“Boring” IMF Report Contains Interesting Information on Dubai

The typical reaction to a report issued by one of the multilateral agencies is a polite "yawn" as one consigns it to the bin. That is a mistake that both investors and lenders make because these reports often contain important information. Information the IMF gains through its special access to the sources.  And which often is better than that given creditors or rating agencies.

What can be learned from these reports? 

1. Insights into fundamental factors or conditions that can help one look beyond the current hype – whether it's irrational exuberance or unjustified pessimism. From these agencies' autopsies of earlier financial problems, one can develop an insight into the factors that were associated with problems in other countries. Not universal laws. Nor magic equations that infallibly predict the future. But reasonably good early warning indicators that help one identify situations that lead to potential problems or are themselves symptoms of such problems.  One can also develop some ideas about the likely exit path if a problem hits. What happened in other countries? How severe and how long were those problems? And some "back of the envelope" comparative metrics one can use to make directional (but not exact) predictions of the path and severity of a  similar problem in another country.  Or at least set bounds on the severity estimate and likely paths.  This information is not only useful when the crisis hits, but when one is considering whether to make the initial investment.  Or if one has made the initial investment (or loan) when might be a good time to get out. - hopefully before the crisis occurs.   For example of this sort of information see the comparative analysis of real estate crises in four countries on Page 23 which might give some insight into the potential impact on UAE banks.
2. Then robust data on that country with which to apply these insights - or at least as robust as the country is able or willing to disclose.  One can use that data to see if those same conditions that caused problems in other countries are developing in this country. To what extent? Or, if the crisis has hit, what are the new vulnerabilities and exit path? 
3. Finally, other information - facts and judgments. For example, this report contains  an estimate of the amount of debt of Dubai Inc and the Government of Dubai.  The maturity profile. And, as I've noted in earlier posts, sometimes in the diplomatic language of the reports, one can discern the multilateral agency's assessment of problems and it sconcerns.  In some cases pointing out problems.  In other cases pointing out trends that will lead to fundamental changes from past. behavior  As an example of the latter look at the discussion the labor market in structural issues below.

Here's the link to the IMF "Staff Report for the 2009 Article IV Consultation" with the UAE so you can not only follow the analysis below, but also read and "wring" out additional bits of information.  This post long as it is does not discuss every insight or bit of information in the Report.

Pages 38 to 49 contain a special section on the Dubai World Debt Situation. 

Let's take a look at these first as they are likely to be of the most immediate interest to most readers.  But don't skip the section after that which discusses the main body of the Report.  It has some interesting information.  

Now to the topic of keen interest - the Dubai World Restructuring.

