz Kuwait. Links to their GCC Fixed Income Reports are in the table immediately below.  Click on the dates to access the reports.  Note the CDS data in a report is from the close of the previous day.

23 Nov	24 Nov	8 Dec	9 Dec
306.7	323.4	559.4	598.71

The increase is 292 basis points or 95%. To put this into context, a 10 basis point increase in the credit spread on US$1 billion results in an extra US$1 million in debt service.   Note: a change in credit default spreads does not change the credit spread on existing debt. It might, however, influence the price on new debt.

We can also compare the impact on several other states in the region and use the changes in their CDS spreads as a context in which to view the market's reaction to Dubai.

Country	23 Nov	24 Nov	8 Dec	9 Dec
Abu Dhabi	99.7	99.99	145.56	177.32
Dubai	306.7	323.4	559.4	598.71
Bahrain	172.02	171.94	209.78	212.22
Qatar	93.83	93.57	111.68	119.38
Saudi	74.9	74.9	95.7	98.51
Egypt	217.7	217.7	240.0	241.6
Lebanon	259.98	259.99	269.6	269.6
Turkey	192.24	195.3	192.08	192.08

The major impact as expected is on Dubai.

However, Abu Dhabi was affected as well with a 77% increase in its CDS spread. This makes little if any sense. The Emirate has substantial financial wealth and an even more substantial liquid "bank account" (oil) in the ground.

Bahrain's CDS went up 40.2 basis points, roughly 23.4%. Qatar's up 25.6 bp or 23.6%. Saudi's up 23.6 bp or 31.5%.

Lebanon's moved up 9.6 bp - a negligible 3.7%.  Considering the credit metrics of Lebanon, one might wonder as Qifa Nabki did in a recent post about Lebanon's capacity to service its debt.

And for added context here are some ex-region comparatives.

Country	23 Nov	24 Nov	8 Dec	9 Dec
PR China	78.62	78.62	98.51	75.1
France	27.0	27.11	26.83	28.05
Germany	22.42	23.32	22.94	24.46
Japan	70.9	71.58	91.78	66.5
UK	65.71	66.8	77.04	83.74
USA	31.83	31.83	33.49	34.96

From this chart, it's clear that 9 December was either (a) a day of higher than usual nervousness or (b) a day on which one or two counterparties were shedding risk in their portfolios. Presumably, now that the market has rediscovered (but if history is a guide, only for a while) country risk, some financial institutions may be moving to trim down outsize exposures through buying a bit of insurance.  In this process, the UK suffered the most damage with an 18 bp increase or 27.4%.

Some caveats:

1. The CDS market is thin.  Several same direction trades (all buys or all sells) can move the market price.
2. As with other financial instruments, sometimes sophisticated market participants engage in herd behavior and are known to be prone to irrational exuberance or stark terror.  
3. As mentioned above, a change in the CDS spread does not automatically change the credit spread on an existing loan or bond.  It may however influence the price at which new debt is raised.
   

The take away is that these price changes are not necessarily an accurate reflection of credit risk as I hope the changes in spreads on Abu Dhabi and Lebanon note show. 

In fact Bill Gross at PIMCO (Pacific Investment Management Company) is buying up Abu Dhabi and Qatar bonds believing they are mispriced and that he can get a bargain now.  Bill is such a large player that his deals can move the market.