FW: Looming Dubai Sharia Debt Defaults Trigger Global Markets Turmoil

The Iconoclast Friday, 27 November 2009 Looming Dubai Sharia Debt Defaults Trigger Global Markets Turmoil by Jerry Gordon While we in America were enjoying Thanksgiving feasts and family events, the looming Nakheel property debt default in Dubai was roiling debt, equity, oil commodity and foreign exchange markets.  Some analysts asked was this a so-called 'Black Swan event'?.  Others noted the swooning Sukuk (Sharia compliant) bond market with severe drops in trading values for debt issued by Malaysia and Indonesia that raised questions bout the issuers sovereign debt risks.  This has trigged a flight to safety, temporary of course, to US dollar denominated Treasuries and the US dollar in foreign exchange markets.  At the Seeking Alpha financial blog, the likelihood of a Black Swan  debacle seems remote; however the Eastern Europe sovereign debt markets appear more ominous. Note this comment in the Seeking Alpha post on the likelihood of a Black Swan event arising from the Dubai World Sukuk bond default: The events in Dubai are the furthest thing from a Black Swan event as we have all known about this problem for the better part of 6 months or more. The country is in poor financial shape and is, basically, insolvent without a bailout from its neighbor Abu Dhabi. The rulers of the two nations are related. I would be willing to bet that the bailout will come in some fashion, but only after an example is made of the smaller nation, but is this a Black Swan event? What is a more relevant question is will a technical default on Dubai's debt be a trigger for something bigger? The effects of these issues are unknown to me at this time because I do not know how China will respond, although I have my speculations, nor do I know what exposure US or European banks have to the Middle East at this stage of the game. I am willing to bet their exposure, especially JP Morgan (JPM), BoA (BAC) and Citi (C), is much higher than we all think since interest rates in that area of the world are much higher than the "norm" in the US and Western Europe. However, the real Black Swan events that I think are being ignored are the ones in Eastern Europe where currency devaluation and real sovereign default is actually happening and has been happening for some time now. Not that you ever hear about that from the media, but read about it sometimes in European blogs or news outlets - and it is disturbing. Basically, I believe the greenback will have the stay of execution I have been expecting for some time now and it should rally nicely on this possible default news. In reality, a Dubai default means very little to the US other than a sovereign nation defaulting, but it will trigger a flight to quality. The extravagant Dubai Palm Island and Dubai World building projects were bound to end in tatters for this small Emirate in the Gulf region. Now its wealthier emirate cousins in neighboring Abu Dhabi will likely bail out this commercial disaster for the good of the ummah.  It is also safe to say that the big interest shown in the Sharia bond market by the likes of JPMorgan Chase, Barclay's Capital, HSBC and others in the innovative capital markets may waned. Witness, these financial reports: "Dubai debt default fears spill into world markets" AFP The shock from Dubai's move to suspend payments due on a slice of government-backed debt spilled over on Thursday into world markets and caused a sharp weakening in global Islamic bonds. The move to restructure the state-owned Dubai World and the proposal to request a minimum six-month moratorium on its maturing debt has also triggered fears of a domino effect . . . pushing debt rating agencies to slash the grading of Dubai companies. The shock announcement has begun to undermine some stock prices, with traders in Paris partly blaming it for a 2.06 % drop in the CAC 40 index on Thursday morning. The fear of Dubai's default "fed a climate of insecurity and crisis of confidence at a time when fears are mounting about excessive public debt," said Xavier de Villepion, an analyst with Global Equities. Islamic bonds in Asian markets were also weakened following Dubai's announcement, Dow Jones News reported. A selloff in the Sukuk (Islamic bonds) of the Indonesian government and Malaysia's national oil company Petronas was linked by people in the market to Dubai's decision, it said. The once rapidly booming Dubai city-state, which has fallen a long way after being hit hard by the global financial crisis, said on Wednesday it intended to ask the creditors of its largest and most-indebted company,  Dubai World conglomerate which owns Nakheel, to "standstill" debt maturity for at least six months, as it restructures the company. Note this bit of schaden freude from Izabella Kaminska on the FT Alphaville blog,. regarding the foolish cupidity of Barclay Capital bullish report issued on Dubai debt just a few weeks before this debacle and its sudden turnabout. My, my, what a difference a few weeks make. Earlier this month — when all still seemed relatively well in the UAE emirate of Dubai — Barclays Capital was among those touting Dubai-related debt as a decent investment for clients. The bank even confidently predicted the repayment of the now infamous Nakheel Sukuk. In fact on November 4 — the day Moody's slashed its ratings on five Dubai government related entities — BarCap analysts wrote: We expect several developments to act as positive catalysts for Dubai's sovereign spreads. First, the likely repayment of the Nakheel Sukuk in December. Second, Dubai's ability to raise the second USD10bn tranche with the support of Abu Dhabi. Third, a successful conclusion of the merger between Emaar and Dubai Holding, as well as a solution allowing mortgage providers Amlak and Tamweel to resume lending. On that basis, we recommend a long position in Dubai sovereign credit and see today's negative price actions as an opportunity to buy. While the newly issued Sukuk is our preferred instrument, we also feel comfortable in a recommendation to sell 5y CDS outright or against the CDX EM Index in a relative value trade. Moody's, by the way, had warned Dubai's government was under no obligation to extend support to any government-related issuers either directly or through the support fund. They also wrote: "Moody's is therefore making a greater distinction between its view of the creditworthiness of Dubai's GRIs and that of the Dubai central government, which is itself viewed by Moody's as benefiting from support from the U.A.E. federal government." Unsurprisingly then when you fast forward to November 25 there's been a bit of a self-acknowledged u-turn from BarCap on the issue of Dubai debt. As they wrote in a note on Wednesday: Today's news carries a series of unexpected and surprising headlines when the Dubai Government announced that Dubai World will ask creditors for a standstill agreement to extend the maturities of all debt repayments by Dubai World and its property unit Nakheel until May next year. This announcement fundamentally changes our views expressed in our latest notes in November. Adding: Today's statements are relatively confusing and could underestimate market reaction to the broader set of liabilities of UAE entities. In particular, as spreads were widening on the back of an imminent default scenario by the largest bond issuer in Dubai, another Dubai government entity, with significant financing needs was announcing its willingness to issue. On the back of today's developments, we reassess our view towards Dubai as a whole. Fundamentals remain challenging and with uncertainty around the support and political agenda of Abu Dhabi concerning Dubai Inc, spread levels do not seem justified. The credibility of Abu Dhabi to support Dubai with respect to its financing needs is dented, in our view, eroding the main pillar of Dubai's creditworthiness. Dubai's 5y CDS spreads widened by about 130bp when the news emerged, also sending jitters through wider markets. The uncertainty and unpredictability around upcoming debt repayments implied by today's events will add to pressures on Dubai spreads, which may lead to a re-pricing of Dubai and UAE risk, in our view. For the further financing needs of Dubai, today's announcements imply an increased dependence on Abu Dhabi, as international investors are likely to be much less receptive for Dubai paper than they have been lately. Well, well. Who'd have thought, eh?  Sic Gloria transit the Sharia bond market and some of its biggest proponents in the world's capital markets.