1. Page 39 Paragraph 6 "Dubai Inc. dominates the economy of Dubai (Annex Box 1). Dubai Inc. is a network of commercial companies and investment arms owned directly or related closely to the Ruler of Dubai, his family, or the Government of Dubai (GD). At its simplest, Dubai Inc. consists of three holding companies, Dubai Holding (owned by the Ruler), Dubai World, and the Investment Corporation of Dubai (both owned by the GD). A few other companies are owned jointly. Each holding is present in Dubai's growth engines and this overlap has fostered competition as well as duplication. Each holding has choice assets with solid earnings, as well as start-ups requiring large amounts of capital upfront, particularly in property.3Dubai's private companies are mostly owned by old merchant families. The private sector is fairly small and dependent on Dubai Inc.'s business." What this suggests is that the collapse of the Dubai development model (leveraged real estate development) and the sharp decline in many (but not all) foreign assets are going to have a serious effects on Dubai until there is a turnaround in Dubai Inc's fortunes.  Probably not a near term event.
2. That's reinforced by Paragraph #8 on Page 40 "DW's real estate interests are concentrated in Nakheel Properties, Limitless World, and Istithmar World. Nakheel's focus is Dubai; Limitless World, a more recent company, has comparatively more overseas real estate ventures; and Istithmar World is an investment arm with several overseas property-related interests. Although consolidated financials of Dubai World are not public, Nakheel and Limitless likely constitute about half of Dubai World's assets, the rest being held mainly by DP World, JAFZ, and Istithmar. Nakheel's remaining interests in overseas properties were transferred to Istithmar in September 2008." Assuming the statement that troubled real estate assets are roughly 50% of Dubai Inc's holdings, there is going to be a substantial ongoing drag on the Emirate.  Cashflow from existing projects is likely to be negative - diminished cash from operations eroded by heavy financing  charges.  And limited opportunities to sell the assets.   As  new projects are likely to remain stalled.  Since property and construction have represented 25% of economic activity, a slowdown in new projects will be another stress on Dubai.  Even assuming a relatively quick agreement with creditors on a restructuring, these problems are going to weigh on Dubai. Talk of any sort of a rebound in 2012 seems very premature. 
3. On Page 41, you'll find a handy chart showing the companies belonging to each of the three holding companies: Dubai Holding, Dubai World, and ICD. And the following pages contain some additional information on the various entities in each of the three.
4. On Page 45 there is a breakdown of DW debt between local and foreign banks. "Information on debt within the DW standstill perimeter has become clearer than on debt of DW's consolidated or Dubai Inc.'s debt. At this time, and after the payment of the Nakheel 09, the standstill perimeter is about $22 billion (in local and foreign currencies), of which $12 billion is in the form of syndicated loans, $7.5 billion corresponds to bilateral loans and $2.5 billion to bonds. The share held by national banks is 45 percent of the total ($10 billion), of which 2/3 is to Dubai-based banks (6 percent of their book) and 1/3 to Abu Dhabi banks (3 percent of their book). The national banks also hold 80 percent of the Nakheel 10 and 11 sukuk bonds. The debt subject to negotiation is owed by Nakheel, Limitless, and by DW at the holding company level (DW Holding, DW Group Finance), the largest component being at the holding company level. The extent and form of the needed debt restructuring will become clearer as the negotiations between DW and its creditors progress."  This quantifies the UAE bank exposure and raises some questions about market access.  Was this exposure built up in the last few years as foreign creditors reduced appetite for DW debt? Were local banks "stuffees" on deals the market wouldn't absorb?
5. Page 49 has IMF estimates of the Emirate of Dubai's Debt with a breakout of Dubai Inc's debt.  And then a further allocation within the constituent parts of the Dubai Inc . The headline number which you've probably read elsewhere is some US$109.3 billion for the Emirate.   That is 130% of the Emirate's GDP - not a comforting ratio.  But the IMF estimate does NOT reflect all liabilities.  There are amounts due to contractors for work already performed.  Advance payments taken from customers for real estate purchases.  So the total amount of Dubai's liablities is likely to be much more.  The debt burden measured in US$ or in terms of percentage of GDP is therefore much more.  All of which implies a severe economic burden to unwind the position - to pay down the debt.  To de-leverage.   In an article today, The National estimates another US$ 60 billion.  Whether that's the right number or not isn't clear.  Unfortunately, the financial statements of DW, DH and ICD  are not available.  Otherwise one could use these to round out the liability estimate.   So with the caveat that US$109.3 billion may be significantly understated, let's drill down to see what additional ew can learn.  First a look at the overall composition of debt among the various Dubai Inc entities and the Government of Dubai.  A boom built on a "credit card".
   

Entity	Total Debt (US$ Billions)	Percentage
Dubai World Entities To Be Restructured	US$ 14.35	13.1%
Other Dubai World (DW Ports, etc)	US$ 11.69	10.7%
Dubai Holding	US$ 14.79	13.5%
ICD	US$ 20.40	18.7%
Other Dubai Inc	US$ 24.35	22.3%
Dubai Inc Total	US$ 85.59	78.3%
Government of Dubai	US$ 23.70	21.7%
Total All Govt Related Dubai Debt	US109.29	100.0%

Now an estimated maturity profile (amounts in US$ billions) to outline cashflow demands on Dubai.  For the DW entities to be restructured, their problem is a near term two-year window of "bunched" maturities.  This occurs at a time when there are much heavier cashflow demands on other Dubai Inc entities. It doesn't seem that there are resources that could be taken from other entities in the Group to tide over Nakheel, Limitless and Istithmar.  And with these sort of amounts, a clear need for refinancing.  The Emirate remains dependent on banks and investors - probably foreigners as the Central Bank of the UAE tamps down on credit from local banks.  At best higher margins.  At worst limited access which in itself might tip other entities into restructurings.  A difficult situation to navigate.

