Turkish bank sub: sink or swim
A test case for calling subordinated debt is about to be heard in the court of the capital markets
Turkish banks are set to increase their tier two debt issuance at the start of 2024, offering a test of whether issuers that have not called such debt at the first opportunity — as is the expectation when deals are priced — will suffer at the hands of investors when they next visit the market.
In the last two years several Turkish banks — most notably Isbank and Garanti, but several smaller issuers too — have not called their subordinated debt when given the option. That runs contrary to what is expected when the bonds are first structured and priced, with step-up coupons after the call baking in an incentive to redeem the bonds and issue new ones.
Unorthodox monetary policy and high inflation in Turkey meant that there were points at which investors were not sure if even the sovereign could print, never mind tier two debt from a bank.
Meanwhile, dollar and euro interest rates, and spreads — Turkish bond spreads in particular — are much higher now than they were when those bonds were first issued.
That meant Turkish banks were faced with a tough choice: call the debt and keep investors happy but risk an expensive refinancing, or worse, no chance to sell a bond at all; or keep the cash on their books but irritate investors who would have expected to be able to reinvest their redemptions at higher yields.
Many banks called the debt, it was a strategic ploy. For when the market eventually reopened, as it looks to be doing now, they would have feared punishment from investors had they not redeemed those old deals early when it came to pricing new debt.
Those that did not call the bonds hoped that western banks that also didn't exercise call options on subordinated debt would provide an example of how easily forgiven banks are after such an event. But that may be wishful thinking. Big international banks weigh much heavier in bond indices, meaning some investors have to buy their bonds, whether they are in a grump with the issuer or not. The two cases are not directly comparable.
With crunch time approaching, with the issuance of new bonds, we are about to see which group made the better decision. A rush of Turkish tier two is coming at the start of next year. Two fund mangers in London identified Isbank — a non-caller — as likely being one of those likely to bring a bond.
If enough banks bring deals in early 2024 then we should have a clear indication from the reoffer spreads as to whether investors favour those who acted in their interests by calling the bonds.
But if no clear pattern emerges, there are two explanations. The first is that instead of punishing only the banks that did not call, investors are punishing the whole sector. The second is that while investors may have promised to deliver hellfire and brimstone, their final verdict was rather more tame and they did not have the will or ability to really mete out punishment.
Whatever happens, it is a situation that investors and issuers will watch closely. If the non-callers are the only group to suffer then there will be a clear argument that investors have asserted a level of discipline.
If not, and even if the whole sector widens, the jeopardy of not calling is removed, at least relative to peers. An element of the widening may well be due to increased investor wariness but other factors will have been brought to bear too. Either way, a lot more Turkish banks will keep in mind that their option to call debt is exactly that, with no further obvious premium to be paid.