Debts run up by state development fund 1MDB have roiled Malaysia’s markets and led to calls for its leader to step aside
KUALA LUMPUR, Malaysia—A state investment fund is at the center of a burgeoning political and financial controversy that is roiling markets and leading to calls for the ouster of Malaysia’s prime minister.
The fund, 1Malaysia Development Bhd., or 1MDB, was set up to spur economic growth in Malaysia. But it has rolled up more than $11 billion of debt that it now struggles to repay, and has invested in such projects as power plants in foreign countries and an oil venture abroad that yielded no oil.
Another fund initiative: Amid a close election, it indirectly supported Prime Minister Najib Razak’s campaign, according to an examination by The Wall Street Journal.
The fund paid what appeared to be an inflated price for assets acquired from a Malaysian company; the company then contributed to a Najib-led charity that announced projects, such as aid to schools, that Mr. Najib was able to tout as he campaigned.
Concerns over 1MDB’s high debts and limited transparency have triggered four government investigations. The concerns also have set up a confrontation between Mr. Najib and his mentor, Mahathir Mohamad, who led Malaysia for 22 years.
Mr. Mahathir says 1MDB’s assets are too meager for its huge debts. “What happened to that money?” Mr. Mahathir said in an interview. “They can’t explain.” He has publicly called on Mr. Najib to resign, as have other former allies from the ruling party and opposition politicians.
Were the prime minister to heed such calls, the result could be a setback for U.S. interests in Southeast Asia. Under Mr. Najib, relations with the U.S. have improved as Washington tries to build up its alliances in the region to counter China’s rise.
Mr. Najib, who is chairman of 1MDB’s board of advisers, has said he did nothing wrong and has urged critics to wait for the results of the investigations. His office didn’t respond to specific questions about the fund’s activities, including about any role in election-related spending.
“Unfortunately, the prime minister’s political opponents, unwilling to accept his record or the facts, continue to try to undermine him with baseless smears and rumors for pure political gain,” his office said.
Debt levels
Though wholly owned by the government, 1MDB isn’t government-funded, except for a small initial amount; it has to raise money in the debt markets for its projects. In an “F.A.Q.” section of a news release in December, 1MDB said there was no reason to be concerned about its debt level.
Still, the fund has at times rescheduled its debt repayments. And in May, 1MDB got a $1 billion capital injection from a state fund in Abu Dhabi—a close ally of Malaysia—to help meet a looming loan repayment. Interest costs ate up half the fund’s revenue in the year ended March 31, 2014, the last for which the fund has filed a financial report.
Arul Kanda, 1MDB’s president and group executive director, said the fund hopes to repay debt by selling assets, which he said are worth more than its borrowings. In an emailed response to questions, he said the government has guaranteed only 14% of 1MDB’s total debt, limiting its exposure.
Mr. Arul, who was appointed in January, also said that “1MDB’s financial decisions are driven by the best interests of the business, not political considerations.”
Worries about 1MDB’s debt have helped make Malaysia’s markets among the worst performers in the world in recent months, according to investors. Malaysia’s currency, the ringgit, has fallen 6% against the U.S. dollar this year, to its weakest in almost a decade. Though credit-rating agencies consider Malaysia’s debt safe, government bond prices have fallen, and foreign investors are pulling cash out of the country’s markets at an accelerating rate.
Some investors are betting the Malaysian government will end up bailing 1MDB out. Moody’s Investors Service has estimated such a rescue could cost as much as 1.4% of the country’s annual economic output. Meanwhile, Malaysia is facing low prices for its major exports: oil, natural gas, palm oil and rubber.
“At the end of the day, this entire entity is owned by the Ministry of Finance,” said Dhiraj Bajaj, a fund manager with Swiss bank Lombard Odier Darier Hentsch & Cie., who bought more 1MDB debt after recent declines, betting the government will step in with a bailout if needed.
Prime Minister Najib faced political problems almost immediately after he took office in 2009.
His party, the United Malays National Organization, had only narrowly retained power a year earlier. UMNO has headed every government since Malaysia gained independence from Britain in 1957. It has been losing the financial backing of the country’s ethnic Chinese minority, who dominate the economy but have been growing frustrated with government programs that favor ethnic Malays. The ebbing support, according to party insiders, forced Mr. Najib to look for other sources of financing.
Mr. Najib formed 1MDB in 2009, saying the fund would develop lucrative industries and create a new financial district in Kuala Lumpur that later was named after his father, the country’s second prime minister. Besides its development efforts at home, the fund has poured money into investments such as power-plant purchases abroad and a since-liquidated venture with a Saudi oil company. The fund has said it made money on the oil venture but hasn’t disclosed details.
Paying a high price
In one power-plant deal, the seller was Genting Group, which calls itself Malaysia’s leading corporation. The sprawling real-estate, plantation, hospitality and casino company owns New York City’s only casino and just broke ground on a $4 billion Chinese-theme casino in Las Vegas. The 1MDB fund in October 2012 acquired a Genting unit that owned a 75% stake in a 720-megawatt coal-fired power plant near Kuala Lumpur. The price, which was equivalent to about $740 million at the time, came to 2.3 billion Malaysian ringgit. Genting later reported it had a 1.9 billion-ringgit extraordinary gain on this sale, implying a value for its stake in the power plant of just 400 million ringgit—or less than one-fifth what 1MDB paid for it.
