1MDB bond default: high-stakes damage not ruled out

Bondholders and bankers were scrambling to assess the fallout of a bond default triggered after scandal-ridden 1MDB failed to meet a coupon payment of US$50 million on its US$1.75 billion notes even as the development fund sought to assure investors it has the capacity to meet all other financial obligations and that cross defaults are limited to two bond tranches.

Opposition lawmaker Tony Pua, however, highlighted the government could be forced to step in and bailout 1MDB to the tune of at least RM20 billion (S$6.9 billion).

In any event, the breakdown in relations between 1MDB and International Petroleum Investment Company (IPIC) - its once staunch ally and partner from UAE, and with which the finance ministry has an inter-guarantor agreement to indemnify of all its obligations entered on behalf of 1MDB - appears to be heading towards a long-drawn legal tussle over numerous issues including responsibility for the US$50 million payment

In a statement on Tuesday morning after the lapse of a five-day grace period for payment, the finance ministry-owned entity said as a result of the default on the US$1.75 billion fixed rate 5.75 per cent notes due 2022 issued by 1MDB Energy (Langat) Ltd, "1MDB confirms that cross defaults have been triggered on the 1MDB RM5 billion Sukuk due 2039 and the RM2.4 billion Bandar Malaysia Sdn Bhd Sukuk due between 2021 and 2024".

On Monday, IPIC had assured it would honour its obligations as a guarantor of the notes in the event the guarantee is called upon.

Ahead of the deadline, 1MDB president and group executive director Arul Kanda indicated in an interview with The Edge Weekly that the entity did not expect bondholders of the RM5 billion and RM2.4 billion notes - mostly local pension funds - to recall the facility immediately as they could end up taking a hair-cut instead if push comes to shove.

"Of course the local funds will play ball with the government," said a corporate executive.

Another observed few would be prepared to set the ball rolling for fear of getting into Putrajaya's bad books, but added his institution was going through all related instruments and notes held by it to check if there is any impact.

Even so, the ramifications of the default and potential high-stakes damage appear inevitable as the sovereign funds of Malaysia and the UAE head for a long-drawn legal tussle over numerous issues including the liability for the US$50 million payment

Bloomberg reported the ringgit declined 0.8 per cent on Tuesday. It said prices from Nomura Holdings Inc showed the cost to protect Malaysia's sovereign notes with credit-default swaps was up by 1 basis point to 165 basis points.

Financial markets expect more turmoil given the major disagreements between both sovereign funds including a dispute over payments amounting to US$3.5 billion by 1MDB to IPIC subsidiary Aabar Investments PJS.

A Malaysian parliamentary select committee looking into 1MDB found the funds had been transferred to a similarly named company Aabar Investments PJS Ltd that was registered in the British Virgin Islands and since de-registered. IPIC and Aabar maintain the BVI registered company is not part of their group.

Mr Arul now contends the possibility of a "massive fraud" perpetuated by IPIC and Aabar's former chief executives, Khadem Al Qubaisi and Mohamed Badawy Al Husseiny, both currently being questioned by Abu Dhabi authorities. In 2012 under Mr Khadem's leadership, IPIC had guaranteed two 1MDB bond tranches totalling US$3.5 billion plus US$2 billion in interest in return for which 1MDB put down an initial US$1.4 billion deposit with the BVI-registered Aabar.

On the missed coupon payment, 1MDB maintains IPIC agreed to pay under a binding term sheet entered into in May 2015.

IPIC, however, asserts that 1MDB and the finance ministry are in breach of the terms of the binding sheet and other ancillary documents, and hence its and Aabar's obligations under the sheet have terminated. Moreover, it claims the finance ministry agreed to indemnify IPIC for all amounts it may be required to pay in respect of the notes and guarantees.

Mr Pua, who sat on the select committee, said under the inter-guarantor agreement, IPIC would ultimately make a claim on the finance ministry for whatever sums paid on 1MDB's behalf.

Such is the mayhem since IPIC rather belatedly asserted this month that it had not received the purported US$3.5 billion in payments that 1MDB's debt rationalisation plan has come apart.

Prime Minister Najib Razak who has become inextricably linked with 1MDB's problems since he ultimately called the shots in the entity that was established under his watch, is understood to be furious about recent developments.

Just as 1MDB's massive debts of RM50 billion appeared to be more manageable after energy and property assets were sold, IPIC's intransigence has blown the plan wide open. Worse, corporate executives say its disgruntled former ally could throw up even more discomforting facts about 1MDB, the transactions of which have raised red flags and investigations locally and in at least six countries.

This article was first published on April 27, 2016.
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