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Thursday, 15 November 2018

A golden opportunity in stressed Turkish markets

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Turkey’s secondary debt markets are starting to offer select opportunities following this year’s collapse in the Turkish lira and as a growing number of borrowers face difficulties caused by the weaker currency and a difficult operating environment.

Bonds denominated in US dollars are already changing hands at wider spreads and senior secured bank debt issued by the country’s large industrial conglomerates is starting to find interest among secondary buyers.

Sellers are being driven in many cases by pressure from foreign shareholders to offload positions against a backdrop of a growing number of stressed loans that constrain both banks’ balance sheets and their management time. Commensurate pressure has not been seen for Turkish state-owned banks, which are for the time being content to sit it out and wait for stability.

Further complicating matters is the less-than-transparent Turkish bankruptcy regime which is loosely based on the Italian model and remains very creditor-friendly. A lack of restructuring know-how is also limiting the scope of most restructurings to an “amend-and-extend” model, which only delays the inevitable and is set to create many zombie companies where debt remains unlikely to be collected in the long run.

The Turkish lira has collapsed by around 40% this year, diving more than 30% in August, and prompting the Central Bank of Turkey to tighten its benchmark short-term rate from 8% to 24% to protect the currency.

Inflation hit 24.5% in September – in large part due to Turkey’s need to import the bulk of its fuel and energy – and there are fears of widespread default on foreign currency-denominated debt, largely issued in US dollars and euros, which must be serviced out of a sharply depreciated currency and in the context of sharply higher input costs.

A tweak which might alter the debt ratios of Turkish companies was provided by a government measure introduced in September which lifted the requirement for companies to count foreign exchange losses when assessing whether to file for bankruptcy. This might increase the universe of potential restructurings as companies seek ways to stave off liquidation.

According to JP Morgan, there is around US$146bn-equivalent of external debt maturing in 2018 issued by Turkey’s private sector and, given the dire foreign exchange and economic backdrop, a considerable proportion of that debt looks likely to be restructured.

While refinancings are still coming through, especially in the financial sector, the cost of borrowing has increased by 150bp–200bp even for top-tier banks. For the syndicated deals that are getting done, paper remains better offered in the mid to high 90s days after signing, showing the potential for further weakness in bank syndications.

As Turkish banks mainly rely on foreign syndications to fund US dollar assets, this has the potential to create more stress in the corporate debt market.

A key focus for the market currently is in the form of so-called “Stage 2” loans which are classified as impaired but not yet non-performing. These loans increased to around 7% of total loans at the end of the first half of 2018 as many Turkish corporates engaged in a round of debt restructuring.

Although the Turkish Banking Institute estimates that non-performing loans comprise just 3.5% of banks’ balance sheets, the figure is likely to be much higher, with S&P estimating that the total could hit around 15% within the next two years. And there is ongoing concern about the Turkish banking system’s exposure to the large conglomerates and to risky sectors such as construction, energy and project finance.

CREATING VALUE

At SC Lowy, we believe that the secondary market participants can create value for both Turkish banks as well as the stressed companies themselves.

As restructurings go beyond the amend-and-extend route, ultimate recoveries for creditors will improve and the additional breathing room provided to companies will support the health and growth prospects of the real economy.

With the experience of Spanish and Italian secondary loan activity fresh in market participants’ minds, the Turkish market seems to be in a state of preparedness for history repeating itself, with a stressed underlying economy and companies in dire need of creative capital structure solutions.

As Turkish market participants increase their familiarity with global best practices of risk management and restructuring, the Turkish secondary loan market will offer immense opportunity for anyone that is keen to dive in. We intend to remain in the forefront of that effort.

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