Entity	2010	2011	2012	2013	2014	Beyond
DW To Be Restructured	US$ 5.2	US$ 4.6	US$ 1.9	US$ 1.1	US$ 0.3	US$ 1.3
Other DW	US$ 0.2	US$ 2.0	US$ 5.7	US$ 0.5	US$ 0.0	US$ 3.2
Dubai Holding	US$ 3.5	US$ 3.2	US$ 0.8	US$ 0.5	US$ 2.1	US$ 4.6
ICD	US$ 2.0	US$ 5.8	US$ 5.7	US$ 3.0	US$ 0.1	US$ 3.8
Other Dubai Inc	US$ 4.7	US$ 8.8	US$ 4.9	US$ 1.8	US$ 0.6	US$ 3.6
Total Dubai Inc	US$15.5	US$24.4	US$19.0	US$ 6.9	US$ 3.2	US$16.5
Govt of Dubai	US$ 0.0	US$ 0.0	US$ 0.0	US$ 1.8	US$21.9	US$ 0.0
Total Dubai Govt Related	US$15.5	US$24.4	US$19.0	US$ 8.6	US$25.1	US$16.5

Note: Amounts do not add exactly due to rounding.

Now to the rest of the report.

1. Page 4: "With foreign investor confidence shaken and international capital markets less accessible, Abu Dhabi's policy of selective support to Dubai will play an important role in limiting contagion to the U.A.E. economy and the banking system." The key takeaway here in case anyone out there missed it is that Abu Dhabi is not writing a blank check to bail out its neighbor. And that reason for that is clear. In fact there are 109 billion reasons. 
2. Page 6: "The crisis unfolded with differential impact on Abu Dhabi and Dubai. It highlighted three key issues: (i) the contrast between growth based on hydrocarbon resources and that based on nonhydrocarbon diversification funded by maturity-mismatched leverage; (ii) the spillover effects and financial support structures in the federation; and (iii) the volatility of markets in response to a lack of information disclosure and transparency. In particular, the debt announcement undermined the widely held market perception of implicit government support, including from Abu Dhabi."  
3. Page 11 contains a series of charts that provide in graphic terms (sorry for the pun) an indication of the nature of the problem and some potential early warning indicators. First is the dramatic increase in foreign borrowing from BIS banks. The second is a chart showing the explosion in local borrowings beginning in 2004 where the growth curve moved from roughly a 6 degree angle to over 60 degrees. As noted in Paragraph #38 on Page 20 some US$ 100 billion of credit above the trend line was extended. Third is a dramatic rise in short term borrowings. Anyone familiar with the Asian Crisis of 1997 would recognize this pattern.  It's very similar to what happened in Thailand.  If that lesson had been assimilated, perhaps Dubai would not have crashed.  Or at least those who paid attention would have avoided the collapse.
4. Paragraph #21 on Page 13 brings home the point that while the IMF is projecting 0.5 percent growth for the UAE in 2010, that growth is going to be very uneven. Abu Dhabi's growth will be propelled by a significant public works program.  Dubai is going to stagnate.  Footnote 2 on Page 7 gives an indication of the growth differentials. If these 2009 statistics are any guide to the future, Dubai will experience negative growth again in 2010. Very roughly  8% or so negative assuming Abu Dhabi repeats 2009's 6% growth and using a very crude 60/40 split.
5. Page 14 contains a box with a detailed discussion of the  mechanics of the Dubai special insolvency regime for Dubai World. It also raises two questions as to whether its decisions will be recognized outside the Emirates (I'm guessing they will unless they seem to be overly slanted towards the borrower) and whether the special tribunal will enforce foreign judgments against DW entities. If the intent is that the tribunal is applying "global standards", then it should enforce foreign judgments - again presuming they are reasonable.  If one wants to play in the Premier League, one has to follow the rules.
6. Page 16 some quotes on the Dubai model of development. "Even though Dubai has achieved an impressive degree of diversification and has become a major trading and services regional hub, recent events call into question the sustainability of enhancing growth through large-scaled and highly leveraged property development. The Dubai authorities recognized that the recent events require a reassessment of Dubai's real estate sector to ensure the economic and financial viability of the emirate's corporate sector. As a result, over the medium term real growth was likely to be slower but more sustainable than in the period preceding the crisis. The authorities were of the view that Dubai had a top quality infrastructure, and that its hospitality, trade and logistics engines should continue to benefit from Asia's pull. Although the scope of the restructuring was still being defined, the focus would be on refinancing the property sector."  The question is what replaces the old model.  The implications for growth seem to be clear.  Less growth. Normal commercial activities are not going to deliver the growth that a speculative property boom did.   Less growth also has a negative implication for debt service abilities.  For the rise of asset values.
7. Page 18 a confirmation that the Dubai crisis has strengthened Abu Dhabi's hand. "The authorities emphasized that the crisis had encouraged greater cooperation between the federal and emirates levels of government and between the emirates themselves. Going forward, Abu Dhabi would continue to support Dubai in its efforts to achieve a viable position. However, the Abu Dhabi authorities emphasized that Abu Dhabi was not legally liable for DW debt and that any decision to extend support would be made on a case-by-case basis. In this regard, they stressed that they did not want to create moral hazard by supporting potentially nonviable corporations, but would provide support if necessary to limit contagion to the .A.E. economy and banking system." Greater co-operation will mean more centralization. Abu Dhabi will benefit from that. And "moral hazard" probably also encompasses the hazard to Abu Dhabi's check book given the size of Dubai's obligations. 
