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Durig Capital Fixed Income Review
This week we again turn to the far eastern country of Mongolia to find what we believe are better yielding U.S. dollar corporate bonds relative to the amount of risk that investors typically find in more common or more popular domestic U.S. corporate bonds. Increasingly known for its vast mineral resources, Mongolia is the fastest growing country in the world with an amazing 17%-a-year growth rate. As the Mongolian economy transitions away from a long history of oppression and into free markets, the sheer abundance of its very low cost resources has unlocked great market opportunities for their county. The financial sector is considered as one of the most geared to Mongolia’s rapid economic growth, which is being fueled by development of its world class mineral resources, and the following review shows why we believe adding these very short 29 month, 8.5% coupon, Yankee bonds from the Trade & Development Bank of Mongolia to our Foreign and Global Fixed Income Portfolio offers great cash flow and helps to lower overall portfolio risk through a broad and diverse investment strategy..
The Mongolian Economy
With a population of less than three million and a territory as large as Western Europe, Mongolia’s extensive mineral deposits and attendant growth in mining-sector activities have transformed Mongolia’s economy, which traditionally has been dependent on herding and agriculture. The country opened a fledgling stock exchange in 1991, and joined the World Trade Organization in 1997. Growth averaged nearly 9% per year in 2004-08 largely because of high copper prices globally and new gold production. By late 2008, Mongolia was hit hard by the global financial crisis. As a result, Mongolia’s real economy contracted 1.3% in 2009. In October 2009, Mongolia passed long-awaited legislation on an investment agreement to develop the Oyu Tolgoi mine, considered to be among the world’s largest untapped copper deposits and expected to account for one-third of Mongolia’s GDP by 2020. In March 2011, six big mining companies prepared to bid for the Tavan Tolgoi area, the world’s largest untapped coal deposit.
Mongolia purchases 95% of its petroleum products and a substantial amount of electric power from Russia, leaving it vulnerable to price increases. Due to severe winter weather in 2009-10, Mongolia lost 22% of its total livestock, and meat prices doubled. Inflation remained higher than 10% for much of 2010-12, due in part to higher food and fuel prices. Mongolia’s economy grew by 6.4% in 2010 and 17.5% in 2011 on the strength of commodity exports to nearby countries, high government spending domestically, and very notably, the development of Oyu Tolgoi. Foreign direct investment into Mongolia is heavily skewed towards mining, and following calls by nationalist politicians to renegotiate the investment agreement with Rio Tinto and the passing of the controversial Strategic Sectors Foreign Investment Law (SSFIL) in May of last year, the attractiveness of Mongolia as a destination for foreign direct investment lost its luster. As a result foreign direct investments fell 17% y-o-y to US$3.9bn in 2012 and are down 58% in the two first months of this year, while GDP growth slowed to 12.3% last year from 17.5% a year earlier.
However, on April 19, 2013, the Mongolian Parliament passed amendments to SSFIL aimed at easing restrictions and creating more favorable conditions for foreign investors. While the investments of state owned or state participated companies will still need parliamentary approval in cases where the investment exceeds a 49% stake, parliamentary approvals for foreign non-state owned companies and threshold of MNT100bn (US$70mn) have been removed. While the Mongolian government is still in dispute with Rio Tinto regarding the cost-overruns and some compliance matters at the Oyu Tolgoi mine, Prime Minister Altankhuyag Norov charged the Mining Minister Gankhuyag to speed-up the land, foreign labor force, customs documentation permits and take actions on solving water, environmental, power plant, third-party laboratory, and infrastructure issues. These appear to be positive steps towards boosting the severely hit investor confidence, and we think that the new rules will prompt renewed foreign investments in this underexplored market with huge economic potential.
Standard & Poor’s credit rating for Mongolia stands at BB-. Moody’s rating for Mongolia sovereign debt is B1. Fitch’s credit rating for Mongolia is B+.
A Look at the Issuer
The Trade and Development Bank of Mongolia LLC (TDB), the oldest bank of Mongolia, was founded in 1990 and is based in Ulaanbaatar. It is one of the largest Mongolia banks, and together with its subsidiary, TDB Capital LLC, it has about 1219 staff providing various banking and financial services including large corporate, SME and retail lending, deposit-taking, trade finance, remittance, cash management, treasury, foreign exchange and investment banking through a network of 47 branches. TDB acts as a primary lender to most of Mongolian leading corporations as well as foreign corporations and foreign representative offices across all major industrial and commercial sectors. Leveraging this pre-eminent position and its long-standing customer relationships, the Bank has consolidated its market-leading position in the handling international trade finance and remittance, with access to credit lines from major international lenders and correspondent banking relationships with over 150 international financial institutions.
TDB is 73.1% owned, directly and indirectly, by US Global Investment LLC, an intermediate parent company, which is in turn owned equally by an individual, Erdenebileg Doljin, and Central Asia Mining LLC. The latter is the ultimate parent company, and is owned by two individuals. Goldman Sachs acquired a 4.8% stake in TDB in February 2012. Apart from the treasury stock of 3.4%, the bank’s remaining stake of 18.3% is owned by a number of individuals, who are minority shareholders. At the 2012 “Global Banking & Finance Review” awards, Trade and Development Bank of Mongolia was awarded for the “Best Corporate Bank Mongolia 2012” from among best commercial banks in the world.
