Dubai's Generous Restructuring Proposal

* username: rupertbu

What a difference four months makes. Having sent global markets into a tailspin in November with a high-handed shock announcement of a $26 billion debt restructuring, Dubai now has offered a very creditor-friendly deal on Dubai World and Nakheel debt. The markets welcomed the plan. But one longer-term fear might be that this odd restructuring is actually too generous.

That it is generous is clear from the terms: The Dubai government is proposing to convert its $10.1 billion debt claims on Dubai World and Nakheel into equity, thus subordinating its claim to other creditors. It is then offering to inject $9.5 billion of fresh cash—$3.8 billion from its own resources and $5.7 billion from an undrawn loan from Abu Dhabi—suggesting that this deal has the tacit approval of its richer neighbor. Stunningly, holders of Nakheel's Sukuk bonds due in 2010 and 2011 will be paid in full and on time if the deal is approved.

Bank creditors should also get repaid in full, although maturities are being extended. Dubai World's lenders are being offered new five-year and eight-year debt carrying an as-yet-unspecified interest rate. Nakheel bank lenders will be asked to roll over existing facilities at a new rate.

This was better than the market was expecting, with talk previously circulating of haircuts on principal as well as extensions on debt maturities. Unsurprisingly, Dubai stocks rose 4.3%, the cost of insuring the emirate's debt against default fell around 0.50 percentage point to 3.75 percentage points and Dubai-related corporate bonds rallied.

One important implication of the lavish treatment for bondholders may be that Dubai's companies regain access to international funding; a capital -markets default could have complicated refinancing.

Dubai has taken a big step to repair the damage caused by last November's shock. But to some extent, the restructuring proposal involves the emirate doubling down on its damaged economic model, underlined by its continued belief that Nakheel—the constructor of the iconic palm-shaped islands that have become a symbol of excess—is a key part of the economy.

Dubai is betting on a recovery in real estate and financial markets to lift the value of the assets, enabling the debt to be repaid later and the equity stake to generate value for the government. If that bet fails, then all Thursday's proposal will have achieved is to kick the can down the road. That, however, would be a familiar tale from the financial crisis.END