1MDB Trades Like Junk as Investors Weigh Wind-Down: Asean Credit

The Deputy Finance Minister Datuk Chua Tee Yong was either being fooled or fooling us when he said banks’ extension on its loan shows confidence in the 1MDB.

1MDB Trades Like Junk as Investors Weigh Wind-Down: Asean Credit
2015-02-23 16:00:01.0 GMT

(For credit-market columns, click on TOP CM.)

By David Yong

(Bloomberg) -- 1Malaysia Development Bhd.’s bonds are trading like junk as investors seek greater clarity over the state investment fund’s plans to wind down and sell off assets.

Investors are demanding a 439 basis-point premium over similar maturity Treasuries to hold the Kuala Lumpur-based company’s securities, compared with an average of 415 for speculative-grade quasi-sovereign notes in the region, a JPMorgan Chase & Co. index shows. Its $3 billion of 4.4 percent notes due 2023 closed at 86.72 cents on the dollar on Feb. 16, a record low. They traded at 87.62 cents on Monday.

1MDB said last week it won’t undertake any new investments after it sets up separate entities for property projects and raises cash from selling its power business. The group settled a 2 billion ringgit ($550 million) loan Feb. 13, after two repayment deadline extensions sparked concern a default may trigger cross defaults on its some 49 billion ringgit of total debt. The group will need to show progress in asset sales and avoid fire-sale prices to regain market confidence, Phillip Capital Management said.

“The problem is they have a lot of assets that aren’t generating enough cash flow to service their debt,” Ang Kok Heng, the fund manager’s Kuala Lumpur-based chief investment officer, said by phone on Feb. 23. “Going forward, there will be other bonds due for payments or maturity. These could be new pressure points.” Phillip Capital manages 2.3 billion ringgit and doesn’t own 1MDB’s dollar bonds.

Cayman Islands

1MDB’s next two dollar bond coupons are due on March 9 and May 11, according to data compiled by Bloomberg. The company struggled to meet its loan repayment despite redeeming a $2.32
billion Cayman Islands investment.

1MDB’s 2023 bonds are rated A-, four levels above non-investment grade, by Standard & Poor’s, the same score the ratings company gives Malaysia. Weakening public finances and lower oil prices mean Malaysia’s rating may be cut by one level in the first half by Fitch Ratings Ltd., according to ING Groep NV, which says corporate governance concerns at 1MDB may have “some minor influence.”

“The thing about 1MDB is the uncertainty,” Tim Condon, ING’s Singapore-based head of Asia research, said by phone Feb. 18. “Recent loan servicing difficulties have created stress on Malaysian financial assets and further such news could have the same result.”

The Edge newspaper reported on Monday that 1MDB may require a 3 billion ringgit cash injection from the Ministry of Finance, citing people it didn’t identify. As 100 percent owner, the ministry will be involved as required in the interests of maximising shareholder value, 1MDB said in e-mailed statement, adding that it will issue official announcements relating to its business, implementation of a strategic review, and financing arrangements when appropriate.

Cross Default

A default on 1MDB’s loan, and subsequent cross default on its other debt, may have proved damaging to Malaysia’s sovereign rating, given that 1MDB is owned by the ministry, Credit Suisse
Group AG said in a Feb. 9 report.

“1MDB is becoming relevant to fixed income and equity investors alike as they scramble to understand what it is, and what impact it could have on Malaysia’s banking system and sovereign rating,” Stephen Hagger, a Kuala Lumpur-based analyst at the bank, said in the note. “Former Prime Minister Mahathir Mohamad, along with the opposition, repeatedly question the goings on at 1MDB. As a result, it’s becoming highly politically charged.”

‘Letter of Support’

Since 1MDB’s debt repayment concerns surfaced in late October, Malaysia’s ringgit has slumped 9.9 percent to levels not seen since March 2009, Bloomberg data show, making it the region’s worst performing currency over the period. Indonesia’s rupiah has weakened 5.4 percent while the Philippine peso is up 1.5 percent.

The 2023 notes have lost 9.6 percent this year, versus a 0.8 percent gain for investment-grade quasi-sovereign bonds in Asia and a 1 percent increase for the region’s speculative grade dollar corporate debentures, JPMorgan indexes show.

1MDB Global Investments Ltd., the offshore subsidiary that issued the notes, is rated on par with Malaysia because of a “letter of support” from the government, according to S&P. That support is effectively a state guarantee, said Kim Eng Tan, the rating company’s senior director of sovereign ratings.

“Market prices likely reflect the significant uncertainty surrounding the company right now,” Singapore-based Tan said by phone on Feb. 18. “If the issuer doesn’t repay the bonds, we’ll
consider it to have become the direct commercial financial obligation of the Malaysian government. If the Malaysian government doesn’t fulfil this obligation, then we treat it as the government defaulting on its own debt.”

Credit Risk

Prime Minister Najib Razak, who chairs 1MDB’s advisory board, told opposition lawmakers in October that the government wasn’t liable for 1MDB’s debts if the company went bankrupt.

The cost to protect Malaysia’s sovereign debt against nonpayment for five years jumped to 150.5 basis points on Jan. 13, the highest level since August 2013, according to data provider CMA. At 118 basis points on Feb. 20, that shows a 9.6 percent probability the nation will default on its obligations, compared with 7.4 percent for the Philippines and 11.6 percent for Indonesia, which are rated two and four credit scores lower respectively by S&P.

Any fallout resulting from a downgrade in Malaysia’s creditworthiness would present buying opportunities, according to ING’s Condon, who at the moment recommends buying the ringgit and the more liquid Malaysia government bonds instead of 1MDB’s debt. He also suggests selling credit-default swaps on Malaysia after the recent widening relative to contracts on other Asian sovereigns.

1MDB started life as part of the Terengganu Investment Authority, a body created in 2009 to invest oil royalties from the eastern state of Terengganu. When Najib became prime minister that year, it was renamed 1MDB, became a national entity and its funding source was changed to government-backed debt instead of oil income.

“The headlines and price volatility make me a bit worried but as long there’s no change in sovereign support I see value” in the bonds, Mikko Kuisma, a money manager in Helsinki at FIM Asset Management Ltd., which manages about 5.4 billion euros ($6.2 billion) including 1MDB debt, said on Feb. 17. “There could be more transparency.”

1MDB’s borrowings climbed to 41.9 billion ringgit in the year ended March 2014 from 36.2 billion ringgit a year earlier, according to accounts it filed in November. Its power assets were acquired in 2012 and 2013 for 12.5 billion ringgit, Credit Suisse said in its Feb. 9 note.

“1MDB has stated that it intends to list its power assets, but this process appears to have faced numerous setbacks,” Hagger said on Feb. 9. “Investors are concerned.”