Learning on the job
The increase in debt restructuring situations in the GCC will test the region’s insolvency regimes and institutions and lenders’ and borrowers’ ability to reach agreements. The surge of defaulting companies is unprecedented in the region and the untested legal landscape for restructurings is complicated by the shortage in experience of debt workouts. However, this situation is spurring momentum to modernise insolvency and creditor rights regimes. Furquan Kidwai reports.
After much talk about the resilience of the GCC market in these tough economic times, the recession has finally bitten. The increasing number of corporate defaults and real estate devaluations, and ongoing credit contraction, have all contributed to market woe.
It has been a busy period for the region’s lawyers. But the region’s have also been forced to look at the long-untouched insolvency and bankruptcy laws, which have struggled to cope with increased market stress. Regulators and government officials fear loosing future foreign investment, should the workout regime be perceived as weak .
With a significant portion of the global sukuk issuance being GCC based, stress has also started to appear in some sukuk deals – exacerbating the anxieties of investors in these Shariah-compliant securities. But the silver lining will be the emergence of a more scientific, less speculative risk pricing regime, providing comfort to creditors regarding their rights, revealing investor friendly legal regimes. Conversely, opaque decision making will undermine the Islamic finance industry.
In Bahrain, the ongoing controversy with Saad and Algosaibi groups has embroiled the sukuk market. The US$650m Golden Belt sukuk holders are negotiating dissolution proceedings with their trustee. Despite the pessimism of some bankers for any resolution in favour of creditors, sukuk holders can reasonably expect priority treatment, given their ownership of leased assets. At best, sukuk holders will be exposed to real estate risk, via the possibility of taking ownership of underlying assets.
Kuwait’s Investment Dar restructuring exercise led to a coupon payment default on its US$100m sukuk. According to the offering circular, the trustee is within its rights to dissolve and sell trust assets back to the issuer, but the current negotiations between Investment Dar and its creditors will determine the enforcement priority of sukuk holders. Although the market anticipates sukuks will be treated at par with unsecured debt, it will stimulate the industry if shariah-compliant lenders are given some credit for their asset-based securities.
The UAE sukuk market has been relatively quiet, but all eyes are on the upcoming redemption of the Nakheel sukuk. Investors, being exposed to the Dubai’s notorious real estate sector, have genuine concerns, but the Dubai government is likely to prevent Nakheel’s default: such an event would put Dubai’s future investment prospects at risk. Yet discounting the support of government, Nakheel is unlikely to have sufficient liquidity to repay approximately US$3.5bn to its creditors. Declining asset values in Dubai’s real estate market offer little respite to sukuk holders if they are to enforce their rights – if any – on the assets.
One possibility is a government backed refinancing package from local lenders. While banks might balk at increasing their exposure to the Dubai real estate market, ‘it is too tempting for local banks to turn their backs on some lucrative distressed real estate opportunities with implicit government support,’ according to one local banker.
Bank and Corporate restructuring
According to a report by Standard & Poor’s, at least 30 GCC banks have exposure to either Saad or Algosaibi groups, threatening potential losses of US$9.6bn. Given the lack of transparency in the figures, these figures could rise significantly, once the exposure of foreign banks is realised. Market whispers are of circa US$22bn exposure.
Debt repayment challenges have also surfaced within GCC corporates. Leverage build-up during the boom years is now being reversed along with declining margins, replenishing cash reserves, falling commodity prices and tightening credit conditions. However, the big-name groups are unlikely to have any difficulty restructuring their repayment schedule, thanks to their reputations and deep rooted banking relationships. Capital market transactions should also increase as these stricken companies mend their balance sheets via rights’ issues.
While the precise outcomes of these entanglements remains to be seen, one result of the uptick in defaults and restructuring will surely be reform both the Middle Eastern market and the Islamic finance industry. If handled correctly, it is an opportunity for the region’s markets to emerge stronger in the longer term.