Malaysian banks' exposure to troubled 1MDB is credit negative

A Moody's report says Malaysian banks' exposure to troubled 1MDB is credit negative, but manageable.

Last Thursday, Malaysia's Prime Minister and Finance Minister Najib Razak, said that the country's banks' exposure to 1Malaysia Development Berhad (1MDB, unrated) totaled around 5 billion ringgit (US$1.36 billion) as of January 2015.

The credit rating agency said this reported exposure, which marks the first time that the government has publicly disclosed Malaysian banks' exact exposure to the troubled government-owned development company, is credit negative, but relatively small compared with Malaysian banks' capital buffers, and the worst-case credit loss would be manageable for the banks.

The announcement addresses questions about 1MDB's potential liabilities to Malaysian banks, particularly considering that the company's total debt as of 31 March 2014 was 41.9 billion ringgit, more than 8 times the amount of the banks' exposure.

Of 1MDB's total debt, 5.8 billion ringgit (0.5% of GDP) was backed by an explicit government guarantee and an additional 11.0 billion ringgit (1.0% of GDP) was supported by a government-issued letter of comfort as of 31 March 2014. Other borrowings were either collateralized - like those from the Malaysian banks - or supported by third-party guarantees, such as from the International Petroleum Investment Corporation (Aa2 stable).

"We do not expect these liabilities to migrate to the federal government's balance sheet. However, a 950 million ringgit line of credit that the Ministry of Finance extended to 1MDB earlier this year, in part to alleviate 1MDB's liquidity pressures, carries a risk that further government support would materially undermine the fiscal consolidation trend that underpins our positive outlook on Malaysia's A3 sovereign rating," the agency reported.

Although no Malaysian bank has publicly confirmed or denied its exposure to 1MDB, Moody's suspects that some of Malaysia's large banks have moderate exposures. It also understands that bank loans to 1MDB are well collateralized, so any possible losses for the banks will be smaller than their exposures.

The Malaysian government established 1MDB in 2008 as a strategic development company. During the past few years, the company embarked on large-scale acquisitions and accumulated substantial amounts of debt. The company recently changed its senior management and has undergone a strategic review of its operations.