By Daniel Stanton

SINGAPORE, March 6 (IFR) - Mongolia completed a stunning turnaround in the global capital markets last week, pricing part of a $600 million sovereign bond more than 300 basis points (bps) inside a shorter issue sold less than a year ago.

Not only that, but the country managed to reward bondholders who had shown loyalty throughout a period of uncertainty, giving them a healthy one-day gain, on paper, of 7.5 points.

After signing a new funding agreement with the International Monetary Fund, the sovereign completed an exchange offer for its state-guaranteed Development Bank of Mongolia bonds due on Mar. 21, as well as offering a new money tranche to other investors to round up the deal size.

Holders of 82 percent of the S$580 million DBM bonds agreed to exchange into new sovereign seven-year notes at par. The yield for the new notes was set at 8.75 percent, the minimum shown in the Feb. 24 guidance.

That accounted for $475.989 million of the new issue size. The remaining $124.011 million was marketed to other investors to raise new money. Guidance started at 8.25 percent area, before tightening to 7.7 percent, plus or minus 12.5 bps, and eventually printing at a cash price of 106.016 to yield 7.625 percent.

That meant the new-money tranche priced more than 100 bps inside the exchange tranche. Some questioned if the exchange could have been priced at a lower yield, but the main objective of the whole exercise was to achieve the highest possible exchange rate ahead of the DBM maturity, as well as rewarding existing bondholders. Mongolia's outstanding 2021 bonds were seen at around 6.98 percent, implying a fair value of around 8% for a seven-year issue.

The new notes are rated B-/B- (S&P/Fitch). Moody's has a Caa1 rating on Mongolia, but did not rate the new issue. HUGE IMPROVEMENT The final pricing was a huge improvement from March last year, when the Government of Mongolia sold a $500 million five-year at par to yield 10.875 percent, the highest yield on any sovereign bonds since 2011. Orders for that deal were a modest $750 million.

More than 200 accounts placed orders totalling $3.3 billion for the new $124 million tranche and, apart from the small allocations, investors had nothing to complain about when the bonds shot up to a cash price of 107.5 the next day.

"It was like trying to drive a truck through a pinhole," said a source close to the deal.

Undoubtedly, the size could have been increased, but the issuer showed prudence, given that it has just entered an IMF programme and was focused on dealing with the short-term maturity.

The existing DBM bonds were issued under Reg S only, so the new sovereigns were marketed under 144A/Reg S and allocations were weighted towards U.S. investors to ensure the broadest investor diversification.

U.S. investors took 76 percent of the new-money tranche, with European accounts next on 18 percent and Asian investors on 6 percent. Fund managers bought 90 percent of the notes, public institutions bought 7 percent, insurers and banks bought a combined 2 percent, and others bought 1 percent.

The seven-year tenor was chosen to avoid clashing with Mongolia's other existing dollar maturities, in 2018, 2021 and 2022. The next challenge will be to refinance a $500 million sovereign bond due on Jan. 5, 2018.

DBM's 2017s had traded at a cash price as low as 90 in February last year, but the agreement last month of a $5.5 billion funding deal with the IMF and other agencies, as well as the extension of a 15 billion yuan ($2.2 billion) swap line with the People's Bank of China for another three years, has helped assuage investors' concerns, at least in the medium term.

"Mongolia has a lot of potential, but it is monolithic and commodity heavy, so the challenge for the country is to diversify into other industries," said a fund manager.

Credit Suisse and JP Morgan were joint bookrunners for the transaction. SC Lowy was financial adviser to the Mongolian government.

(Reporting by Daniel Stanton; Editing by Steve Garton and Vincent Baby)