THE DARK WORLD OF FINANCE – PART 4 “1MDB BONDS”

In this part, I would like to focus, again on something that has not been highlighted in most discussions – the bonds issued by 1MDB. As my earlier focus, I want to highlight the dark side of these matters – which seemingly been missed by most due to the opaque nature of the subject.

First, let I have to lay down the financial facts, so that we can analyze them at the end of this article. Please bear with me for some of the details as they are necessary for us to dissect the subjects later on.

LIST OF BONDS ISSUED UNDER 1MDB

  1. Issued in May 2009 (Malaysia and in Ringgit): Islamic Medium Term Notes (IMTN) matured in various tranches from 2011 until 2039, issued in 29 May 2009; Total Face Value of RM5,000,000,000 at profit rate of 5.75%; This bond was issued locally, under Islamic Murabahah principles, issued directly under 1Malaysia Development Berhad (formerly Terengganu Investment Authority). The Notes were exempted from ratings, the full principle of RM5 billion is guaranteed by the Malaysian Government; it is an unsecured Notes. Total coupons to be paid from 2016 until 2039 (i.e. the final coupon; coupons are paid semi-annually) would be RM6,612,500,000, plus the principle RM5,000,000,000 is to be paid in a lump-sum in 2039. Hence the total obligations from the IMTN (from 2016 till 2039) is RM11,612,500,000.
  2. Issued in 2012 (London and in US Dollar): 10 YEAR NOTES matured in 2022, carrying a coupon rate of 5.75%; Guaranteed by IPIC (Abu Dhabi); Face Value of US1,750,000,000 by 1MDB Energy Originally rated by Standard & Poor’s with AA ratings. Issued in London, where Goldman Sachs was the sole Book Runner of the issuance. Based on the coupon rate, US100 million has to be paid yearly to the Notes holders, and until 2022, the total coupons to be paid is US600 million; which means the total obligation is about US2.350 billion.
  3. Issued in 2013 (London and in US Dollar): 10 YEAR NOTES matured in 2023, carrying a coupon rate of 4.4%; Backed by some forms of guarantee by IPIC or Aabar and some forms of letter of support from Malaysian Government; Face Value of US3,000,000,000. Originally rated by Standard & Poor’s with AA ratings. Issued by 1MDB Global Investments Ltd; Issued in London, where Goldman Sachs was the sole Book Runner of the issuance. Based on the coupon rate, US172.5 million has to be paid yearly to the Notes holders, and until 2023, the total coupons to be paid is US1,035 million; which means the total obligation is about US4.035 billion.
  4. Issued in February 2014: Bandar Malaysia Sukuk with maturities between 2021 to 2024, issued in February 2014; Face Value of RM2,400,000,000. It is backed by 194 hectares of Sungai Besi land. The yield was 5.85% for 7 Years to 6.05% for 10 Years Sukuk. Tabung Haji subscribed to RM920 million of the Sukuk, the balance was subscribed by other local FI, based on Private Placement. It seems that the Sukuk was issued as Zero Coupon, which means thay it was issued at discounts based on the prevailing yield at issuance date (which were between 5.85% to 6.05%), hence the total cash proceed to 1MDB should be in the range of about RM1.2 billion.

Comments:

  1. There are other bonds or IMTN issued by 1MDB subsidiaries such as Jimah Power and others, which are not included. Similarly there are other shorter term debts which were subscribed by KWAP and other local financial entities; as well EXIM Bank, MOF, local borrowings related to the IPPs (Tanjong, Powertek, etc.).
  2. For the US Notes issued in London, Goldman were paid US592 million as fees/commissions; which is about 11% of the Face Value/proceeds.
  3. Currently the US Dollar Notes due in 2023 are priced in May 2016 at about US82 (assuming US100 is Par Value),a discount of US18 dollars, which give the current yield of 7.87%; as normally in any bonds, yields rise as prices falls.
  4. The issue of the “guarantee disputes” with IPIC relates to the Notes issued in 2012 and 2013; The total amount of the guarantee is US2.35 billion + US4.035 billion = US6.38 billion (plus some other costs), which brings a total of disputes of US6.5 billion.

Based on USD/RM exchange rate of RM4.10/USD, the total exposure of 1MDB to the above mentioned bonds stood at: RM26.65 billion for US Dollar denominated Notes + RM13 billion for RM denominated bonds = RM39.65 billion.

