In October 2007 Euromoney asked a senior banker how long Dubai’s property bubble would last. "One more year," he answered. As Euromoney reported then, the source estimated that in practice Dubai banks had a 25% exposure to the local property market.
Since then, build-bigger solutions, negative real interest rates and escalating raw material costs have increased Dubai’s vulnerability to a real-estate crash.
Banks in Dubai have tightened their real estate-related lending policies over the past month. The move was overdue. The United Arab Emirates’ central bank says banks will not be allowed to extend more than 20% of their deposits to the real estate sector. But this regulation has been poorly defined and easy to get around.
Many of the ways in which banks in Dubai are exposed to the property market cannot be covered by the 20% limit. Real estate is the economy’s main component, and its linchpin. The jobs of thousands of people to whom banks have given consumer loans and credit cards depend on the sector.
Compared with such countries as the UK, the mortgage market in UAE makes up a small proportion of the economy. However, observers say loan-to-value ratios have regularly exceeded 100%. And mortgages, they say, have been widely dressed up as personal loans.
In the UAE as a whole, the average loan-to-deposit ratio of banks has passed 100%. The three biggest Dubai banks admit, on average, that real estate lending takes up 13% of their loan books. Personal loans take up 21%.
With reports that prices for Dubai’s flagship Palm development are down by 40%, this alone would be a cause for concern. An HSBC report issued in mid-November furthermore showed a 4% fall in the secondary property market in Dubai as a whole. It said advertised villa prices fell 19% in October.
Speculators, who previously fuelled the astronomical price rise, might now accelerate the downturn. Owner occupancy in Dubai is far lower than, say, in the UK, where many buyers in Dubai came from. As confidence in the emirate falls, international investors are pulling back to cover their losses at home.
The problem in Dubai is transparency: how to know for sure how much prices have fallen, how much the banks are exposed to real estate, and how much public-sector debt Dubai has taken.
A Citi report in mid November said highly leveraged state companies of so-called Dubai Inc might have difficulty refinancing in 2009, when borrowing worth roughly $25 billion comes to maturity. At 40 cents in the dollar, trading on the debt of Nakheel, the state-owned developer of the Palm project, suggests as much.
Mergers within Dubai Inc could help but some reckon it is all over-leveraged. Two wrong companies do not make a right. And in a global downturn, there will be lower returns from Dubai Inc’s cash cows in the port, airline and aluminium industries.
Abu Dhabi will help. It will increase liquidity through the central bank. Abu Dhabi has its own, much smaller, property bubble. Abu Dhabi banks have benefited from Dubai’s real estate bubble. It is not in Abu Dhabi’s interest to see Dubai suffer a humiliating financial crash.
However, for Abu Dhabi, the centre of the UAE’s federal government, Dubai’s crisis is a chance to quietly put a brash child in its place and teach it a lesson. Sources tell Euromoney that Dubai has already gone begging to its oil-rich neighbour, for $45 billion. Abu Dhabi apparently said Dubai could have a loan for $15 billion, maximum - if it offered as collateral some choice assets, such as aluminium firm Dubal, and Emirates Airlines.
Dubai’s hallucinatory financial visions are over. In its own way, it is joining the rest of the world in long-overdue crisis and retraction. Abu Dhabi, which has similar ambitions, will stop Dubai becoming a ghost town, but only just.