The Daily Update - 1MDB settles but pressures remain

In 2009 Malaysian PM Najib Razak established Malaysia’s sovereign wealth fund, 1Malaysia Development Berhad (1MDB), with the intention to fund economic development projects within the country. However all number of corruption probes and fund misappropriation scandals have plagued the state fund with the US Department of Justice (DoJ) claiming that at least USD 3.5bn of raised funds have been ‘stolen’. To add to the troubles, a year ago 1MDB missed a USD 50m coupon payment thus ‘defaulted’ on a USD 1.75bn bond issued on 2012. The USD bond was unconditionally and irrevocably guaranteed by the Malaysian Government (Ministry of Finance, MOF) and backed by Abu Dhabi’s sovereign wealth fund, International Petroleum Investment Company, IPIC.

Questions over of who should pay the bondholders soon intensified with 1MDB and the Malaysian government looking for help from IPIC, while IPIC expected the sovereign to bail the state fund out. IPIC then slapped 1MDB with an arbitration case in a London court where it has been claiming USD 6.5bn, stating ‘The failure of 1MDB and MOF to perform their obligations, cure their defaults or put forward acceptable proposals has left IPIC in the position where it must pursue its claims in arbitration’.

One year later we have heard that 1MDB has agreed to pay IPIC USD 1.2bn, via two payments, by the end of the year and will be responsible for all future interest payments on the remaining two USD denominated issues, 1MDB Energy 5.99% 2022 and 1MDB Global investments 4.4% 2023, backed by IPIC. However, 1MBD remains under pressure while at least six countries continue proceedings over money laundering investigations and embezzlement; although the company claims to have no knowledge of this. During this time, rating agency Moody’s has withdrawn its Aa2 rating for the 1MDB bond maturing in 2022, in June last year citing ‘business reasons’, and last month S&P followed suit, withdrawing its rating on both USD bonds on the back of the termination on the ratings agreement contract; both bonds are now unrated. Meanwhile the ratings across all IPIC debt have remained unchanged at Aa2/AA.

Regular readers are aware that IPIC is one of our favoured issuers and we have continually held the 6.875% 2041 bond, since issue in 2011. The Aa2 bond offers an exceptional expected return and yield above 15% and over 4 notches of credit protection. We have however never held any bonds issued by 1MDB despite the two outstanding issues having offered very attractive expected returns coupled with high credit ratings. Ahead of the bond default, the Aa2 rated 1MDB 5.99% 2022 issue had a very attractive expected return and yield around 19% and was over 8.5 credit notches cheap, while the 4.4% 2023 issue, rated A3, could have returned as much as 15.2% with a yield of 5.55%, and over 5 credit notches of protection.

Classified as quasi-sovereign issues, with very attractive expected returns and credit spread protection, one would assume these bonds would have been perfect fits in our portfolios, however, we decided against taking positions in either as a result of our credit work; which highlighted underlying fundamental issues within the state-owned investment company.