Six months after receiving the go-ahead from the EU to begin negotiations this October, Turkey has suffered uncertainty over its membership bid as a result of EU constitution referendums in France and the Netherlands. But, as Kathryn Wells reports, Turkish debt has overall maintained its impressive performance, and as a result some rare corporate issues may even make it to market.
It is a sign of Turkey's progress in the international capital markets that the French no vote in a recent referendum on the EU constitution had relatively little impact on the sovereign's spreads once the result was announced.
While this was partly because the result had already been priced in to its secondary levels, it is also thanks to investors' growing confidence in the country's overall performance.
While the referendum result has been read by some market observers as a set-back for Turkey's own EU aspirations, others believe that the result will have little long term effect, especially as Turkish membership will not happen before 2015 at the earliest. "A month ago, the market thought a no vote would be catastrophic for Turkey," says Chris Tuffey, head of emerging market syndicate at Credit Suisse First Boston in London. "Now, it looks like the vote going against them should be a temporary set-back rather than terminal."
Turkish spreads began to widen at the end of the first quarter of 2005, amid a more generalised emerging market sell-off. By the end of May, Turkey's benchmark 2030 bond was trading at 380bp over US Treasuries, some 120bp tighter than where the bond was trading at the height of the emerging market volatility in the second quarter of 2004, although still wide of the record tight level of 307bp in the first quarter of 2004.
"There are several reasons behind the volatility in Turkish spreads in recent months," says Tuffey. "Partly it is a result of how much they have tightened over the past couple of years, and partly it is due to the strong participation of the local market, which has hit trading levels and volatility."
The republic kicked off its funding programme in style on January 13, raising 40% of its $5bn external borrowing requirement for the year with its biggest ever bond. For the third time running on its dollar issues, it chose Citigroup and Morgan Stanley as leads.
The 20 year deal was not Turkey's longest — it sold a $1.5bn 30 year issue in 2000 and another in January 2004 — but with books of $12bn it made the biggest splash.
The bond's launch was boosted by an unexpected upgrade from Fitch Ratings, from B+ to BB-. Fitch remarked on Turkey's strong prospects for continued policy discipline thanks to political stability, its adoption of a new IMF programme and the approach of EU accession talks.
It then continued its policy of frontloading with a Eu1bn 12 year issue via Deutsche Bank and UBS in early February. That deal showed how much sentiment in Europe towards Turkey has changed for the better over the last couple of years, irrespective of the French vote.
"Previously, its investor base in dollars was dominated by emerging market funds and in euros by European retail and banks," says Dennis Holtzapffel, head of emerging market syndicate at UBS in London. "Now there is a large euro denominated institutional investor base in Europe that takes an interest in Turkey as well."
Turkey has gradually been realigning its borrowing strategy over the last couple of years, which had previously been as high as 70%/30%, in favour of dollars over euros.
"Turkey's euro curve has outperformed its dollar curve for most of this year," Holtzapffel says. "Turkey's 2015 dollar bond has been trading at around 270bp over mid-swaps, while its 2017 euro issue is at 227bp over mid-swaps. Turkey should look to benefit from this pricing differential going forward by bringing more of its issuance in euros."
Because of its restored reputation on the international debt markets in recent years, Turkey could become the latest emerging market sovereign to manage its external debt profile more actively. Earlier this year its parliament passed a new law on public finance and debt management that opened the way for the exchange and redemption of Eurobonds.
"Turkey has a lot of debt maturing in the near term and it would make sense for the sovereign to consider liability management," says May Nasrallah, head of European liability management and restructuring at Morgan Stanley in London. "Turkey has many high coupon bonds that were sold when its economy was not performing as well as today. Turkey wants the world to see it as part of Europe, not as an emerging market, and this would help that desire."
Exchanging its external debt would allow Turkey to lengthen its maturity profile and reduce its borrowing costs. "We have identified some shorter dated maturities, both dollar and euro denominated, which by virtue of their high coupon and low level of liquidity, could be candidates for exchange by the Treasury," Sevin Ekinci, an analyst at WestLB in Istanbul, said in March.
"The government has said that it is motivated by maturity and cost so this suggests that the outstanding bonds of short maturity might now be swapped for longer term debt," explains Nick Eisinger, a director of sovereign ratings at Fitch in London. "In addition, it might seek to take advantage of low market spreads to refinance more expensive outstanding bond debt. With the market beginning to turn, the window of opportunity might be small. That said, some of the coupons on debt issues some time back are still much higher than what Turkey could get today even in a deteriorating marketplace."