THE FINANCIAL ACCOUNTS OF 1MDB (for 2014)

[For those interest to have a copy of 1MDB Accounts for 2014:  1MDB AFS 2014]

[Please note that 1MDB had announced that the above accounts couldn’t be relied upon, and Deloitte had recused itself as the auditor. Therefore, at best the above account could be considered as a draft, and yet to be qualified.]

A short analysis of the accounts are as follows:

The total revenue for 1MDB Group stood at Revenue: RM4.258 billion and about RM3.29 billion comes from the IPPs (independent Power Plants from Power Purchase Agreements incomes).For 2014, the biggest costs for 1MDB is finance cost: RM2.398 billion, due to the heavy gearing of the Group. And the significant assets are generally under three categories:

  1. The ownership of the various IPPs, under Edra Energy.
  2. The Sungai Besi and TRX lands (valued at about RM7 billion) (See Note 13 of the Account)
  3. “Portfolio Investments” under “Segregated Portfolio Company” (USD1.56 billion/RM5.18billion) (See Note 18 of the Account).

Deloitte make special explanations to the accounts under “Critical Accounting Judgements” which covers four main areas:

  1. Treatment of the “Segregated Portfolio Company”
  2. Valuation to the various lands held
  3. The pre-existing terms and conditions of the Power Purchase Agreements of the IPPs
  4. Portfolio of US1.56 b (RM5.18) with various overseas financial institutions.

ANALYSIS

Let me divide the analysis into a few segments so that we can focus on the issues that matters.

US Notes Issued in London & IPIC Guarantee Disputes (US6.5 billion exposure)

  1. The Notes issued had a few major shortcomings: the rates and yields of the issuance for a relatively short term notes (i.e. 10 years) are NOT to 1MDB’s advantage. You would issue in US Dollar in London ONLY IF you could get the net yields of below 4% or better. Based on the yields/rates disclosed, we are far better off to issue in Ringgit and in Malaysia.
  2. The exposure to the US Dollar was UNHEDGED. This is absurd and outright stupid. No sovereign wealth funds in this world go and borrow based on “open exposure”. If we count the costs of hedging (if we take one), or the costs of US Dollar exchange rates – the real costs of funds now would be anywhere in the 8% to 10% range. If this is the case – then why do we go to London and issue in US Dollar, and what exactly the “added value” that Goldman had brought to the table?
  3. The fees of USD590 million (or RM2.4 billion) to Goldman (somewhere about 11% or more of the proceeds) – is highest ever known. This is not counting the legal fees and other fees (ratings agencies, etc.). If we issue in Malaysia, the total fees should go above 2.5% (max), plus all the income to our banks are kept in Malaysia and benefits our own local employment.
  4. Based on the bond documents, once default had occurred, the whole principle plus outstanding interest would come due. And the terms of guarantee would stipulate that the guarantor becomes fully liable for the “full guarantee” amount with immediate effect. This is already became a reality as of now. The question is who is responsible for the guarantee (and hence to pay the amounts required).
  5. From IPIC point of views, they do not seems to be any advantage and financial gains from fulfilling this guarantee. It is akin to someone becomes a 3rd party guarantor for a car loan of someone else. Logically they will fight tooth and nail. And even if they lose, they will be a VERY sore loser, and Malaysia risks our relations with Abu Dhabi and the Arabs.

In short, the issuance of these Notes are blatant disregard to the interest of the stakeholders of 1MDB (the people), and a rip-off of an extremely large scale. Note that I am not commenting on the alleged misused of the funds raised, which is beside the issues raised here. Furthermore, at risk is also the relationship and investments from the Arab countries into Malaysia. The results will set the tone for this relation for a very long time into the future.

Local Bonds (RM13 billion exposure)

  1. By any counts the costs of funds for local bonds are high. This is given that 1MDB is a 100% government backed entity, which, if careful work are done, with proper structure, the costs of funds should be below 4% (or whereabouts). Shaving 200 basis points or more in these papers would means saving of at least RM4 to 5 billion from the total of RM13 billions of Ringgit bonds exposure.
  2. The purpose of RM5 billion IMTN is for “working capital purposes” – of which again should had raised lots of alarm bells to any risk managers. The Bonds are further not secured by any assets, which is again an absolute violations of the spirit of Islamic Debts, which is asset backed. This is similar to obtaining a 5 billion Overdraft facility from bank. It is absurd.

In short, even the local papers were done in manners that are imprudent financially. It should had raised eyebrows from the financial markets that something major is amiss.

