Monday, March 1, 2010

On haircuts and debt settlements.

There has been recent talk, some of it unsubstantiated press rumors, that Dubai World, the debt laden Government Related Entity of Dubai, has been contemplating, on the advice of its consultants, to consider as much as a 40% haircut on the debt and repayment of the balance over seven years with no interest. Needless to say, banks had two reactions ignore the rumor, (hard to do in the present day) or just balk as the audacity of the whole idea. Haircuts and debt repayments only happen to work, if that is the word to use, when there is literally no hope for any possibility of the principal debt ever being repaid. If the rumor was an attempt to test the waters, then the consultants need a fair dose of understanding that you hold a dialogue with the banks and do not pretend to have a conversation through the rumor mill, this always backfires.

While I am not privy to the discussions or indeed the people who are making these decisions, so what I venture our is conjecture and my recommendations may well be off the mark; yet as a three decade resident in the financial world of UAE, and an ardent well wisher for the country I would imagine a solution oriented approach is what is needed. What are the options ahead for this debt settlement?

In the first place we must be clear that the entire extent and complexity of the Dubai World debt is not entirely public and in similar vein neither is the possible cash flow profile over the next few years really known to the general public. Thus, if a seven or five year repayment is suggested it goes without saying that the cash flow projections will have to match this settlement profile. Keeping this in mind I would suggest the following.

1. When considering a haircut of any amount there has to be a clear understanding that this is seriously hurt the image and the standing of not only Dubai but also UAE within the financial community. Even if such an offer is accepted it will be with the gesture and lack of goodwill to provide additional funding in the future even when things are better. Bankers have a long memory and will remind you of their losses from decades back. Any haircut that is suggested has to be tied to an incentive. My suggestion would be to offer the banks a 70% settlement with the balance 30% to be strucurted as a Zero coupon bond with a long maturity and the caveat that this 30% would be exempted from payment under a formula for early payments. Thus if the 70% is to be paid say in seven years then for each year this amount is paid earlier there is a percentage of the 30% zero coupon bond that is written off. This creates an incentive for DW to pay early to get the discount. Ofcourse, the 70% should carry a new negotiated interest rate.

2. While legally there is the possibility of a bankruptcy to be considered and a financial 'guru' even said to me that there is no harm in such a route being explored and mentioned the examples of Enron, Japan Air Lines and many others. My simple response is that those were not GRE's and were joint stock companies with a broad public shareholding, DW's default will in the end be seen as a moral default of the entities behind it and this is not an option that should be even discussed.

Then the smart one's will ask are we not in a catch 22 situation?

In a sense yes, but then we have to consider long term solutions. Here is what I would do.

1. Within the UAE finance structure the Dubai Government should consider a long term Treasury Bond issuance program. These bonds should not only be seen as a monetary measure to deal with the deficit but also to restructure the debt of the GRE's in a manner similar to what many governments around the world do. US Treasuries are issued all the time and new issues retire old bonds and the cycle goes on under a long term program. It is precisely the lack of this program that has resulted in the funding of long term project needs with short term borrowing resulting in this mess.

2. The current Federal and Abu Dhabi Government assistance should also be rolled into this Treasury Bond program and perhaps even seek a tier one issuance with the Federal Government or Abu Dhabi government subscription of the earlier issues. This will bring much needed liquidity into the trading of these Treasury Bonds.

3. The UAE Central Bank to support such a program in the classification of these as investment securities rather than as simply loans to Dubai Government.

4. Set out the assessment of the cash flows of Dubai World and seek an debt retirement program which is realistic and not based upon the hope of things improving. It will mean that more detailed information on the cash flow and asset profile of the company and then to see how this can be managed to meet the obligations. With the backdrop of a Treasury Bond program the pressure to come up with three, five or seven year debt repayments will be overcome as the Treasury Bonds, through their liquidity and re-issuance programs will be able to manage a more orderly debt retirement rather than a pressured situation as we sit in today.

The reality is that any settlement of this debt has to be realistic in its scope and intent; failure to recognize the sensitivity of the situation within the financial world would have repercussions that might be hard to deal with. It is therefore vital that for the good the country's standing a positive approach is important in this situation. I am not convinced that haircuts and interest waivers is the solution, this is not giving the right message.