Immediate impact of bond issue on CDS

The level of liquidity pressure facing Dubai is far less than credit default swap (CDS) spreads currently imply, said a new report by EFG-Hermes.

There has already been a decline in the price of insurance on bonds by 200 basis points. Insurance cost of $10 billion (Dh36.73bn) bonds in Dubai costs just $750,000.

Dubai launched a $20bn bond issue on Sunday. The first tranche of $10bn was fully subscribed by the UAE Central Bank. The markets welcomed this news with stocks on the Dubai Financial Market (DFM) opening up more than five per cent yesterday, with DFM and Emaar Properties among the top gainers. Analysts maintain that the support from the Central Bank is a strong positive signal for equity and credit markets in the country.

The Central Bank had $44.5bn in foreign exchange reserves in September (most recent data) but has since provided liquidity to several of the country's banks. The instruments are five-year bonds that carry an annual interest rate of four per cent.

The bond issue should ease the cost of insuring against a default, which in recent weeks saw five-year CDS on Dubai debt rising. The fall in the CDS is also bound to lower risk premia on Dubai banks.

According to EFG-Hermes' estimate, Dubai's outstanding debt has been raised to $74.2bn in total, comprising $62.9bn from wholly or majority owned entities and $11.4bn from minority owned entities.

The Borse Dubai refinancing attracted significant attention as it was the first public sector entity facing a debt rollover and also due to the large amounts involved. "At the time of writing, it appears that the debt has been raised through a mixture of syndicated lending ($2.5bn) and shareholders funds ($1bn), as we would expect," said EFG-Hermes.

Other features of this rollover, according to the report, include debt being re-priced from 130 bps previously to 325 bps and the maturity has been reduced to one year from three years previously. An additional fee of 75 bps is chargeable should the loan be extended for an additional year.

"We believe this is a reflection of the overall tougher conditions prevailing in the credit market," it said. "Perhaps most importantly, the funding gap was provided by shareholders funds."

This sends a strong positive message to the markets that the level of liquidity pressure facing Dubai is not as severe as CDS spreads currently imply. "The involvement of the government also sets an important precedent that state assistance will be provided as and when needed," the report said. However, EFG-Hermes maintains that the critical underlying assumption behind the current CDS spreads was a view that federal assistance would not be forthcoming – something that was negated first by the rollover of Borse Dubai's debt and now with the Central Bank subscribing to half of Dubai's $20bn bonds. EFG-Hermes believes that a federal plan for the real estate sector is in the pipeline, as the sector is very important for Dubai.

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