The Financial Standing of 1MDB

  1. 1MDB critically relied on the sale of its Edra Global Energy Berhad to pare of its debts. It was announced on 23 November 2015 that the Share Sale and Purchase Agreement was executed between 1MDB and China General Nuclear Power Corporation. Under the Sale, the CGN Group agreed to acquire 100% of 1MDB’s ownership in all its energy assets (comprising Edra Solar Sdn Bhd, Edra Energy Sdn Bhd, Powertek Energy Sdn Bhd, Jimah Teknik Sdn Bhd, Jimah O&M Sdn Bhd, Mastika Lagenda Sdn Bhd and Tiara Tanah Sdn Bhd, collectively the “Edra Operating Companies”). The CGN Group would also assume all the relevant gross debt and cash of the Edra Operating Companies. What is not known until now is the net proceeds of the sale to 1MDB, and what the other salient terms of the SSPA are.
  2. Once, Edra is sold, then 1MDB would be only a real estate venture, namely for 3 pieces of lands: Sungai Besi Bandar 1Malaysia, Tun Razak Exchange (TRX) and Ayer Hitam land in Penang. All these land are currently valued at somewhere RM7 to 9 billion.
  3. Which means the annual revenue will drop significantly from RM4 billion to almost negligible (since they are all from the power business), unless sales of lands are being made. Any realization of ‘real revenues” from real estate development and construction ventures are still far from coming anytime soon.
  4. I wonder after that how the financial standings of 1MDB would look like. Since many of the obligations are coming thick and heavy from 2022 onwards. We would see this clearly once the full effect of the Edra sale could be accounted for (which should be seen in 2016 accounts).

Segregated Portfolio Company Issues (US1.5 billion)

  1. This is the so called payments for Joint Ventures such as the “Petro-Saudi” deal, Abu Dhabi Malaysia Investment deal, etc.
  2. This is what had been highlighted in the current US DOJ Civil Suit, which claims that monies were siphoned off to somewhere else.
  3. 1MDB’s account claims that these are “portfolio investments’ with reputable overseas financial institutions. Deloitte is having a tough time to confirm or deal with this issue. Hence, once the US DOH suit is on, Deloitte, being an American company has to back out.
  4. In 1MDB’s account, this is an opaque matter, since no details were provided in terms what are the investments in, and actually where it resides.

This subject would be of interest to see what will come out of it. Will it be written off, or some funds would be returned back to 1MDB. It is also hidden within 1MDB’s subsidairies, such as Brazen Sky, Abu Dhabi Malaysia Investments, and alike. Let us wait and see what will finally come out of this issue.

THE ORIGINAL PURPOSE OF 1MDB – TEMPORARY GLITCH OR OUTRIGHT WRONG?

If the original purpose of 1MDB was to do “smart finance” of Leveraged Buyouts (LBO), or through “smart leveraged structures” – then by all counts as I had described above, it had failed extremely miserably. LBO is “quick in” and “quick out”; it is about “arbitraging” the short term versus long term, and make gains for the differences. It is about repackaging undervalued assets and flog them off with a higher valuations. It is about “arbitraging the difference in terms of costs of funds and returns on investments”. Any guys with a decent MBA or CFA could answer all the above. My short say is: whoever conceived the idea, and whoever implementing them just simply lost and do not know what they are doing. If it continues this way, the final tally could be anywhere, only God knows.

Simply put, the total exposure of 1MDB is already above 5% of our GDP; and “per capita” exposure to the Malaysian public now stood at anywhere RM1,300 to RM2,000 per head of every living Malaysian today. In short, everyone of us has to be responsible for that amount (including babies and infants, old people, etc.)

Furthermore, what are the “VALUE ADDED” activities that these monies do for Malaysia? If I borrow at say 8% and my returns are 18%, then the value added is about 10% (roughly). And in the current case, the costs of borrowing is effectively at anywhere around 6 to 8%, and to get returns from the real estate ventures (which will be what’s left in 1MDB after Edra Sale), would means that it has to generate somewhere 12 to 15% in gross returns. Any seasoned developers know that is a tall order. We all know that real estate are subject to major cyclical movements globally and locally. This is against the backdrop of real estate glut that is already gripping us today – which means the timing would be off by some years (which could be 10 years, for normal down cycle). I am not counting yet in terms of the socio-economic impact to the people (in terms of affordability) and other social obligations the projects has to undertake (being a government project).

My last word on this is: Good luck 1MDB. You need some genius to overcome and make yourself to be worthy of anything. Otherwise, you will go down in history as the largest debacle of this decade.

 

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