Saturday, December 27, 2014

9% Yields With TDBM's Very Short 10-Month Yankee Bonds, Matures September 2015

Summary

  • Profits have increased eight-fold since 2009.
  • With GDP growth for 2014 expected to be approximately 7%, Mongolia remains one of the fastest-growing economies in the world.
  • Mongolia's largest and oldest bank. 
This week, we take our third look at Yankee bonds from the Trade and Development Bank of Mongolia (TDBM). Since 2009, this issuer has not only become the dominant market presence within its national banking industry, but its profits have increased eight-fold. Since reviewing TDBM in May 2013 and again in September 2013, it has continued to increase its market share in the Mongolian banking industry claiming 38.3% corporate lending and 51.9% trade financing market shares. These bonds have a short 10-month maturity, maturing in October 2015, with an excellent yield of over 9%. Mongolia's economy continues to grow at a healthy rate. With GDP growth for 2014 expected to be approximately 7%, it remains one of the fastest-growing economies in the world. This is due in large part to Mongolia's rich and largely untapped mineral resources.

This exceptional growth, coupled with TDBM's solid market share, has attracted international interest including a partnership with Goldman Sachs (NYSE:GS). Additionally, TDBM continues to expand, opening its first international branch in Tokyo, Japan earlier this year. We believe the addition of these TDBM bonds to a balanced income portfolio offers solid cash flow and lowers overall portfolio risk through diversification in the global debt and currency markets, and we are adding these bonds to our fixed income portfolios, FX1 and FX2.

Mongolia's Economy

Mongolia, whose economy has traditionally been dependent on herding and agriculture, has recently experienced staggering, rapid growth due to the large amount of identified, but mostly untapped mineral resources. With double-digit GDP growth the past four years, Mongolia is solidly moving towards a more industrialized economy. A major contributor to this growth is the massive $6.2 billion Oyu Tolgoi (OT) copper and gold mine. With phase one completed and phase two slated to begin construction, the Oyu Tolgoi project will produce more than 300,000 tons of copper concentrate a year once construction is fully completed. It is expected to boost Mongolia's economy by a third by 2020.

Two other favorable developments we feel favor the continued growth of the Mongolian economy are the repeal of the SEFIL legislation and changes to Mongolia's 2006 Minerals Law. The Strategic Entities Foreign Investment Law (SEFIL) was an effort to protect the country's strategic sectors in minerals, infrastructure, telecommunications, media and defense. SEFIL's effect on foreign direct investment (FDI) was dismal with FDI decreasing by 47% between January and August of 2013. To minimize further economic damage, Mongolian parliament passed the new Investment Law in October 2013, effectively voiding SEFIL. Secondly, in July 2014, Mongolia's parliament amended the Minerals Law to increase Mongolia's area available to mining and exploration from 8% to 20%, as well as lift a 2010 ban on new licenses. These moves should renew foreign direct investment and encourage additional mining activity.

Trade and Development Bank of Mongolia (TDBM)

Banking is essential to a growing economy. Trade and Development Bank (TDBM), with claimed market shares of 38.3% in corporate lending and 51.9% in trade financing, is Mongolia's largest and oldest bank. Established in 1990, it provides banking products and services throughout the country with a network of 51 branches. Banking services provided include large corporate and retail lending, trade finance, remittance, cash management, treasury, foreign exchange and investment banking. TDBM 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 preeminent position and its long-standing customer relationships, the Bank has consolidated its market-leading position in the handling of international trade finance and remittance, with access to credit lines from major international lenders and correspondent banking relationships with over 150 international financial institutions. As an example of its continued growth, TDB successfully opened its first international office in Tokyo, Japan in July 2014.

As a testimony to TDBM's dominant market position within one of the world's growing economies, Goldman Sachs acquired a 4.8% stake in TDBM in February 2012. In a statement, TDB commented that "Goldman Sachs' global expertise and financial strength will help us grow further and enhance our offering." According to sources, the Goldman Sachs investment was kept below 4.99 percent because buying a higher stake would have triggered increased requirements under US legislation.

