High yield heaven
Turkey’s macro-economic picture has taken a back seat as politics has taken centre stage. Rates are not compressing as fast as had been expected due to inflation risks, while the country remains burdened with a heavy current account deficit and an inverted fixed income curve, leaving it vulnerable. But international bond issuance is healthy, as Hardeep Dhillon reports.
Turkey’s current account deficit stands at US$40bn, roughly 6% of GDP, and the country has to find a way of raising money to redress this balance. Nigel Rendell, senior emerging markets strategist at RBC Capital Markets estimated Turkey needs to raise between US$20bn-$25bn from the international capital markets this year.
Foreign direct investment (FDI) has rocketed over the last five years due to government reforms, and has become a substantial means of fund raising in Turkey, but there is concern this source could start to dry up as growth in the Eurozone slows. This leaves the bond markets to pick up the slack left by declining FDI.
“Turkey has become reliant on overseas investment inflows to cover the deficit and traditionally used the equity market, but there is also scope for bond issuance as investors are attracted to the high rates on offer,” said Rendell.
Turkey continues to need foreign financing both at the sovereign and corporate level. “While many countries have reduced the issuance abroad, Turkey remains very active in this market,” said Turker Hamzaoglu, economist for Turkey and covering the Middle East North Africa region at Merrill Lynch. From its US$5.5bn funding programme for 2008, the sovereign has already issued a US$1bn tap of its outstanding 6.75% 2018 bond in January, and a new US$1bn 30-year deal in February. Though Turkey balances issuance between the dollar and euro markets, bankers expect the bulk of the remaining US$3.5bn supply to be dollar denominated.
“The yield curve is quite steep and the sovereign prefers as long a duration as possible and would find it easier to tap a longer maturity, either the 2018 or the 2038, with US institutional investors,” said Stefan Weiler, JPMorgan’s head of Turkey and CIS countries in debt capital markets. A euro transaction at the five or seven-year tenor is a possibility, due to the borrower’s redemption profile, but this is questionable because secondary flows in euros have been limited.
Turkey may aspire to issue more euro-denominated debt, but the current difficult conditions in that market means the focus is firmly on dollars. Despite many Turkey specific issues on the agenda regarding the economy and politics, and Standard & Poor’s changing the country’s rating outlook to negative from stable, Turkey will be able to fulfil its targeted amount of issuance as long as sentiment improves, said Loni Saul, director in debt origination at ABN AMRO.
Though bankers do not exclude the possibility of the sovereign undertaking another liability management exercise, to add to its first and only such feat in 2006, many feel it an unlikely scenario. JPM’s Weiler said that Turkey needs first to achieve its US$5.5bn funding target, which would probably require most of the year to accomplish. If the sovereign achieves its target by the summer it leaves the door open to such a move in the second half, though there is a low probability of this occuring, said Weiler.
The first exercise was undertaken when markets were very supportive and Turkey had already completed a significant amount of its targeted annual funding needs, giving it room to do a liability management exercise. “I see it less likely compared to previous years as conditions are totally different. You lose one of your key potential issuance windows for an exercise where you do not necessarily raise a lot of money and just restructure your existing bonds,” said Saul.
“If there is a new exchange, I doubt it will be in the euro market due to the different type of investor base and a higher premium for new issues,” said Ahmet Bekce, managing director in syndicated loan and bond origination CEEMEA debt markets at Citi. “It makes sense for Turkey to focus on longer maturities than trying an exchange.”
Growth in eurobond issuance in Turkey has been slow and though the only Turkish corporate deal this year is February’s US$150m five-year bond for Bankpozitif, bankers are hopeful more supply will be forthcoming. Corporates have been able to achieve better pricing for long term funding from the banking sector and have shown little willingness to launch bond transactions to either reach foreign investors or diversify their investor base. Those that have issued have been companies with funding difficulties in the bank loan market or holding companies borrowing long term at more efficient funding costs. “The current environment of risk aversion means transactions are hard to price but prime Turkish names, those operating companies dominant in their sectors and with strong management, might consider coming to the bond market,” said Saul.
A number of banks have issued senior and tier two bonds, and more banks will consider visiting the market this year or next to boost up their capital and issue tier two deals. Under Basel II, dollar denominated Eurobonds will receive a risk weighting of 100%. “There are a number of banks with significant holdings of dollar and euro denominated bonds, so capitalisation needs, in addition to M&A or privatisation, may prompt LT2 transactions,” said Weiler.
Another factor that could boost supply is the closure of the Diversified Payments Rights (DPR) securitisation market, which banks have utilised for long term funding. The Turkish banking sector raised almost US$6bn in 2006 and US$2.5bn in 2007 in the DPR market, but as transactions received a credit guarantee wrap, the turmoil in the monoline and mortgage markets has helped curtail issuance.
“Banks do not seem to have another alternative to fund long term at attractive prices. Some might consider senior bond issuance but it will be a discussion of whether it makes sense for bank from a price perspective,” said ABN’s Saul.
The bond markets will probably look increasingly attractive to select corporates and banks as low interest rates make it a relatively inexpensive form of funding. “If the markets are supportive in the second half of the year, more institutions may raise long term capital via bonds,” predicted Citi’s Bekce.
Turkey’s domestic lira market has been sporadic and slow with liquidity focused on the government and its substantial issuance of Treasury bills though auctions. The government has borrowed TRY15bn as of end-March and another TRY80bn is likely to be issued this year, with the roll over ratio likely to be between 70-75%.
“We see inflation at high single digits for most of the year and until inflation makes a move down (possibly the fourth quarter at best) the interest in Turkish lira bonds will not be great from international investors,” said ML’s Hamzaoglu. “As domestic demand struggles to recover, consumer loan growth is likely to lose some steam and domestic banks will still find it attractive to buy Turkish lira bonds at the current high real yields.”
The 10% real interest rate is too expensive for Turkish corporates or banks and the situation will only change if the rate environment becomes more favourable.
On the international side, there has been roughly TRY17bn of issuance with the bulk from the high-grade sector and AA or AAA supranational or agency borrowers. Borrowers are playing the currency and swapping back into dollars and euros to get more attractive rates. “ The market is driven by the swap market and difference between interest rate and yield curve versus the swap curve,” said Bekce.
Turkey is one of the highest yielding markets, and has thus become popular with investors. “Despite macro risks, investor appetite remains quite positive as yields of 15% are too attractive for investors to ignore,” said Nik Romuld, emerging markets syndicate at RBC CM.
In addition to attractive yields, investors also buy Turkish lira denominated bonds for a foreign exchange (FX) entry point level as essentially much of the gains are on a FX basis. The Turkish lira market has been the beneficiary of the volatility affecting the Icelandic krone market, and there has been some asset allocation back into Turkey.
“Turkey feels like an established market these days and is more driven by redemption flows and currency allocation than a lot of new money being poured in, as was the case initially,” said Steven Dirou, vice-president, syndication at TD Securities. “There is a pretty healthy redemptions schedule, but this will not kick off until the final quarter of 2008.”
Despite current uncertainty, the next few months will provide more clarity over the market’s direction and the levels of activity. “We will start to see more Turkish issuers, banks and also corporates, looking at the bond markets,” predicted Bekce. “That development though has to be matched by conducive market conditions but it is a changing dynamic that people should keep an eye on.”