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Don’t call me, maybe

Retro blue phone

No sense in calling Turkish banks' tier two bonds

Three Turkish banks have call dates coming due on their tier two instruments before the end of this year. They should not exercise those options, no matter how angry it makes investors.

OdeaBank has a tier two with a call date in August, while Fibabanka's and Vakifbank’s fall in November. The reset levels on these bonds, if they are left outstanding, make the debt much more expensive for the issuer than at the time the bonds were issued. Moreover, their regulatory benefit starts to diminish.

This will have led many investors to conclude that the bonds will be called early, perhaps netting some a profit but certainly, in a market of rising rates, allowing them to reinvest higher yields.

But the Turkish bond market has performed so badly since these notes were printed in 2017 that the issuers cannot refinance this debt for cheaper than the coupon reset level they will pay if they do not call the bonds.

Syndicate bankers in London say that with Credit Suisse having last month paid a 9.75% coupon on its new AT1 bond, it is anyone’s guess what sky high number a Turkish bank would need to pay for subordinated debt.

That assumes a clearing level exists. Turkey is awash with macroeconomic worries — huge inflation, zany economic policy and so on. The OdeaBank and Vakifbank tier twos carry a CCC+ rating from Fitch. The Fibabanka tier two has a B- rating.

Not exercising the call option on these deals not only saves the issuer money but underpins the banks’ capital positions by continuing to provide a hedge against lira depreciation — which Fitch says is currently the greatest risk to Turkish banks’ capitalisation — and supporting their total capital ratios.

The only reason to call the bonds is the borrowers' reputation among investors. When the notes were printed, investors bought them at a price that reflected an expectation of them being called at the first opportunity. The peril is that supposedly, when a bank that has not called a deal returns to the market, it will be penalised.

Garanti BBVA decided not to call its $750m tier two debt in May. It was a decision that rocked the market as Turkish banks had previously always called their deals.

But despite that decision from Garanti bankers and investors are still viewing each call date independently. There is no hard and fast rule being applied to Turkish banks; no assumption that none or all of them will call, despite them all being in roughly similar situations.

The decision for each call will be down to several factors such as the size of the bond in question, the cost of refinancing and each bank’s own capital position. But right now, it is mostly about how each issuer views the reputational risk of not calling.

There is much pressure on Turkish banks to call these deals. In reality though, will investors really punish those who leave their bonds in place?

There is precedent, even in developed markets. Issuers as highly rated as Deutsche Bank did not call their tier two bonds during the financial crisis and investors seem to barely remember when they print new ones.

Secondly, in the back of investors minds now, there will always be Garanti, which did not call. Yes, these are different banks, but the top five banks in Turkey are viewed as fairly similar propositions by international investors.

Investors will also be aware that different management may be at the helm the next time the issuer comes to the market. The decisions taken in future years will be about the market at that time, about the size of that deal outstanding, and about their capital positions at that point and, as with this year, the reputational risk.

The history of the issuer's option exercise decisions will likely make very little difference, just as it was brushed aside for Garanti this year.

All of this is why the perceived loss of pride in calling a bond should be small beer for the Turkish banks. After all investors have read the fine print, As with all investments and especially in emerging markets, the details and risks of unexpected situations matter. They knew this was a possible outcome when buying the bonds. Issuers have every right to take this financial win and very little reason not to.

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