The Government of Mongolia staved off its latest re-payment difficulties on Thursday with the successful completion of an exchange offering and bond issue.
Getting investors to swap their $580 million Development Bank of Mongolia (DBM) notes for a new longer-dated sovereign issue was of critical importance to the country given it only had $1.27 billion in foreign exchange reserves (three months' cover) to repay the debt, which falls due on March 21.
But its marketing efforts more than paid off. A total of $3.3 billion in investor demand overwhelmed the $124 million new-money component of the eventual $600 million liability management exercise.
However, investors’ enthusiasm was almost entirely driven by the recent intervention of the International Monetary Fund (IMF), which agreed an Extended Fund Facility (EFF) with the country on February 19.
Mongolian spreads have been on a roll since February 10 when the certainty of IMF help became clear. Secondary market prices of DBM's bond (coming up for redemption) immediately jumped three points. They then spiked a further two points to a mid-price of 99.5% on February 20 when the exchange offering was announced.
Bankers said the government's main aim was to entice as many holders as possible in the 5.75% March 2017 issue to participate in the exchange offering. It took the notes out at par, resulting in an exchange ratio of 82%, or $475.989 million in notional bonds.
The exchange offering was funded by the new $600 million transaction, which was priced at 106% on a coupon of 8.75% to yield 7.625%. This seven-year offering had initially been marketed at 8.125% before indicative pricing was narrowed to 12.5bp either side of 7.75%.
In pure yield terms, participating investors have been given a 112.5bp pick-up over Mongolia's outstanding 5.125% December 2022 bond. This has a 1.25-year shorter maturity than the new deal and was trading on a mid-yield of 6.5% on Thursday.
On top of this, they have also been able to switch from a Reg S to 144a structure and swap quasi-sovereign for pure sovereign credit.
Bankers said about 220 investors placed orders amounting to $3.3 billion, but the government retained its $600 million overall cap making allocations very difficult.
"Most of the note holders who participated in the exchange were Asian since the original deal was Reg S," one banker explained. "So the government wanted to tilt the new money component towards US investors to balance it out a bit."
As a result, the $124 million new money component had a split of 76% US investors, 18% Europe and 6% Asia.
From the sovereign's point of view, it has not only secured the money to pay off its most immediate liabilities, but has also extended its maturity curve out to 2024.
In addition, it has managed to stand out in an extremely busy new issue market, with many emerging market borrowers rushing to get ahead of the Fed, which looks increasingly likely to raise interest rates in March.
And perhaps most importantly of all, Mongolia has been able to reduce its financing costs since a year ago when it was last in the international bond markets.
In March 2016, Mongolia was facing a balance of payments crisis and only able to build a $780 million order book for a $500 million deal. That five-year Reg S/144a offering priced at 99.99% on a coupon of 10.875% to yield 10.877%.
Spread compression
However, investors who participated in the deal have since done extremely well, although they had to endure a torrid ride last August when the bond plummeted 12 points over the course of the month.
But they have been rewarded by an equally impressive rally since Feb 10, with the 2021 bond climbing from a mid-price of 103.38% to 114.25% at Thursday's Asian close.
This means that Caa1/B-/B- rated Mongolia has been able to close the gap with similarly rated Asian sovereigns such as B3/B/B rated Pakistan and B1/B+/B+ rated Sri Lanka.
When it came to market last March, Mongolia's outstanding January 2018 bond was trading at a 423bp premium to Pakistan's April 2019 bond. This has now narrowed to roughly 29bp.
In yield terms, Mongolia’s new 2024 bond has come at a 150bp premium to the 6.12% mid-yield of Pakistan's 8.25% April 2024 bond and a 144.5bp premium to the 6.18% mid-yield of Sri Lanka's 6.85% July 2025 bond.
In a ratings release to accompany the new bond, Standard & Poor's says a "higher rating is unlikely over our two-year rating horizon."
So for investors, the key question now is how much further Mongolia’s bonds can rally from here. Can they get back to the 4% to 5% levels Mongolia was trading at in 2012 when its economy was riding the commodities boom?
Diversifying away from commodities is one of the key planks of the country’s IMF programme. The supranational has agreed a three-year $440 million loan package and access to $5.5 billion in multilateral funding from other agencies including the World Bank and Asian Development Bank.
In return, the government will work with the IMF to reduce its budget deficit, bolster its reserves and improve governance. Indeed, the first trigger for the most spread recent rally was parliamentary ratification of legislation to make DBM independent of government - a pre-condition of IMF help.
This then paved the way for a second upward price rally on February 19 when the EFF was formalised.
Firmer economic footing
In the online roadshow for its bond issue, the Mongolian government predicts that GDP growth will now bounce back from a forecast 1.8% in 2018 to 8.1% in 2019.
Notwithstanding efforts to find new sources of economic growth, it will be the country's mineral wealth, which will re-invigorate its economic prospects. In particular, the world’s largest copper mine, Tolgoi Oyu, will become operational in 2019, potentially contributing up to one third of the country’s GDP.
Development work was halted in 2012 after the previous government became embroiled in a revenue sharing dispute with the project’s majority owner, Rio Tinto. It was only settled in May 2015.
In the interim period, the country’s reputation and economy took a severe hit when the commodities boom ended after the Chinese economy slowed. This was compounded by the previous government’s anti-FDI acts, including the hated Strategic Foreign Investment Law.
In its place, the Mongolian People's Party swept back into power last summer, winning 65 out of 76 parliamentary seats.
The new government has subsequently enacted an Economy Recovery Plan, which forecasts a drop in the fiscal deficit from 8.4% in 2018 to 5.6% in 2019. In its online roadshow, it also forecasts that foreign exchange reserves will climb from an estimated $2.77 billion in 2018 to $3.54 billion in 2019.
Mongolia’s latest bond has enabled the sovereign to re-establish its debt management credentials, but it is not out of the woods yet. The country is experiencing its second dzud (harsh winter) in as many years and it still faces plenty of financial headwinds, with a further $650 million in foreign currency bonds falling due next year.
Joint global co-ordinators for the latest bond issue were Credit Suisse and JP Morgan.