The treasury is expected to go down the route of a voluntary auction. "This method is transparent, promotes investor competition and opens the possibility of raising additional cash," said Ekinci. "However, it can expose the issuer to higher market risk and execution costs."
Turkey has large repayments due to the IMF until 2007. Repayments of just over $7bn are due in both 2005 and 2006, before falling to $5bn in 2007 and only around $1.5bn in 2008. "Clearly," said Ekinci, "the swap of the bonds we have identified into longer maturities would substantially reduce the burden in 2006 and 2007, when obligations to the IMF are sizeable."
Auto sector heads corporate pipeline
There is also the prospect of corporate supply to complement the steady flow of sovereign paper.
Oyak Group, one of Turkey's largest conglomerates, may become only the third company from the country to tap the international bond market since 2002 if it is successful in privatisation tenders later this year.
The government is keen to show its commitment to privatisation, progress with which has been long awaited. It hopes to raise around $1bn from privatisation this year, with tobacco monopoly Tekel, and fixed line operator Türk Telekomunikasyon, among likely candidates.
"The privatisation process in Turkey is providing some excellent investment opportunities," Caner Oner, Oyak's chief investment officer, told EuroWeek in February. "And there may be such an opportunity that becomes available that will require us to borrow. We want to be ready."
Although this would be Oyak's first Eurobond, it has begun to build a profile in the syndicated loan market after signing two deals last year. The first, a $115m one year loan, was signed in April 2004. This was followed in October by a further $125m one year facility.
Pricing on the April loan of 90bp over Libor came down to 80bp over Libor by October.
Oyak Group is Turkey's third largest conglomerate, behind the family-owned Koç and Sabanci groups. It has controlling stakes in companies in such diverse industries as logistics, cement, automotive and financial services.
Several banks are also looking to diversify away from their traditional syndicated loan funding base, including Deniz Bank, which mandated Merrill Lynch earlier this year for a $300m five to seven year transaction.
A report from rating agency Fitch in March suggested that Turkey's leading car manufacturers are likely to end the country's dearth of corporate bond supply, either in the second half of this year or in early 2006.
Only one company, Petrol Ofisi AS (POAS), the country's largest fuel distributor, has issued since TV manufacturer Vestel Electronics in 2002. Vestel itself made a return to the market in early May, pricing a $200m seven year bond that it used to fund a buyback of its $225m 11.5% bond due 2011. By the timing of pricing the new bond, it had received offers for sale from holders of 94.4% of the paper.
ABN Amro and Credit Suisse First Boston arranged the bond sale. Despite extremely difficult market conditions that saw Turkish spreads fall by three points, the leads were able to price a $225m deal, up from an originally announced $200m issue, at 99.231 with a 8.75% coupon to give a spread of 150bp over Turkish government debt.
Ford Otosan, Toyota, Oyak Renault, Hyundai Assan and Tofas — a Fiat joint venture — are the leading domestic car manufacturers in Turkey, catering primarily to the export market.
International car manufacturers have located operations in Turkey over the past 20 years, thanks to the availability of cheap labour and the country's position within the EU Customs Union. They have, however, yet to develop and feed much domestic appetite for their brands among the 70m population.
According to Fitch: "The sector leaders are strong candidates for issuing bonds in the domestic or international markets given their scale and their export successes. The parents' credit profiles support the Turkish issuers, either directly by providing tangible support or indirectly by letting the Turkish operations assume a greater role within the auto group's European strategy.
"Their capital markets activities are viewed to be supported by their scale and their ability to diversify their revenue base in terms of products, increased importance in their global parents' European vehicle strategies, but also in terms of regions by building up a certain level of export volumes, to be protected from a downturn in domestic demand."
Some bankers argue that few large multinationals would choose to fund through their Turkish joint ventures if they could raise funds cheaper under their own names. But others believe that individual borrowings can make sense for such diverse companies.
"Turkey is the new European accession play," says one emerging market syndicate head. "Its spreads have tightened massively. Until now most of its borrowers have been able to get such good rates from local banks that the Eurobond markets have remained unexplored. But the potential for issuance is there, especially as some multinational borrowers don't want the cross-currency risk and so insist that their operations in each country are self-sufficient."
Ford pursued such a strategy in Brazil in the 1990s, with its Ford Brasil operations selling three bonds totalling $600m between 1992 and1997. Those deals benefited from a support agreement from the Ford US parent company.
Bankers see Ford Otosan as the most likely of Turkey's car producers to issue, particularly because it has some experience of the international markets. In 1999 it raised $130m through a private placement with protection from US government insurance agency Opic.