Much of the land backing a $1.03bn sukuk bond from Dubai property developer Nakheel is unreclaimed seabed, bank sources said, leaving trade creditors holding the paper with scant recourse to tangible assets in the event of a default.
The Islamic bond, or sukuk, is part of Nakheel's $16bn debt restructuring deal which repays trade creditors 40 percent in cash and 60 percent via the bond.
The two assets that back the sukuk are a strip of waterfront land and a still partially submerged crescent that will form part of a man-made island shaped like a palm at Jebel Ali, on Dubai's outskirts.
The land plot consists of 350 million sq ft of undeveloped land at Waterfront South. The remainder is made up of 1.3 billion sq ft along the Palm Jebel Ali crescent, of which only 10 percent has already been reclaimed from the sea.
"I've tried to find it on Google Earth, but all I found was an undredged plot of land," said Ahmad Alanani, senior executive officer for fixed income at Exotix.
Nakheel declined to comment.
The sukuk prospectus does not outline the assets allocated to support the sukuk but a term sheet distributed to creditors details the area.
Such intangibility would usually cause investors to steer clear but Nakheel's trade creditors have limited options, said a Dubai-based trader.
"You take what you are given or you get nothing," he said.
Many contractors, who waited over two years for their cash owed, have sought to exit the instrument in the secondary market. Their concerns are less about the quality of the assets and more about liquefying the position, said one source knowledgeable about the dealings.
Bids for one auction of sukuk worth 320 million dirhams being sold by an international contractor were due on Tuesday, according to two bankers.
The paper is trading at a chunky discount and an auction process was unlikely to raise the price. On Wednesday it was at between 75.7890 and 78.316 for a corresponding yield of 17.555 percent and 16.631 percent.
That is down from 78.900 to 80.050 for a yield of 16.415 percent and 16.011 percent a day earlier.
"Those looking to buy into the sukuk will not do so because of the valuation of the collateral backing the paper or the issuer's cash flow generation capacity," Alanani said.
"They are more likely to do so as a play on the Dubai government backstopping any obligation from the developer," Alanani added.
Nakheel narrowly avoided a 2009 sukuk default after Abu Dhabi stepped in with a last-minute lifeline. Two other Nakheel sukuk, which matured in 2010 and 2011, were paid in full by Dubai. Nakheel's previous sukuk were based on a dusty strip of land which was part of the Dubai Waterfront project.
Nakheel is now wholly-owned by the Dubai government as part of its parent Dubai World's debt restructuring.
Asset quality concerns, and ambiguity over what happens if a default occurs, have been a major problem for the sukuk market. By law, international investors cannot lay claim to Dubai land.
"From a sharia standpoint sea or no sea, there is still a 'physical' plot of land secured for the sukuk," said Khalid Howladar, senior credit officer at Moody's.
"From a credit risk perspective it is of course a concern. Assuming investors could take security over such an esoteric asset in the first place, the land itself may be valueless without the reclamation/construction efforts of Nakheel."
In the sukuk prospectus Nakheel says it has postponed any reclamation efforts for the near-term, leaving sukuk holders with an investment backed by seabed for the foreseeable future