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01 December 2023

Narrowing CDS spreads to determine recovery

By Yazad Darasha

The news of the Dubai Government's $20 billion (Dh73.4bn) bond and Borse Dubai's successful refinancing may put a floor under equity prices but credit default swap (CDS) spreads will determine the UAE markets' direction, new research has said.

"The equity market received its first slow-burn catalyst with the Abu Dhabi bank refinancing package, and then the news of the Bourse Dubai refinancing. [Last week's] federal support for Dubai should add further positive weight to equity market sentiment," HSBC said in a report.

"However, while we feel the sentiment related to proactive action could place a floor under equity market prices, the sustainability of any strong sharp upwards momentum is uncertain. Moreover, equity markets are likely to take their lead from CDS spreads, which have widened significantly in recent weeks, and their direction is likely to remain a leading light for a while longer.

"Should the expected contraction in CDS spreads continue, allowing the credit market to incorporate a more reasonable risk premium, a sustained recovery within the UAE equity market is more likely to be seen," HSBC said.

Any successful revival of the UAE markets will depend on the banking system being able to free up liquidity and deploy capital into the right areas, the lender said.

"The equity markets, while likely to react positively near term, are more likely to turn quickly towards the longer-term demand fundamentals for sectors such as banking, property, construction, tourism and logistics," it said.


From the banking sector's perspective, the fact that the UAE Central Bank has subscribed to the Dubai bonds' first tranche of $10bn "is a near-term positive" as it removes the uncertainty over any potential default by Dubai and assures the emirate of federal support.

"In the short to medium term, this is likely to support the quality of credit exposure to corporate and consumer counterparties. While we believe that 2009, and possibly 2010, will see a progressive rise in non-performing loans as the property bubble fully unwinds and the fallout from dampened economic activity feeds through into banks' balance sheets, the bad-loan trajectory may not be quite as bad as might have been the case if this support was not forthcoming," the report said.

"Second, there is, as yet, no mention of the manner through which the cash raised will feed through to liquidity-starved corporate entities. However, it is possible, even likely, that a part of this cash will be fed through the Dubai banks to provide the financing required.

"With the Abu Dhabi banks the comfortable recipients of its government's cheap capital injection, the Dubai banks have been suffering by comparison. We think the Dubai Government could possibly feed liquidity or capital (Tier 1 and/or Tier 2) through the banks as a second stage of this package," HSBC said.

This would alleviate the financing problems of geared corporate entities and provide capital and liquidity support for banks, it said. "This move could provide a chink of light in an otherwise gloomy environment."


Real estate and non-infrastructure related construction are interlinked with the banks to fund credit and, given that this may take time to flow, suggests that performance is likely to be limited until later on in the economic cycle, the bank's analysts said.

"Stability in the physical real estate market may begin to be seen over the coming months, as the market has tended to have a high proportion of cash sales (traditional range of 35-50 per cent of sales – currently estimated to be around 45 per cent). This should act as a guide to real estate equity prices over the longer term."

Ongoing Dubai-related real estate construction projects now face a brighter prospect, the report said. "While several ongoing projects have been slowed and face reconfiguration, the ability to continue to execute – arguably at a slower rate than previously – appears more certain.

"The key is likely to be whether the $20bn is sufficient liquidity for the refinancing of specific existing projects and how these are to be prioritised, since realty and construction names are only one part of the equation."


"The fact that tourism and logistics are two sectors based on more global demand factors could serve to curtail near-term enthusiasm," HSBC said.

"The ability of the market to understand just how much capital and at what rate it is available for future development dictates the magnitude of focus by investors on these names.

"Arguably, though, specific areas of the economy are likely to benefit from an immediate injection of capital. This is most likely to be seen within those companies that are exposed to the infrastructure and Dubai Inc related companies. This comes in the form of ensuring that working capital commitments and immediate development projects are maintained. This in itself highlights that this package may be more than just aid for the banks, which the Abu Dhabi package three weeks back satisfied. More importantly, equity markets are likely to begin to finally accept that the UAE is less of a tale of separated fortunes and that the federal government is keen to ensure the UAE does indeed have a united future."


Investors are likely to turn their focus on specialty finance companies in the near term, HSBC said.

"To take a longer-term positive view on the earnings pick-up by brokerage houses and exchanges may be too early. The overall success appears down to the return to the market of both the international and local investor.

"While aversion to near-term default risk has been undertaken through this bail-out, the global environment still faces a high level of equity risk. For international investors who are not benchmarked to the UAE markets – a result of the UAE not being included in the MSCI index – there is no relative necessity to be invested. Hence, their sustained return is likely to be delayed.

"Local investors are facing a market that is down about 75 per cent over the past 12 months and confidence needs to be rebuilt. Adding to local investors' woes is the fact that real estate asset prices remain depressed and some traders remain impacted from leveraged positions held as the market declined over the past year.

"We expect this to limit the return of liquidity in the near term," HSBC said..


Telecommunications are most likely to be a third derivative beneficiary on the basis that this package addresses economic stability. Refinancing needs of the sector are minimal within the UAE, as etisalat is a net cash positive company.

"Moreover, the package may serve to limit concerns on sharp population contraction within the UAE and hence subscriber addition concerns may be alleviated," it said.