This time last year, Turkish banks were charging towards the bond market. But as the wider financial markets took a turn for the worse in the early summer they scattered without pricing a deal. Only a few select issuers have dared to venture back since.
The reasons for the banks wanting to use the bond market have not changed. There is a need for project finance as Turkey upgrades its infrastructure and that finance needs to be long term 10 years or longer. For the banks own borrowing to match that lending, they must turn to the Eurobond market as the tenors needed are simply not available in the syndicated loan market, their historical staple.
But for the money raised in the bond market to be successfully used for on-lending, the rate at which it is borrowed cannot be too high. With the market having been volatile over the last year, the rates available have simply not been favourable. The yield of Akbanks $1bn 5.125% 2015s for example jumped from 4.7% in early May to 6.5% in October, though have recently rebounded to just under 5%.
"We have no Eurobonds planned for this year at the moment," says Batuhan Tufan, head of financial institutions at Garanti in Istanbul. "The main reason is that the secondary market spreads are elevated and so the primary pricing is too expensive to make it a good option for us. We also dont see significant loan demand from the corporate sector, so there is not much on-lending demand. Once we add the balance sheet charges and the capital charges on the funds we have borrowed, that price becomes too expensive for our clients."
Tufan says that it is impossible to give an exact figure for the level at which Eurobond pricing becomes attractive, as corporate loan demand needs to pick up and spreads need to come down.
"Turkish banking spreads are around 450bp-500bp over swaps and those would probably need to improve by about 100bp before new deals become interesting, but that is a factor of many things, including the Turkish sovereign Eurobond spread coming down," he says.
Despite the low consumer demand reducing the pressure on banks to raise bonds, the need for infrastructure financing remains. Indeed, the project finance pipeline in Turkey is around $100bn.
"For some projects the sponsors have decided to wait or seek alternative funding solutions from ECAs or IFIs, because at current commercial loan rates the projects yield much lower equity IRRs," says Tufan. "For sizeable infrastructure deals, the government has stepped in to support and agreed to provide VAT exemption and more importantly Treasury backing in the form of debt assumption in order to facilitate long term lending at this point."
But the banks want to return to the bond market when possible and are continuously monitoring the market for opportunities.
"The Turkish bank Eurobond pipeline did not materialise in the second half of last year, but that was entirely due to challenging market conditions," says Gaurav Arora, an origination official at Royal Bank of Scotland. "As and when the market improves, Turkish issuers will use the available windows of opportunity. Traditionally the Turkish banks have relied on syndicated loans and theyre still cheaper versus other sources of funding, but the banks do want diversification and longer tenors to rectify the chronic asset-liability mismatch."
Even with the widened levels, there have already been a few Turkish banks in the market this year. Vakifbank and Turk Eximbank both state-owned have both issued in dollars.
Turk Eximbank is something of anomaly because of its unique position as an export credit lender for Turkey and has the task of boosting Turkeys exports and so helping the country to reduce its current account deficit.
Apart from the state-ownership, Vakifbank has a similar business to most other strong Turkish banks, making it more striking that it has tapped the bond market this year, while issuers such as Garanti Bank and Akbank have chosen to keep their powder dry.
For Vakifbank, the advantages of going ahead with its bond plans outweighed the reasons to wait. Its $500m 5.75% five year debut bond, placed in April this year, was 5.2 times subscribed. "Our wholesale borrowing is only 9.2% and we were keen to extend our maturities, so we thought it a good idea to go ahead with our bond issue this year," says Birgül Denli, international banking and investor relations at Vakifbank. "It could also be a chance for us to gain market share in project finance lending as other banks have not been tapping the bond market so do not have that longer tenor funding to on-lend. Were certainly liquid in foreign currency though and theres no real pressure to fund."
Denli says that its next dollar deal is likely to be in 2013, though the bank does not rule out tapping the market again this year if wider market conditions improve.
Vakifbank is also marketing a Swiss franc deal, via BNP Paribas, Credit Suisse and Royal Bank of Scotland, joining Akbank in trying to sell such a note. Akbank roadshowed its Swiss deal in February this year though has yet to place it.
"With the growing pressure on traditional funding sources, financial institutions are looking to diversify their funding sources in terms of new investor base and currencies," says Arora. "Swiss francs is a strategic diversifier in terms of the pool of investors that issuers can access most of the issuers acknowledge and recognise this but its a question of how much they are willing to concede in terms of cost of funding to access that strategic pool of liquidity."
Arora argues that investors who buy Swiss franc issues are not accounts that typically invest in dollar or euro issues, so in using this market now, issuers are also not cannibalising any future potential euro or dollar demand.
Basel II is coming
In July, the Turkish banking sector will reach another milestone in its development the introduction of Basel II. The biggest effect on the banks is expected to be on their foreign currency denominated Turkish government securities portfolio. According to Basel II, domestic securities will be weighted at 0, whereas the weight of the FX securities will go up to 100%, as Turkey is a non-investment grade country. Under Basel I, because Turkey is an OECD country, foreign currency denominated Turkish government debt is weighted at 0.
