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MENA CDS activity of late is eerily reminiscent of the risk “contagion” caused by investors questioning Dubai’s debt-servicing capabilities in late 2009 when [irrational] fear spilled-over to Abu Dhabi as well even though the latter’s fiscal integrity was never seriously in question, a fact later confirmed when it underwrote a bailout. But if such objective measures are largely ignored in the market of default probability perception, perhaps it should come as no surprise that more nuanced, subjective ones such as the differences between the historical, social and economic dynamics of say, Saudi Arabia versus Egypt, also fail to be carefully analyzed. Even The Economist’s latest stability rankings, for instance (see chart)–the result of ascribing a weighting of 35% to the share of the population that is under 25; 15% to the number of years the government has been in power; 15% to both corruption and lackofdemocracy indices; 10% for GDP per person; 5% for an index of censorship and 5% for the absolute number of people younger than 25–seem inadequate. An accompanying piece, for instance, notes that in Saudi Arabia (whose marginalized Shia population is, unlike in Bahrain, a relative blip) the unity of unrest seen elsewhere may be structurally unlikely: “Building an opposition movement is difficult in Saudi Arabia. [While] grievances are plenty: about living standards, poor schools, lack of jobs, the government is adept at using repression, propaganda, tribal networks and patronage to divide and weaken any opposition. Middle-class liberals are wary of democratising steps that might give more power to anti-Western Islamists. State-backed clerics have denounced the Egyptian and Tunisian protesters, and issued fatwas against anything similar in Saudi Arabia. Only in the [admittedly oil rich] eastern province—home to a large Shia population—is there much tradition of protest. But community leaders there are cautious, and desperate to avoid any accusations that they are a ‘fifth column’ for Iran.” Barclays too notes that addressing how immediate tensions in the region may unfold is at least partially dependent on a given military: “Bahrain’s military is almost entirely composed of Sunnis and there is a significant foreign element in the ranks as well. Hence, they may be more willing to brutally suppress dissent than their Egyptian counterparts and the regime may not be as concerned about possible splits within the officer corps,” it wrote to clients. That said, perhaps such “nuance” is just noise from the collective market’s point of view. The real concern for Saudi Arabia may not be the emotional state of its Shias but rather the physical soundness of the 18-mile-wide strait Bab el-Mandab.
According to Bruce Powers, a Dubai-based technical analyst and financial commentator, “it seems like investors have now distinguished between Dubai’s problems and [those of] Abu Dhabi.”
On a relative basis the Abu Dhabi Securities Exchange General Index (ADI) has been showing strength compared with the Dubai Financial Market General Index (DFMGI). That strength is likely to continue into the foreseeable future barring conclusion of Dubai’s debt restructuring. Although there are similarities in the chart patterns of each market, the ADI has broken through its downtrend line resistance level while the DFMGI remains below it.
Herd-caused contagion afflicted the perception of risks for assets across the Gulf last fall on worries about possible Dubai-related defaults, as well as questions over the emirate’s vision for its long-term financing. At their peak, even credit default swaps for five-years bonds jumped 177 basis points for Abu Dhabi, and 119 for Qatar, respectively, despite no apparent concern per se over the strength or volatility of their cash flows. Analysts noted, for instance, that Qatar has the world’s second largest gas reserves, and oil-rich Abu Dhabi has the biggest sovereign wealth fund, worth approximately $700bn.
While touting Abu Dhabi-based Aldar Properties, investment bank Prime Holding notes in a recent research note that “the prevailing economic downturn has had a limited impact on Abu Dhabi’s long-term development plans,” and that “the Capital’s rich hydrocarbon reserves and years of prudent fiscal spending have helped Abu Dhabi maintain an enviable liquidity and financial position with sovereign reserves estimated at over USD600 billion.” That said, “[the emirate’s] real estate sector continues to suffer from years of underinvestment and therefore exhibits strong pent-up demand for prime-quality residential and commercial units, retail and hospitality space.” Prime’s sum-of-the-parts (SOTP) DCF analysis yields a fair value of AED5.8 per share, “indicating an upside potential of 17.2% over the current market price.”
