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Dubai premium to Malaysia soars on default risk: Islamic finance
Investors are exaggerating Dubai’s risk, and the sukuk’s yield will probably fall when they see a solution to Europe’s debt problems, saidSamer Mardini, the Dubai-based vice president of fixed-income and Islamic financial products for the Middle East and North Africa at SJS Markets
Bloomberg
2011-10-10 04:01 PM
Investors are demanding the highest yields in six months on Dubai’s unrated Islamic bonds relative to Malaysia’s investment-grade sukuk on concern the emirate may struggle to pay $31 billion of debt maturing by the end of 2012.

The yield on Dubai’s 6.396 percent Shariah-compliant notes due in November 2014 jumped 76 basis points last week to 6.40 percent Oct. 7, widening the premium over Malaysia’s 3.928 percent bonds due in June 2015 to 337 basis points, data compiled by Bloomberg show.

The spread rose to 353 basis points on Oct. 4, the widest since March 16, as investors see double the risk of Dubai failing to make repayments than Malaysia, credit-default swaps show.

The sheikhdom racked up $113 billion of debt to transform itself into a tourism and commercial hub, according to the International Monetary Fund, almost defaulting in 2009 and receiving a $20 billion bailout from nearby Abu Dhabi.

Emerging- market bond funds saw record capital outflows in the week to Sept. 28, data compiled by research firm EPFR Global show, and yields on developing-nation sovereign debt jumped the most since 2008 in September amid concern the European debt crisis will spur a global recession.

“Dubai names have been punished in recent days on account of a growing sense of risk aversion,” Ahmad Alanani, the head of fixed-income sales for the Middle East and North Africa at Exotix Ltd., said by e-mail on Oct. 4.

“That said, I believe that Dubai is on the right path to recovery given the successful restructuring of its major government-related entities and the concerted de-leveraging effort we are witnessing by way of asset sales.”

Default Swaps

Nakheel PJSC, the government-owned builder of man-made islands off Dubai’s coast, issued 3.8 billion dirhams ($1 billion) of bonds that comply with Islam’s ban on interest to its contractors and suppliers in August as part of a $16.1 billion restructuring deal.

The developer’s former parent company, Dubai World, reached an accord with creditors to restructure about $25 billion of debt in March after roiling world markets in November 2009 when it asked for a standstill.

Jebel Ali Free Zone FZE, a business park owned by Dubai World, must pay 7.5 billion dirhams when its Shariah-compliant debt matures in November 2012.

DIFC Investments LLC, a unit of the emirate’s tax-free business financial center, has $1.25 billion of sukuk due in June.

The sheikhdom will support its “strategic” investments, including those needing debt refinancing, after restructuring about $25 billion this year, Mohammed Al Shaibani, director of the Dubai ruler’s court, said in a Sept. 22 interview in Washington.

‘Confidence Issue’

“It’s basically a confidence issue,” Ahmad Najib Nazlan, a deputy treasurer at Kuala Lumpur-based Bank Muamalat Malaysia Bhd., said in an interview Oct. 6.

“Malaysia, as the biggest sukuk market in the world, has better credit ratings than Dubai,” he said, adding the recent restructurings of debt in Dubai has also weighed on market sentiment.

The cost of insuring Dubai’s debt against default through five-year credit default swaps jumped 23 basis points to 537 basis points on Oct. 4, the highest level since March 2010.

The contracts fell to 503 on Oct. 7, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Default swaps on Malaysia’s debt, which is rated A3 by Moody’s Investors Service and A- by Standard & Poor’s, the fourth-lowest investment grades, declined 22 basis points last week to 178.

The South-East Asian nation’s economy will grow 5.2 percent this year, while Dubai’s will expand 2.8 percent, according to the IMF.

Malaysia accounted for 66 percent of total outstanding Islamic bonds in 2010, or $94 billion, according to a March report by the central bank.

Rising Yields

Global sales of the bonds, which pay asset returns to comply with Islam’s ban on interest, climbed to $18 billion in 2011, compared with $11.8 billion in the same period last year, data compiled by Bloomberg show.

Persian Gulf sukuk have declined 1 percent since the end of June, according to the HSBC/NASDAQ Dubai GCC US Dollar Sukuk Index, in which Dubai’s Shariah-compliant debt has the second- highest weighting. Non-Shariah emerging-market bonds dropped 1.4 percent in the period, according to JPMorgan Chase & Co.’s EMBI Global Composite Index.

Foreign-currency Islamic debt sold by companies and governments in Malaysia returned 0.1 percent, the Bloomberg Malaysian Sukuk Ex-MYR Index shows.

‘Exaggerating’ the Risk

The yield on Dubai’s sukuk touched 6.60 percent on Oct. 4, the highest level since February. The yield dropped to 6.40 percent on Oct. 7, and is 192 basis points higher than the average for Islamic bonds in the six-nation Gulf Cooperation Council, which includes Saudi Arabia and the U.A.E., the HSBC/NASDAQ Dubai GCC US Dollar Sukuk Index shows. The yield jumped 20 basis points last week to 4.48 percent on Oct. 7.

“Investors are exaggerating Dubai’s risk,” and the sukuk’s yield will probably fall when they see a solution to Europe’s debt problems, Samer Mardini, the Dubai-based vice president of fixed-income and Islamic financial products for the Middle East and North Africa at SJS Markets, wrote in an e-mail on Oct. 5.

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