Analysis The public feud between Shuaa Capital and its creditor, the Dubai Banking Group has all the ingredients of a financial soap opera.
Banking spat reveals boom-time excess
The public feud between Shuaa Capital, the investment bank, and its creditor, the Dubai Banking Group (DBG), over a Dh1.5 billion (US$408.6 million) convertible bond has all the ingredients of a financial soap opera, sending Shuaa's shares up, then down, and finally forcing the market regulator to intervene in the dispute last week. The saga also focused investors' attention on the legacy of short-term convertible bonds and other debts that were sold in the boom and are approaching maturity at a time of reduced liquidity and weaker economic confidence. "Last year, it made sense for everyone here to borrow as much as they possibly could," Youssef Nasr, the chief executive of HSBC Middle East, told a recent Moody's credit conference in Dubai. "It was basically a play against very negative interest rates." But a funding strategy that once made sense amid rampant economic expansion - taking out one short-term loan after the next, when rates were cheap and offerings abundant - is now causing chief financial officers sleepless nights across the region. The struggle between Shuaa and the DBG highlights the vulnerability of companies who raised short-term funds using debt that now need to be redeemed or rolled over. Should the DBG, part of Dubai Holding, get its way, Shuaa will be forced to pay back the Dh1.5bn it borrowed so easily in 2007 when oil-fuelled confidence in local markets was at a peak. If Shuaa has its way, the DBG will have to accept the terms of the original deal and convert the bonds into Shuaa shares instead. The shares are worth substantially less today than they were 18 months ago when the bonds were issued. Georges Makhoul, who heads the Middle East and North Africa operations of Morgan Stanley, says the mismatch caused by short-term finance paying for long-term projects is the nub of the problem. "It is the type of leverage and how you use it that gets you into trouble," he says. "Infrastructure projects like the ones undertaken here in the region should not be financed with short-term leverage and bank lending, but instead funded with long-term infrastructure type of bonds and leverage that would run up to 30 and 40 years. "What you need now is the restructuring of the existing leverage. If the returns are long term and you fund with short-term debt, then you face this crisis every year where you wonder how you are going to pay for it." There are many companies in the region that are now struggling under the burden of short-term debt issuances. Tamweel and Amlak, for example, the country's largest home lenders, are two more exaples of the mismatch between short-term funding, much of it as interbank lending, and long-term commitments to home buyers. Nakheel, the developer of Dubai's palm-shaped islands, is seeking to refinance a $3.5bn sukuk that comes due at the end of this year. Its efforts to refinance this debt are seen by credit agencies as a litmus test for how they assess Dubai government-controlled companies. Nakheel issued its three-year sukuk in 2006, when a downturn in the feverish Dubai property market seemed impossible. The bond came with an annual profit rate (the Sharia-compliant equivalent of an interest rate) of 6.345 per cent. To ease its cash flow, however, Nakheel arranged to pay just half of that, or 3.1725 per cent, during the life of the bond, pledging instead to pay the rest at maturity. What seemed a sensible move, given the then-rapid rise in property prices, has now become a burden. As the fallout from short-term borrowing becomes widely visible in local markets, analysts and credit rating agencies are asking what lessons can be learnt from the surge in corporate borrowing of recent years. "Debtors were planning on certain cashflows which did not materialise as the markets went haywire," said one senior UAE-based banker. "Restructuring is the way of the day. Until there is fresh lending, there will be pressure to restructure and extend the loans." Longer-term corporate bonds may represent a more sustainable route to providing funding for companies planning to expand or develop projects, analysts say. "A lot of these loans need to be rolled over into long-term borrowing, and that should be done by way of corporate bonds," says Mohieddine Kronfol, the managing director at Algebra Capital. Many bankers fear that despite the recent increase in appetite for Gulf corporate debt, there may not be enough liquidity available for all the loans that are now approaching maturity for them to be rolled over. "The recovery is still on a very weak footing and if credit were to taper off once again or if we saw another safe-haven run, things could turn ugly again," Mr Kronfol says. Companies that need to restructure their debt or raise new capital are faced with a local debt market that remains tight, despite recent indications that bank lending is starting to grow again. Behind closed doors, bankers admit they remain reluctant to open their vaults. "Local banks are not really in a lending mode," a senior UAE banker says. Another local banker says: "If I feel this is an opportune time for lending, then yes, I will start, but I don't think we should rush into it." With local equity markets recovering, the price of oil rebounding and a renewed flow of government funds priming regional economies once more, credit analysts fear companies seeking to raise funds will repeat the mistakes of the past by relying on short-term debt. "The recovery and the fact that oil is once again at around US$70 per barrel makes people comfortable, it slows down the recovery process, it lulls us into complacency," Mr Kronfol says. The past three months has seen a flurry of activity in regional debt markets after a dormant first quarter. Recent sovereign and semi-sovereign bond sales have included issuances by the governments of Bahrain, Qatar and Abu Dhabi, as well as companies such as Q-Tel and Aldar. "Despite significant bond issuance volumes since the beginning of the year, liquidity remains fragile for corporate issuers in EMEA [Europe, Middle East and Africa]," Jean-Michel Carayon, a senior vice president in Moody's Corporate Finance Group, said last week. Most bankers and economists agree that the UAE has taken some tangible steps towards easing the liquidity crunch, such as the recent $10bn bond issue by the Dubai Government, intended to help developers tackle their most immediate funding requirements and pay their contractors. The UAE last week passed a law on government debt that enables the Federal Government to borrow by selling bonds, while also establishing limits on that government borrowing. Saudi Arabia's Tadawul exchange also started trading sukuk last week. However, there have been few new corporate ratings and no new corporate bond issues by non-government backed entities. "The private sector has been slow in playing its role," Mr Kronfol says. "Whether Dubai's debt stands at Dh80bn, Dh90bn or Dh100bn is irrelevant," Mr Makhoul says. "What is relevant is where the cash flow is coming from to service that debt, not to pay back the total, but to service it one piece at a time." firstname.lastname@example.org