With details of the debt standstill proposal for Dubai World and its subsidiaries now published, the banking sector is hoping to benefit from the trickle-down effect.
The promise in Dubai's news
Four months of negotiations ended last Wednesday in a windowless Dubai hotel conference room where Dubai World tabled its restructuring proposal to a small gathering of creditors. Investors breathed a sigh of relief the following morning when the terms of the offer were made public. Markets rallied and contractor creditors greeted the offer with cautious optimism. Granted, the 97 bank creditors must still decide whether the proposal is acceptable. But the formula for a possible restructuring of US$23.5 billion (Dh86.31bn) of Dubai World's debt looks likely to make life easier not just for local banks, but also for customers seeking to obtain loans to buy cars, homes and other items. The trickle-down effect could also help to relieve the pressure on the country's financial system created by bad loans. If Nakheel were to fully repay its small builders - those to which it owes as much as Dh500,000 each - and partially satisfy its obligation to its bigger builders, new cash would flow into the system. Subcontractors, many of whom borrowed from banks, could repay their loans. That at least, is the theory. "The biggest positive for me is that the trade creditors would be paid a lot of money," says Deepak Tolani, an analyst at Al Mal Capital in Dubai. "That puts cash in the hands of trade creditors, and subcontractors will start to get repaid." The 40 per cent cash payment proposed by Dubai World implies nearly $4bn going to contractors, according to calculations by Saud Masud, an analyst at UBS in Dubai. "There were so many contractors who were not being paid in time and kept rolling over their credit facilities," says John Tofarides, an analyst at Moody's Investors Service in Dubai. "Some of that money could be directed back to the banks, and that should mobilise some new lending elsewhere." A second major part of the proposal - the full repayment of two Nakheel sukuk valued at an overall $1.8bn and due this year and next year - would also be expected to benefit local banks. According to the IMF, banks in the UAE hold 80 per cent of the Nakheel sukuk. Repayment by the property developer would also return cash to the system. Also significant is that because the proposal does not foresee any immediate haircuts, large write-offs by local banks would be averted, at least in the near term. Local banks have already been hit hard by the downturn in the general economy, and especially in the property sector. Consequently, the value of many of the assets on their books has been greatly reduced. But while more cash makes everyone happier at first, it is unclear how much new lending Nakheel's repayments would generate. "The proposal definitely lifts the cloud hanging over stocks, including bank stocks, but the liquidity issue is still there," Mr Tolani cautions. In recent months, growth in lending and customer deposits has been sluggish. Bankers regularly call on the Central Bank to inject fresh liquidity into the system. Instead, the regulator points to its well-capitalised banks and insists it has made available Dh120bn of additional facilities since late 2008. UAE banks are capitalised at an average 20 per cent, which is far higher than the average for their international peers. However, international and local banks have cut back on fresh lending, and interest rates remain stubbornly high. Bank profits fell sharply last year after banks began making higher provisions because of non-performing loans. Layoffs among workers, the fall in property prices and a trade slowdown have caused a growing number of commercial and retail customers to default on their loans. The Central Bank expects the proportion of non-performing loans at UAE banks to rise to an average of 6.5 per cent this year. Some analysts believe the figure could rise as high as 10 per cent, if the local levels of non-performing loans for Standard Chartered Bank and HSBC, the two biggest international lenders in the country, are anything to go by. Last year, they had estimated non-performing-loan rates of 9.5 and 12.2 per cent, respectively. "It still does not mean that banks will now lend to everybody," says Janany Vamadeva, an analyst at Al Futtaim HC Securities in Dubai. "However, this restructuring deal would remove a major unknown and could boost the macroeconomic situation." Until last Thursday, when they received news of the debt proposal, many banks had feared having to accept significant haircuts on their loans to Dubai World. A 40 per cent haircut, for example, means a debtor pays back only $60 dollars of his $100 dollar loan principal. In that case, the bank has to write off $40. For some lenders, such as Abu Dhabi Commercial Bank, which lent Dh9bn to Dubai World, any haircut would have seriously impaired their profitability. Some analysts say that if large haircuts had been imposed, some banks might have had to raise fresh capital. Any solution involving rolling over old debt into new debt means few or no write-offs for banks. It is unclear even among analysts whether banks would have to write off lost income or income not earned if they received lower interest payments on loans to Dubai World that were rolled over. In the meantime, many hope that a settlement between Dubai World and its creditors triggers the desired resumption in bank lending. "This gives a boost of confidence into the banking system because it shows that Dubai has the willingness to support Dubai World and Nakheel," Mr Tofarides says. firstname.lastname@example.org