8. Page 20 gives some idea of the credit growth that lead to the crisis. " The U.A.E. financial system entered the global crisis exposed to a highly leveraged economy. The system is bank-based and focused on the domestic economy. Commercial banks expanded credit very aggressively during 2004–08, generating about $100 billion of credit above the underlying trend growth. Credit growth was the fastest among emerging markets by a good margin, and the capital base was disproportionately low for such growth (figure 4). During this period, banks by and large did not retain sufficient profits to maintain capital buffers, despite their exposure to an economy with significant leverage. Nevertheless, banks remained highly rated throughout 2004–08, in part reflecting perceived support from governments and in some cases government ownership. In addition, banks' liabilities (deposits and interbank loans) have been under 3-year blanket federal government guarantees since September 2008."  Hence the Central Bank of UAE initiatives to force banks to retain capital by limited cash dividends for 2009 and imposing tighter provision requirements.
9. Pages 23 to 25 present stress tests of the banking system for various haircuts. Paragraph 41 on Page 23: "However, the DW debt situation has increased the need for additional capital as these contingencies have become more likely to materialize. The uncertainty created by the prospective debt restructuring implies that banks may need material capital buffers above the regulatory minimum to maintain adequate ratings for dealing with market counterparties. To illustrate, assuming that banks need at least a 14 percent CAR, the additional capital needs would be about $6 billion or 2.7 percent of GDP. 5he possibility of a principal haircut on the DW debt subject to the standstill cannot be ruled out, an outcome which would have a significant effect on banks' provisioning. As an illustration, staff estimates that the capital top up could reach 3.4 percent of GDP for a 25 percent haircut and 4.3 percent of GDP for a 50 percent haircut of DW debt subject to the standstill."  Something every equity investor in UAE banks should be considering in terms of anticipated performance. As well as something for foreign counterparty banks to consider in terms of the amounts, types, and tenors of credit they extend.  While the UAE has demonstrated a very strong intent to support its banking system, a careful creditor always looks at the underlying strength of the obligor. 
10. Page 24 provides an assessment of the quality and capacity of the Central Bank of the UAE as a regulator. "While the extra capital need appears manageable, the exercise underscores the importance of contingency planning, supported by intensified supervision. The global financial crisis is testing the CBU as a regulator, as it did with many other regulators. The DW standstill has increased the potential for surprises and, consequently, the need for a more pro-active supervisory approach and effective enforcement. The CBU could for example use more systematically its power to block dividend distributions in the interest of building larger capital buffers. There may also be a need to re-assess how exemptions to large exposure limits are granted in the case of GREs. Finally, CBU inspections follow a traditional model of rolling examinations of individual institutions, whereas the current situation suggests the need for simultaneous cross-firm examinations of specific risks such as sectoral concentration, name-lending, or deteriorating funding standards. In the latter case, the CBU's limited resources, including for off-site analysis, hinders such an approach." A clear criticism of a failure to control banks' exposure to groups like DW.  The Central Bank of the UAE has taken the IMF's advice.  It has limitied2009 cash dividends.  Paragraph 45 on Page 25 details other measures it is implementing: a 1.25% general reserve on risk weighted assets and the new 90 day non accrual rule. 
11. Pages 26 and 27 discuss three structural issues. Labor markets and the need for uptiering skills. As this unfolds, it's likely that labor will be imported from different countries than it is now.  This is going to have some strong implications for those countries, e.g., a decline in worker remittances, loss of safety valve for unemployment, etc.  The need for long term financing and the lack of adequate local financing sources. Until markets for term financing can be developed, a dependence on foreign financing will remain - probably with the same short tenor preference on the part of foreign banks and investors which was in part responsible for the current crisis.  Inadequacy of data that limits the government's ability to monitor the economy and formulate policy. This issue is also related to debt management since each Emirate has been responsible for its own finances.  Without co-ordination (ideally central direction) there is a potential for problems.

Those 67 "boring" pages were packed with a lot of information and, as well, hopefully some lessons useful for future investment decisions - both at the underwriting as well as the monitoring stages.  And there's still more to "mine" from the report.