1MDB bond fates diverge as Abu Dhabi vow trumps Najib support

[SINGAPORE] The fortunes of bonds in Malaysia's troubled investment fund are diverging this month: those guaranteed by Abu Dhabi's sovereign wealth fund have rallied, while notes with support from Malaysia's own government have dropped.

1Malaysia Development Bhd, whose advisory board has been headed by Prime Minister Najib Razak, holds talks with creditors Monday at 10:00 pm Hong Kong time after defaulting last month. Its 4.4 per cent 2023 notes, backed by a letter of support from the government, slumped 6.4 per cent in May, set for the worst slide in 16 months. The fund's 5.99 per cent 2022 bonds, on which Abu Dhabi's International Petroleum Investment Co paid interest earlier this month in its role as guarantor, gained 1.9 per cent. That's the most since at least September 2014.

The contrast reflects growing investor concern about the Malaysian government backing as Mr Najib grapples with an economy forecast to expand at the slowest pace in seven years amid a collapse in oil prices. 1MDB is at the centre of multiple investigations from Switzerland to the US amid allegations of money laundering and embezzlement. Even as the firm has consistently denied wrongdoing, it's brought negative attention to the government.

"In the past, people could just look at the support as enough," said Sean Chang, head of Asian debt investment at Baring Asset Management Ltd in Hong Kong. "But now, the macro picture is very different. Malaysia is a commodity exporter and if this kind of market environment persists, it may not do them a favour. A straight guarantee is more clear-cut and people are happy to hold on to those exposures."

With another coupon due this month, 1MDB referred requests for comments on its interest payment plans to previous statements it had made on the matter. The company said on April 26 that "it will meet all of its other existing financial obligations and has ample liquidity to do so."

The Malaysian finance ministry reiterated on May 11 that it will "continue to fulfil all of its outstanding financial commitments including any explicitly guaranteed debt and debt which carries a government letter of support, to domestic and international investors."

1MDB itself didn't make payments on two IPIC-guaranteed bonds in the past month because of a dispute with the Abu Dhabi sovereign wealth fund. On April 25, the fund defaulted on a US$1.75 billion privately placed bond, missing a US$50 million interest payment. IPIC, which was also co-guarantor on those notes, said it would only make the payment if the Malaysian fund first failed to do so.

On May 11, IPIC paid US$52.4 million of interest due that day on 1MDB's 5.99 per cent securities after saying 1MDB reneged on it. While IPIC said it made the payment, this time it did so on the due date unlike in April.

1MDB's failure to make payment in April triggered a cross default on the RM5 billion (S$1.7 billion) of 5.75 per cent Islamic bonds due in 2039 and RM2.4 billion of notes maturing in 2021 to 2024, according to company statements. 1MDB will have to pay RM143.8 million of coupons on the 2039 notes, which are guaranteed by the Malaysian government, on May 30, according to data compiled by Bloomberg.

Investors are betting that such guarantees are stronger signals of backing than the letters of support, such as the one on the 2023 debentures.

"Admittedly, the letter of support on the 2023s can essentially be considered an implicit guarantee at best," Imtiaz Shefuddin, a Singapore-based credit analyst at Societe Generale SA, said in a May 19 note to clients. Still, previous cases involving such letters have shown that the government has honoured its obligations, he said.

Investors may ask for clarity or reiteration of the state's support for the 2023 debentures on Monday's call as the notes under-performed those backed by IPIC guarantees.

The 2023 notes last traded at 81.95 cents on the dollar on May 10 to yield 7.87 per cent, or 598 basis points more than like-maturity Treasuries, according to Bloomberg data. As an indication, Malaysia's sovereign bonds due in 2025 yielded 3.05 per cent on May 20, or with a risk premium of 122 basis points.

"The 2023 bonds are cheap relative to the sovereign," said Julian Jacobson, a fund manager in London at FPP Asset Management LLP. He previously owned the notes. "The difference in the spreads is down to corporate governance."

BLOOMBERG