Dubai World Restructuring: Implications of Low Interest Rate

One of my regular readers (or at least I think so), The Real Nick, raised a question to an earlier post of mine on this topic. "Please Sir, get to the point - what's the bottomline? How much less is this "gracious offer" from a de facto defaulter than what the original yield would have been for the lenders?"

A good question. And one that might of interest to others out there among SAM's vast readership. Heck, if Gulf Finance House can claim to have a proven business strategy, then I for sure am on much sounder ground claiming a "vast" readership. I have as the saying in Karachi goes a veritable "war chest" of readers out there.

This post addresses TRN's question and throws in a few other observations.

First, to his question what is the bottom line? How big will the discount be? 

It will depend on two factors. 

1. The original interest rate on the original loan. 
2. The repayment pattern of the rescheduled obligation.  

As to the first, the original interest rate, its effect will depend first on whether the loan or bond was priced on a floating or a fixed basis. For those on a floating rate, the question will be the margin. For any of the technically inclined out there I am ignoring basis risk.

As to repayment pattern, the longer the average life of the rescheduled debt the higher the haircut. Or in other words, If larger payments occur later in the repayment schedule the average life will be longer than if there were equal payments.

ASSUMPTIONS

To do the math we need several inputs.

First interest rates. Not all DW obligations are at the same rate. Not all margins are public. And I'm not inclined to try and estimate an average rate on US$22 billion of debt. So I've arbitrarily picked two rates: (a) 2.0% as a "margin" over floating rate LIBOR and (b) 5.5% as a fixed rate (which is the rate on the Nakheel Sukuk #2). These should be representative enough to give some ideas.

On the repayment pattern, I've come up with three scenarios. To keep things simple I've assumed annual payments of interest and principal in arrears, that is, at the end of the year. It's likely that the banks will want semi-annual payments. At least of interest. 

1. Scenario A: 6 equal annual installments. 
2. Scenario B: Staggered Installments of 0%, 10%, 15%, 20%, 25% and 30%. 
3. Scenario C: Staggered 0%, 0%, 10%, 15%, 20%, and 55%.
   

One more variable required to calculate the cash flow received for interest: LIBOR. Let's assume 1.00% for our "Base" Case. One year LIBOR is around .87%.

For the floating rate instruments, the discount rate will be the margin plus LIBOR. That's 3%.

For the fixed rate instruments, the discount rate is an invariable 5.5%.

A lot of assumptions.  Many if not all of which will be different when the deal is struck.  But, at this point, all that's really required are directional results to get a sense for likely impacts. These working assumptions will also serve to illustrate how the variables work and interact.

Here are the results.

Base Case: 1% LIBOR, Floating Rate Discount 3% Fixed Rate Discount 5.5%

Original Rate	Scenario A	Scenario B	Scenario C
Floating 2.0%	6%	8%	9%
Fixed 5.5%	14%	17%	20%

 

Alternative Case: 2% LIBOR, Floating Rate Discount 4%, Fixed Rate Discount 5.5%

Original Rate	Scenario A	Scenario B	Scenario C
Floating 2.0%	6%	8%	9%
Fixed 5.5%	11%	13%	15%

 

COMMENTS

1. The worst case under the 100% repayment is a bullet at the end of year six. With a 1% LIBOR and the 5.5% and 3% discount rates, that translates into a 22% and an 11% discount. 
2. For all scenarios, as LIBOR approaches 5.5%, the haircut on the Fixed 5.5% instrument reduces dramatically. That's because the discount rate remains fixed. With the Floating Rate, each time the rate goes up we add the 2% margin to it to determine the discount rate. What this means is that to get to a 1% haircut on the floating rate obligations, LIBOR needs to be around 200%. 
3. On an economic basis, the discount rate on both the fixed and the floating should be the same given the same repayment schedule and assuming that recovery is the same, that is, both instruments have the same probability of default ("PD") and same loss given default ("LGD"). 
4. Through the magic of accounting, one instrument (the fixed) is favored over the other. Mathematically, one can construct other scenarios where this favoritism reverses, though the issue with alternatives is the likelihood of their occurrence. As well, in an environment of 200% LIBOR, collecting DW's debt is going to be a rather minor issue among much larger problems. 
5. What this analysis suggests is that the repayment schedule is likely to be a prime driver of the haircut. A schedule with principal repayments weighted to the back-end will result in larger impairments under IAS #39 and thus larger haircuts.
   