As a result of the high loan growth of 142% in 2011, TDB’s Tier 1 and total capital adequacy ratios (CAR) declined to 8.2% and 12.7% at end-2011 from 10.2% and 16.3% at end-2010, respectively. Despite significant loan growth during 1H 2012, its Tier 1 and total CAR improved to 9.1% and 14.5%, respectively, as of June 2012 helped by a capital injection from Goldman Sachs in February 2012. At the end of December 2012, TDB’s total assets reached MNT 2623.0 billion ($1,851 million) and capital funds reached MNT 295.2 billion ($208 million), representing 22.9% and 30.0% market shares respectively. The Bank has had a strong earnings track record with MNT 15.0 billion ($10.58 million) in 2009, MNT 20.7 billion ($14.6 million) in 2010, MNT 48.5 billion ($34.2 million) in 2011 and MNT 64.8 billion ($45.7 million) at the end of December 2012.
At the recent Mongolia 2013 Investment Summit in London, the President of the Trade and Development Bank, R.Koppa, stated that a total of USD 68 billion is needed to develop Mongolia in the near future. He said that 20 billion USD of it will be spent in the mining sector, 12 billion in infrastructure, 8 billion in urban development, 2 billion in agriculture, 20 billion in trade and industry, 2 billion in environmental protection, 2 billion in social development and 2 billion in finance. He also pointed out that 14 billion USD will be raised from Foreign Direct Investment, 18 billion from internal sources, 6 billion from government bonds, 16 billion from international capital markets, 12 billion from international financial organizations and the rest, 2 billion USD, from donor countries.
Moody’s states that the probability of systemic support for TDB is high, given the bank’s large market presence in Mongolia. The systemic support indicator for Mongolia (i.e. the government bond rating) is B1, which leaves the bank’s local currency bank deposit rating at its standalone rating of ba3. TDB’s foreign currency deposit rating is B2, and is constrained by the country ceiling. Moody’s rating of B1 (stable) is underpinned by TDB’s good franchise value as one of the largest banks with expertise in corporate banking in Mongolia where it held 29.5 corporate lending market shared at end December 2012. TDB serves approximately 400 major Mongolian corporations in almost all major business sectors. An upgrade of the sovereign rating could be positive for the banks ratings, especially if it can maintain its currently healthy asset quality, capital, and profitability metrics throughout the economic cycle.
As the leading banking and financial services provider in Mongolia, it appears that TDB is well positioned for continued growth and profitability as an integral and vital component within the rapidly expanding Mongolian economy. Considering last week’s parliamentary approval of recent amendments to Mongolia’s Foreign Investment Mining Laws, it is our opinion that that the Trade and Development Bank of Mongolia will benefit from the renewed interest of investment monies ready to enter the country.
The default risk is Trade and Development Bank’s ability to perform. As most rating agencies still rating Mongolian sovereign debt at single B, the country’s low rating pretty much ensures a glass ceiling equivalent to the only nation it operates within. However, considering their historical and recent performance, their sound tier one capital position, a reasonably easy access to the additional capital the may be needed for its continued rapid growth, and its good (stable) credit rating from Moody’s, it is our opinion that the default risk for this very short term bond is minimal relative to its more favorable return potential. Furthermore, it is our opinion that if or when the credit ratings of Mongolian sovereign debt rise, it increases the possibilities of a more favorable rating for TDB.
The hardest risk for us to identify is the geopolitical risk. Perhaps the most prominent issues are Mongolia’s apparent lack of stability in the legal environment that supports investment, successful project financing and the guarantee of the sanctity of contracts. However, considering how difficult it has become to understand many of the political changes and potential changes for bondholders (ala General Motors) in our own country, we again suggest that the uncertainties of changes on a foreign soil are much less formidable than in times past. With that said, it is our opinion that diversification into other forms often serves to reduce risk. Our strategy here, as with other Yankee bonds, is to focus on unique or required services that can be seen as adding key economic value to the society it’s associated with. As a primary lender to many of Mongolian leading corporations, TDB is a key player in the development of its world class mineral resources, and is highly regarded as one of the best operators in its homeland.
TDB is relatively small compared to other financial institutions, and many factors such as presidential elections, trending populism and patriotism, China’s weakening demand for coal, cheaper coal prices, positive changes from strategic investments, the draft mining law, sales of Chinggis bond and the international attention on Mongolia will all have their own impacts on Mongolia’s economy. However, it often appears that companies outside of the United States might also have an internal cash flow advantage. Consequently, we see these TDB bonds as having similar risks and maturities to other Yankees bonds such as Bio PAPPEL (CDURQ), Vedanta Resources (VDNRF), or Mongolian Mining (MOGLF), which we have reviewed previously on our Bond-Yields.com blog.
Summary and Conclusion
All things considered, it is our opinion that TDB has positioned itself as a leader within the Mongolian financial sector. As Mongolia continues to develop its world class resources, we think these short term Trade and Development Bank U.S. dollar bonds represent both sound diversification and a high yield relative to the fiscal risks that we can identify, and believe that their lower “B” ratings are largely attributable to the sole country that they currently operate within. Therefore, we are these high yielding Yankee bonds from TDB to our list of Foreign and World Fixed Income bonds.
Yield to Maturity: ~7.65%
Disclosure: Durig Capital and certain clients may have positions in TDB 2015 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
To know more about this Trade & Development bond call our fixed income specialist at 971-327-8847.