The mood among bankers working in the Turkish international bond markets is distinctly bullish. As Philip Moore discovers, optimism abounds in the sovereign sector while there is real hope that corporates and financial institutions will at last be turning to the unsecured bond markets for their financing needs.
The recent volatility that hit global fixed income markets is unlikely to do any long term damage to the Turkish government's longer term borrowing strategy, even though it played havoc with Turkish sovereign spreads in May.
Those spreads widened by between 40bp and 70bp depending on currency and maturity, although bankers say they are confident that this spread widening will have reversed by the time the government revisits the market — most likely in September or October.
There are a number of reasons why bankers say they are relaxed about the implications of May's volatility on Turkeys borrowing. First, they argue that for all the noise about Turkey's current account deficit, the country's longer term economic fundamentals remain robust, suggesting that the events of May amounted to a healthy correction rather than the start of a protracted downturn.
"With tourism revenues rising over the summer and more clarity on benchmark interest rates we will see a stabilisation or perhaps a strengthening of the currency," says Ahmet Tacer, director of debt capital markets, CEMA, at Deutsche Bank in London.
A second reason explaining why bankers are unruffled about widening sovereign spreads is based on the long term trajectory of the pricing commanded by Turkey in the international capital market, which has been unerringly favourable in recent years.
"The Libor spread of Turkey's 2030 bond has tightened by about 400bp since 2001," says Tacer. "Even though markets have been volatile recently, it is now trading at 210bp, which is a reflection of the long term strength of investor demand for Turkish government bonds."
Other bankers agree that even if the pricing tide has temporarily turned against Turkey, it still has much in its favour. "Turkey clearly has plenty of time to complete its funding programme for 2006," says Tijen Taraf, director at debt capital markets group, CEMEA at UBS. "The question is whether or not the government will have to pay a premium compared with tightly priced deals in the past, which might be a psychological challenge, given the impressive credit spread tightening of Turkish bonds in recent years."
A challenge for the issuer, perhaps; but a welcome development for investors. "From the investors' perspective the recent sell-off may be welcomed, because it may give them the chance to re-enter the market at more attractive levels," adds Taraf.
Panic? What panic?
A third, related reason for bankers' relaxed stance is that any funds that have been fleeing Turkish government Eurobonds amount to what they describe as hot money. "In no shape or form has there been any panic from real money accounts during this recent phase of market turbulence," says Tolga Tuglular, managing director and co-head of sales and derivatives marketing for European emerging markets at JP Morgan in London.
Instead, Tuglular explains that hedge funds that have been building up positions in less liquid areas such as the local debt and currency markets have been using the liquidity in the sovereign Eurobond market as the most convenient way of hedging their exposure. "We have seen some hedge funds selling in order to square off their positions, but real money accounts are waiting for markets to settle before coming back into the market."
A final explanation for bankers' confidence in the prospects for Turkey's borrowing programme is that the government can hardly be said to overburden its investor base. The sovereign's borrowing requirement for 2006 is around $5.5bn, and with little competition from other local borrowers that is a modest total.
In line with the government's usual strategy of frontloading and pre-funding its annual funding requirement, Turkey had raised $2.4bn of that total by the mini-crash of May. The government wrapped up its funding for 2005 last November, when it tapped its existing $1.5bn 2015 deal for an additional $750m via UBS and HSBC. Priced at 223bp over US Treasuries, that transaction generated total demand of more than $4bn, with 71% of the bonds sold outside Turkey.
That meant that Turkey's Eu350m tap of its Eu650m July 2012 bond in December kicked off the government's funding for 2006 ahead of time. The order book for that tap, led by Dresdner Kleinwort Wasserstein (DrKW) and JP Morgan, was worth some Eu600m, comfortably allowing the borrower to bring the 2012 bond up to the key Eu1bn threshold.
As ever, Turkey was quickly out of the traps in the new year, with a $1.5bn 30 year bond launched in the first week of January 2006 via Citigroup and Deutsche Bank. That deal was priced at 258bp over US Treasuries, or 206bp over mid-swaps, and amassed orders of about $6bn. That deal was followed in January with a Eu750m 10 year transaction led by Credit Suisse, DZ Bank and UBS, which was also healthily oversubscribed.
A preference for dollars
In spite of that highly successful euro benchmark, for the time being at least Turkey is maintaining a currency split that in recent years has demonstrated a marginal preference for dollar over euro issuance.
Intuitively, bankers say that it would make sense for Turkey to reverse that balance and to make a political statement of intent by focusing more intensively on the euro market. But as accession talks gather momentum, there would also be more economic logic to the government tapping the euro market more actively. "As the accession talks progress, the EU will become an increasingly important trading partner for Turkey," says Andrew Dell, head of emerging markets debt finance at HSBC. "For a sovereign borrower to have its liabilities more closely aligned with its distribution of trade is a sensible objective. I certainly believe we will see more strategic issuance in euros going forward."
