Fears that Dubai's debt problems are not limited to troubled state conglomerate Dubai World battered investor confidence in the world's top oil-exporting region and sent shares across the Gulf tumbling on Wednesday.
Investors have been left in the dark since the Gulf business hub announced on Nov 25 that it sought to delay payment on Dubai World debt while it overhauls the sprawling state firm, which builds and operates everything from ports to luxury flats.
While Dubai's government has tried to ring-fence profitable businesses from the $26 billion restructuring at Dubai World, its problems have led to credit downgrades on all government-linked firms amid investor fears that state aid would not be forthcoming in times of trouble.
Moody's Investors Service said on Wednesday it was reviewing the ratings of issuers related to the government not just of Dubai, but of neighboring emirate Abu Dhabi and the federal government of the seven-member United Arab Emirates federation.
Dubai and Abu Dhabi are both part of the UAE, the world's third-largest oil exporter. Banks lent Dubai government-linked firms on the implicit understanding that they were backed by the federal government or Abu Dhabi, home to most of the UAE's oil.
International banks are not going to see this as a Dubai World problem. They will see it as a state problem, a regional problem, Keith Edwards, head of asset management at Doha-based firm The First Investor, said.
Dubai World unit Nakheel, the developer whose debt is at the center of the crisis, has a $3.5 billion bond maturing Monday. The bond's trustee, Deutsche Bank, held a conference call on Wednesday to coordinate the administrative process, sources said, but it was not clear what would happen next.
Refinancing for anything with Dubai's name on it is now going to be very difficult, said David Butter, director for Middle East and North Africa at Economist Intelligence Unit.
The crisis has exposed the difficulty Dubai authorities will have in trying to cordon off ... real problem areas.
WHO ELSE IS IN TROUBLE?
Ratings agencies said downgrades could accelerate a payment clause for $2 billion in debts at Dubai's power and water firm. A spokesman at the utility firm, DEWA, rejected the notion.
But, underscoring potential problems for other Dubai firms, a unit of Dubai Holding, which belongs to the emirate's ruler, sold its stake in Egyptian investment bank EFG Hermes
Analysts said the move highlighted Dubai Holdings' vulnerable position as most at risk of defaulting on debt after Dubai World as capital markets become reluctant to lend Dubai.
Dubai's Emaar Properties
One Dubai-based analyst, who declined to be named, said investors had feared that the government would pressure Emaar to take on cheap Dubai Holding assets at high prices.
No one knows the value of Dubai Holding, whereas Emaar's assets we can value, the analyst said. The main issue is that we don't know the debt of Dubai Holding or total liabilities.
Dubai's predicament stands in stark contrast to the six-year boom when it snapped up assets, lured celebrities and courted the media with projects such as the world's tallest building.
But whereas neighbors funded growth with proceeds from soaring oil prices, Dubai borrowed to invest through a network of state-linked conglomerates that offered limited transparency.
In the wake of the crisis, Dubai's government has said its assets, which include Emirates airline, would not be involved in any firesale to plug Dubai World's debt, though assets belonging to the conglomerate itself could be sold.
Dubai World has already said prized assets from Istithmar World, profitable port operator DP World
But in a sign that Dubai World may struggle to keep its trophy buys, Istithmar World sold its W Hotel in Manhattan in a foreclosure auction on Tuesday for $2 million. It bought the property for $282 million in 2006.
With time running out for a deal on Nakheel's bond, bankers said bondholders may have to accept some impairment, leaving Dubai World free to negotiate with longer-term debt holders.
Banks need to stabilize the market and achieve that by not falling behind other creditors, one banker said.
But vociferous minority holders of Nakheel's bond are demanding repayment, which could tip both Dubai World and the builder of the emirate's palm islands into default and potentially damage larger claims.
The cost of insuring Dubai's debt against restructuring or default rose sharply on Wednesday as investors grew increasingly nervous about Dubai World's restructuring.
Nakheel's December bond fell 2 points on Wednesday to a record low of 45 cents on the dollar, compared with 110 just before the standstill request.
This does not really enhance Nakheel's ability to meet near-term obligations, said Roy Cherry, vice president research, real estate and construction at Shuaa Capital.
Nakheel added to battered sentiment after its financial statements showed liabilities jumping 7 percent in the first half and it made a loss of over $3.6 billion.
Dubai's stock index <.DFMGI> tumbled to a 38-week low with building and real estate firms all down by the daily limit. Dubai led a retreat across all Gulf Arab markets, despite assurances from the region's top officials that the economy was sound.
(Additional reporting by Inal Ersan, Rania Oteify, Tamara Walid, Rachna Uppal, Enjy Kiwan, and Martin Dokoupil; Writing by John Irish and Lin Noueihed)