1MDB Bonds Upgraded by JPMorgan Focused on Abu Dhabi's Guaranteeby
Difficult for IPIC to walk away from guarantee, JPMorgan says
1MDB spreads `too wide' relative to those on Abu Dhabi's IPIC
JPMorgan Chase & Co. says drops in bond prices at 1Malaysia Development Bhd. amid a dispute with Abu Dhabi’s sovereign wealth fund have created a buying opportunity.
The bank upgraded its recommendation on 1MDB’s 5.99 percent 2022 notes, which are co-guaranteed by Abu Dhabi’s International Petroleum Investment Co. and the debt-ridden Malaysian issuer, to overweight from neutral. It said the yield spreads with IPIC bonds are “too wide.”
“The IPIC guarantee appears explicit, irrevocable and unconditional -– it appears difficult for IPIC to walk away from it,” London-based analysts Zafar Nazim and Sergio Calci wrote in an April 22 research note. "IPIC has made no comment that would make us feel that the company is considering disputing the guarantee."
The Malaysian state fund sold two securities in 2012 in a $3.5 billion offering arranged by Goldman Sachs Group Inc. On April 18 it skipped a $50 million interest payment on one of them, amid a dispute that’s spilled over to who should stump up the cash. IPIC said in a stock exchange filing Monday that it will make the $50 million interest payment, "but only after 1MDB defaults on its payment obligations in respect of such notes."
Failure to pay the coupon by an April 25 grace-period allows 1MDB bondholders to invoke IPIC’s guarantee within 10 days, according to Standard & Poor’s.
Nazim declined to comment beyond his April 22 note in an e-mail to Bloomberg News on April 23. There were no immediate replies to e-mailed requests for comment to 1MDB and IPIC.
As investors wait for the end of a grace-period April 25, inquiries continue across the globe into the affairs of 1MDB, whose advisory board is headed by Malaysia Prime Minister Najib Razak. Authorities in Malaysia, Switzerland, the U.S. and Luxembourg are examining claims the development fund was used to funnel money to politically connected individuals.
IPIC announced on April 18 an end of its obligations tied to $3.5 billion of 1MDB bonds in a filing to the London Stock Exchange, citing failure by the Malaysian fund to fulfill their “binding term sheet” in May 2015. 1MDB said on the same day that the interest payments on its debentures remains IPIC’s responsibility.
“We expect full payment as is written in the bond prospectus,” said Lutz Roehmeyer, who helps manage $12 billion assets at Landesbank Berlin Investment, including 1MDB’s 5.99 percent notes. “Should the bond default out of technical reasons or unwillingness to pay, the issuer should expect no mercy from bondholders and lawsuits.”
The dispute had pushed the yield premium on the 5.99 percent notes to more than three times that of IPIC’s 5.5 percent 2022 bonds, even though both 1MDB and IPIC securities have the same ratings from S&P and Moody’s Investors Service, Nazim and Calci wrote.
1MDB has enough cash to pay the $50 million of interest that was due and in fact its surplus is 11 times that amount should it decide to make the payment, President Arul Kanda said in an interview last week. But it’s IPIC, which earlier agreed to pay interest on the bonds, that should be making the payment, he said, adding that he sees an “amicable resolution” with IPIC.
Until the 1MDB-IPIC dispute is resolved, it would be difficult for 1MDB bond prices to trade up to their potential, the JPMorgan analysts said. “A statement by IPIC affirming its intention to honor the guarantee irrespective of the dispute (or its outcome) could help."
1MDB’s 5.99 percent notes traded at a spread of 472 basis points more than Treasuries if held to maturity, versus 151 basis points on IPIC’s 2022 bonds, the JPMorgan analysts said in their April 22 report. That’s “too wide” even if the more complex case of 1MDB justifies a bigger premium, they said.
The typical gap between guaranteed and guarantor bonds is 40 to 70 basis points in emerging markets, excluding “challenged” countries like Brazil and Ecuador, they wrote. A non-payment event on April 25 -- while not their base case -- could result in better entry point for investors, the analysts said.
1MDB’s 5.99 percent bonds fell to 99.6 cents on the dollar to yield 6.07 percent on April 22 from 102 cents on April 18, according to Trace prices.
“Looking from the outside, one can never be sure of the risks, unless the bonds offer a very attractive return potential,” said Julian Jacobson, a fund manager in London at FPP Asset Management LLP.