The impact is expected to be partially offset by lower risk weightings of mortgages and retail and SME loans, but according to an impact study carried out by the Turkish banking regulator in March 2011, the effect on the banks capital adequacy will be around 140bp, bringing the average capital adequacy ratios of the sector to 16.7%, down from 18.3%.
"It is still pretty comfortable," says Okan Akin, vice president, EM corporate at AllianceBernstein in London. "The investor perception of the Turkish banking sector wont change much when Basel II is introduced because its already pretty positive. [Russian state-owned] Sberbanks just announced that it is buying Denizbank and when you consider that Sberbank is willing to spend $3.6bn on the eighth largest bank in Turkey, its clear that the sector is well perceived."
The acquisition is one of two being discussed in Turkey. Denizbank has been put up for sale by the troubled Dexia, while Finansbank, owned by the National Bank of Greece, is the other acquisition target.
"The Turkish banking sector is still profitable and current shareholders still want to benefit from that," says Tufan. "The names that are mentioned as potential acquiring targets for new shareholders are pronounced because of their ownership, rather than because of their lack of profitability."
Most observers expect the adoption of Basel II will bring more transparency to the sector.
"Its an important milestone though for the Turkish banking sector and will probably make loan pricing more rational, though wont necessarily increase or decrease those prices," says Tufan.
Inevitably, the effect on the balance sheet of each bank in Turkey will be different, and there is still some negotiating to be done, with some banks saying that the regulators risk weighting for Turkish sovereign bonds could still change so that it is less than 100%.
"At the moment we think our capital position will go down only 60bp-90bp, which is less than the average of 140bp-160bp expected for the whole sector," says Denli.
Vakifbanks tier one capital ratio is currently 13.35%, and Denli estimates says that it will be over 12.5% after Basel II is put in place. The Banking Regulation and Supervision Agency requires that the countrys banks must have a capital adequacy ratio of over 12%.
Eurozone exposure low
Turkish banks appear confident facing the year ahead. With the dark cloud of the eurozone crisis ever present, they of course have concerns, but those worries seem to originate from the sovereign level and its current account deficit.
Their confidence comes from their lack of direct exposure to the eurozone periphery. Because of a combination of Turkish regulation and high interest rates available in the country, the banks have little invested outside their home market.
"Turkish banks have little or no exposure to the eurozone," says Tufan. "For us, when comparing foreign currency bonds of eurozone countries to Turkeys, buying Turkeys always seemed the more attractive option as the yields were higher and we knew our home market better. Historically, the spreads of the eurozone countries were of little interest, and when the spreads were higher, we had no interest for different reasons."
AllianceBernsteins Akin agrees that the exposure is small, almost non-existent. There is even less to Turkeys neighbour Greece.
"In Turkey, there is only $100m exposure to Greece, which really isnt much at all," says Denli. "At our bank, we only hold Turkish sovereign risk."
From an investor point of view, the only real black mark on the Turkish banking sector is the rising non-performing loan levels, but even those are not out of control, with the Turkish regulator taking steps to slow the growth of lending by Turkish banks. Denli says Vakifbanks NPLs have already started declining, from 2.4% to 2.34% during the first quarter of 2012.
"NPLs are going up, but it looks as though it will be a soft landing, as central bank policies seem to be working to slow growth of the banking sector," says Akin. "The average NPL rate for the banks is around 3% and thats still pretty low. In 2008-2009 there was a spike in NPLs but the sharp recovery meant that the collection of the loans was more successful than expected so that has been benefitting the sector. That benefit is coming to an end though, so well have to see what effect that.
Turkish banks uphold role as EM loan stalwarts
|Loan bankers focused on Turkeys financial institutions could be forgiven for not noticing the record low loan volumes that have blighted the CEEMEA region this year. |
Since March, top tier Turkish borrowers Akbank, Garanti Bankasi, Isbank, Yapi Kredi and Vakifbank have all returned to the syndicated loan market as most of them have almost every year since 1987 to successfully hoover up $6.04bn-equivalent of liquidity between them.
"Turkish financial institution syndication is almost like an example of business school theory of how things should work," says Hiren Singharay, managing director and head of syndications Europe, Africa and South Asia at Standard Chartered. "It is unparalleled across the world."
As well as clockwork regularity, the feature that sets Turkish bank deals apart from other emerging market loans is the wealth of ancillary business consistently on offer. Turkish financial institutions are fully aware of how important this is in enticing in international lenders. "There were 41 banks involved [in our last deal] that wanted to maintain a relationship with us," says Birgül Denli, international banking and investor relations at Vakifbank. "We can provide ancillary business to each of those theres certainly enough ancillary business to go around, otherwise they wouldnt do this deal."
But secondary business comes at a price. Since 2009, Turkish borrowers have tightened the all-in margins on their loans. Vakifbank set 2009s benchmark at 250bp on a $667m-equivalent facility. This tightened further to 200bp by the end of the year when Garanti squeezed lenders in October. At the time, bankers complained that the pricing was too low, and would have to move up the following year.
