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Monday, 23 October 2017

Answering the doubters

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The sovereign has relieved the funding pressure with a flurry of issuance following a challenging 2011.

To view the digial version of this report, please click here.

The Republic of Turkey is usually the first sovereign out of the blocks from Eastern Europe, the Middle East and Africa, so when it did not immediately tap the market at the start of January, it appeared to be a sovereign under pressure.

The main area of concern for investors was the sheer amount of debt that Turkey needed to raise. Despite being an established and sophisticated borrower well-known among the international investor community, Turkey has had its 2011 sovereign issuance programme severely affected by events. The huge global volatility caused by political upheaval in the Middle East, the natural disasters in Asia and the ongoing global financial situation have meant that it missed its funding target of US$5.5bn.

Turkey’s domestic economy also spooked investors, with rising inflation and a high current account deficit exerting pressure at home, while the eurozone crisis and political upheaval across the Middle East triggered a more general flight from emerging market credit. With some upcoming maturities to refinance,  the country had set itself a funding target of US$5.2bn for 2012, including the previous year’s shortfall. Added to its reputation as an early entrant into the bond markets, and there was a growing sense that this was a sovereign that needed to deliver.

Opportunity knocks

After sitting on the sidelines for the first two weeks in January, Turkey saw a window of opportunity as the European Central Bank’s provision of cheap loans through its three-year long-term refinancing operation acted as a buoyancy aid to the listing eurozone. On January 19 it tapped the dollar market with a US$1.5bn 10-year offering via Barclays Capital.

“Turkey’s transaction in January relieved the perception of any funding pressure. They achieved size, with the US$1.5bn proving larger than any of their more recent transactions. They showed early in the year that they had significant market access, laying the framework for the subsequent reopening,” said Fabianna del Canto, director in the debt syndicate team at Barclays.

This was the first US dollar deal in 2012 from a Central and Eastern Europe borrower and the largest deal from the sovereign in the past two years.

With the deal pricing at 6.25%, representing a new issue premium of 20bp and attracting US$4.5bn in orders from 184 accounts, Turkey achieved its aim of starting the year with a bang. The largest portion of the new paper was allocated to US investors, which took 40%, followed by a 33% take-up by Turkish funds. Accounts in the UK bought 20% of the bonds and European investors took the rest. The deal tightened, enabling the sovereign to re-open the bond on February 9 with a US$1bn tap that attracted a further US$3.3bn in orders.

Turkey benefited from the broader rally in emerging market credit – and credit in general – since the start of the year, and its reputation as first-mover puts it in the best position to swallow up the wall of investor cash that flowed into the asset class at the start of the year.

Odilbek Isakov, associate director in debt capital markets at HSBC said: “There has been a 100bp tightening of Turkey US dollar September 2022 bonds since they were issued on January 19. There has been a tremendous strengthening of the cash bonds on the back of increased inflows to emerging markets bonds in general.

Facing the challenges

Bankers also point out that after a miserable 2011, Turkey had become something of a whipping boy for investors, but has got to grips with its economic challenges. 

Investor concern about inflation and the current account worsened last year when Turkey’s economy expanded at the fastest pace after China  among the G20 nations, spurring demand for imports that increased the current account deficit to a record US$78.6bn in October, equivalent to about 10% of GDP.

The central bank responded by more than doubling the rate it charges for funds to lenders at the end of the year. Inflation slowed in February to 10.4% from a three-year high of 10.6% a month earlier. Central bank governor Erdem Basci told a press conference at the end of January that higher lending costs would reduce import demand and steer the economy to a “soft landing”.

Between December 2011 and January 2012 credit default swaps on Turkish sovereign bonds jumped 75bp, a move which lured back investors looking for value.

Isakov added: “The government has taken measures to shift the current account deficit from one funded by short-term capital inflows to one funded by longer-term capital and foreign direct investment and that positive change in the composition of capital flows has become visible since the second half of 2011.”

Having raised nearly half of its annual funding target with the two dollar trades, in March the sovereign’s next move was to diversify its borrowing risk as it tapped the yen market for the second time in a decade with a new ¥90bn 10-year deal that was enhanced by Japan Bank for International Cooperation.

The deal with Daiwa Capital markets, Nomura and SMBC Nikko as joint arrangers, priced with a 1.47% coupon and a spread of yen offer-side swaps plus 40bp, right in the middle of the guidance range. It also set a new low pricing in the JBIC-guaranteed Samurai issuance by emerging market sovereigns, beating the previous low of 43bp over set by Uruguay’s smaller ¥40bn 1.64% deal.

Japan: at ease with Turkey

As well as carrying symbolic importance – it was the first one to be approved after last year’s earthquake – it demonstrated the extent to which Japanese investors are becoming more comfortable with Turkey as a sovereign. At more than US$1.11bn equivalent, it took Turkey’s total funding for the year to more than US$3.6bn.

“This was a really smart deal,” said one source. “There is strong demand in Asia for this product and there is a scarcity of supply of JBIC-guaranteed paper. It gave Turkey exposure to an investor base that is protected from the problems in Europe or in the US.”

It also built on the solid foundations the sovereign laid in February when, in its first yen issue since 2000, it raised ¥180bn at 1.87% transaction, priced at 48bp over via Daiwa, Mitsubishi UFJ Morgan Stanley and Mizuho. That deal came with a 95% JBIC cover, and in the March 2012 the guarantee had dropped to 94% of the issue – a positive step as it reflected increased investor appetite.

“It [yen market] gave Turkey exposure to an investor base that is protected from the problems in Europe or in the US”

In dollar terms, the order book reached around US$2.5bn, but the issue was capped by the JBIC guarantee. The JBIC guarantee is essential because without it a Ba2/BB/BB+ rated sovereign like Turkey cannot access the risk-averse yen market at a meaningful price or size.

JBIC’s guarantee coverage allowed for a price gap of about 180bp compared with where Turkey’s standalone US dollar paper trade.

Turkey’s recent US$1.5bn tap in January of its outstanding 6.25% Global bond due 2022s, priced at 445.3bp over US Treasuries, was trading about plus 330bp or dollar Libor plus 325bp prior to pricing.

In yen terms that translated into 215bp over swaps, in stark contrast with the Samurai’s price of just 40bp over.

Turkey had to pay an increased guarantee fee to JBIC, but even with that factored in, it is thought that the sovereign’s all-in cost on the yen transaction still represented a substantial saving to issuing in dollars.

With the bulk of its funding now complete, Turkey has the flexibility it earned at the start of the year.  The sovereign may return to the dollar market or tap the euro market later in the year  to complete its funding, while in keeping with its reputation for innovation and quest for funding diversity, the sovereign is said to be considering its debut issue of Islamic bonds this year.

A sovereign sukuk issue from an economy regarded as one of the most progressive and successful in the Muslim world would signal intent on Turkey’s part to play a bigger role in Islamic finance. The size of the global sukuk market is estimated at more than US$100bn. (See “Slow, but steady start”)

While Turkey has sent a clears signs of strength to investors, economic fears have not disappeared altogether. Rising oil prices could lead to a further widening of the current account deficit while Turkey’s curve widened in the middle of March when there was a sharp rise in US Treasury yields. Against this, some hope that 2012 might be the year when Turkey will be upgraded to investment-grade status.  

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