TDBM has also earned many distinguished awards from the international banking community. "Global Banking and Finance Review Awards" most recently recognized Trade and Development Bank of Mongolia as the 2014 Award Winner of the "Best Commercial Bank Mongolia."

TDBM is Profitable with Solid Ratios

For the nine months ending 9/30/2014, TDB's net profits were MNT 76.1 billion as compared to MNT 71.2 billion for the same time period in 2013. This represents a gain of almost 7%. For the past five years, TDBM has shown outstanding growth in its annual profits.

Year20092010201120122013
Profit (MNT)14,971,55120,697,23942,101,83163,126,724139,263,685

Tier 1 capital ratio has continued to recover from a five-year low of 8.18% in 2011, to 9.97% in 2012 and 11.62% in 2013. As of 9/30/2014, TDBM's Tier 1 capital ratio is 11.96%. The capital adequacy ratio has remained strong at 15.12% for 2012 and 15.07% for 2013, and 15.31% as of 9/30/2014. TDBM's total assets increased from MNT 2,700 billion in 2012 to MNT 5,124 billion in 2013. Assets as of September 30, 2014, are MNT 5,223 billion. Moody's gives TDBM a rating of B3.

Moody's states that the probability of systemic (government) support for TDBM is high, given the bank's large market presence in Mongolia. This translates to a virtual "backstop" for TDB in the event of a financial crisis. TDBM's own senior unsecured debt rating is B3, which is the similar to the Mongolian government. Moody's rating of B3 (stable) is underpinned by TDBM's good franchise value and expertise in corporate banking in Mongolia. TDBM 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.

Higher Yields

The yield indicated for this issue is over 9%, with a very short maturity of only ten months. Given that domestic one-year treasury bonds currently yield less than 1%, this bond is extremely attractive given the risks outlined below.

Risk Considerations

The default risk is Trade and Development Bank's inability to perform. TDBM's growth has been and remains strong. Also, with TDB's dominant market share, it is highly unlikely that the Mongolian government would not assist the Bank in the event of a financial crisis.
Rio Tinto (NYSE:RIO), the majority owner of the Oyu Tolgoi mine, has been involved in a stand-off with the Mongolian government over cost overruns and tax issues that have stalled phase two development at the mine. Mongolia's Parliament has just appointed a new Prime Minister and Rio Tinto is hopeful that an agreement can be reached with the new government that will enable development to continue.

Geopolitical risks are also present and difficult to predict. The full recovery of foreign direct investment since the repeal of SEFIL has yet to be realized. The crucial step of commencing development on phase two of the Oyu Tolgoi mine would provide a significant boost to foreign capital inflows and broader economic activity. Additionally, China, Mongolia's most significant export destination, has struggled with its own economic slowdown and falling commodity/mineral prices. However, Mongolia has recently been working closely with Japan on proposed investment and infrastructure projects. These projects would help Mongolia continue its journey toward a more industrialized economy.

These bonds have similar duration and/or risks to other emerging market bonds denominated in US dollars that we have reviewed, such as 12.25% Transener Sinking Bonds, 8% Ceagro Agricola Yankee Bonds, or 7.7% Mongolian Mining Corporation Bonds.

Summary and Conclusion

Although the economic growth in Mongolia has slowed recently, its growth is still at least double that of most of the industrialized economies of the world. Trade and Development Bank of Mongolia has performed well in the past five years. It remains the dominant player in Mongolian banking, the "go-to" financial institution for many of the country's largest companies, as well as for many international companies coming to do business in Mongolia. Its partnership with global finance giant Goldman Sachs brings a world of global connections within many different industries. We believe the over 9% yield with a short 10-month maturity represents excellent return given the risks we've identified. With a solid growth history the last five years, TDBM is well positioned to profit from a growing Mongolian economy.

Issuer: Trade & Development Bank of Mongolia (TDBM)
Coupon: 8.5%
Maturity: 10/15/2015
Ratings: B3
CUSIP: Y8904HAD7
Pays: Semi-annually
Price: 99.50
Yield to Maturity: ~9.17%

Disclosure: Durig Capital and certain clients may have positions in TDBM 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.

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