Banking & Business Review, UAE Digest

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COVER STORY

FEAR STALKS
Fear of the unknown is the worst kind of destabilizer. When you don’t know what is in store for you, it places you in the most awkward situation. Businesses, companies, employers and employees in Dubai are all going through this uncertainty as they try to second-guess how each one would be affected in the wake of the global financial crisis which has taken stranglehold of an unprecedented nature on the affairs of the emirate.   Much of the concern over Dubai is focused on the direct impact of a real estate slowdown, which almost certainly entails delays and cancellation of projects, directly affecting banks and financial services as they have substantial exposure to the property sector. With credit crunch acquiring precarious dimensions, both business credit and personal finance channels are drying up, jeopardizing retail consumption spending, which is vital for the smooth running of the emirate’s economy. Added to this, the possibility of bankruptcy, particularly of smaller developers coupled with the shrinkage of real estate dependent industries such as estate agency, architecture and advertising is resulting in increasing lay-offs.  These issues are seen further compounded by the effects of a global recession, affecting retail, tourism, leisure and ports businesses, implying a slowdown in the rate of immigration, which is the main driver of  Dubai’s economic boom.   There is a visible drop in the footfall at all shopping malls as customers are becoming more cautious with their money in keeping with the somber mood all around. The hospitality industry, particularly hotels and restaurants are reporting a decline in business while the flow of visitors and tourists has taken a hit from the global turmoil. On the other side, there is a steady increase in the outflow of people due to loss of employment and the deteriorating economic outlook over short and medium term.   A sustained drop in the oil price, a sharper-than-expected drop in real estate for the Dubai economy as a whole, sustained negative levels of immigration and a lack of further progress on increasing transparency are seen as other major downside risks. Issues relating to transparency, lack of official statistics and a ‘regulatory framework that often plays catch up’ with the market have all made the depth of the problem incomprehensible.   The stock markets are suffering from a crisis of confidence, with share prices factoring in a worst case scenario bordering on systemic collapse. Although the government is taking measures to restore confidence, it is seen as a time-consuming process as investors and the market as well as the authorities adjust to new realities, and initial reactions from all segments of the economy are downbeat.   Dubai has thrived on the oil-surplus earned by the GCC, Iran , Russia , and private savings from South Asia and OECD countries. Since the oil surplus could evaporate quite quickly, Dubai is probably much more vulnerable than countries such as Kuwait or Saudi Arabia that generate the surpluses. The strong domestic demand that was driving Dubai ’s growth was based on the influx of expatriates, which filtered down to a booming financial sector and the sharp increase in real estate prices. If the global oil surpluses shrink, this is not only likely to ease the inflow of expatriates, but could also result in some retrenchment. Hence, it seems highly unlikely that Dubai will be able to sustain the growth momentum that has been in play since 2005.

