COUNTRY BRIEFING FROM THE ECONOMIST INTELLIGENCE UNIT

The global credit crunch and collapse of at least one US financial institution are starting to have a severe impact on projects in the real estate sector in the Dominican Republic. In recent years the Caribbean country has received strong inflows of investment and finance to develop the high-end tourism and second-homes market. No project has been more ambitious than Cap Cana, on the island’s eastern-most tip. But the development’s financing and cash flow have dried up, putting it—and perhaps other similar projects—under an ever-darkening cloud.

With a total cost estimated at US$1bn and an expanse of 30,000 acres, Cap Cana is the Caribbean’s largest resort development, encompassing a complex of 5,000 residences, multiple luxury hotels, golf courses, shops and restaurants. The price of the homes starts at US$895,000 for a one-family unit and go into the multi-millions for villas.

The multi-year project, which was expected to take 12-15 years to complete, secured initial financing in November 2006 with a successful international issue of US$250m in corporate bonds, due 2013. It received a subsequent bridge loan of US$100m from Morgan Stanley and Deustche Bank to be repaid with the proceeds of a second bond issue of US$500m planned for the end of 2007. With the US subprime mortgage crisis already under way and risk aversion among investors rising, that bond issue never materialised (there was limited interest and those investors willing to take part were demanding a prohibitively high interest rate of 11.75%).

To stay afloat, Cap Cana was relying on a US$250m loan commitment from Lehman Brothers this year, but that investment bank went bankrupt in September amid the growing financial crisis in the US. This prompted the resort’s management to dismiss 1,200 workers according to local reports, and to suspend construction until a new financing source could be found.

Looming default

Given the scarcity of funding, on November 3rd Cap Cana was unable to meet a US$12m interest payment due to holders of its corporate bonds. It instructed its trustee to make the payment out of a special debt-service reserve account in order to avoid default, essentially depleting that account. Cap Cana now has 60 days to replenish the fund or will again be at risk of payment default.

Meanwhile, Fitch Ratings, a credit-rating service, on October 31st downgraded its rating on those notes from “B” to “CCC/RR4”, and placed the rating on “Rating Watch Negative”, suggesting that additional downgrades are possible. According to Fitch, deteriorated market conditions have increased the refinance risk associated with the US$100m bridge loan to Cap Cana that comes due on November 19th, making default on this and its other obligations more likely.

More casualties likely

Illiquid debt markets and a decrease in property sales have put Cap Cana and similar projects in the Caribbean region under severe strain. (The Lehman Brothers collapse also paralysed work on another tourism project, in the Turks and Caicos Islands, being built for the Ritz-Carlton hotel chain.) Much of Cap Cana’s debt is secured by sales receivables and the value of the underlying property. Given the illiquid nature of the collateral and rising risk that construction will not mean targets, the project is facing a reduced value of receivables and worsening cash-flow problems. Meanwhile, the price of Cap Cana’s existing bonds has declined sharply in the market as investors have lost faith in the developer’s ability to pay.

It is highly doubtful that the project developers will be able to secure affordable financing in the current international environment with which to both replenish the trustee’s reserve fund and to meet the November 19th debt repayment date. They will have to hope for a capital infusion by new or its existing direct investors. Without this, the much-vaunted Cap Cana project—the Dominican tourism sector’s crowning glory—could become insolvent, and, as is feared by some local experts, could collapse entirely.

This will have negative effects not only for external creditors, but also for the local investors in the project, led by the Hazoury family, as well as for local banks, suppliers and contractors. The state-owned Banco de Reservas reportedly loaned the equivalent of US$147m to Cap Cana for mortgage credits, and other private banks may have also extended financing.

Bursting the bubble?

The same problems facing Cap Cana could well afflict other high-end property projects in the country, including the ongoing development of resorts in Punta Cana, the country’s most important tourist destination, as well as Roco Ki, another huge residential and vacation complex.

Some may now argue that Cap Cana was always overly ambitious and costly for a country like the Dominican Republic, a middle-income developing country with a GDP of US$46bn and a per capita income of US$4,900, but one with large swaths of poverty and infrastructure problems, such as a chronic energy crisis. But the Dominican Republic’s tourism sector has been highly successful, and developers, along with the government, have seen diversification into higher-end tourism and real estate offerings to be a necessary step to increase revenue and value added in the sector.

Nonetheless, Cap Cana and other projects—including in the broader Caribbean and in Panama, another hotbed of high-end property development—were probably caught up in the same type of real estate frenzy that infected the US and other countries around the world. Some projects may have to be scaled back and others closed down, as the financial crisis persists and global recession advances. This will inflict collateral damage on the construction industry, employment and the country’s external accounts, as less foreign investment flows in. The fall-out from the global crisis, it appears, has started to rain down.