In a second sign that 1MDB paid a high price, the fund’s financial statement for the fiscal year ended in March 2013 said the power unit’s property, plant and equipment were worth a little under 500 million ringgit at the time of acquisition.
The fund cited 1.7 billion ringgit of “intangible assets,” which were the value of the plant’s agreement to sell power to a state-owned entity. But this valuation appeared to be contingent on Genting obtaining a renewal of its power-sale agreement, which was running out in 2016.
Genting announced the terms of the sale to 1MDB in August. Equity analysts at the time noted the size of the deal was positive for Genting given its contract to sell power was ending. In early October, Malaysia’s Energy Commission, an independent body which regulates the energy sector, announced Genting had won a 10-year extension to sell power through 2026. A few days later, Genting and 1MDB finalized the sale.
Soon after the purchase, 1MDB appeared to recognize that it had overpaid for power assets. In its financial accounts for fiscal 2013, the fund took an “impairment” charge of 1.2 billion ringgit, writing down part of the premium it had paid to acquire power assets from Genting and another Malaysian company.
ENLARGE
The 1MDB fund said the premium it paid reflected the experience of the staff of the Genting unit. Mr. Arul, 1MDB’s president, said in a December news release that the valuation was “commensurate with their existing and future potential” at the time.
A few months after the sale, a unit of Genting called Genting Plantations Bhd. made a donation of about $10 million to a Najib-linked charity, according to a spokesman for Genting Plantations. The charity, Yayasan Rakyat 1Malaysia, lists Mr. Najib as chairman on its website. Stock analysts at the time said the surprise donation reduced the company’s net profit in the first quarter of 2013, and said they didn’t expect it to be repeated.
Though set up to help underprivileged Malaysians through education and sport, this charity soon got involved in spending that appeared designed to help Mr. Najib retain power in a May 2013 election.
It and other charities linked to the government spent millions of dollars before the voting in Penang, a northern state that was an important election battleground. Mr. Najib visited Penang during the campaign and announced that Yayasan Rakyat 1Malaysia would donate two million ringgit (about $660,000 at the time) to two local schools. These schools serve Chinese communities that are not a poor demographic, but whose support would be crucial to win voting in the area.
Mr. Arul, 1MDB’s president, referred questions about the matter to Genting and to the charity.
A Genting spokeswoman declined to comment on the charitable donation or the valuation of the plant sold to 1MDB.
The charity, too, declined to comment. Regulators say the charity has failed to file required financial statements since its inception in early 2013.
Before the election
Also active in Penang just before the May 2013 election was 1MDB itself. The fund purchased land in the state days before the voting.
Mr. Najib, campaigning in Penang, promised to build low-cost housing on the land.
Critics said 1MDB’s spending amounted to the use of state funds for electioneering. “They’ve shown they’ve got lots of cash to throw,” said Lim Guan Eng, Penang’s chief minister and a member of the opposition Democratic Action Party.
Mr. Arul of 1MDB declined to comment on the fund’s land purchase. He referred questions to Mr. Najib, whose office didn’t address such specifics in its response.
Opposition politicians also have criticized 1MDB for raising billions of dollars just weeks before the 2013 election. In March 2013, the fund sold $3 billion in bonds.
Goldman Sachs Group Inc. arranged the bond sale and took on extra risk to get the deal done quickly at 1MDB’s request, according to a person familiar with the matter, earning unusually high profits as a result. Goldman, which also was 1MDB’s financial adviser on the purchase of assets from Genting, declined to comment. The 1MDB fund, when asked about criticisms of the fund-raising, pointed to a past statement it had made in defense of the $3 billion bond, which said it was issued at a typical discount.
The results of the May 2013 election turned out to be the worst yet for UMNO’s ruling coalition. It not only didn’t prevail in Penang but didn’t win a majority of the national vote, either. Mr. Najib remained in power only because of electoral rules that give more parliamentary seats to candidates from UMNO’s rural heartlands.
Last month, in an election to fill a vacant seat in parliament, 1MDB used the Twitter feed of its foundation to promote the government’s candidate. A 1MDB spokesman declined to comment.
The financial situation appears to be deteriorating for 1MDB. The fund has shelved plans for an initial public offering of its power plants, a move it had hoped would raise $3 billion.
The government recently stepped in with a $260 million emergency line of credit after 1MDB had to renegotiate a loan payment to a consortium of banks.
“Like many companies, we examine our financial arrangements and restructure these from time to time in order to ensure that the company is receiving the best possible terms,” said 1MDB’s president, Mr. Arul.
The 1MDB fund recently sold some land to another state fund, one that invests money for Malaysians who want to make a pilgrimage to Mecca. Mr. Arul denied suggestions from critics that a sale to another government fund amounted to a partial bailout. The pilgrimage fund’s chairman said he expects to make a profit on the deal.
Malaysia’s police, auditor general and a parliamentary committee are investigating the fund’s investment activities. This month came word of a fourth probe, as Malaysia’s central bank launched an investigation of 1MDB’s offshore borrowings and foreign investments.
—Celine Fernandez contributed to this article.
Write to Tom Wright at tom.wright@wsj.com