MIDEAST MONEY-Booming Gulf sukuk market brushes off Dana Gas debacle

Wed Nov 7, 2012 9:00am EST

* First failure to redeem bond by a UAE company

* In past might have caused crisis; market now more mature

* Precedents exist for restructuring sukuk

* Deeper market makes investors less vulnerable to a default

* Yields on other sukuk continued to drop after Dana miss

By Bernardo Vizcaino

DUBAI, Nov 7 (Reuters) - When a natural gas producing company in the United Arab Emirates missed repaying a $920 million Islamic bond last week, it became the first UAE company to fail to redeem a bond on time. But the region's debt market barely blinked.

Yields on some firms' outstanding Islamic bonds, known as sukuk, dropped to fresh record lows as investors continued pouring money into them. Other companies laid plans for new issues of sukuk.

The incident underlined the extent to which the Gulf's Islamic debt market, which is playing an increasingly important role in funding companies, has strengthened in the past year. Not long ago, a billion-dollar payment miss would have triggered a crisis of confidence in the market; now, it is almost ignored.

"The market has matured enough to appreciate that this is not a sukuk or Islamic finance issue but rather a credit issue," said Rizwan Kanji, debt capital markets partner at law firm King & Spalding in Dubai.

"After the potential defaults a few years ago, the market's reaction initially was that sukuk didn't work and as a result the market reacted negatively. Fast forward three years and we're in a similar scenario but the market has reacted differently. You're not seeing the headlines screaming that Islamic finance doesn't work."

Privately owned Dana Gas, headquartered in the emirate of Sharjah, failed last Wednesday to repay its five-year sukuk on maturity. The firm has been hit by delays in recovering revenues from operations in Egypt and Iraq's Kurdistan.

Immediately after the payment miss, prices of Dana's sukuk and shares plunged because of fears that its bond holders, who include big foreign investment firms such as BlackRock and Ashmore Group, might declare it in default, letting them take legal action to liquidate assets backing the sukuk.

On Wednesday this week, Dana said it had reached an "in principle" agreement with creditors to restructure the sukuk; it would pay back part of the bond and issue two new sukuk to finance the remaining amount. Details of the possible deal were not revealed.

Although indebted firms in the UAE have restructured billions of dollars of bank loans since Dubai's real estate market crash in 2009-2010, no UAE company before Dana has failed to repay a maturing bond, conventional or Islamic.

PRECEDENTS

In the past, Dana's difficulties would have been seen as a reminder of regulatory and legal risks in the Gulf's sukuk market. Islamic finance was born in its modern form only in the 1970s, leaving courts and investors with relatively few precedents to use when sukuk ran into trouble.

Because of Islam's ban on interest, sukuk are not pure debt and do not pay conventional coupons; they pay returns earned by real assets, which are temporarily leased to sukuk holders via channels such as special-purpose vehicles. The complexity of such structures can complicate restructuring talks.

A near-default on a $3.5 billion sukuk by Dubai's state-owned property developer Nakheel in 2009 caused the Islamic debt market to freeze up, partly because of uncertainty over how the issue might be handled. Ultimately, the sukuk was repaid with last-minute aid from the Abu Dhabi government.

Now, however, the regional market may have built up enough experience with threatened defaults and restructurings to be confident that they can be handled without damaging faith in the overall market.

Investment Dar, a Kuwaiti-based firm, defaulted on a $100 million sukuk in 2009; it eventually restructured it in 2011, converting part of creditors' claims into equity in the company.

Saudi Arabia's Saad Group defaulted on its $650 million Golden Belt sukuk in November 2009; the case is being heard in Saudi courts.

Several Malaysian sukuk, including Ingress Sukuk Bhd, Tracoma Holdings Bhd and Nam Fatt Corp, have defaulted since January 2009; they have been dealt with by Malaysia's well-developed legal framework in much the same way as defaults on conventional bonds.

The most important factor supporting confidence in Gulf sukuk may be the ballooning size of the market. As the euro zone debt crisis made Western debt markets less attractive this year, Islamic investors in the Gulf and southeast Asia poured money into sukuk, triggering a record amount of new issues.

Globally, $109 billion worth of sukuk were issued in the first nine months of 2012, up 69 percent from a year earlier, with the rise driven primarily by Malaysia and Gulf governments, according to research by Zawya, a Thomson Reuters company.

So far this year, $13.9 billion of dollar-denominated sukuk have been issued in the Gulf Cooperation Council, comprising Saudi Arabia, the UAE, Kuwait, Qatar, Oman and Bahrain. That is almost double the $7.8 billion of conventional bonds issued - a reversal of conventional finance's traditional dominance.

A report by credit rating agency Standard and Poor's last month said the reliance of GCC companies and infrastructure projects on sukuk could increase further in coming quarters.

With the sukuk market deepening, investors are better able to spread their risks and less vulnerable to any single default.

YIELDS

This has helped to keep yields from rising on other sukuk during the Dana debacle.

The yield on the $400 million, five-year sukuk issued by private Dubai-based mall developer Majid Al Futtaim Holding in January has fallen more than 1 percentage point since the start of June; it continued to drop, falling 6 basis points to 3.54 percent, after Dana missed its payment.

Five days after Dana's miss, Saudi Arabian dairy and food producer Almarai Co said it would issue the second tranche of a riyal-denominated sukuk programme to private investors in coming months. It raised 1 billion riyals ($267 million) through the first tranche in March.

Chavan Bhogaita, head of the markets strategy unit at National Bank of Abu Dhabi, said Dana was viewed by investors as an isolated case which did not have implications for the sukuk market or the corporate health of the UAE in general.

"It isn't a high-profile GRE (government-related entity) but rather a stand-alone corporate that is going through some financial distress - frankly, institutional investors appear to be taking this in their stride," he said.

If Dana and its creditors fail to reach final agreement on restructuring the sukuk, the dispute may be referred to an arbitrator, said Nasser Al Osaiba, partner at Dubai-based law firm Global Advocates and Legal Consultants.

If the case reaches the courts, it is likely to be resolved in a British court rather than in the UAE court system, he added. The Dana sukuk is listed on the London Stock Exchange, though the gas production assets behind the sukuk are to be handled under UAE law, according to the prospectus.

A September report by London-based investment firm Exotix estimated a liquidation of Dana's sukuk assets could yield a recovery value of 47 percent of par for investors. Such a poor prospect may have deterred creditors from going after Dana's assets and persuaded them to discuss restructuring the sukuk, which might give them a better return over time.

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