With its path to EU membership ? however distant ? looking ever clearer, Turkey's bond spreads tightened impressively throughout 2004. For investors looking to play a new round of the EU convergence game, Turkey offers an increasingly attractive place to invest. By Kathryn Wells.
In less than two years, Turkey has completed a striking turnaround from regional basket case to genuine EU membership contender.
Thanks to the political stability created by the country's first non-coalition government for many years, investors have been able to focus their attention on Turkey's impressive economic performance.
The booming economy has provided support to Turkey's bid to join the EU. In December, EU leaders made a historic decision to open talks on membership with Turkey. Entry from about 2015 is now a possibility.
?This is the first time in years that Turkey's numbers have looked so impressive,? says Petri Kivinen, head of emerging market origination at Dresdner Kleinwort Wasserstein (DrKW) in London. ?As a result, it has been comments coming from Europe about its membership hopes that have been driving spread movements.? Turkey has beaten IMF targets for GDP growth, with growth of 7.9% predicted for 2004, while inflation has been tamed to single digit levels.
With 10 countries joining the EU last May, yield hungry investors have been forced to cast their net further. ?High grade buyers have seen that the first wave of convergence is nearly over and are looking beyond to the second and possible third waves of convergence, particularly now that Turkey appears to be on track towards membership,? explains Mike Elliff, head of emerging market origination at ABN Amro in London. ?We saw significant new investors participating in Turkey's most recent euro issue and we expect more euro investors to add or increase lines for Turkey over the coming months.?
But there should be further room for EU related spread compression in 2005. ?Turkey has made progress, albeit slowly, towards the EU,? says Jonathan Brown, head of emerging markets syndicate at JP Morgan in London. ?This is not entirely priced in and 2005 should see more spread tightening. Turkey saw a tremendous rally in 2004, but it does not yet have a genuine EU investor base. However, it now has the support that Romania and Bulgaria enjoyed several years ago.?
Turkey's growing investor base will also help to drive spreads tighter, according to Dennis Holtzapffel, head of emerging market syndicate at UBS in London. ?Turkey will probably also benefit from upgrades by Moody's and Fitch following Standard & Poor's recent upgrade to BB-,? he says.
The sovereign borrowed more in euros in 2004 than in 2003, but its issuance remains skewed towards dollars. This should continue until it develops its euro curve further, bankers say.
?Turkey's euro curve remains more expensive than in dollars,? says Carlyle Peake, head of emerging markets syndicate at DrKW in London. ?The sovereign has not developed a long dated position in euros yet. It will make sense for Turkey to reposition its issuance more in euros in the coming years as it approaches EU accession, particularly as most of its trade is already done with the EU.?
The balance also reflects the preference of Turkish investors. ?Domestic investors buy twice as much dollar paper as they do euro denominated and Turkey's US investor base is much deeper,? says Marc Lewell, vice president on JP Morgan's syndicate desk in London. ?This means that Turkey will continue to favour the dollar market, where there is a greater perception of liquidity.?
In another encouraging development, petrol distribution firm Poas priced a $175m five year Eurobond via JP Morgan in July ? the first international corporate bond from Turkey since May 2002, when Vestel Electronics sold $200m of five year paper.
Bankers hope this might lead to further corporate mandates, although it remains a challenge to compete with domestic banks.
?Because yields on domestic bonds are so low, Turkish banks have found other ways to remain profitable,? says Kivinen. ?This is why there has been a rise in corporate lending, and explains why few companies have chosen to issue Eurobonds when there is so much liquidity domestically.?
In November, Vakifbank picked ABN Amro, Citigroup and JP Morgan to arrange a $300m five year Eurobond scheduled for the first quarter of 2005. While this is not expected to presage a surge in bank issuance, several more deals may follow. ?The reduced cost of funding in the bond markets might encourage others to follow,? suggests Holtzapffel at UBS.
However, subordinated debt could prove more attractive. In October Finansbank sold a $200m subordinated bond ? the first from Turkey ? opening the way for similar transactions.
?The driving force for the deal was Finansbank's change in strategy from holding government securities and lending to the government to running down its T-bill portfolio,? Alex von Sponeck, director of EEMEA securitisation at Merrill Lynch in London, told EuroWeek at the time. ?There has been a big increase in consumer lending, lending to small and medium sized enterprises, credit cards, and retail lending like mortgages and so on. This growth strategy meant that a potential capital constraint would have been reached soon, and to keep up the pace of growth and capture further market share, they needed a capital increase.?
Finansbank followed this up with a $350m unwrapped securitisation of remittance flows in November, in the same week as Isbank sold a similar $600m three tranche deal that included an unwrapped tranche of $100m.