IMPAIRMENT TESTS - PLURAL

Under generally accepted accounting principles like IFRS impairment is not a one time event during the life of a financial instrument or asset. Whenever there are signs of potential impairment, the holder must re-evaluate the asset. If further impairment has occurred, an additional provision must be booked. For non equity investments IAS #39 allows the write-up of impaired assets. Thus, provisions no longer needed can be reversed through the income statement.

If indeed DW reschedules on a floating rate basis, then whenever LIBOR changes, the future estimated cash flows change. When the cash flows change, a new impairment test is required.  Since banks may  reverse provisions, if all that changes are interest rates increasing, then some writebacks may be possible.. Over the proposed six-year tenor, fixed rate instrument holders will have the potential for larger writebacks than those holding floating rate paper given the structural factors mentioned above including the current low level of interest rates.

ACCOUNTING HAIRCUTS & ECONOMIC LOSSES

As noted above there is a discrepancy between the IAS #39 mandated haircut for DW based solely on the nature of the pricing on the instrument. That is, based upon its original rate and whether that rate was floating or not.

In the real, non accounting world, economic loss is what matters. Economic loss is not dependent on the pricing convention on the instrument. It is dependent on the instrument's cash flows and risk adjusted discount rate. The latter a function of the holder's WACC adjusted for any additional risk posed by this instrument over its general WACC.

PRICING AND FUNDING

It's also important to understand that on loans or bond rates like LIBOR are pricing references. The holder is not required to obtain his financing at LIBOR or whatever the benchmark is. Nor is it required to match fund the loan or bond. If interest payments are based on six month LIBOR, the holder can fund with shorter date money (daily, weekly, monthly, quarterly) or longer dated money (nine months, twelve months). The funding or "gapping" pattern chosen would depend on the shape of the yield curve.

Nor does making a loan at LIBOR plus a margin guarantee the lender will be able to secure funding at LIBOR. If it has to pay over the benchmark, that is not the borrower or issuer's problem. It is the holder's Similarly, in the case where the holder can source funds for less, it gets to "keep" the difference.

If a bank has a very large base of US Dollar retail customers, its cost of funds may be below LIBOR. On the other hand, small banks and most GCC banks probably can't borrow at LIBOR – but have to pay a premium over that rate. 

What this means for DW lenders is that those whose cost of funds is above LIBOR the "accounting" haircut is going to be higher than those whose cost is lower.   Though it won't be visible as the funding cost difference will be part of the undifferentiated amount of interest expense.

Dubai World - More Speculation on Rescheduling - 6 Years at Libor Flat

AlQabas has an article quoting informed bankers (are there any better kind?) on the latest proposal said to be "on the table" from DW:

1. 100% of principal
2. Six Years
3. Libor flat
4. Deal to be announced next week (I believe we heard that last week too.  And maybe the week before. Or the week before that one.)

AlQ then goes on to point out that if banks accept Libor flat, they will have to recognize a loss based on the difference between the interest rate on their existing loans and Libor.  And that this loss will have to be recognized in this year's financials (that assumes they agree this year).  

That's something I've noted before.  Since AlQ is agreeing with me, I'll have to note their keen acumen and clear thinking. 

While IAS #39 forces this unhappy event on the banks, one benefit is those banks who carry their DW loans at cost (e.g., "originated loans") get to use their current contractual rates as the discount rate.  These rates, granted in happier times, do not reflect the current higher margins applicable to Dubai. Those investors who carry DW as "available for sale" have to use the current market rate for DW debt which will be higher and thus their impairments will also have to be higher. 

Are there many lenders carrying DW's debt as available for sale or mark-to-market? Generally commercial banks carry loans at cost.  Depending on the investor, it may have booked the bonds at cost.  Or available for sale.  Or trading assets.  The latter two will need to be discounted using current market rates.  Ouch!  Though rates should come in a bit after the restructuring is finalized.  There's a good bit of "uncertainty" in the current margin.

