For a year or so, the movers and shakers of the small but oil-rich United Arab Emirates have watched the unfolding of the credit crisis in the West with a mixture of dismay and denial. It won't happen here, was their view. And for a long time it didn't. But now it is. The price of oil, the lifeblood of the Persian Gulf economy, has fallen more than 60% since its mid-July peak. Real estate, the other mainstay, especially in oil-poor Dubai, has been quick to follow. An industry source in Dubai estimates that prices, which rose about 14.4% in the first eight months of this year, have suddenly dropped by 20% to 30%, with some developments seeing 50% declines.
With prices for villas and apartments falling and sales grinding to a halt, big developers such as Nakheel, which is building the iconic palm frond-shaped projects on fill dredged from the sea bottom, are halting construction and laying off staff. Jobs, though on a lesser scale, also are being lost at investment banks such as Morgan Stanley (MS) and Goldman Sachs (GS), which have seen the Gulf as one place business was not drying up. They are now trimming staff, to the alarm of the local authorities, who have staked their future on the Gulf's becoming a global financial center.
A chill wind is blowing through the Gulf. Credit has dried up; stock exchanges have crashed; and the region's once-vaunted Sovereign Wealth Funds, set up to save for a future when oil reserves are exhausted, have instead sustained huge losses, potentially in the hundreds of billions of dollars.
The diciest situation is unfolding in the UAE, where the sheikhs of Dubai—the second-largest of seven emirates—are at last realizing that they need to call time on a decade-long, debt-fueled building and acquisition spree. That admission came most explicitly in the recent naming by the ruler of Dubai, Mohammed bin Rashid al Maktoum, of what looks like a war council composed of nine of the top executives of what is known as Dubai Inc. That's the network of companies such as Dubai World, Emirates Airline, and Dubai Holding that are controlled by the ruling family and the government. "Yes, we recognize the new reality," said the Council's Chairman Mohamed Alabbar on Nov. 24. "Make no mistake."
It has long been assumed that if Dubai got into trouble, it would be bailed out by its neighbor, Abu Dhabi, one of the great oil powers and the deep pockets behind the UAE. Already there are signs of a rescue process beginning. It's being handled at the UAE federal level, with Abu Dhabi likely providing whatever funding is needed. Trading in the shares of two publicly traded but partly state-owned mortgage finance companies, Tamweel and Amlak Finance (AMLK), was suspended on Nov. 20. The two companies, which account for about 50% of the mortgage market, with $5.5 billion in assets, are to be merged into a little known federal government entity called the Real Estate Bank of the UAE.
In addition, the UAE has guaranteed all bank deposits for three years and has earmarked about $33 billion for support of the banking system. Nominally, the capital is coming from the central bank and the UAE Ministry of Finance, but, as one analyst put it, "All money in the UAE comes from Abu Dhabi."
What bankers and other executives are trying to work out is how costly the rescue of Dubai is going to be and how it will be paid for. The Dubai elite are hoping they can restructure their businesses largely on their own without major support from next door. Alabbar said that the big Dubai real estate developers, Emaar Properties (which he chairs), Nakheel, and Dubai Properties, which together command 70% of the market, would now work together to control supply. He also promised that there would be no major defaults. "The government can and will meet its obligations," he said.
For the first time, Alabbar provided some disclosure on Dubai Inc.'s debt. He pegged Dubai's state obligations at $10 billion and said the debt of affiliated companies was $70 billion. That's roughly equal to the emirate's $80 billion GDP. He also said Dubai's assets are about $350 billion. Analysts, though, say that only a fraction of that could be quickly turned into cash.
Analysts have applauded the straight talk, though some grouse that there is still little disclosure on matters such as cash flow. "This is precisely what everyone was looking for," said Mushtaq Khan, regional economist at Citigroup (C).
Some credit analysts are relatively comfortable that Dubai can manage through the downturn. "Our analysis is that their interest payments are covered approximately 10 times by cash flow today," says Farouk Soussa, an analyst at Standard & Poor's (MHP). Soussa notes, however, that in the current climate those flows could fall.
Going Sour Fast
But the problems in Dubai may be only just beginning—and could get very expensive. Real estate industry insiders note that the downturn could be especially messy because the property market in Dubai is relatively new and hasn't yet been tested by a slump. The market is turning sour very fast. Many small developers are likely to get in trouble. Speculators, a big factor in Dubai real estate, are likely to walk away from properties they have bought on small deposits with the intention to resell them quickly. It's also not clear that the banks will be able to enforce foreclosures, particularly against property owned by UAE citizens.
Certainly, stock prices and credit metrics are showing signs of distress. Credit default swaps for Dubai Holding, the umbrella company for the ruler's hotels, real estate, financial firms, and other assets, have soared to a point where it would cost $1 million to guarantee $10 million in debt against default, according to financial researcher Markit. Dubai Holding recently said it had paid off $653 million in loans and bonds.
Emaar Properties shares have fallen by about 85% so far this year. Just about all of the big Dubai companies have real estate at their core, so a crash in real estate prices rather than the "healthy correction" Alabbar spoke of on Nov. 24 could be extremely costly.
And how much money does Abu Dhabi really have? Analysts are coming around to a more conservative figure in the $450 billion to $500 billion range, rather than the much higher numbers circulating earlier this year. Whatever the big number is, it is likely smaller than it used to be. Brad Setser, Geoeconomics Fellow at the Council on Foreign Relations in New York, estimates that the Abu Dhabi Investment Authority has lost $100 billion or more in recent months as its global holdings of equities, real estate, and alternative assets have taken big hits.
Of course, Abu Dhabi ultimately has the capital to meet the needs of Dubai and other problems in the UAE, but a massive bailout could be uncomfortable even for one of the wealthiest countries in the world. "It's an interesting question whether Abu Dhabi has sufficient liquid assets to cover all of the emirates' needs next year if oil prices remain low," Setser says.
What will be the cost to Dubai? Sources in the emirates say that sales of crown jewels such as Dubai Aluminum and the port at Jebel Ali have been discussed. While Abu Dhabi heavyweights sometimes criticize Dubai for its fast and loose culture and helter-skelter building, they don't seem to want to humiliate their neighbors or see them fail. After all, a meltdown in Dubai would hurt Abu Dhabi as well. "They don't want to embarrass them," says one financier. "Projects will stop, but they may not say so. That's the way things are in this part of the world."
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