What Dubai debt rescue boils down to

Insight Abu Dhabi's eleventh-hour rescue has averted what could have been a lengthy legal battle over the $3.52bn in bonds that Nakheel was due to pay Monday.

Abu Dhabi's eleventh-hour US$10 billion (Dh36.72bn) rescue package has averted what could have been a lengthy legal battle over the $3.52bn in bonds that Nakheel was due to pay Monday, and given time to restructure the rest of Dubai World and its debts. Analysts and executives said the new aid had also set important new legal and economic precedents. Yesterday's announcement was followed by a new decree establishing a legal framework for Dubai World's reorganisation that could help other companies and creditors by filling several gaps in the UAE's bankruptcy laws.

Most importantly, analysts said, the aid package marked a new level of financial co-operation between Abu Dhabi and Dubai that could fundamentally change the way the two emirates approach development, with greater co-operation and planning. "The biggest conclusion will be that there will be a closer relationship in planning projects between Dubai and Abu Dhabi," said Nicholas Maclean, the director for the Middle East at CB Richard Ellis in Dubai.

But analysts also said the new aid package was unlikely to completely restore faith among investors in the UAE and its creditworthiness. The announcement failed to eliminate concerns that Dubai may still be unwilling to rescue other companies it owns, they said, warning that paying off Nakheel's bondholders might raise the risk of more confrontations with investors in the future. "The apparent see-sawing of government policy on this issue has undermined market confidence and that will take time to rebuild," said Tristan Cooper, the head analyst for Middle East sovereign funds at Moody's Investors Service. "Policy transparency and predictability will be the key to an enduring restoration of investor sentiment."

Since last month Moody's, the credit ratings agency, has lowered its ratings on several Dubai Government-owned companies to below investment grade. The new $10bn will come in the form of bonds similar to those Dubai sold to the Central Bank in February, a source close to the Government said. Those bonds pay 4 per cent over five years. The new bonds will be on similar, but not identical, terms. How that money will be provided to Dubai World and Nakheel has not been settled, but Nakheel has been assured it will receive the funds to pay the $4.1bn it owes investors, from the $3.5bn bond and profits.

Dubai has asked Nakheel to exercise its 14-day grace period while the transaction is arranged. But the aid does not end Dubai's debt worries. The rest of the $10bn left after paying Nakheel's bonds, will be used to pay contractors and other trading partners. Dubai companies still face $50bn in debt repayments over the next three years, said Eckart Woertz, an economist at the Gulf Research Centre in Dubai, in a recent report. As much as $13bn of that needs to be repaid next year, Mr Woertz estimated, with another $25bn due in 2011.

"Reliance on Abu Dhabi in the ongoing restructuring process will increase and will come with trade-offs," he wrote. Analysts and bankers said greater co-operation would ultimately be good for the UAE, perhaps reducing the type of development approaches that had produced so many competing projects in a country of just 4.5 million people. Analysts have argued it made sense to renegotiate Nakheel's debt in light of the losses the company had suffered due to Dubai's property slump.

The market turmoil sparked by the announcement that Dubai was appointing an administrator at Dubai World and requesting a six-month standstill on the group's debt repayments must have convinced all the parties involved that paying off the bonds would be less costly than if they let Nakheel default. "Given the problems with Nakheel's economic model, the fact that these projects would not have the desired returns, it doesn't actually make economic sense to pay out at par," said Rachel Ziemba, an economist at RGE Monitor in New York. "But the reputational risk, higher credit costs across the UAE, were likely too high."

The decision to pay Nakheel's bond was also aimed at placating a minority group of bondholders who appeared determined to oppose the standstill, the source close to Dubai's Government said. A group of investors based in New York and headed by the hedge fund QVT Financial had threatened to take legal action if the Nakheel bonds were not repaid on schedule. Nakheel's bond is an unusually complicated instrument; an Islamic sukuk subject in its documentation to English law but bound to Islamic principles and only enforceable by courts in Dubai.

Most significantly, it was guaranteed by Dubai World, the only Dubai Inc bond that offered creditors such protection, said Chavan Bhogaita, the head of credit research at the National Bank of Abu Dhabi. By paying off Nakheel's bondholders, Dubai aims to avoid fighting legal claims by creditors on Dubai World's other assets, which could have complicated efforts to restructure the $22bn in remaining debts at Dubai World, and its two property divisions, Nakheel and Limitless.

With the group's most problematic bond out of the picture, Dubai World hopes it can pursue a more consensual restructuring with its remaining creditors. Nearly all of that is owed to about 97 banks, Mr Bhogaita said. "The issue here is whether you're willing to jeopardise the broader restructuring for the sake of the bond," he said. "And what many people have missed is that the restructuring is not about the bond, it's about the bank debt."

Analysts said Dubai and Dubai World might find Dubai World's other creditors in no mood to agree to a standstill after Nakheel's bondholders were paid in full. But by establishing bankruptcy protections for the conglomerate, the source said, the hope was that Dubai World would gain greater leverage over them. Some analysts, including Ms Ziemba, said rescuing Nakheel, which had suffered the brunt of Dubai's property slump, risked leaving other creditors and borrowers with expectations of similar treatment.

Before the announcement that Dubai would not automatically ensure repayment of Dubai World's debts, many investors had assumed that those debts enjoyed implicit guarantees - especially that they were backed by Abu Dhabi. But analysts and financial executives said the announcement had made clear that Dubai's other companies could not take Abu Dhabi's assistance for granted. Dubai is also determined to make it clear that other creditors cannot expect the Nakheel treatment.

"The moral hazard is gone," said one adviser to the Abu Dhabi Government. @Email:[e-mail]