Downgrades reflect Dubai World fallout

Abu Dhabi helped stem the contagion from Dubai World's debt restructuring, but the support will come at the price of slower development in the capital.

Abu Dhabi has been seen as bullet-proof, but it will be affected, says Saud Masud, the head of research at UBS in Dubai.
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New warnings about debt levels at six companies controlled by the Abu Dhabi Government could raise pressure on the emirate to slow the pace of development as it grapples with the unanticipated effects of Dubai's financial travails.

Citing a lack of explicit government guarantees for the companies' debts, Moody's Investors Service yesterday lowered its assessment of the creditworthiness of Abu Dhabi National Energy (Taqa), Aldar Properties, Dolphin Energy, the International Petroleum Investment Company, Mubadala Development and the Tourism Development and Investment Company. Moody's also lowered its credit rating for Etisalat, which is controlled by the Federal Government.

The Abu Dhabi Department of Finance, in a strongly worded response, said it disagreed with the ratings decision and expressed explicit support for several companies downgraded. A credit rating doesn't assess the likelihood of a default, however, only the potential for one. A credit rating downgrade can occur even when a borrower's fundamentals are strong, but its ability to withstand a potential financial shock changes. Moody's warned of the risk of a downgrade in December, after Dubai requested a standstill from Dubai World's creditors. The move on November 25 to take control at Dubai World and ask creditors to renegotiate as much as US$26 billion (Dh95.49bn) of debt shook long-held assumptions among analysts and investors that the debt of government-controlled companies enjoyed implicit guarantees.

A string of ratings downgrades followed for Dubai companies. Moody's is the only one of the three major ratings agencies to extend its concerns over implicit guarantees to Abu Dhabi. Its decision to do so reflects growing concern that Dubai's troubles not only place a long-term financial burden on Abu Dhabi and the rest of the UAE, but also that they have begun to weigh on economic growth in a way that oil wealth may not be able to completely offset.

"Abu Dhabi has been seen as bullet-proof," said Saud Masud, the head of research at UBS in Dubai. "But it will be affected." The negative reaction to Dubai World's restructuring has already hampered what was a fast-growing market for UAE bonds, removing another important source of funding for local companies and governments. Ultimately the downgrades are likely to raise the cost of borrowing for Abu Dhabi companies relative to other borrowers in international credit markets as they seek to build out the Government's 2030 plan. "Obviously, it raises the cost of financing," said Fabio Scacciavillani, the director of macroeconomics at the Dubai International Financial Centre.

Falling property prices in Dubai, moreover, have started to pull prices down in Abu Dhabi, analysts say. That is prompting banks to become more conservative about lending as they brace for an increase in loan losses among property investors and at Dubai World. Uncertainty over property prices, credit availability and rising borrowing costs is putting the brakes on private-sector economic growth, economists say. While the Government of Abu Dhabi has plenty of cash to offset the decline in private investment, analysts say, doing so risks reversing efforts to diminish the dominant role of the Government and its oil revenues in the local economy.

But the Moody's move yesterday could also help remove a misperception in the market that gave government-owned companies excessively cheap access to funds thanks to their government connections, thereby encouraging them to take on too much debt. "The idea that lenders should only decide who to lend to, and at what rate, based on only a rating is in my view a shortcoming of the financial system," said Mr Scacciavillani. "It's like putting complex issues on autopilot."

Fears of just such downgrades may be one factor that prompted Abu Dhabi to provide the funds to pay off the sukuk in December. After Moody's put the Abu Dhabi companies on review in December, fears emerged in the capital of an "AIG-style" contagion, in which Dubai World triggered a cascade of defaults that might in turn trigger a cascade of loan losses and defaults. A similar domino effect prompted the US Federal Reserve to bail out the giant insurer American International Group with an $85bn credit facility in late 2008.

Abu Dhabi stepped in with pledges of $10bn of credit for Dubai, to come on top of the $10bn of assistance provided in February last year by the Central Bank. Dubai has already used roughly $15.1bn of that money. Bankers and analysts say Dubai is almost certain to need even more cash injections as time goes on. In a report issued last month, the IMF estimated that Dubai had $109bn of outstanding bonds and syndicated loans, with $15.5bn of them coming due this year. "Dubai will need rolling bailouts for the next three years," Mr Masud said.

Abu Dhabi's Government and corporations sold billions of dollars of bonds last year to help fund infrastructure plans and promote more diverse capital markets. Abu Dhabi and the companies it controls issued at least $10bn of new bonds in the first 10 months of last year as global credit markets eased after the financial crisis. In October, appetite for new debt was so strong that Dubai was able to venture back into credit markets, selling $1.93bn of Islamic bonds.

Analysts estimate that Abu Dhabi's two largest sovereign wealth funds have at least $425bn of assets, and the IMF said in its report that the UAE's combined assets were still in excess of the country's GDP. In January, Moody's followed its review by issuing a report warning that it might have to cut its ratings on the Abu Dhabi companies if officials failed to convince it that the companies would never be allowed to go the way of Dubai World.

What appeared to worry Moody's was that the Dubai World decision demonstrated the potential for selective, or strategic default. In other words, governments might choose not to bail out some government-controlled companies, even if they could afford to. Moody's January report on Abu Dhabi said government support might be less likely if a company could be allowed to default without affecting its operations or losing control of them. Governments are also less likely, Moody's said, to support companies that are financially weak.