Jackie Horne
Finance Asia
Thursday, 21 April 2016

The Federation of Malaysia returned to the international bond markets on Wednesday with a $1.5 billion wakala sukuk whose success will almost certainly be overshadowed by the gathering storm engulfing state-owned 1Malaysia Development Berhad (1MDB).

The investment fund faces a cross-default across its $11 billion outstanding debt after one of its guarantors failed this Monday to make a $50 million interest payment on a $1.75 billion note that matures in 2022. It has now entered a grace period, which ends on April 25.

The event forced the government to issue a supplementary note to the preliminary offering circular for its sukuk on Tuesday. It said that non-payment will “constitute an event of default, which could result in acceleration of the 2022 notes and could result in cross-defaults or cross-acceleration of other indebtedness of 1MDB.”

The government added that it is liable for up to M$5.8 billion ($1.5 billion) in guarantees and a further $3 billion through a letter of support to 1MDB, but “does not believe any amounts it would be required to pay with respect of 1MDB’s indebtedness would be material to the government.”

Sovereign ploughs on

Having roadshowed the new sukuk last week, the sovereign opted to proceed with the deal on Wednesday.

Syndicate bankers on the dual 10- and 30-year Reg S/144a sukuk said 1MDB’s problems did not really affect the transaction since it attracted a respectable final order book of $6.3 billion.

There was also a skew of roughly two thirds of demand for the 10-year tranche ($3.9 billion), which attracted strong interest from Malaysia and one third for the 30-year tranche ($2.4 billion), which was popular with Asian insurance funds.

However, overall demand was two thirds of the $9 billion level the sovereign attracted one year ago, suggesting the wider repercussions of 1MDB’s potential default are affecting sentiment towards Malaysia and its government headed by prime minister Najib Razak.

Pricing of a $1 billion 10-year tranche was fixed at par with a profit rate of 3.179% to yield 135bp over Treasuries. This was the tight end of revised guidance, which was narrowed from an original yield around the 150bp area.

A total 110 investors participated with a split, which saw 65% placed in Asia, 11% in Europe, 19% in the Middle East and 5% in the US. By investor type, banks took 20%, asset managers 22%, private banks 1%, pension funds and insurers 27% and central banks and sovereign wealth funds 30%.

A $500 million 30-year tranche was also fixed at par on a profit rate of 4.08% to yield 145bp over Treasuries. This tranche was initially marketed around the 165bp area.

This tranche has 85 investors with 54% in Asia, 12% in Europe, 10% in the Middle East and 24% in the US. By investor type fund managers took 48%, pension funds and insurers 31%, banks 12%, sovereigns and central banks 8% and private banks 1%.

The two nearest comparables were the sovereign’s two sukuk issues from 2015. Sales desks said the two have widened very slightly over the past two days.

Malaysia’s $1 billion 3.043% April 2025 issue was trading on a G-spread of 130bp on Wednesday. Bankers said the new deal priced about 1bp through fair value.

The sovereign’s $500 million 4.236% April 2045 issue was trading on a G-spread of 141bp. Bankers said the long-dated tranche priced flat to fair value.

“Only in Asia would you see a 10bp curve between 10- and 30-year paper,” one banker commented. “But it’s testament to the fact there’s been a real scarcity of long-dated paper from this region.”

The banker added, “There was some interest from the US for the 30-year tranche and good interest from the Middle for the 10-year even though it was expensive for funds in that region. The latter formed a core part of the demand, but Asia and particularly Malaysia led the deal.”

In a research note ahead of launch, RHB Securities said it expected demand to be strong given a lack of sovereign sukuk issuance so far this year and strong foreign inflows into ringgit-denominated government bonds, which should spill-over into the dollar issue.

The Malaysian currency has been one of the world’s best performing currencies in 2016, rising 11.3% again the dollar. Only the Zambian kwacha and Brazilian real have put in a better performance among emerging market nations.

As a result, RHB reports that foreign investors increased their holdings of government bonds by M$11.5 billion in March to M$226.6 billion, prompting a 1% month-on-month increase in foreign exchange reserves to $97 billion.

Malaysian sukuk issues have also been among the best performing in their asset class. The Bloomberg Malaysia sukuk ex-MYR Index has risen 3.47% in the year to last Friday.