A potential secular property convergence in Abu Dhabi can also be traded via Sorouh Real Estate and RAK Properties, the emirate’s second and third ranked property firms by market cap.
Bank of America’s tail-risk warning may indeed be precisely the impetus needed for another Abu Dhabi (the emirate of last resort?) -financed bailout, though there is some question as to whether the technical defaults of two state-owned firms–Dubai World, an investment firm, and Nakheel, a real-estate subsidiary of Dubai World–necessarily imply the defacto default of the sovereign emirate as a whole in the first place. In fact, argues Gavan Nolan, a research analyst at Markit Group, a financial information services company:
“It should be made clear that the Dubai sovereign is not in any immediate danger of a default. The standstill, if it is mandatory, may constitute a technical default on Nakheel and Dubai World. However, the Dubai government did not make an explicit guarantee on the companies’ debt, and are under no legal obligation to honour the debt. This is clearly the position Dubai’s wealthy sister emirate Abu Dhabi favors. Its actions this week seem to indicate that, while it will support the sovereign, its backing is conditional. The funds are available – Abu Dhabi has immense oil resources and the world’s largest sovereign wealth fund. Indeed, Dubai has already been advanced funds by Abu Dhabi. But it was quite clear that Nakheel and the rest of Dubai World will not be allowed to benefit from the largesse.”
The exact point was trumpeted by Saud Masud, a Dubai-based real estate analyst, in a comment made to Bloomberg:
“Abu Dhabi and Dubai have decided to seek to bolster long-term confidence in the market by forcing weaker parts of government businesses to take responsibility for bad decisions and could involve defaults at some Dubai firms, Masud said.”
Less debatable, however, is the absurdity of the hitherto resulting regional contagion, which immediately drove up the cost of protecting emerging-market sovereign debt against default. Default swap contracts on Abu Dhabi rose 23 basis points to 183, Qatar climbed 17 to 131, Malaysia was up 11 at 104, Saudi Arabia climbed 18 to 108, while Bahrain rose 22.5 to 217. Having said that, one could buy the theory that the Dubai announcement is merely the requisite impetus whereby the ‘risk rally’–which having essentially been on since March seemed destined to eventually taper–unwinds. If the rally does unwind, moreover, frontier and emerging markets, which represent the tail end of the risk curve, would be the first to feel it. Templeton Asset Management Ltd.’s Mark Mobius, for example, said on Friday that Dubai’s attempt to reschedule debt could indeed cause a “correction” in emerging markets.
Yet even a market correction per se should not correlate with a higher sovereign default risk–this is where the current, broad brushstroke of contagion should be arbitraged. Abu Dhabi and Qatar, for instance, remain as resource and reserve rich as ever, objectively speaking. But fund managers clamoring to keep in tact whatever YTD returns they have may be hesitant to brashly step in front of the bus so quickly–suggesting the sudden and drastic point spike may even have some more legs to it. Nevertheless, ultimately, as Silk Invest’s Baldwin Berges reminded investors on Friday, “the major driving forces for the GCC region’s economy are still intact: high reserves, low taxes (competitive advantage) and geographic location. It’s all about perspective, investor sentiment and above all valuation. The medium term investor could be looking at a great opportunity here.” Nolan concurs:
“The sovereign CDS market sometimes has a habit of conflating geographical proximity with economic similarity (eastern Europe earlier this year springs to mind). Unlike Dubai, the countries mentioned above have significant natural resources and their public finances are in better shape. To an extent this has been reflected in CDS spreads for some time (see chart above). It seems that Dubai is something of a special case and its problems are not necessarily found elsewhere.”
