What next for Nakheel?

Hindsight is a wonderful — and sometimes amusing — thing.

Nakheel campaign via Lucid Designs

That was part of a recent web project for Emirates property-developer Nakheel — as well as the basis of a billboard campaign across Dubai.

The website showcased all of Nakheel’s property holdings, and then presented readers with the question “What next?” The reader could then select one of the lanterns floating serenely on their screen and add their own idea. Once submitted, the lantern would be added to a sea of other user-generated ideas.

Who wants to bet that “debt standstill” was one of them?

FT Alphaville mockup of Nakheel portfolio website

According to Lucid Designs, the outfit that came up with the concept for the website, the project was put on hold before completion.

But the idea of prescience on the Nakheel-front is not far-fetched. There are a number of rather far-sighted articles on the company’s troubled sukuks.

To wit, one blog post at The Current Account — Abu Dhabi newspaper The National‘s economics blog — dated August 12, 2009 and titled “Trusting implicitly: Nakheel’s sukuk”.

Here’s an excerpt:

There’s a growing level of concern in local financial circles about how Dubai will handle the December maturity of Nakheel’s $3.5 billion Islamic bond, or sukuk. Many say it has no choice but to pay off Nakheel’s bondholders, who bought the bonds on the understanding that government-owned Nakheel enjoyed the backing of the government.

In some ways, therefore, the situation is akin to the troubles experienced by Fannie Mae and Freddie Mac, which last year fell victim to the subprime lending crisis. When the extent of their financial difficulties became apparent, investors realised that Fannie and Freddie enjoyed merely implicit backing from the US government, not an actual Federal guarantee. Investors started dumping Fanne and Freddie’s so-called “agency paper,” putting further stress on the US housing market. Eventually, the US government provided explicit backing to Fannie and Freddie’s debt.

Economists, analysts, bankers and lawyers are unanimous in saying that the same is true of Nakheel. A cat was thrown among these pigeons back in April when Nakheel itself suggested that a restructuring wasn’t out of the question. The National’s Asa Fitch and Bradley Hope wrote an excellent piece on the issue in May.

Conventional wisdom is that if Nakheel attempts to restructure the bonds, or reschedule them, the investment community will punish Nakheel by demanding it pay much higher interest rates in the future, or shun its debt altogether. The same impact, they warn, could be felt by other companies in Dubai Inc., with repercussions for Abu Dhabi and the rest of the GCC’s government-linked companies.

Government-related entities, and even governments, do default, however. If they didn’t, they would all have AAA ratings. The fact that they don’t implies that there is a risk of default, even a technical default such as a restructuring.

And Nakheel’s bonds, according to the prospectus Nakheel issued for the bonds when it sold them back in 2006, do not enjoy any government guarantee. They are, in some cases, guaranteed by Dubai World. Both Nakheel and Dubai World are government owned, but are joint stock companies, meaning the government’s liability for their credit is limited to their paid-up capital. Other than the threat of facing the outrage of the investment community and having to pay higher rates to borrow for years hence, the Dubai government has no apparent legal obligation to pay Nakheel’s creditors.

It may be financial heresy to do so, but one can make a case for Nakheel demanding that bondholders take at least some of the pain. For one thing: the prospectus itself outlines a variety of risks to Nakheel’s ability to pay off the bonds. During the global liquidity bubble, when even Iraq could borrow at 400 basis points over US Treasuries and individual investors in America were buying Zimbabwean bonds in search of yield, no one may have believed that any of those risks were real. That’s why economists at the time called it a “mispricing of risk.”

And just to hammer that point home, here are the latest headlines from Reuters:

RTRS-TOP DUBAI FINANCE OFFICIAL SAYS THERE IS A BIG CONFUSION BETWEEN GOVT OF DUBAI AND DUBAI WORLD -TV

11:06 30Nov09 RTRS-TOP DUBAI FINANCE OFFICIAL – RESTRUCTURING MIGHT AFFECT CREDITORS IN SHORT TERM BUT THERE ARE LONG-TERM BENEFITS

11:07 30Nov09 RTRS-TOP DUBAI FINANCE OFFICIAL – THE GOVERNMENT DOES NOT GUARANTEE DUBAI WORLD’S DEBT

Neither, incidentally, does the United Arab Emirates.

Related links:
The issue of shariah compliance and the Nakheel sukuk
– FT Alphaville
UAE central bank makes reassuring noises – Naked Capitalism
CSI Dubai - FT Alphaville

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