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3/6/2009

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  The global rating agencies are now veering around the view that the impact of the difficult global macroeconomic and financing environment on Dubai   would be much more serious than it was considered earlier. According to Standard & Poor’s, for instance, the medium-term risks to Dubai’s economy have, increased as demand in the real estate sector shows clear signs of abating, raising the possibility of a sharp correction in this market. The impact on Dubai ’s overall economy would be significant as construction and real estate account for almost 50 per cent of Dubai ’s GDP, it feels.   “Plunging oil prices, an economic slowdown, the falling stock market, and pressure on real estate prices are raising major hurdles for Dubai-based banks,” said Standard & Poor’s credit analyst Emmanuel Volland. “Looking forward, these factors are expected to lead to a major slowdown in business growth and deterioration in asset quality and profitability.” This comes at a time when liquidity has also deteriorated rapidly. Loans granted by banks in the have been growing annually by an average 35 per cent over the past four years. After Qatar , this is the fastest rate of loan growth observed in the Gulf. The pace of growth even accelerated in the first half of 2008, boosted by massive borrowings from the government and government-related entities. While customer deposits also increased rapidly, this could not keep pace with the growth in lending. As a result, the loan-to-deposit ratio exceeds 100 per cent for the whole banking sector, forcing banks to rely on wholesale funding that is more expensive and could prove volatile, S&P analysts said.   The rating services said it revised its outlook on the ratings of six Dubai-based Government-Related Entities (GREs) to negative from stable. The entities include DIFC Investments LLC, DP World Ltd., Dubai Holding Commercial Operations Group LLC (DHCOG), Dubai Multi Commodities Centre Authority, Jebel Ali Free Zone (FZE), and JAFZ Sukuk Ltd. Similarly, it downgraded other rated companies including major real estate players and banks on the basis of deteriorating economic outlook. The outlook for Emaar has been revised to negative from stable, although the ‘A-’ long-term corporate credit ratings have been affirmed, while Dubai Islamic Bank, Emirates Bank International and National Bank of Dubai have been downgrade to negative.   “The outlook revision reflects the impact of the difficult global macroeconomic and financing environment on Dubai to which the ratings on these six entities are directly linked,” said Standard & Poor’s credit analyst Farouk Soussa.   S&P said the impact on Dubai ’s overall economy would be significant as construction and real estate account for almost half of Dubai ’s GDP. Dubai ’s position as a global commercial and financial hub also exposes it to the risk of a prolonged downturn in global trade and financial intermediation. The agency expects that GDP growth will slow to around 6 per cent in 2009, from an average of 15 per cent in recent years.   It said the negative outlook on the six GREs reflects the worsening economic prospects of the emirate to which all six ratings are directly linked. “The ratings will be lowered should the economic slowdown be deeper and longer than currently expected, or if liquidity concerns raise financing risks to the governments and its GREs,” Soussa pointed out.   The outlook revision of Emaar reflects a rapid weakening of the real estate markets in Dubai , and the uncertainties about the depth of the downturn and the pace of eventual recovery. A  prolonged downturn could negatively impact its view of Emaar’s business risk, and it could also lead to deterioration in Emaar’s currently healthy financial position, said Standard & Poor’s credit analyst Alf Stenqvist.   The ratings on Emaar continue to reflect the group’s important role and strong position in the Dubai property development market and its close relationship with, and 32 per cent ownership by, the government of Dubai . The rating includes a two-notch uplift from the stand-alone assessment to reflect implicit support from the