According to many analysts, global sukuk issuance may receive better pricing than other types of bonds given the relatively comfortable liquidity levels of Islamic institutions vis a vis their conventional counterparts. For instance, the Abu Dhabi-based Tourism Development & Investment Company (TDIC), whose inaugural $1bn conventional bond tranche under a$3bn Global Medium Term Note (GMTN) Program this past summer was oversubscribed while being priced to yield 390 basis points over U.S. Treasuries, is hoping to raise close to another $1bn for general corporate purposes, per two unnamed bankers. Among other current endeavors, TDIC is working on “spin-offs” of the Louvre and Guggenheim museums in the UAE capital. Additionally, last month the Jeddah-based Islamic Development Bank raised $850 million through a five-year sukuk priced at par that yielded 40 basis points over five-year mid-swaps, and 77 points over five-year benchmark U.S. Treasuries respectively. Meanwhile, ratings agencies Fitch and Standard & Poor’s both assigned an AA rating to the TDIC issue, while Moody’s assigned Aa2. Per S&P, the sukuk market has languished in 2009, falling roughly 16%. That said, the agency sees a “strong pipeline” of issuance in waiting. Nevertheless, citing a tepid investor response to a four-year lockup period, HSBC recently delayed the launch of its first Sukuk-based fund.
Citing Dubai’s deteriorating credit worthiness–government debt is expected to reach some 40% of GDP by year’s end–Fitch placed the UAE’s largest telecoms firm, Etisalat, which is 60.03% owned by the UAE and is the second-largest operator in the MENA region by market capitalization, on watch with a negative outlook. The firm’s AA- credit rating could be downgraded, Fitch warned, if government officials did not further articulate its willingness to cover the company’s debts (some commentators astutely noted that what this is in fact asking is to what extent will Abu Dhabi’s massive oil reserves further insure its arguably profligate sibling). “While the [UAE’s] sovereign credit remains strong, the lack of clarity on the process for non-budgetary financial transfers between the UAE federal government, central bank and individual emirates, is a source of weakness,” the rating agency noted.
The downgrading of Etisalat, however, would be curious, and almost certainly arbitraged away. The company enjoys a share price to operating cash flow ratio of 8, and a beta of .63, meaning it is less volatile than the overall market. Most important to its prospects for sustained profit growth, however, is a growing portfolio of overseas assets. This is especially vital to operations as the UAE’s mobile penetration rate has now exceeded 209%, meaning every single resident of the country currently has two lines to his or her name. While 90% of its revenues are UAE-derived, Etisalat is poised to capture emerging market share: in addition to the seventeen countries it currently operates in, the company acquired an Indian operator earlier this year and has submitted bids in Sri Lanka and Libya.
Government-owned National Bank of Abu Dhabi (NBAD), the nation’s second-largest bank by assets and largest by market value, was ranked among the 50 safest banks in the world in 2009, per Global Finance. The annual ratings compare the long-term credit ratings and total assets of the 500 largest banks around the world. This on the heels of a second-quarter profit fall of 9.3% from a year ago (though net profits were up 17.7% from the first quarter).
Earlier this month NBAD formally announced its intentions to not only double its operations in Egypt, but also to expand into the “fast-growing” Indian market. Earlier this year, the government-owned bank set up a representative office in Libya, with the aim of strengthening its presence in that country and North Africa. And sources also suggested last month that the bank, which already has three outlets in Sudan, plans to be one of the principal financial institutions in that market.
National Bank of Abu Dhabi (NBAD), the country’s second-biggest bank by assets ($45 billion), will open branches in Jordan and Hong Kong before the year’s end, given the fact that there exists a strong contingent of citizens from said countries in the UAE. The Bank will also expand into Libya (one branch next year), Oman (three branches by 2010) and Egypt (twenty-two branches by 2013), according to Qamber al-Mulla, senior general manager, International Banking Division, who noted that further growth may lead the firm into the banking sectors of Morocco, Algeria, Lebanon and Turkey. The Bank beat analysts’ estimates earlier this week when it reported a 9.5% drop in second-quarter profit. Moreover, it told Bloomberg that it expects its loan book to grow to 15% in 2009 after a rise of 11.1% between June and December. That said, non-performing loans (NPL) across Gulf banks are expected to rise by 3-4x their current levels, Moody’s related in June, due to the economic slump and the falloff in property prices, the report notes.