One thing not mentioned by AlQ nor here at SAM earlier.  As part of the test for impairment, the banks will have to assess the likelihood of DW fulfilling its promise to pay 100% of principal. and be reasonably certain of full recovery.  If this is  doubtful, then an impairment has to be taken as well for the unrecoverable amount of principal.  

Frankly, from where I sit I think a lender to Nakheel or Limitless would be hard pressed to make such an assessment - unless of course there was adequate additional support - collateral, a government guarantee., etc.   Imagined islands in the Gulf or vast tracks of  undeveloped waterfront property onshore might pose some challenges in collateral valuation.

Finally, a flat Libor will cause some "blood in the waters" for those banks who do not borrow at Libor.  This will be buried within their net interest margin (by virtue of a higher funding cost) and so not explicitly visible as related to DW.  Smaller banks and wholesale banks are likely to suffer the most.  Those banks with large retail franchises where they are largely (but not entirely) price setters for cost of  retail deposits will be slightly better off.  Price takers won't fare as well.

Dubai World - When is a Haircut Not a Haircut? Apparently, When We Say It Isn't.

The National has an article describing the various options to be offered creditors of Dubai World which contains some real howlers:

Creditors will be offered "new debt".  

While I'll admit this is conventional "banker speak", a rescheduled loan is about as new as that recycled left over on your dinner table.  It's the same old debt in a slightly different package..  It's like the dinner from Saturday that you quite didn't finish that turns up on your plate on Sunday.  It's not a new meal even if your wife has added Hamburger Helper.  A new loan would be a voluntary extension of credit.  Trapped money is the financial equivalent of a leftover.

But the real gem is the following.

“Receiving 100 per cent of the principal and zero per cent interest is better than taking a 30 to 40 per cent haircut. On this basis, the banks involved will not have to incur a loss other than the time value of money which is not insignificant but may be better than the alternative,” said Jawad Ali, the managing partner of the Middle East offices of the law firm of King and Spalding.

If you get back less money from a debtor than you advanced after taking into consideration the time value of money, it's a haircut.  A loss is a loss.  Pretending it is something else makes as much sense as saying that Dubai World wanted to help banks have solid earning assets on their books so its extending the maturities on its loans to help them out. 

As I pointed out in an earlier post, equal amortization of a loan over five years at a 5% interest rate is equivalent to a 13% haircut and at 10% a 24% haircut if one were being paid back immediately.   

Also as I noted, reputable firms of accountants working in reasonably developed  markets would apply IFRS (or US GAAP) and require a bank to  recognize an impairment against the asset.  And guess what, the loan would be written down using present value techniques - which recognize the time value of money.

However, in this matter I will defer to learned counsel's assessment of the firms and markets he practices in.  Financial institutions from developed countries will see right through this transparent scenario.

Dubai World - Debt Rescheduling Proposal - Just A Maturity Extension?

According to Gulf News, recent discussions suggest that the rescheduling may just an extension of maturities with no haircuts or other features which would offend the sensibilities of DW's lenders or investors.

Time will tell.  Until then we're all still free to speculate.

Dubai World to Meet With Local Creditors - No or Low Interest Repayment Option?

The National reports that DW is planning meetings with local creditors - Abu Dhabi Commercial Bank and Emirates National Bank.  These meetings follow ones held earlier this week in London with "international" banks.

The goal of this series of meetings is probably twofold.

First to test some restructuring ideas with these major banks to get feedback.   Second as a way of managing the process - trying to influence future negotiations by framing the bankers' expectations.  

One of the options that apparently is being considered is a low or no interest repayment of 100% of the principal over some extended period.

Let's look at some examples to see what sort of discounts one can achieve through this device.

1. A bullet repayment 10 years from now of 100% of principal equals a present value of 61% of face at a 5% annual discount rate.  Changing just the repayment to 5 years from now raises the present value to 78%.
2. Using the same two scenarios above but applying a 10% discount rate, the 10 year bullet has a present value of 39% of face and the 5 year bullet is worth 62%.
3. Amortizing the loan in 5 equal yearly installments gives present value of 87% at 5% and 76% at 10%.
4. If there is unequal amortization of 0%, 10%, 15%, 25%, and 50%, then the present value of at 5% discount rate is 82% and 68% with a 10% discount rate.

