The Development Bank of Mongolia (DBM) has proved that emerging and frontier market investors are still willing to engage - and en masse - for the right credit after completing a highly successful return to the international bond markets this week.
The country's re-vamped development and export-import bank priced a $500 million five-year deal in New York on Tuesday off a $4.1 billion peak order book.
DBM’s success caps almost two years of an IMF-led economic makeover that has pulled Mongolia back from the brink of a sovereign default and transformed it into a frontier market darling (once more).
Investors are always eager to buy into credits with positive momentum. And they are likely to be all-the-more keen right now, given how many have been burned by the wider emerging market sell-off. This shows no sign of abating thanks to the Federal Reserve’s intention to continue to raise interest rates.
Sonor Luvsandorj, head of financial markets and insurance at the Mongolian Ministry of Finance, told FinanceAsia that DBM was successful because the country’s “macroeconomic parameters have strongly improved and substantially outperformed IMF estimates”.
In 2017, for example, Mongolia achieved 5.1% GDP growth compared to the IMF’s initial -0.2% target. In 2018, growth has picked up again, and hit 6.3% during the first half of the year. This prompted the Asian Development Bank almost to double its 3.8% forecast to 6.4%.
Luvsandorj said this “relative outperformance versus other and larger economies” is why Mongolian bonds have similarly outperformed their peers, enabling DBM to set such an “attractive benchmark” for itself.
Fund managers agree. One Singapore-based investor told FinanceAsia that, “Mongolia has been rewarded for doing all the right things. DBM is the kind of high-yield play investors like because its bond is likely to tighten in fast.”
And such was the case during the first day’s trading on Wednesday. After being priced at 98.973% on a coupon of 7.25% to yield 7.5%, the transaction closed in Asian trading hours at a 6.4% bid.
At this level, it was trading at a 95bp premium to the Government of Mongolia’s 8.75% March 2024 bond on an interpolated basis. The latter also tightened in 24bp on Wednesday to a 6.6% bid level according to bankers.
They believe that the differential between the two may contract since similar entities such as Eximbank Indonesia and the Brazilian development bank, BNDES, are currently trading about 20bp to 30bp over their respective sovereigns.
INCREASING HORSEPOWER?
Many wonder, however, how much further Mongolia’s secondary spread performance has to run relative to its nearest comparables.
A simple analysis with B3/B/B rated Pakistan shows how the two sovereigns have experienced very contrasting fates over the past two years. Back in March 2017, for example, Mongolia was in the throes of negotiating an IMF package and exchanging DBM bonds for pure sovereign debt.
At that point, its 8.75% March 2024 bond was trading about 150bp over Pakistan’s 8.25% April 2024 bond.
Exactly one year later and it was Pakistan heading into the arms of the IMF. The situation had reversed and Pakistan had widened to 70bp over Mongolia.
That differential has become even more marked over the course of 2018. Today Pakistan is being quoted at about 108bp over Mongolia.
The Mongolian government is understandably keen to maintain this positive trajectory.
In particular, it hopes that Moody’s and Standard & Poor’s will follow Fitch’s lead and upgrade it back to the B2/B/B level it commanded in 2016 when the country’s resources-led economy was coming under pressure. Fitch lifted its rating back to B in July, while the two US agencies both have their B3/B- ratings on stable outlook.
Earlier this year, former finance minister, Choijilsuren Battogtokh, told FinanceAsia that Mongolia is serious about diversifying its economy away from resources and pushing through structural reforms to underpin a ratings upgrade.
NEW REMIT
One of the most important concerns is DBM itself. It has been given a new charter and a remit to invest in profitable projects. Instead of functioning as a quasi-government ATM machine, it has been given a big capital injection and shorn of its non-performing loans.
CEO Batbayar Balgan told FinanceAsia that DBM is diversifying its loan portfolio in line with this new strategy.
“DBM's exposure to the mining sector is currently 8% compared to 30% in the past,” he commented. “We’re now financing projects like cashmere to deleverage our mining sector risk.”
The bank’s financial advisor, Florian Schmidt, added that the bond deal has also enabled DBM to put its balance sheet on a more sustainable footing.
“DBM wanted to extend the duration of its debt stock by refinancing short-dated US dollar debt and eliminate interest rate risk by switching floating into fixed rate exposure,” he commented. “Its duration adjusted cost of capital has also been reduced.”
This short-dated debt included loans from Credit Suisse and the China Development Bank, plus some short-term deposits from a group of Korean banks.
Batbayar said that DBM has been affected by the progressive withdrawal of liquidity from global financial markets. “We wanted to replace our floating rate dollar debt to ensure our borrowers aren’t negatively impacted,” he concluded.
The bank also achieved another strategic aim to expand its investor base. Bankers said that when they conducted initial price discovery, investors fell into two distinct camps.
“There was one camp which thought that DBM needed a 50bp to 150 premium to the sovereign and another that was looking for 200bp to 300bp,” noted one investment banker.
In the end, DBM felt confident enough to go out with initial guidance around the 175bp mark backed by strong indications of interest out of Europe. This was enough to tempt some investors from the wider pricing camp leading to a $3.2 billion final order book and allocations to 217 accounts.
Interestingly, the leads decided not to allocate any private banking demand and placement remained skewed towards Europe, notably a couple of big UK funds and dedicated frontier market funds in Scandinavia.
This resulted in a split of 37% EMEA, 39% US and 24% Asia, of which asset managers accounted for 86%, pension funds/insurers 12% and others 2%
Lead managers for the Reg S/144a bond were HSBC, JP Morgan and Morgan Stanley.