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3/6/2009

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government of Dubai . The rating also reflects the group’s current strong cash flows, low debt leverage, and strong asset base.   Constraining rating factors include the weakening of the Dubai real estate market, the concentration of the group’s operating cash flows in a relatively small number of large projects, and the group’s aggressive geographic expansion into markets with higher political and economic risk. On Sept. 30, 2008 , the group had total interestbearing debt of about Dh9.1 billion ($2.5 billion), the agency pointed out.   It said Emaar’s expansion in the Middle East and North Africa has so far offered only a limited cushion against the downturn in Dubai, and the company’s US operations are loss making. The negative outlook reflects the weakening of real estate markets, which if prolonged and more severe could put pressure on Emaar’s cash flows and financial position, and subsequently could lead to a downgrade in the medium term, it said.   A Citicorp report described the Dubai real estate sector particularly vulnerable, as the emirate created generous mortgage financing to build demand. “We believe bank lending in the UAE is particularly exposed to Dubai ’s real estate sector, as this includes not only simple mortgage loans, but loans to non-bank financial institutions (mortgage financiers) and corporate loans to real estate developers or other companies that have exposure to real estate. With banks and mortgage companies now demanding higher equity payments on new mortgage loans to protect themselves from a fall in prices, demand for real estate has dropped,” it pointed out.   Although Citicorp analysts do not foresee a collapse in real estate prices, they feel that with real estate in the US , Europe and most other countries already softening, there is an additional risk that home-owners in Dubai may opt to shift their wealth to “corrected” markets before something happens in Dubai . “This means an upperbound for Dubai real estate has been created, and if the current gloom continues, this ceiling may shift down over time”.   “With few buyers in the market, pipeline projects are unlikely to be completed. Less capitalised private developers that account for about 20 per cent of the market, and have specialised in off-plan sales, may have to exit the market. Recent statements by the dominant government-owned developers such as Emaar, Nakheel and Damac that they may cut back their workforce, is a clear indication to us of the problems ahead. How this process is managed will determine whether the problems in the real estate sector could infect the banking sector,” they pointed out.   Another source of concern is the refinancing risks associated with UAE-based borrowers. As global market appetite eased with the credit crunch in mid-2007, Dubai based quasi-PSEs and local banks increased their reliance on syndicated loans. For instance, the volume of international bonds issued by Dubai entities in 2007 overshadows the much larger Saudi Arabia . As of June 2008, UAEbased entities had outstanding bank loans totalling $96 billion and securities of $53 billion.   The high levels of leverage in some entities that are part of Dubai Inc., coupled with tight domestic liquidity and global risk aversion, make refinancing that much more difficult. Information on maturities varies and the range is quite wide at $15-37 billion due until end-2009. According to S&P, UAE borrowers faced maturities of S$9 billion in the final quarter of 2008, and most of this is repayments on syndicated loans. It is widely believed that with global aversion to lend, it is highly unlikely that foreign banks will be willing to roll-over such loans. In effect, how the authorities manage this exposure will determine investor confidence in Dubai itself.   The worsening credit environment has raised concerns over the scale of Dubai 's debt and its ability to service it, given that Dubai has relied extensively on leverage to fund its growth strategy. As a result, credit default swap (CDS) spreads on Dubai-based entities have widened significantly over the past few months, implying a

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3/6/2009

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relatively high probability of default. For example, According to EFG-Hermes, current spreads suggest that the market is pricing in a 40 per cent probability of default for Dubai Islamic Bank, 46 per cent for Dubai Holding Commercial Operations, 57 per cent for DP World, and 42 per cent for the Dubai government. Analysts, however, also note some of the positive aspects of the situation. Although the real estate sector remains precarious, they say they are impressed with the maturity of certain policies put forward by the government of Dubai . Off-plan real estate transactions are now heavily regulated to discourage speculation, and fraudulent real estate transactions have been made public to delink banks from real estate developers.   They point out that the decision to allow local banks to increase upfront equity even at the cost of reducing demand for mortgages, is a telling example of how the authorities want banks to be immune from a sizeable correction in real estate valuations. But, given the excess supply that currently exists, they believe it also suggests the government of Dubai is looking at a long-term adjustment in the sector, whereby once demand picks up in 2010, the spare capacity will be taken up. The costs entailed in such a holding phase would have to be borne by the government of Dubai , or the broader federation.   In this context, Standard Chartered said in a report that the liquidity support facility introduced by the central bank has not produced the desired results. As liquidity became tight, the authorities responded with two facilities. First, the central bank introduced a liquidity support facility (LSF) to make it easier for banks to borrow from the central bank. The second facility involved direct injections of liquidity to banks in the form of two-year deposits.   The central bank also tried to revive the repo window, announcing that all banks could repo certificates of deposit (CDs) of 14 days or more, with the repo term subject to the remaining life of the collateralized CDs (up to a maximum of 3 months). Banks are also allowed to borrow against other debt security holdings with no embedded options (with eligibility criteria decided by the central bank).The estimated size of the two facilities is Dh120 billion in total. According to the Standard Charted report, while the policy response has been appropriate and decisive, the transmission mechanism for monetary policy is not functioning. The main obstacle is the absence of a fully functioning permanent repo window. The bank feels that the fresh injection of cash can only be used to help local banks reduce their loan-to-deposit ratios which are in excess of 100 per cent and cannot be used for any new lending purposes. The impact on the interbank market has therefore been limited, helping the three month EIBOR to only ease by 30bps. -K Raveendran  

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3/6/2009

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