What's the bottom line?  One can achieve quite a hefty "haircut" through this tool.

The Nation suggests that banks might want the zero interest or low interest option as a way of avoiding taking the "hit" to income up front.  I think it is highly likely that any reputable accounting firm is going to let a client who uses IFRS as the basis for financial reporting "get away" with carrying the loan at its nominal value.  This is clearly a restructured loan. 

The relevant Chapter and Verse are IAS #39 Paragraphs 58 and 59 which deal with impairments in value.  Haircuts, no interest or below market interest rates,  tenor extensions, other concessions that a lender would not normally agree to along with several other items are cited as evidence of  potential "impairment" in Paragraph 59.  

Paragraphs 63-65 deal with calculating impairments for assets held "at cost".   Present value the projected cash flows at the original interest rate on the instrument.  Any shortfall between original cost and present value is an impairment loss which must be taken immediately to the income statement.

Paragraph 66 deals with impairments on assets "held as available for sale".  There the discount rate is the "market" rate for that asset at present. Since this is an impairment not a fair value adjustment, it also goes through the income statement.

Dubai World Rescheduling - Draft Restructuring Plan to Be Presented?

 

Two reports out.

Maktoob quoting a Reuters story quoting unnamed bankers states:

1. DW will put forth an initial proposal to creditors as early as this week, but problems valuing Nakheel are delaying finalization of the Plan.  AA:  That probably means the values at Nakheel are much less than anticipated.  And does one use current depressed values?  Or assume that these will increase over some time period?
2. "what's being offered will not be as bad as feared"  AA:  Perhaps a good negotiating strategy.  If banks are worried about a 40% haircut a 20% haircut might sound "good".

The Financial Times has another take also from unnamed bankers - presumably a different lot that Reuters spoke to:

1. Meetings with major creditors in London starting this week.
2. Initial outline plan to be offered.  Two options.  Bigger haircut and shorter tenor.  Smaller haircut and longer tenor.  Some injection of new funds.
3. Potential for split among creditors as different groups may wish to see any new funds or concessions focused on those members of the DW Group with most impact on them.  By way of example, the article mentions local banks possibly preferring support being directed to Nakheel and Limitless given exposure of other local bank clients to these two entities.

This is a key issue.  As I posted earlier, often the most contentious debates and negotiations in a restructuring take place among the creditors.   The problem for DW is that if the creditors get hung up among themselves, DW suffers as well.  And the Emirate.

“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.

Dubai World - Debt Tribunal Opens But No Claims Lodged Yet

The National reports that the special tribunal has received about 100 inquiries on the process for filing claims though no claims have been filed yet.

The article also notes that if DW files a notice of an intent to restructure the Court can grant it a 120 stay of legal action to develop such a plan and present it to creditors.

Whether or not the company can restructure as is hoped depends on its economic position.  If that is weak and there is no external support, then it's hard to see how it can continue except under a disguised wind down.

I'd guess that this is precautionary move on the part of creditors.  They are preparing for a breakdown in the debt restructuring or some other need to prove their claims.

Earlier one of the reasons given for the delay on the DW side in presenting concrete proposals to its creditors was that it needed to "sort out the mess in its accounting".  If that is indeed the case, then it is perhaps just as likely that not all liabilities were recorded properly.  Back in the early 80's when oil prices collapsed many Saudi and foreign contractors found out that those "change orders" which their clients had needed done on a rush basis were not documented properly.  Whether it was a matter of proper procedures or a way to ride the trade and get discounts, the Saudi authorities slowed payments down dramatically.  Some improperly documented changes were disallowed.  A creditor (particularly one whose obligation is not a clear cut loan or bond) might be wise now to make sure its debt were acknowledged by the obligor.  And if not to prepare to litigate.

Arabtec Stops Work on Nakheel Project Due to Non Payment

This article from The National is not encouraging.  AlFurjan is one of Nakheel's largest projects (housing).

If Nakheel is unable to conduct its business, it's not going to generate a cash flow.  It's also going to have a knock-on effect on other firms.  Not good news for bankers. Especially since a promise was made to use the Abu Dhabi $10 billion contribution to pay suppliers and contractors.

