CDS report: Dubai has more in common with Latvia than Iceland | FT Alphaville

CDS report: Dubai has more in common with Latvia than Iceland

Gavan Nolan of Markit wrote this CDS report

European credit and equity markets suffered a torrid session today as the debacle in Dubai sparked a fresh bout of risk aversion. The Markit iTraxx Europe index ended the day at 89.5bp, over 5bp wider than yesterday’s close. It breached the 90bp earlier today, the first time it has done so since the beginning of the month. The Markit iTraxx HiVol index was over 7bp wider at 140.5bp, while the Markit iTraxx Crossover closed at 540bp, 27bp wider on the day.

Events in the Middle East dominated trading yesterday and so it proved today. Dubai‘s spreads continued to widen, reaching 550bp at the close. It was compared to Iceland by some in the media but its current levels have more in common with Latvia, a sovereign dependent on external largesse for its solvency. The handling of the Dubai World restructuring has been an exercise in poor communication. An unnecessary information vacuum has been created, with investors unsure of their positions. The cancellation of a planned teleconference for Nakheel bondholders due to oversubscription was typical of the whole affair.

What investors are coming to terms with is the fact that Dubai’s wealthy neighbour Abu Dhabi is unwilling to bailout Dubai’s avaricious state-owned companies. Dubai Inc, as it’s known collectively, has a huge debt burden that the likes of Nakheel have used to fund their extravagant projects. Most investors assumed that there would be some level of support from Abu Dhabi. However, it appears that this extends only to the sovereign, and many are now questioning the depth of this commitment.

Markit chart of UAE CDS

Dubai’s credibility has taken a hit and will find it difficult to recover from. Investors are still awaiting details of the Nakheel standstill, and it is likely that any level of coercion will trigger a technical default. This will not trigger CDS on the sovereign. But Dubai’s spreads now have a considerable risk premium attached, and its mishandling of the episode will cost it dear when it next returns to the international capital markets.

The problems in the Gulf reverberated around Europe. Banks, in particular, were under pressure as investors tried to ascertain exposure to the UAE. Figures from the Emirates Banking Association showed that HSBC had the largest exposure to the country, with Standard Chartered a clear second. Both banks saw their spreads widen, though Standard’s relatively small balance sheet meant that it was the worst performer in the banking sector.

Markit chart of StanChart and HSBC CDS