Dubai's debt problems shook European banking shares on Thursday despite the emirate's efforts to minimize the impact of a debt restructuring plan at two of its biggest companies that raised fears of default.

Banks shares, which had recovered over the last six months on hopes the worst of a global economic crisis was over, fell to lows not seen since May on fears of exposure to Dubai.

Dubai, whose extravagant building projects have been largely put on hold since the crisis, said on Wednesday it would ask creditors at flagship firms Dubai World and property developer Nakheel, to delay repayment on billions of dollars of debt.

On Thursday, it tried to revive some confidence, by saying its profitable DP World would not be involved in the restructuring.

It might be a move to distinguish the solvent from less solvent companies in an attempt to shift the weight away from the less exposed entities, said John Sfakianakis, chief economist at Saudi Fransi bank.

That doesn't entirely allay market concerns but it could signal the beginning of a restructuring and re-categorization process.

Wednesday's announcement sent the cost of insuring Dubai's debt against default soaring and bond prices tumbling.

State-run Dubai World has $59 billion of liabilities, its subsidiary Nakheel said in August, a large proportion of Dubai's total debt of $80 billion.

BONDS EXTEND LOSSES

Nakheel's Islamic bond prices extended losses on Thursday, falling 12 points to 72, their lowest level since February, according to Reuters data.

The debt, which was originally due to mature on December 14, 2009, traded as high as 110 on Wednesday before the Dubai government said it would ask creditors for a standstill.

Dubai's credit defaults swaps are being quoted as high as 500-550 bps, some traders said, while the cost of insuring Qatari and Abu Dhabi debt has also surged since the news.

Bahrain's five year CDS jumped 37 basis points to 231.5 bps on Thursday as regional sovereign, but some analysts downplayed the regional fallout.

I would not rush into talking about contagion. Anything from Abu Dhabi or Qatar is backed by serious money. Dubai is a lot more leveraged, said Youssef Affany, a relationship manager at Citi who specializes in the region.

There will be some level of solidarity from the emirates and the big neighbor, Saudi, he said.

Analysts expect financial support from deep-pocketed Abu Dhabi, a neighboring member of the United Arab Emirates, to keep Dubai afloat. But Dubai will most probably have to abandon an economic model that focused on heavy real estate investment and inflows of foreign capital.

The announcement appeared to be timed to minimize its impact on regional markets; it came after the stock market shut and just before the eve of the long Eid al-Ad holiday, which will close many firms and government offices in Dubai and the Gulf until December 6.

Dubai's economy was hit hard as the global credit crunch over the past year ended a six-year boom in the region and sent the emirate's once-flourishing property sector into decline.

Last weekend, the ruler of Dubai, Sheikh Mohammed bin Rashid Al Maktoum, reshuffled the board of the Investment Corporation of Dubai, which manages his wealth, and changed the chief of the Dubai International Financial Center.

The reshuffle, which removed boom-era leaders from key positions, was widely seen as a shift toward more conservative stewardship of Dubai's resources.

(Writing by Lin Noueihed, editing by Elizabeth Piper)

Dubai United arab emirates