Certainly, the sovereign's experience in the market to date suggests that there is a very substantial reservoir of demand among euro-based investors for Turkish exposure. Its Eu1bn 12 year benchmark in February 2005 via Deutsche Bank and UBS, for example, was a triumph.
Aside from being its first deal in euros beyond the 10 year point on the yield curve, the order book of Eu5.5bn was a resounding vote of confidence from European institutions obviously convinced by Turkey's convergence story. Those institutions bought into February 2005's euro benchmark at 205bp over mid-swaps, compared with original guidance of 215bp over.
That investor base has not materialised overnight, but is the product of well over a decade of marketing the Turkish credit in western Europe, and especially in Germany. "If you look back to the 1990s Turkey was a very active borrower in the Deutschmark market," says Ray Harte, managing director of EEMEA origination at DrKW in London. Turkey, he says, was very successful at capitalising on the socio-cultural links between Germany and Turkey. "There was a natural bid from Landesbanks and Sparkasse which filtered through to retail investors in Germany and Switzerland, attracted by coupons as high as 10% or even 12%."
Much of that European investor base has remained loyal to the Turkish credit, even if the yields they are offered are no longer quite as irresistible as they were in the 1990s. And that solid base has been complemented by a growing group of institutional investors as the returns available to them in the convergence countries of central and eastern Europe vaporised in the run-up to EU accession. "German institutions such as Deka were among the first to start buying into Poland and Hungary at 200bp or 300bp over Libor," says one banker. "And when those credits fell to Libor plus 40bp or 50bp they found that they were forced to look further east, which meant moving into credits like Ukraine and Turkey."
Corporate, FIG frustration
Given the level of demand that appears to have been built up for exposure to the country, a number of bankers express their frustration that the market has been something of a one-trick pony.
To date, issuance has been dominated by the sovereign, with very little in the way of corporate issuance that would provide investors with more diversification — not to mention more yield. In the case of a very elusive corporate deal such as the $225m seven year issue from the Baa3/B- rated Vestel Electronics in May 2005, for example, which was led by ABN Amro and CSFB, investors were offered 150bp over the Turkish government curve.
There are one or two corporate bond mandates that are in the public domain. Citigroup and HSBC, for example, have the mandate to lead a Eurobond for Efes Breweries International to support its acquisition of the Krasny Vostok Brewing Group in Russia. But M&A-driven deals of that kind, say bankers, remain the exception rather than the rule in Turkey.
While corporate supply from Turkey has been thin on the ground, so too has plain vanilla issuance from financial institutions. Banks have tended to steer clear of the unsecured international market with very good reason, because securitisation in general and the market for diversified payment rights (DPR) transactions in particular has allowed them to pierce the sovereign rating.
"Banks have used the DPR market very effectively to raise wrapped and unwrapped medium term funding," says Gilles Franck, head of debt capital markets origination for emerging markets at BNP Paribas. "I see that continuing to be the main source of banks' international financing in the bond market."
Others agree, but say that banks' dependence on the future flows securitisation market is purely a reflection of Turkey's rating. "If Turkey continues with the strong economic performance and is upgraded to investment grade, we are likely to see more unsecured issuance from the local banks as well as the corporate sector," says Deutsche's Tacer. "The Turkish banks' balance sheets have been growing rapidly and ideally they would like to maintain capital adequacy ratios above 12% or 13%, and the subordinated bond market would offer a much more efficient way for them to maintain those ratios and improve their return on equity."
At DrKW, meanwhile, Harte is upbeat on the prospects for diversification of the market for Turkish Eurobond issuers. "We are close to finalising issuance documentation for a number of Turkish industrial companies which we are hopeful of bringing to the market before the summer recess, subject to market conditions," he says. "If there is no discernible upturn in the market, those new issues will have to be put on ice until September."
But irrespective of short term influences, he says that from both a supply and demand perspective, the outlook for corporate issuance from Turkey is likely to brighten over the coming months and years. "In some cases supply will be driven by corporates' desire to refinance existing and more expensive sources of debt," says Harte. "But it will also be driven by companies recognising that Turkey's growth prospects over the next three to five years are very positive. That will lead to more M&A opportunities, so with rates having fallen it makes sense for companies in a number of sectors to leverage up their balance sheets."
Increasingly, that view is being shared by other bankers. "The local loan market is very liquid at the moment, with a lot of appetite from both local and foreign financial institutions," says JP Morgan's Tuglular. "But companies like Sabanci have already indicated that they are planning to invest up to $3bn in power generation, which will need to be financed, at least partially. In the first instance these requirements will be met by the local and international loan markets, but over time it will start to filter into the bond market."
Rising supply of Turkish corporate paper, says Harte, is likely to find no shortage of takers from yield-hungry investors attracted by the convergence story. Many of those investors missed out on the big convergence rally that took place in markets such as Poland and Hungary some years ago, and will be eager to ensure that they do not make the same mistake in the Turkish market.