Abu Dhabi bailout
The government of Abu Dhabi announced on Monday that it is giving US$10 billion to the government of Dubai. Dubai, in turn, will give the money to 100%-owned Dubai World. DW will forward about US$4 billion of that to its property development subsidiary, Nakheel, to repay a large sukuk that came due on the 14th. DW will use the rest of the money for debt payments and working capital while it tries to restructure itself. (See my earlier posts for more background on the Dubai World debt problems.)
The Nakheel sukuk was suspended from official trading after the standstill request made late in November. But gray market transactions were reportedly done at just above fifty cents on the dollar. Courageous buyers will have doubled their money in less than a month.
I think it’s reasonable to conclude that three weeks elapsed between the time Dubai requested a debt standstill and yesterday’s bailout announcement because Dubai didn’t have the funds to bail DW out. It had to get them from Abu Dhabi. We don’t know if any strings were attached to the $10 billion gift, or if more money will be forthcoming, if needed–and it probably will be. My guess is that the answer to both questions is “yes.” (I’m not alone in thinking this. See Bloomberg’s comments.)
Why a bailout?
Why not default? I think there are four reasons:
1. the possibility of cascading defaults. We know that a lot of DW debt was held within the United Arab Emirates. If Nakheel defaulted and this triggered a disorderly process of unwinding of more of the DW group’s debt, the negative impact on UAE banks could have been severe.
2. the sharia supervisory board. All sukuk activities, including presumably liquidation, are overseen by a group of scholars who ensure that they are sharia-compliant. Because there have been virtually no prior sukuk defaults, it would be impossible to predict what actions the supervisory board would recommend. Suppose it decided that because of negligent management by DW (or some other reason), sukuk holders could make claims against all the assets of DW, not just Nahkeel’s? A ruling in this case might also set a precedent for other sharia boards in Dubai to follow.
3. some holders apparently didn’t want to negotiate. Nahkeel sukuk was originally sold to few if any Americans. But as Nahkeel’s problems emerged, it appears that some US and UK hedge funds accumulated positions at lower prices in the secondary market. Armed with credit default swaps that would pay off in the event of a default, these owners had different interests from the rest. For them, the worst outcome would be a protracted negotiation that resulted in a decline in sukuk value but no default.
4. reputational damage. Despite the facts that the Nahkeel sukuk was issued by a Dubai entity and that the prospectus clearly said the government assumed no obligation to guarantee repayment, possible default was giving the entire UAE a black eye. I’d bet that Abu Dhabi was less concerned that foreigners thought the sukuk had a sovereign guarantee that buyers in the UAE thought it did, too.
One odd consequence of the DW troubles is that the rating agencies have begun to focus more carefully on the financial problems of Greece. Greece is a short step away from having its government bonds downgraded to a level where the EU will no longer accept them as collateral for borrowings by the Greek central bank, thus shutting off credit from the rest of the EU. This is an issue, but it has nothing to do with Dubai. Go figure.