However, pricing dropped again in 2010 to 150bp as fears of a prolonged global financial crisis began to subside and borrowers began pushing harder on terms. Prices reached their low in 2011 when Turkeys biggest banks borrowed at an eye-watering 100bp all-in.
But this year, Turkeys borrowers have felt the pinch as eurozone turmoil has pushed lenders to buck the three year downward pricing trend and all-in margins have leapt by 45bp to 145bp. Loan bankers have complained that the price hike isnt enough considering the higher cost of funds that they are facing. But for Turkish banks it still represents a 45% year-on-year increase in borrowing costs.
"We consider that a fair rise, as this is the clearing level for deals," says Batuhan Tufan, head of financial institutions at Garanti in Istanbul. "But it is also reflective of the relationship angle to all of these loans."
Pricing could still have a little way to go, but is unlikely to breach 175bp all-in, according to Singharay.
Demand has not centred only on the countrys biggest borrowers. Turkeys Alternatifbank signed a $197.5m-equivalent loan on May 29. The borrower is paying a 225bp all-in margin a result of having less ancillary business to offer than the top tier banks.
And smaller Turkish banks have proven popular in Islamic financing circles. Türkiye Finans signed an oversubscribed $350m murabaha facility on May 15 after launching at $150m. It paid a pre-fee margin of 200bp. The loan remains the largest ever signed by a participation bank (the term used for Islamic banks in Turkey).
Participation banks Bank Asya, Türkiye Finans, Kuveyt Turk and Al Baraka Turk are all expected to be more prominent borrowers over the next few years, says Singharay. They will attract different syndicates to Turkeys bigger banks with lenders looking for yield, rather than relationship plays. "In Islamic finance, pricing has [not followed] top tier banks with Turkish participation Islamic banks offering around 3%," Singharay adds. "This attracts lots of Middle Eastern banks and the yield pickers."
Turkey wakes up to Islamic finance
|For Islamic investors, Turkey offers both huge potential and unfulfilled promise. Participation banks as its Islamic banks are known account for less than 4% of the countrys financial industry, but this is on the rise. The country has received welcome encouragement from Malaysia, a driving force of the Islamic finance industry, which has promoted links with numerous joint showcases in both Kuala Lumpur and Istanbul. |
The most recent, at the Ninth IFSB Summit in Istanbul, offered the strongest show to date of Turkeys intent. Much of the event was dedicated to the countrys reforms in regulatory structure and standards relating to Islamic finance. Amid discussions, representatives from the Turkish central bank and capital market boards hinted strongly that a sovereign sukuk will be issued this year.
Investors have heard of such plans before, only to see them languish. Either the central bank has found Islamic assets wanting, or it has questioned the efficiency of terms.
Investors also say that the political will to endorse Islamic finance so directly has been lacking in previous years. Despite a predominantly Muslim population, the countrys constitution enshrines a commitment to secularism.
2013 will see the 30th anniversary of a special decree that paved the way for participation banks but the euphemistic name itself suggests an arms length embrace. However, indications of a changing attitude are clear. There is a perceived greater sympathy from Prime Minister Recep Erdogan towards Islamism than previous leaders. The government also wants to position Istanbul as a global financial centre and must include Islamic finance as part of its offering.
Moreover, Turkey is simply doing well. While many of its neighbours in emerging Europe remain mired in recession, Turkey has largely shaken off the financial crisis and posted strong yearly growth.
Many Islamic investors want to diversify away from Middle East and Asian local markets. Turkey is a good candidate because of its strong regulation and profile not a single Turkish bank has failed since the global crisis of 2008.
Turkey is also a country where sukuk could take off in the corporate and bank sectors ahead of any lead from the sovereign. However, to date only one bank, Kuveyt Turk, has actually issued sukuk a $100m club deal in August 2010 followed by a $350m benchmark deal in October last year. The latter issue was priced at 5.875% inside the conventional bonds of its higher rated Turkish peers. This created a positive buzz around the asset class. The result, said bankers at the time, underscored not only the growing appeal of Turkey to Islamic investors but also the extent of the developing co-operation between Turkey and Malaysia, with almost 20% of the allocation going to Asian investors.
International interest for the deal was more even than for the most recent preceding sovereign issue, strengthening the possibility that the government would look to sukuk in future rather than going through the conventional market.
Peer Islamic banks such as Albaraka Turk, Bank Asya and Türkiye Finans were also quick to signal their intention to follow Kuveyt Turks lead, but to date no further sukuk deals have materialised.
Both Asya and Türkiye Finans instead opted for one year Islamic loans this year to support SME lending lines. Market observers suggest these secured borrowings offered better terms than sukuk, but also drew upon an established market in Turkey.
To date, some $5.519bn worth of Turkish Islamic loans have been arranged in nearly 70 deals, according to data from EuroWeeks Islamic Finance Information Service. The first of those recorded by IFIS was a $250m deal for Akbank in 1997. This year has seen $752m of loan deals, while there were $1.232bn last year and $412.53m in 2010.