Moody's Investors Service has downgraded the ratings of Dubai Holding Commercial Operations Group (DHCOG) to A3 from A2 and placed the ratings on review for possible further downgrade.

The Baa1 ratings of Emaar Properties PJSC (Emaar) were placed on review for downgrade.

The rating actions reflects Moody's views of continued fundamental challenges to both companies' business and financial profiles in the wake of difficult conditions on Dubai's property market, despite a recent announcement to merge both entities.

'Whilst Moody's acknowledges that Dubai's property market seems to have largely bottomed out, the financial and structural implications of its decline have taken its toll on both companies' debt protection metrics', says Philipp Lotter, Dubai (DIFC) based senior vice president at Moody's and lead analyst for Dubai Holding.

'Moody's believes that these are likely to weaken further before the full effects of market recovery translate into stronger cash flows, irrespective of the announced merger', Lotter adds.

Both companies recently announced a proposed merger which will see Dubai Holdings merge its three property subsidiaries -- Dubai Properties, Tatweer and Sama Dubai -- with Emaar and likely take majority ownership of the new entity.

Moody's highlights that the combination of Dubai Holding's property business with the more mature portfolio of Emaar is likely to be mildly supportive of DHCOG, whilst negatively impacting Emaar, whose fundamental credit profile is considered stronger than that of DHCOG. Whilst both are highly exposed to Dubai's real estate market, Emaar has a longer track record of operation and thus lower large project concentration than DHCOG. It also benefits from a greater share of more predictable property cash flows from its investment portfolio.

DHCOG's ratings have nonetheless been downgraded due to the ongoing market weakness and the prospects of weaker cash flow over the near to medium term, as most new projects are put on hold and the company becomes more reliant on its hospitality and free zones businesses.

Moody's also highlights that DHCOG now faces some refinancing challenges over the coming 12 months, which however could be eased with Emaar's stronger liquidity. This ultimately depends on the chosen financial and capital structure of the combined group, which has yet to be determined.

Whilst generally positive for DHCOG, Moody's highlights that the addition of Emaar's assets may be insufficient to fully mitigate the effects of a weaker fundamental credit profile.

Upon completion of the proposed merger, Emaar's ultimate government-related stake is likely to rise substantially from its current 32 per cent.

'Whilst the higher government stake in itself may be seen as positive for Emaar's rating, downward pressure remains given Moody's concern by the government's acceptance of diluting Emaar with a weaker business in support of wider market consolidation', says Martin Kohlhase, Dubai (DIFC) based assistant vice president at Moody's and lead analyst for Emaar. 'Thus higher government ownership in Emaar may not be sufficient to mitigate the detrimental impact the merger would have on its fundamental creditworthiness,' Kohlhase adds.

DHCOG's ratings are likely to be confirmed, if the merger leads to a more solid, cash generative real estate business and improved liquidity, whilst maintaining very high support from the Dubai and federal governments and becoming the government's foremost property group for the Emirate. At the same time, ratings could face a further downgrade of one notch, if the combined business faces a more pronounced and deeper crisis of the local real estate market, to which it is now more heavily exposed, and a weaker government support environmen