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MIDEAST DEBT-Dubai defies doubters with bond issue success
* Heavy demand for bonds underlines Dubai's rehabilitation
* Budding recovery in real estate market is key
* Bonds may still be undervalued relative to other markets
* But corporate, economic risks have not disappeared
* Another boom-and-bust cycle cannot be ruled out
By Mala Pancholia
DUBAI, Jan 23 (Reuters) - A $1.25 billion bond issue by Dubai this week underlined the spectacular recovery of the emirate's reputation since its debt crisis. But some investors are wondering whether the world is once again getting a little too optimistic about Dubai.
The flamboyant emirate attracted over $9 billion in bids for a $750 million, 10-year sukuk (Islamic bond) on Tuesday, paying little more than 1 percentage point above what gas-rich Qatar would have paid to issue debt.
Demand for Dubai's debt was so strong that it in addition to the sukuk, it unexpectedly sold a $500 million, 30-year conventional bond at the request of investors.
It was an impressive performance for an economy that a little over three years ago was engulfed in crisis. State-owned conglomerate Dubai World announced a $25 billion debt restructuring, triggering a chain of restructurings, and Dubai needed a $10 billion bailout from Abu Dhabi to avoid default.
This week's bond issue was in high demand partly because Dubai is making progress working through its debt pile and its economy is recovering faster than expected. But the demand is also due to global factors that will not last forever.
"We agree with the view that risks have declined markedly, and are believers in the Dubai success story," said Gabriel Sterne, economist at investment bank Exotix Limited in London.
"But we think yields have tightened by more than risks have declined. Dubai still remains vulnerable to the usual risk-roll call. Rising tensions with Iran; a decline in oil prices; slowdown in Asia."
He added that Dubai's banking system, where non-performing loans were still high, remained a risk. "It's not the worst value in the world, but hard to get excited at these yields," Sterne added.
The single biggest boost to Dubai has been the start of a recovery in its real estate market. Property prices plunged more than 50 percent over several years but rose in some districts last year, partly because of a flood of foreign investment.
Dubai is also enjoying a tourism and retail boom, with passenger traffic through its airport rising at double-digit rates. The economy is growing at a rate of about 4 percent.
Economic growth is easing the slow, agonising process of redeeming and restructuring debts at state-backed companies. Outstanding provisions for bad loans set aside by banks in the United Arab Emirates fell in October for the first time since 2008, central bank data showed last month.
"Dubai Inc has built confidence among international investors in the last year by addressing redemptions in a timely and proactive fashion," said Dilawer Farazi, bond portfolio manager at Invest AD in Abu Dhabi.
Dubai's five-year credit default swaps, used to insure against a government default, have halved in price over the past year to their lowest level since 2008, before the debt crisis erupted.
As much as anything, Dubai's sheer exuberance in a worried, risk-averse world may be improving its image among investors. In the past several months the emirate has announced plans to build, among other things, the world's largest shopping mall, five theme parks, a canal by its business district and a $1 billion replica of the Taj Mahal.
The spread between the yields of Dubai's outstanding 10-year sukuk maturing in 2022 and Qatar's 10-year bond maturing in 2023 has shrunk to 114 basis points from 220 bps six months ago. Qatar is rated AA by credit agencies, the highest rating in the Gulf; Dubai has not arranged to be rated, which is usually a disadvantage in investors' eyes.
Historically, bonds in the Gulf have tended to carry higher yields than those in other areas of the world, partly because the Gulf's debt market has been illiquid and partly because of geopolitical risks in the region.
Although the gap in yields between Dubai and other emerging market bonds has narrowed in the past six months, there is room for it to narrow further as the emirate's image improves and the Gulf's debt market matures, some investors argue.
"If we assume that Dubai is an implied BBB rating and given the improved credit fundamentals, and economic indicators as well as the positive technicals in terms of increased liquidity with local banks and corporates, Dubai government bonds still offer value on a relative basis compared to other BBB or even BB bonds in other emerging markets," said Saeb Elzein, managing partner at Spinnaker Capital (Middle East).
For example, a sukuk maturing in 2022 and issued by Indonesia, rated BBB-, is trading at 3.08 percent, compared to the Dubai bond's 3.88 percent.
But predictions that Dubai will continue closing the gap with other emerging market bonds depend on many assumptions.
One is that restructuring Dubai's corporate debt will continue to go smoothly, without major defaults or a loss of confidence among investors. This is not inevitable - since 2009, much of the debt has not been cut but merely had its maturity dates pushed several years into the future.
The International Monetary Fund estimates Dubai's government-linked entities will need to repay about $9.4 billion of maturing bonds and syndicated loans in 2013 and $31.0 billion in 2014. It calls refinancing these amounts "a challenge".
Another risk is any change to the global conditions which are pushing money towards Dubai. The emirate is a safe haven for investors fleeing unrest in the Arab world, and as economic gloom in the West has forced down interest rates there, Dubai debt has looked attractive.
In the future, a return of political stability to other Arab countries could cause safe-haven money to leave Dubai. And when U.S. Treasury bonds again offer significant yields, Dubai debt may start to seem less attractive.
A third risk may be the sheer level of optimism in Dubai. As it resumes spending on glitzy real estate and speculators once more queue at property developers' officers to buy apartments, some believe a fresh boom-and-bust cycle may be starting.
Last month the United Arab Emirates central bank said it was imposing limits on mortgage loans, a step to prevent another property bubble from forming. But this month it backed away from enforcing the limits after banks protested.
"We hope that new government plans for new cities and infrastructure spending...will be well funded, and are not build on new excessive borrowing," said Elzein.
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