Special Report: Debt-laden Malaysian fund stirs controversy


Leslie Lopez, The Edge

SOMETIME in September 2009, currency traders at Bank Negara Malaysia were jolted by huge purchases of US dollars in the domestic currency market and quickly decided to halt the selling pressure on the local currency. They were promptly told to stand down by their superiors.

The buildup of US dollar positions on that day paved the way for state-owned 1 Malaysia Development Bhd (1MDB) to move US$1 billion out of the country for an investment in a British Virgin Islands entity.

“It was a company we needed to watch, because it came out of nowhere and showed clout,” said another chief dealer at a foreign bank in Kuala Lumpur.

These days, 1MDB isn’t just raising eyebrows. The secretive investment arm of the government is sending shockwaves through international bond markets and raising concern at home with its aggressive borrowings, opaque financial manoeuvres and risky bets. It is also becoming a hot political potato for Prime Minister Datuk Seri Najib Razak’s administration.

Opposition politicians insist that 1MDB is part strategic investment arm and part political slush fund for the Najib government, because of its generous financial handouts to key constituencies of the ruling Barisan Nasional (National Front) coalition.

In just over four years, 1MDB has racked up borrowings of more than US$11.97 billion (RM38.4 billion), corporate documents and published accounts reviewed by The Edge Review show. This huge accumulation of debt is against a backdrop of paltry profits, derived largely from the shuffling of assets on its Cayman Island investment and the revaluation of properties purchased at steep discounts from the government.

No Southeast Asian entity has accumulated so much debt in such a short time, and because the borrowings carry the implicit guarantee of the Malaysian government, bankers and economists say that 1MDB is emerging as a serious contingent liability for the Najib administration.

“1MDB doesn’t have strong cash flows and, at the rate it is borrowing, sooner or later the government will have to step in to take responsibility,” says a chief executive of a Malaysian bank, echoing a widely held view of 1MDB among the Kuala Lumpur business community.

For now, a government bailout may not appear imminent. But close scrutiny of 1MDB’s affairs reveal potential trouble spots that bankers and investment analysts say could suddenly spin out of control and plunge Malaysia into an explosive business scandal.

One potential flashpoint is 1MDB’s original US$1 billion investment in 2009 in 1MDB Petro­Saudi Ltd, an entity domiciled in the British Virgin Islands. 1MDB’s most recent accounts lodged with Malaysia’s Registrar of Companies show that the original investment has since more than doubled in value to US$2.3 billion, and is now “reinvested” in a company registered in the Cayman Islands. But bankers say that spectacular profits, derived from a series of financial flips with little-known entities, have raised concerns about the security of the venture.

1MDB’s dizzying buildup of debt is also drawing international attention because of the fund’s cosy relations with international banking powerhouse Goldman Sachs, which critics say has allowed the US firm to charge supernormal fees.

Over the last two years, Goldman has single-handedly structured and underwritten US$6.5 billion in bonds for 1MDB. Taken together with the US$1.6 billion the US firm raised for the state government of Sarawak on Borneo, Goldman ranks as the largest underwriter of bonds in Malaysia, outranking local powerhouses such as Malayan Banking and CIMB Group, which have long cornered the debt-raising business of state-owned entities.

1MDB declined to comment officially for this article but several government officials and financial executives involved in 1MDB’s investments spoke to The Edge Review on condition of anonymity and argued that the picture isn’t as tenuous as it appears.Repayments on a portion of its loans in coming months will cut 1MDB’s debts to roughly RM34 billion, which is backed by assets valued at roughly RM38 billion, they say. These include liquid assets of cash and other securities valued at RM16 billion.

The officials insist that the Cayman Islands investment is safe and a planned listing of the group’s power-generation assets, set for sometime in the first half of next year, is expected to raise close to RM5 billion and strengthen its financial position.

“Viewed in a snapshot, there are some issues (that could be of concern). But the story going forward is positive,” says one senior government official, who acknowledges that the veil of secrecy surrounding 1MDB has fuelled controversy over the fund’s activities.

Private economists and bankers, however, aren’t so sanguine. They note that 1MDB’s huge borrowings are cause for concern for the Malaysian economy because of rising public sector debt.

Malaysia has consistently run budget deficits since the currency crisis that struck the region in mid-1997. That, in turn, has raised the nation’s accumulated public debt, which currently stands at 53% of the country’s gross domestic product — the highest among the 10-member Asean.

The ratio of debt-to-GDP is a broad measure of the health of an economy and Malaysia has a self-imposed ceiling of 55%. The problem, say private economists, is that the ratio doesn’t take into account liabilities of state-linked enterprises such as 1MDB, which have been on a borrowing binge to fund development activities.

The following account of 1MDB’s rise from a secretive state-owned strategic investment fund to one of Malaysia’s most debt-laden entities is based on documents reviewed by The Edge Review and interviews with dozens of bankers, financial consultants and government officials over the last four years.

Seeds of 1MDB were sown in early 2009, when businessman Low Taek Jho, who enjoys close relations with Prime Minister Najib, mooted the idea of creating a fund to manage the resources of the northeastern Terengganu state in Peninsular Malaysia.