The Turkish covered bond law will be updated any moment now, paving the way for the first publicly syndicated euro denominated, mortgage backed covered bond of a benchmark size in the first quarter of 2014.
Turkey’s banks are eager to get cracking. In July 2013, VakıfBank, which is rated Baa2/BB+/BBB-, posted a filing on the Istanbul Stock Exchange saying that it was planning to issue a €1bn five year covered bond backed by Turkish mortgages that would be denominated in euros.
Though no bank was officially mandated, a funding official at the borrower said it was working closely with UniCredit and Natixis.
In January 2013, Işbank’s deputy CEO, Erdal Aral, told EuroWeek that his bank was planning to issue mortgage backed covered bonds. And Ziraat Bank, which is one of the main mortgage lenders in Turkey, is also believed to be considering mortgage backed covered bond issuance.
“All the big Turkish mortgage lenders are up to speed and in good shape to issue covered bonds that are comparable to the best standards in Europe,” says Piergiuseppe Brunozzi, director of European structured credit solutions at Natixis.
Akbank is also working on a covered bond programme, having last year approached investors for preliminary discussions. “They’re one of the prime issuers out of Turkey which is good, but for an inaugural bond from a new legislation I would expect to see a premium above the sovereign,” said one investor who has been involved in discussions. Issuers should not only be able to offer a premium above the sovereign but should also be able to make a decent saving versus senior unsecured funding.
Senior unsecured bonds from top rated Turkish issuers are generally priced around the 375bp area over mid-swaps which is 100bp-150bp over the Republic of Turkey.
“I believe covered bonds could price tighter than this, giving a sufficient funding advantage yet still offer a good pick-up to the sovereign,” says Müge Ekşi, managing director at UniCredit in Ankara.
Despite the likely funding advantage offered by covered bonds, bankers caution that the associated set-up costs are high, so the decision to embark on a covered bond programme will need careful consideration.
Some issuers are believed to be targeting a minimum 30% saving on the cost of senior funding, after taking into account set-up costs and swap costs, which could be difficult to achieve.
Boudewijn Dierick, head of flow ABS and covered bond structuring at BNP Paribas in London, says Turkish covered bonds would get a limited rating benefit due to the sovereign ceiling and this would affect the comparative funding advantage of covered bonds.
“The key challenge for issuers will be to obtain a sufficient saving versus their senior unsecured cost of funding inclusive of swap and programme costs,” he says. “This may impact investor interest and the pricing difference.”
Mortgage-backed covered bonds are expected to get a two notch rating uplift from an issuer’s senior unsecured rating, suggesting prospective deals will achieve an A3 rating, or the equivalent. As this rating would be higher or on a par with many other successful peripheral European covered bond deals that were priced in 2013, it should be sufficient.
Nonetheless, there is no certainty investors will be lining up to set up credit lines to Turkish borrowers, which for some are strictly off limits. And issuers may not believe that it is worth the time, effort and cost to set up a covered bond programme that is not guaranteed to deliver a good saving.
“Covered Bond programmes do take time and effort to set up, so there is a cost benefit analysis attached to that,” says Rajiv Shah, vice-president, debt capital markets, CEEMEA at BNP Paribas in London.
“Also, Turkish banks will need to work with the traditional covered bond investor base to educate them on Turkey’s credit story.”
But despite high set-up costs and limited rating uplift, bankers argue that covered bond issuance should make sense over time. If history is a guide, issuers typically pay a higher spread for their debut deals. But as their early deals perform, successive funding tends to become cheaper.
“Though fixed costs of setting up a programme are not cheap these can be absorbed over time with successive deals rather than being absorbed in the first deal,” says Ekşi.
In that context, it is probable that other Turkish banks will follow VakıfBank’s example and make a definite commitment to setting up a covered bond programme.
Shah says Turkish mortgage issuers are in regular contact with each other and he believes that once one bank has issued a deal others will follow.
Bankers say the odds-on favourite to bring the first mortgage-backed covered bond is Garanti Bank, which is rated Baa3/BB+/BBB.
On July 4, 2013, it announced that its board had approved issuance of up to €1bn worth of mortgage backed covered bonds.
“Our mortgage pool has reached a good volume and Turkey’s rating upgrades have helped improve demand,” said a funding official at the bank soon after the announcement.