Limitless Seeks to Negotiate Multi-Year Contractor Payments

The National reports that Limitless is approaching contractors reportedly seeking four year payment terms.

As well it seems Limitless is scaling back or perhaps canceling other projects.

What's also interesting is the comment that despite earlier talk about Nakheel settling with contractors no payments have been made.

When you don't have cash, you can't pay.  And then it makes eminent sense to scale back or halt current or new projects.

On the topic of Nakheel, I posted last December on how contrary to what one might expect it was actually a source of cash to the DW Group rather than a cash drain as it apparently upstreamed loans within the Group.  If the funds used to pay its recently matured Sukuk are treated as replacement debt rather than a return of funds owed it by the Group, then its financial position will not have really improved.  It will just be a case of rotation of creditors.

The National: "Dubai to Take a Hit on Debt Exposure"

Frank Kane over at The National newspaper in Abu Dhabi with an update on developments in the  Dubai World restructuring saga.   

The title carries a pretty strong implication that there will not be 100% recovery for the lenders.  Not from the assets of Nakheel and other subsidiaries to be restructured.  Nor from the Shaykh up the road in Abu Dhabi.   And certainly not from his less rich brother in Dubai. 

It sounds like the intent is to offer several restructuring options.  Another sign of less than a full recovery.  No doubt with the tenor of each and certainty of repayment inversely related to the offered recovery amount. 

That's coupled with the news that the DFSF will after all not require that its loans have priority over other lenders'.  As you'll recall that's been a sticking point with lenders.  Having DFSF ahead of them in priority of repayment would make the haircut even larger.  It's unclear to me why this was ever raised in the first place.  Didn't DW realize this would provoke howls of outrage from the lenders?  What were they thinking?  

Or was the strategy to create a controversy to distract the banks?

The step by the DFSF is a way of making the pain of the banks a bit more palatable.  And the retreat could be tactical.  Give the banks a victory on this issue.  Then hit them with the haircut, noting that the DFSF was also subject to it.

One can look at any potential "hit" to DFSF from several perspectives.

Of course, if the DFSF is pari passu with other creditors then it will be subject to the same menu of restructuring options.  One would expect that the DFSF will be willing to take the longer tranches and be more patient with ultimate recovery, including losses.  As a governmental entity,  it will not face the same constraints that commercially oriented lenders will face with regulatory authorities' capital requirements, Basel II, the strictures of IFRS, shareholders, etc.  So it's pain on these scores will be less.  And unlike the lenders who made a bone-headed underwriting decision, the Fund stepped in to save the day so its losses are calculated and done for the "greater good".

The total "hit" taken by lenders can be assumed to be an economic benefit to Dubai - money it would not have to pay to the lenders to make up for any shortfall in assets.  Say the DFSF provides $10 billion to the restructured companies bringing total restructured debt to $32 million.  If there is a 30%  haircut, its gain is 2/3 of the 30% .  That of course ignores the losses that will be felt in the local banks in which it has an ownership interest.  

On the other hand wise and brave lenders out there should be applying any cashflow from the companies against principal.   Those banks from jurisdictions that levy income taxes and allow provisions and write-offs as expenses will also get an offsetting benefit courtesy of the tax payers in those jurisdictions - assuming of course that they actually pay enough taxes.  And where jurisdictions don't allow provisions/write offs as an expense, then reducing interest income (by applying payments to principal) could be a way of generating an expense for tax purposes.

Another bit of news is that DW's expectations now appear to be to reach a comprehensive deal in a couple of months to four months.  My guess is that it will be the latter.  If the restructuring menu has several options, that will be more working parts for the banks to negotiate over.  And then of course more choices to be made with consequent time required to evaluate each.  

The Central Bank of the UAE and Abu Dhabi are being "kept part of the dialogue, like many other constituent parts of the UAE. When the time comes for a proposal, nothing in it will be a surprise to Abu Dhabi."  Which implies of course that in the past they were surprised perhaps unpleasantly by the goings on in the Emirate "down the road from them" with its debt management or perhaps more appropriately mis-management.

Finally, many of the themes sounded by the "government" source in the article are from the script recently recited by the Lord, the Deputy, the IMF, and the Financial Times.  Transparency, fairness, equal treatment, etc.  I guess the bully pulpit can have an effect.