GCC Credit Thoughts – February 1, 2010

GCC Credit Overview – Friday's Recap

• The GCC credit markets opened wider on Friday, echoing the continuation of the jitters being felt in the global markets – the widening in Greece, the CEEMEA SovX Index out by more than 10 bps and Asian equities in the red.
  
• Activity and volumes were fairly low and concentrated in the Abu Dhabi and Qatari quasi sovereigns, most notably RasGas, which widened.
  
• Moody's downgrade of Aldar on Thursday, January 28^th, sent ripples through other Abu Dhabi names that are on Moody's list for potential downgrade – Mubadala, TDIC and Taqa – all of whom ended the day on Friday wider from their opening levels. We saw bargain hunting step up towards the end of the session with Western accounts stepping in to establish a floor in our markets.
  
• The financials took a hit across the board – especially ADCB and CBQ19s.
  
• When some of the regional names are coming off a point or a point in a half, it is important to note the volumes being traded – volumes are light and some of these names with dramatic moves are gapping down rather than moving lower on sizeable trades. One low bid being hit can have a severe impact on the levels a particular credit ends the day at.

Ever since Moody's placed 7 Abu Dhabi GRI's on review for possible downgrade on December 9^th, 2009, I have been closely watching the targeted entities. They include Taqa, Mubadala, TDIC, IPIC, Etisalat, Dolphin and Aldar. Moody's had published a "special comment" on January 7^th, in which they explained the rationale behind their placing UAE GRI's on credit watch negative, with the possibility of multi notch downgrades. They announced that they were trying to determine the level of support that each of the companies would receive from the Government, and that implied level of support would assist in buoying the standalone ratings that those entities may have.

In this same report, Moody's highlighted IPIC and Mubadala as entities that were unable to be differentiated from the Government of Abu Dhabi, and could therefore not be assigned stand alone ratings, and had to be rated in line with Abu Dhabi's sovereign rating – Aa2. So, that left 5 "quasi – sovereigns" that could be impacted with a downgrade. The potential for a downgrade has been worrying for me – I have been asked why I have not been bullish Aldar while remaining bullish on a credit like Dolphin. The rationale in my mine was simple – real estate in the UAE has been painted with the broad brush of negativity – when Moody's says that some of the names that it is placing on review for a multi notch downgrade, I couldn't help to think that it's a real estate entity that would be targeted first. In an already jittery market, no matter how much I like a name or how cheap it may look, the possibility of a downgrade makes me think if I can buy it at a later time at similar if not better levels – with Aldar, I felt that I would definitely be able to do that. Dolphin, on the other hand, seemed like a safe bet. It had come off only slightly from the troubles in Late November, and it is the largest revenue contributor to the Mubadala complex. If Mubadala cannot be differentiated from the Government, then the likelihood of its largest revenue contributor being shunned is low, so I believe the downside to Dolphin's ratings is low – plus, they are far away from real estate and are heavily involved in a sector that is the backbone of the GCC's economy.

Aldar was the first to fall – Abu Dhabi's largest property developer was downgraded to Baa2 from A3, on Thursday, on the back of a weaker commercial and residential market having a negative impact on Aldar's stand alone profile (the baseline credit profile was downgraded from Ba3 to B2) – Moody's also said that they expect Aldar's unit sales and land sales will be significantly lower than expected over the next 24-36 months, and due to this, there may be a shortage in cash flow required to fund the debt that mature during that time. Aldar 14s saw their offer yields expand by 54 bps since Thursday morning and the Aldar 11's (convertible) saw yields expand by 15bps. The 13s saw yields expand by 64 bps.

I like Aldar and the entire Abu Dhabi real estate story – the one thing that is preventing me from banging the drums on the name is my expectation for continue volatility in Abu Dhabi from the pending downgrades and for the UAE as a whole from headline risk and continued uncertainty around Dubai World. Also, as a client pointed out this morning – In this kind of global environment, the GCC markets are usually the first to tank and the last to recover in terms of bond prices. The question remains – not IF to buy a particular name you like, but WHEN to buy it. As an example, I liked the Dubai sovereign at 7.86%, really liked them at 8.06% and loved them at 8.40% - I'm thinking that I will be positively giddy about them at 9.00%? So, if I am a long term investors, I should find a level where I am comfortable and pull the trigger, thinking I am going to hold for the coming future. As a short term trade, the will probably go lower before they go higher (let's see how the Q.4 results shape up for the UAE real estate companies) – by they I mean the GCC credit market as a whole.

