7 min read 7 Apr 21
Summary: With a massive coupon of 10.875% and a hefty spread of 960 basis points over US Treasuries, Mongolia in March 2016 priced a $500 million eurobond. The five-year bond was called the Mazaalai bond, after the extremely rare species of bear that lives in the Gobi desert. The high cost of borrowing reflected the economic challenges Mongolia then faced, including double-digit fiscal and external imbalances, and a temporary slump in mining-driven economic growth.
At such a high cost of borrowing, the Mazaalai bond was rare but quite a few other international bonds have been issued with similarly massive coupons. What makes the Mazaalai bond special is that it was repaid. In 2020, the government tendered the bonds, reducing them to $132 million outstanding. And on 6th April 2021, the Mongolian government repaid the remaining bonds and made history by honouring an international bond with such a high cost of borrowing. Markets do not often like bears, but this one was an exception.
The need for a double-digit coupon might lead a sovereign to decide not to issue a bond. Or it might put investors off so much that there’s not enough demand. For example, Laos marketed a five-year Eurobond with a double-digit coupon three times without any resulting issuance between December 2020 and March 2021.
However, there are various reasons a country would tolerate issuing international bonds with massive coupons rather than declare both the borrowing costs too high and the market window shut:
Massive coupon reason 1: Liquidity crisis
A sovereign might need the bond proceedswhatever the costto weather an intense shock or crisis. The proceeds could be needed for a genuine short-term liquidity problem. For example, Indonesia issued a eurobond with a massive coupon in March 2009 as emerging markets struggled in the aftermath of the global financial crisis. The bonds were repaid once the storm had passed.
Massive coupon reason 2: Delaying tactic
Alternatively, massive coupon bonds might just be a delaying tactic. A government might have a looming solvency problem, but want to prevent a default in the coming months. This could buy time for proper reforms, or just delay the inevitable. Not throwing in the towel can be a useful tactic at certain points in an electoral cycle.
With all this in mind I looked into how many international bonds with massive coupons managed to avoid default and survive to maturity.
To define massive coupons, I started with coupons of 10% or higher – the point at which the coupons on a ten-year bond sum to the amount borrowed. Going back to the early 1980s, I sifted out a sample of 116 US dollar-denominated international sovereign bonds with double-digit coupons from the thousands issued. But global interest rates were much higher then: even Australia, New Zealand and Sweden had issued long maturity ‘Yankee’ bonds in double-digits. So I refined my massive coupon definition to require that the spread of the annual interest rate (over US Treasury bonds) was 700 basis points or more at issuance, reducing the sample to 35.
History suggests that an international bond issued at a spread of up to 700 basis has a good chance of being repaid, although many have still defaulted. Once the spread breaches 800 basis points however, the odds thin, with a current survival rate of 62%. Once over 850 basis points, the survival rate becomes worse than a coin toss with only four of the eleven bonds sampled (that have matured or defaulted to date) surviving to maturity.
The massive coupon bonds each tell part of an interesting story. Here are a few:
I argue from my analysis that issuing an international bond with a spread of 850 basis points or more is to issue into shark-infested waters – there is a high risk of default. But on rare occasions, like a bear sighting in the Gobi desert, economies do bounce back and bonds with massive coupons are repaid. Time will tell if there is a Mazaalai to be found in the Maldives.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.