Dubai Bonds May Yield Same as Companies One Level Above Junk

Oct. 27 (Bloomberg) -- Dubai, in its first international bond sale in 18 months, is being treated by investors the same as Russian companies with the lowest investment-grade ratings.

The sheikhdom’s planned dollar-denominated securities, which aren’t rated, will be sold to yield 350 basis points to 400 basis points over the benchmark midswap rate, said three investors approached for the sale. That equates to a premium of 50 basis points, or 0.50 percentage point, more than debt sold by Russian issuers such as OAO Sberbank, which is rated BBB, two levels above high-yield, high-risk debt, Commerzbank AG says.

“It’s pretty fair to consider Dubai an investment grade credit at the BBB- or even a BBB level,” Luis Costa, an emerging-market debt strategist in London, said in a telephone interview. “Although the credit-quality may be aligned to its other BBB-area peers, you still have to input some premium given the leverage in Dubai.”

Dubai, which until August 2007 amassed $80 billion of debt transforming itself into the financial services and tourist hub of the Persian Gulf, is selling bonds for the first time since April 2008 before oil and real-estate prices slumped. Home prices in Dubai tumbled about 50 percent from their peak in 2008’s second quarter and may drop another 20 percent this year after a construction boom created thousands of houses just as demand began to evaporate, Deutsche Bank AG said in June.

Debt Payments

The second-largest sheikhdom in the United Arab Emirates and its government-linked companies have to meet $6.8 billion in debt obligations in the fourth quarter, Frankfurt-based Deutsche Bank said in a report last month. Property developer Nakheel PJSC needs to repay Islamic bonds, or sukuk, of $3.52 billion in December, while Dubai Civil Aviation Authority has to pay a $1 billion security next month, data compiled by Bloomberg show. Sukuk are securities that are governed by Shariah laws barring investors from profiting from the exchange of money, as happens with interest payments on other bonds.

As Dubai prepares to return to international credit markets, contracts protecting against losses on bonds sold by the emirate are pricing the government lower than investment grade. Bonds rated below BBB- by Standard & Poor’s and less than Baa3 by Moody’s Investors Service, are considered high yield, or junk.

Dubai’s credit-default swaps, which get cheaper as perceptions of credit quality improve, trade more like Egypt, whose debt carries a junk rating of BB+ from S&P.

The contracts linked to Dubai debt cost about 294 basis points, higher than the 211 basis points for Egypt’s credit default swaps. Dubai’s swaps remain the sixth-costliest of 39 emerging markets, according to Bloomberg data.

‘Leverage’

“People realize there is quite a bit of leverage at the sovereign level,” said David Lewis, an emerging-market credit analyst in global research at Bank of America Merrill Lynch in London. “This is not a transparent issuer where the market knows exactly where the spread level should be.”

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A basis point is equivalent to $1,000 a year on a contract protecting $10 million of debt.

Dubai officials are meeting with investors in London this week after marketing to funds in Asia and the Middle East. The emirate plans to sell five-year dollar- and dirham-denominated bonds as part of a $6.5 billion medium-term fund-raising plan, according to the investors. The pricing of the medium-term note, which are unsecured, continuously offered debt obligations typically ranging from nine months to three years, compares with a 50 basis-point yield premium that the Dubai government paid in April last year.

The dirham bonds may be priced in the “high” 300 basis points above the three-month emirates interbank offered rate, which was 1.955 percent yesterday, the investors said.

Support Fund

The offering is separate from a $20 billion support fund that the government set up for state-related companies. Dubai borrowed $10 billion by selling bonds to the country’s central bank in February and will probably raise another $10 billion in November, said Mohammed Alabbar, who heads the government committee evaluating the impact of the credit crisis on Dubai.

At a yield of 350-plus basis points over the midswap rate, Dubai’s dollar bonds would be priced in line with the premium investors demand to own the debt of DP World Ltd., the government-owned port operator which is rated three levels above junk at BBB+ by S&P and three levels higher at A1 by Moody’s Investors Service. DP World’s 6.85 percent, 2017 bonds are trading around 350 basis points over the benchmark U.S. midswap rate, according to Lewis. The rate was 2.866 percent yesterday.

‘Lower Risk’

“If you are looking at DP World then you are looking at a corporate proxy for Dubai,” said Philipp Lotter, a Middle East corporate analyst at Moody’s in Dubai. “Sovereigns would generally be a lower risk than its corporates.”

Commerzbank’s Costa says Moscow-based Sberbank’s debt is a fair proxy. Dollar-denominated bonds sold by Russia’s state- controlled lender that are due February 2015 yielded 6.19 percent yesterday, representing a spread of 357 basis points over Treasuries.

Dubai’s planned pricing makes the offer “genuinely attractive,” said Norval Loftus, the head of convertible bonds and sukuk in London at Matrix Corporate Capital Ltd., which oversees $2.5 billion, after attending investor meetings with the emirate yesterday. “There is no desperation implied at this spread.”

To contact the reporter on this story: Laura Cochrane in London at lcochrane3@bloomberg.net