Proceeds from the bond issue are being used to redeem a $1.2 billion sukuk, which matures this July.

Will 1MDB default?

In the meantime, yields on 1MDB’s outstanding debt have been plummeting. Its May 2022 bond saw yields spike from 4.81% on April 18 to 5.6% on April 19.

The last few days have seen conflicting messages from 1MDB and Abu Dhabi sovereign wealth fund International Petroleum Investment Company (IPIC) plus its subsidiary Aabar Investments PJS.

On April 18, IPIC said that since 1MDB had failed to re-pay it $1.1 billion in principal and accrued interest, its guarantor obligations towards $3.5 billion of 1MDB debt had been terminated. As a result it failed to make a $50 million interest payment on April 18, triggering the potential default.

In the supplementary note to its sukuk offering, the government says the issue concerns a binding term sheet that was executed on May 28 2015 between 1MDB and the Ministry of Finance on the one side with IPIC and Aabar Investments on the other. As part of a debt for assets swap, IPIC agreed to guarantee $3.5 billion of 1MDB debt in exchange for certain 1MDB assets.

1MDB says that it has paid $1.4 billion to IPIC and its subsidiary Aabar Investments PJS under the terms of that agreement.

At the heart of the issue is what happened to money that was funnelled through a BVI-registered company called Aabar Investments PJS.

In a filing to the London Stock Exchange last week IPIC said that it does not own it.

It also added that it is aware of reports that “substantial payments have been made by entities within the 1MDB group to an entity called Aabar Investments PJS Ltd, which IPIC and Aabar understand, from publicly available records, to be a company incorporated in the British Virgin Islands and which was wound up and dissolved in June 2015.”

In a rebuttal, 1MDB said it found it curious that IPIC has waited until April 2016 to issue such a statement.

In a notice posted on its website it said, “1MDB company records show documentary evidence of the ownership of Aabar BVI and of each payment made, pursuant to various legal agreements that were negotiated with Khadem Al Qubaisi in his capacity as Managing Director of IPIC & Chairman of Aabar and/or with Mohamed Badawy Al Husseiny, in his capacity as CEO of Aabar.”

Neither of the two men are now working for IPIC. The Wall Street Journal reports that the UAE authorities have frozen their personal assets and issued travel bans.

A Dow Jones article cites the many regulatory investigations, which have been initiated across the globe in relation to the BVI-registered company and the ultimate destination of the money that was paid into it. In January, the Swiss attorney general’s office said it believed up to $4 billion might have been misappropriated from 1MDB.

Malaysia’s attorney general has said that $681 million of funds deposited in the personal bank account of prime minister, Najib Razak, did not relate to 1MDB. The money was a donation from the Saudi royal family and has mostly been returned.

In a research note French brokerage Octo Finances wrote that, “IPIC has seen its name tarnished on the financial markets as a result of its ties with 1MDB, which faces allegations of corruption, money laundering and misappropriation of public funds.”

It believes IPIC’s recent behaviour makes a lot of sense. “It has to file for default if it wants to prove that it is innocent,” it stated. “The parties will go to court over the matter and the proceedings could be drawn out and tumultuous. ”

Global probes into 1MDB are also now drawing in the group’s bankers. On April 1, the US Department of Justice asked Deutsche Bank and JP Morgan to hand over documents relating to their relationship with the group.

Malaysia’s longest serving prime minister, Mahathir Mohamed, has also returned centre stage, applying for a court order to freeze Razak’s assets. He wants the court to force Razak to disclose all assets held under his name and the names of his nominees.

Last month he also filed a suit against Razak alleging corruption and abuse of power. Gulf News reports Mahathir as saying “I’m trying to fight him legally by filing a case to freeze his assets. But I’m not very optimistic on the outcome as the government’s control on law enforcement is extensive.”

It was an argument long used by jailed opposition leader Anwar Ibrahim.

Meanwhile, the government continues to apply its re-structuring plan for 1MDB, which involves debt-for-equity swaps, asset sales and most importantly of all a future commitment to match debt re-payments with defined cash flows.

Asset sales have included the $4.01 billion sale of Edra Global Energy to China General Nuclear Power in a deal, which closed on March 23. It is also selling its stake in Bandar Malaysia to Iskandar Waterfront Holdings and China Railway Engineering Corp for $1.228 billion.