Malaysia's 1MDB faces fresh debt payment test

By Umesh Desai and Praveen Menon

HONG KONG/KUALA LUMPUR, Feb 27 (Reuters) - Malaysia's debt-laden state fund 1MDB faces a fresh test of market confidence in coming weeks when a bond coupon payment falls due. Failure to pay could trigger a sovereign downgrade.

1Malaysia Development Bhd (1MDB), a property-to-energy fund whose advisory board is chaired by Prime Minister Najib Razak, has built debt of nearly 42 billion ringgit ($11.73 billion) to build a portfolio of power plants.

Investors have been edgy since the fund struggled to repay a 2 billion ringgit (about $563 million) loan to local banks originally due at the end of last year, prompting a selloff in its benchmark 2023 bonds.

The cabinet has also rejected a proposed cash injection into 1MDB of 3 billion ringgit ($830 million), reducing the financing options for the firm, the Malaysian Insider news website reported on Friday, citing unidentified sources. 1MDB declined to comment on the report and the finance ministry did not immediately respond to a request for comment.

The coupon payment of $66 million, due on March 9, in 1MDB's 2023 bond, is relatively small. 1MDB chief Arul Kanda, appointed in January, has said repeatedly the fund is committed to meeting its financial obligations.

The $3 billion bond, large by Southeast Asia standards, is backed by a sovereign letter of support, which offers weaker legal protection than an explicit state guarantee, analysts say.

"If the coupon is not paid within the grace period, we will consider it to have become an obligation of the Malaysian government," said Standard & Poor's analyst Kim Eng Tan.

"If the government doesn't make the payment, the bond will be in default and the sovereign rating of Malaysia will also go to selective default. We (would) consider it as an event of default of the government."

1MDB's debt has weighed on the ringgit and Malaysia's sovereign rating, adding to concerns about the commodity-rich economy already trying to cope with a sharp fall in oil prices.

The fund repaid the 2 billion ringgit bank loan following a last-minute injection of funds in February by Malaysian billionaire Ananda Krishnan, sources said.

Adding to investor concerns though, 1MDB has in the space of a few months replaced its auditors, delayed filing its accounts and been criticised by opposition lawmakers over a lack of transparency.

"The lack of transparency around 1MDB weighs negatively on the sovereign credit profile and is one of the factors weighing on the Malaysian negative outlook," said Andrew Colquhoun, head of Asia-Pacific sovereigns at Fitch Ratings, which does not have a rating on 1MDB.

Spreads on the 2023 bond have blown out by about 200 basis points since the start of 2015 to 450 bps over U.S. Treasuries, a level more typical of bonds with a lower credit rating.

That equates to a yield of about 6.5 percent - comparable to high-yield bonds, which are usually rated at or below BB-plus. That is four notches below 1MDB's bond rating of A-, which is the same as Malaysia' sovereign debt rating.

"Failure to inject more funds into 1MDB will mean markets will turn jittery every time a loan is due," said Hak Bin Chua, analyst with BofA Merrill Lynch. "Investors will also question the government's commitment to back 1MDB in the event of a default."

1MDB, which has delayed a power unit IPO and cancelled a $2.4 billion sukuk bond issue in February, said last week it would explore asset sales as part of a turnaround plan under Arul, the president and group executive director.

"We remain committed to meeting these obligations as they become due," Arul told Reuters this week in response to a query about the March 9 coupon payment. ($1=3.5815 ringgit) (Editing by Neil Fullick)