Back in March, the Bank’s CEO, Michael H. Tomalin (pictured), noted in an interview that the “basic story of the UAE [was] a very strong story,” despite the ongoing property correction.” He also disputed the oft-repeated accusation that the region’s lenders were overzealous, even well-into the early stages of the world’s credit collapse. “I don’t think banks were imprudent in terms of developing the UAE. The job of the banks in the country is to support the economy and to mobilize deposits on the one hand and apply them to projects on the other. They also financed people and businesses so the economy could grow. The economy was growing and what was happening was that the banks were following and supporting the growth in the economy,” he argued. Perhaps his most salient point, however, touched on the difference between capital and liquidity:
“The [UAE’s financial system] system as a whole needs extra liquidity. The issue is liquidity, not capital. The capitalization of banks in the UAE, generally, is very strong. Banks in the UAE are very strong banks, they have very strong capital positions, there is nothing wrong with their capital positions. The difficulty for the UAE, is because nothing to do with the UAE by the way we are part of the global marketplace, foreign moneys that came into this market were withdrawn.”
Over five months later, liquidity in the UAE still remains an issue. While the UAE Central Bank Governor Sultan bin Nasser Al Suwaid said on Friday that “the UAE banking sector has high levels of liquidity compared to a few months ago,” that “banks are back to extending personal and small loans,” and that the availability of cash and credit was “much better now than it was around four months ago,” Tomalin disagreed:
“There is no doubt that there isn’t enough liquidity in the system,” Tomalin. “There has to be either some quantitative easing by the Central Bank broadly speaking–by buying in securities from banks and giving them money–or some easing in the ratios. Because banks are tight for liquidity, there is quite a bidding war for deposits, and this is keeping interest rates higher than they should be.”
Interest rates have indeed remained high–the one-month Emirates interbank offered rate, which banks charge for loans, is 1.98750% compared with LIBOR’s 0.2756%. Earlier this week, the Central Bank noted it would like to create an “official” interbank rate in order to boost lending.
Abu Dhabi-based Agthia Group, a holding company with three subsidiaries operating in the distribution and bottling of mineral water; the production of flour, animal feed and frozen and canned vegetables and the distribution of baby food, tea, juices and jam, reported strong growth (group sales up 18.7%; gross profit margin up 11.4%; and net profits doubled) for the first six months of 2009. Per its Chairman, Rashid Mubarak Al Hajeri, the results are a “testament to the defensive nature of the food and beverage sector. The growth registered this quarter builds upon the strong first quarter performance and sets a positive scene for the rest of the year. Agthia’s performance for the first half of 2009 demonstrates the strength of the company’s core businesses and the effective implementation of management’s strategic and financial initiatives.” According to analysts, the increase in revenue was predominantly driven by sales volumes, with flour and feed up 7.6% (16.6% volume growth), and water and beverages up 42.8% compared to same period last year.
Abu Dhabi-based Etihad Airways announced that it expected revenues to grow 24% to $3.1 billion this year as the company takes deliveries of 11 aircraft and boosts passenger numbers by adding at least six new routes. “We are taking a bullish approach in 2009 despite tough market conditions,” Etihad Chief Executive James Hogan noted. There are risks, there’s a global recession and we are seeing weakening currencies, softening demand worldwide, volatile oil prices. But 2009 and 2010 are also years for Gulf airlines to continue to grow.”
That said, world airlines are set to lose $4.7 billion in 2009 as a result of shrinking passenger and cargo demand, industry body IATA said. The International Air Transport Association had estimated in December the industry would lose $2.5 billion in 2009. “The state of the airline industry today is grim. Demand has deteriorated much more rapidly with the economic slowdown than could have been anticipated even a few months ago,” its Director-General Giovanni Bisignani said.
JGW
Frontier Markets 