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Friday, 20 October 2017

Mongolian bond raises questions

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Emerging Markets

TDBM’s government-guaranteed offering to provide dollars to central bank

Trade and Development Bank of Mongolia’s proposed US dollar bond is turning the spotlight on Mongolia’s finances after the government pledged to guarantee the privately owned lender’s obligations.

TDBM set up a US$500m medium-term-note programme with an irrevocable guarantee from the sovereign, winning it ratings of B2/B+ (Moody’s/S&P). However, some investors are concerned that the main purpose of the offering could be to give the government access to dollars, not repay debt.

“I am hesitant to participate,” said a bond investor. “It seems the government is utilising [the potential issuance] to replenish its US dollar reserves, which have been depleted to critical levels.”

Under the terms of Mongolia’s Debt Management Law, passed this year, the government can only guarantee borrowings of state-owned Development Bank of Mongolia in full, or up to 85% of borrowings of other eligible entities.

However, if the borrower holds government bonds, the sovereign can issue a guarantee for up to the equivalent amount of the paper held.

This means TDBM needs to maintain a holding of at least US$500m-equivalent in government securities for the life of the bonds, if it exercises the full amount of the MTN programme.

The lender said it held Tug1.015 trn, equivalent to US$517m, in government securities as of April 28. If any of the government securities mature before TDBM’s bonds do, the Ministry of Finance will have to issue and sell more government securities to the bank to make up the shortfall.

Provisional government figures for 2014, cited in the prospectus, show that Mongolia’s domestic public debt stood at just US$1.57bn or so, although analysts have warned that its fiscal position is deterioriating.

Standard & Poor’s put its B+ sovereign rating on negative outlook on April 30.

It is also difficult to confirm the amount of domestic debt outstanding because the Bank of Mongolia sometimes removes information on government bond auctions from public view, particularly if these fail due to weak bids. This has happened at least six times for longer-dated bonds offered this year.

Guaranteed?

All this raises the question of what will happen if TDBM is forced to sell off government securities, for example, if it finds itself short of liquidity.

The terms of the guarantee, for which TDBM will pay US$10m, suggest that the bonds would no longer be fully guaranteed if the bank’s holdings of government securities fall below the principal amount.

“When we rate government-guaranteed debt, we also consider the willingness of the government to honour the guarantee. B+ already factors in considerable uncertainty in Mongolia’s policy setting,” said Robert Zhong, director of sovereign and international public finance ratings at Standard & Poor’s.

TDBM will enter into a currency swap with the Mongolian central bank for the full amount of the proceeds, meaning it will give Bank of Mongolia US dollars and receive tugriks, with the swap to be reversed at the end of the tenor. This will give the sovereign a supply of dollars, without adding to its debt burden.

“Once TDBM commits all US dollars from this issuance to a swap with BoM, it has limited channels to convert the tugriks received from BoM back into US dollars”

TDBM has said it will use part of the proceeds from the bonds to repay debts, with a US$330m redemption of its existing notes looming in September.

However, it will not ultimately receive US dollars from the latest offering, which means it may need to seek dollars from Bank of Mongolia within months of swapping the US currency proceeds.

“BoM is effectively the only market-maker for the FX market,” said a Mongolian banker.

“Once TDBM commits all US dollars from this issuance to a swap with BoM, it has limited channels to convert the tugriks received from BoM back into US dollars. Other commercial banks are very unlikely to use their US dollar reserves to help TDBM. The FX market is not liquid at all.”

Refinancing risks

Mongolia and its state-linked entities have several large foreign currency repayments coming due between March 2017 and January 2018, and the sovereign had about US$1.3bn in its current international reserves at the end of March, according to official figures.

DBM has a US$580m government-guaranteed bond due in March 2017 and a “Chinggis” sovereign bond of US$500m is due in January 2018.

Mongolia also has a Rmb15bn (US$2.4bn) bilateral three-year swap line with the People’s Bank of China that is due to expire in 2017, though it might be extended.

Under a debt management plan submitted to parliament this Spring, the government said it planned to repay the DBM and Chinggis bonds through budget revenues or refinancing from international markets.

The government has this year introduced a more foreigner-friendly investment law, which it hopes will draw FDI and boost the economy.

Still, foreign investors will be aware of the risks involved in taking exposure to Mongolia, which also raise doubts about the enforceability of TDBM’s guarantee.

South Africa’s Standard Bank is engaged in a legal battle with a company linked to the Mongolian government, after lending to Just Group, a petroleum distributor. The loan, now in default, came with a guarantee from state-backed copper miner Erdenet Mining Corporation.

“Legal proceedings in London against Erdenet Mining Corporation and Just Group are continuing and we are determined to recover monies owed to us,” said Standard Bank in a statement.

In March, an international tribunal panel under UNCITRA, a commission that regulates international trade alongside the World Trade Organisation, awarded Canada’s Khan Resources US$80m plus interest compounded from July 2009, totalling US$104m as of April 23, after Mongolia’s government cancelled Khan’s uranium licences in 2009 and awarded them to Russia’s ARMZ.

The government indicated it did not intend to comply with the order. Khan’s chairman, Jim Doak, died in his hotel room in Ulaanbaatar last month.

“It is, of course, the Mongolian government’s decision as to whether they want to respect the rule of law and honour the award, or join the small group of recalcitrant sovereigns, who make attempts to avoid their international obligations,” said Khan’s president and CEO, Grant Edey, in a statement last month.

Bookrunners for TDBM’s proposed issue are Bank of America Merrill Lynch, ING and Deutsche Bank.

The issuer, the joint bookrunners and the law firm (Mayer Brown JSM) representing the issuer did not respond to requests for comment.

 

(A version of this story will feature in the May 9 issue of the International Financing Review)

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