The table below shows the yield expansion in the Abu Dhabi quasi sovereigns that were earmarked for downgrade (minus Etisalat and IPIC) – I have used offer yields from Thursday morning and compared them with yields from this morning.

	Offer Yield (January 28th)	Offer Yield (Feb. 1)	Yield Expansion bps
TAQAUH 5.62 12	4.05	4.15	10
TAQAUH 6.6 13	5.02	5.1	8
TAQAUH 4 3/4 14	5.12	5.37	25
TAQAUH 5 7/8 16	6.01	6.15	14
TAQAUH 6.165 17	6.33	6.41	8
TAQAUH 7 1/4 18	6.55	6.59	4
TAQAUH 6 1/4 19	6.39	6.5	11
TAQAUH 6 1/2 36	7.18	7.36	18
ALDAR 8 3/4 14	7.37	7.91	54
ALDAR 0 13	7.49	8.13	64
MUBAUH 5 3/4 14	4.48	4.57	9
MUBAUH 7 5/8 19	6.5	6.6	10
TDICUH 6 1/2 14	5.28	5.34	6
TDICUH 4.949 14 (sukuk)	5.31	5.37	6
DOLNRG 5.888 19	5.68	5.75	7

My colleague put together some thoughts on the case for Aldar and Abu Dhabi real estate – I am sharing that below:

The case for Aldar and Abu Dhabi real estate:

Aldar has close ties to the government of Abu Dhabi:

• Aldar Properties was setup as the property development arm of the Abu Dhabi government to implement the Capital's "Plan Abu Dhabi 2030" and as a result, benefits from frequent operational and financial support from the government, which has also granted the group almost all of its land bank at no charge. This enables the company to benefit, both operationally and financially, in the form of free land grants and financial reimbursements/subsidies, thus facilitating smoother project execution and cost efficiencies.
  
• The Government of Abu Dhabi, directly or indirectly through its affiliates, is the majority shareholder with a 38% stake as of December 2009.
  
• Aldar is a quasi government real estate company that is executing the Abu Dhabi Government's vision of providing affordable housing to UAE Nationals through the Al Falah Development. In addition, the redesigning of the Al Raha Beach projects plans to shift the development focus from the high-end to the mid-income segment, where majority of the demand exists. In line with Abu Dhabi's 2030 vision, it is expected that the population for the state should grow to anywhere between 3.5m to 5m people by 2030.

Abu Dhabi's real estate market is under supplied

• Market consensus estimates that the residential real estate segment in Abu Dhabi should remain undersupplied until at least 2013 with an undersupply situation of 27900 units to persist in 2009/2010.
  

  Aldar may hit recurring rental income of more than AED 1bn in 2011 as forecast by industry estimates, mainly from delivery of units in Al Mamoura, Baniyas, and Injazat Data Centre. This segment may form more than 10% of total Group revenue, and if sustainable, will be able to make up from the shortfall of any drop in land sales in the future. Concern is on gearing and on cashflow generation Aldar does have a fairly high debt burden that is characteristic of its heavy capex requirements during its buildout phase. The group currently has a gross debt balance of AED36.8bn (12% ST, 88% LT) which is a mix of loans, corporate conventional and Islamic bonds, and infrastructure loans. They are sitting on AED11bn in cash though. Capex spend in the near future however is expected to decline to the AED7-8bn from around AED18bn in 2009, placing less stress on their balance sheet. Its worth noting though that around AED10bn of Aldars debt was received from the government of Abu Dhabi on generous terms with no interest and principal payments until 2015. The market expects Aldar to turn cash flow positive from 2011 onwards on the back of a slowdown in capex, a pickup in plot sales, and collection of property sales as well as an expanding recurring income stream.