In May, Moody’s upgraded Turkey’s rating by one notch to Baa3 with a stable outlook, taking the country’s rating into investment grade territory. Moody’s highlighted structural improvements in the economy and an improvement in public finances. In November 2012, Fitch upgraded Turkey from a high yield rating to an investment grade BBB- rating.
The investment grade rating is important because it will mean that a substantially larger group of investors will be able to put their money to work in Turkey than had previously been the case and this should lead to a knock-on improvement in the cost of bank funding.
“The Turkish rating upgrade re-opened the Eurobond market for Turkey and the benefits are already being felt by Turkish issuers,” says Ekşi.
In contrast to the small local currency denominated Turkish SME covered bonds, which have been exclusively placed in the private market, prospective mortgage backed deals are expected to be sized at a minimum €500m, denominated in euros and publicly syndicated.
Moreover, due to their large size and high rating they would be eligible for inclusion in the iBoxx covered bond index, further improving their appeal.
Teething problems now fixed
This bullish outlook contrasts somewhat with the last 12 months when market volatility crimped investor appetite and when other teething problems related to the law became apparent.
Emerging market investor appetite weakened in the second and third quarters of 2013 as the US Federal Reserve warned about tapering its quantitative easing programme. This volatility was compounded in June when sentiment towards Turkey soured on the outbreak of anti-government demonstrations.
Five year Turkish CDS more than doubled from a low of 116bp in May to a high of 250bp in September before returning to trade back inside 200bp by December 2013, according to Markit data.
But a funding official at Garanti Bank is confident. “Investors’ focus is already shifting back to country-specific fundamentals, and Turkey’s fundamentals are still good,” he says, adding that he expects Turkish covered bonds will offer an enticing return for yield-starved European investors.
Apart from market volatility, bankers say that the Turkish market was beset by other minor issues related to the covered bond law, namely swap counterparty hedging arrangements and mortgage loan eligibility.
The Turkish law is based directly on the German Pfandbrief model and, because of that, swap counterparty claims were originally secured up to 15% of notional issuance. This percentage was fine for the sedate German market, but it was insufficient for the more volatile Turkish market.
As swap counterparty claims in excess of 15% would have been unsecured, Turkish issuers were unable to find willing swap counterparties, which are essential for euro covered bond issuance.
“Turkish issuers are keen to diversify funding away from the emerging market dollar denominated investors to covered bonds which have traditionally offered a deep pool of demand for euro denominated covered bonds,” Brunozzi says.
Added to that, the original covered bond law only permitted issuers to collateralise their programmes with mortgage loans that had a certificate of occupancy. But this requirement was deemed unnecessary and, by severely limiting the amount of eligible collateral, issuers would have struggled to build their programmes to a meaningful size.
However, the Turkish Capital Markets Board has consulted with a wide group of different market participants and has resolved these issues.
“The new communiqué from the Turkish Capital Markets Board is likely to be passed within the next few weeks,” says Brunozzi. “It will likely remove certain limits on swap counterparty claims and broaden mortgage eligibility criteria giving issuers a greater opportunity to add more collateral.”
Private SME issuance in stride
In the SME space Şekerbank, Yapı Kredi and DenizBank have all issued covered bond deals. In April 2011, Şekerbank was the first Turkish issuer to price an SME covered bond from the region. In November 2012, Moody’s assigned an A3 rating to the SME covered bonds issued by Yapı Kredi.
DenizBank received an A3 rating from Moody’s for its SME programme in May 2013. The Turkish bank planned to sell up to €300m worth of lira-denominated SME-backed bonds over the year. After placing €172.8m of Turkish lira-denominated bonds to the European Investment Bank, the International Finance Corporation and the European Bank for Reconstruction and Development, it placed a third tranche of TL60m with Bank Nederlandse Gemeenten in late November. All three issuers are expected to make a return in the SME market in 2014.
In contrast to SME deals that were structured as pass-through bonds, mortgage deals could be structured as traditional hard or soft bullet bonds. Repayment of a pass-through covered bond, in the event of an issuer’s default, is dependent on the cashflow of the underlying mortgages, rather than the issuer’s balance sheet.
Irrespective of the choice of structure, the cheaper cost of funding and investor diversification provided by covered bonds will ensure the all issuers with a sufficient portfolio of mortgages will consider bringing deals.