1MDB default highlights uncertainty surrounding fund: Fitch

PETALING JAYA: 1Malaysia Development Bhd’s (1MDB) missed bond coupon payment in April highlights ongoing uncertainty surrounding the finances and governance of the state-owned fund, said Fitch Ratings.
The rating agency said the situation is unlikely to lead to an immediate crystallisation of existing guarantee obligations of the Malaysian sovereign for 1MDB securities affected by cross-defaults.
“The risk to the sovereign credit profile lies more in the potential for the affair to weaken policy focus or contribute to political instability. However, there is little sign of these risks materialising as yet,” it said in a report yesterday.
On April 25 Malaysian state-owned investment company 1MDB missed a US$50 million (RM202 million) coupon payment on a 5.75% bond due in 2022 as part of its dispute with International Petroleum Investment Company (IPIC), Abu Dhabi’s sovereign wealth fund.
IPIC had guaranteed the bonds under a debt-for-asset swap agreement made in 2015. IPIC subsequently made the payment.
The affected bonds are not explicitly guaranteed by the Malaysian sovereign. However, the default on the 2022 bond triggered a cross-default on a 1MDB RM5 billion sukuk due in 2039 that benefits from an explicit sovereign guarantee.
“Payment under the guarantee would only be required if bondholders vote to require acceleration under the cross-default clause. We believe that there is unlikely to be a majority among bondholders for acceleration,” Fitch said.
It noted that the only other 1MDB debt benefiting from an explicit sovereign guarantee is a RM800 million loan from the country’s social security organisation (Socso).
“The default on the 2022 bond does not trigger a cross-default on this loan. The lender could require acceleration under a ‘material adverse developments’ clause, but we believe that this is unlikely.
“We have long viewed 1MDB as a close contingent liability of the sovereign, given its strong links with the state, including Prime Minister Datuk Seri Najib Abdul Razak’s role as chairman of its advisory board (which is being dissolved as the fund is wound down),” it said.
At RM5.8 billion, 1MDB’s sovereign guaranteed debt amounts to roughly 0.5% of forecast 2016 GDP (gross domestic product). Total debt currently disclosed by 1MDB is close to RM33 billion, or nearly 2.7% of forecast 2016 GDP.
“Federal debt was 54.5% of GDP at end-2015, so the assumption of the guaranteed debt would risk breaching Malaysia’s statutory 55% ceiling, a risk that would increase if additional, unguaranteed debt were assumed.
“A breach would probably not in itself trigger a negative sovereign rating action (as we said when we affirmed Malaysia at ‘A-’/Stable in February), assuming the sums involved were around our estimates. The ‘A’ category median debt:GDP ratio is 52%.
“However, the ceiling has helped provide fiscal discipline. The potential rating impact would depend on whether breaching it led to a sustained deterioration in fiscal discipline and public finances and a sharper than anticipated rise in debt ratios, as noted in our rating sensitivities,” it said.
Fitch said other points to monitor will be any effect on government policy-making and effectiveness, and on investor confidence.
It said the 1MDB affair has not had a discernible impact on policy-making, as the government has maintained fiscal consolidation and budget reforms.
However, it said that if its ability to implement economic policy weakened, this could be negative for the sovereign rating.
“So too could a broader deterioration in political stability, or in governance (already a credit weakness for Malaysia) that damaged the credibility of policy-making institutions,” it added.
Fitch said Barisan Nasional’s huge win in the Sarawak state election at the weekend suggests that the spillover from the 1MDB affair on politics remains contained so far.
“Market reaction has been relatively modest, but a large or sudden pullback by international investors could create risks to economic performance or financial market stability, given the large non-resident holdings of government securities,” it said.