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Tuesday, 24 October 2017

Lira, lira, yields on fire

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Two Turkish banks and one Russian bank have launched inaugural Turkish lira-denominated international bond issues this year, taking advantage of investor appetite for higher yields to open a new funding option for issuers. However, with the outlook for the Turkish currency less than certain, investors may find they have taken a bigger bet than they had bargained for.

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Credit investors joined with currency managers in Europe, the US and Asia to snap up Eurolira offerings from Akbank, GarantiBank and Russian-owned Sberbank in recent weeks, with Turkey’s strong financial sector driving enthusiasm for coupons around four percentage points higher than the same bonds issued in dollars.

Bookrunners reported that aside from the credit risk, a key driver was exposure to the lira, which rose 5.6% against the dollar in 2012 as the Turkish banking sector grew 12.6%, according to the Banking Regulation and Supervision Agency.

“Investors were happy to step outside their comfort zone to pick up additional yield,” said Stefan Weiler, head of debt capital markets for CEE, CIS and Africa at JP Morgan. “With credit risk seen as minimal there was a willingness from bond investors to take exposure to the currency.”

First out of the gate in January was Baa2/BBB– rated Akbank, the issuer of the country’s first dollar-denominated Eurobond in 2010, which raised TL1bn (US$532m) with a five-year security yielding 7.5%. A great deal by any reckoning on a cross-currency swap basis, that worked out at 170bp–175bp over three-month dollar Libor.

Books were a weighty near TL3bn. It was followed a month later by the country’s second-largest private bank GarantiBank. Its TL750m five-year 144a/Reg S bond appeared a less smooth affair, though primarily thanks to external circumstances. In the end the bank priced the paper, which had a book of TL1.2bn, at 7.5%, the same level as Akbank had done, though at a time when Akbank’s bond had tightened in secondary to around 7.3%. 

Garanti came to the market as the results of the Italian election were shaking nerves in the market, the US Federal  Reserve appeared to be sending mixed messages and right after Russian Sberbank’s own Eurolira bond. 

In fact, “the deal achieved exactly what Garanti wanted,” said Neil Shuttleworth, head of EEMEA debt capital markets syndicate, at Deutsche Bank who led the deal. A banker away from the deal said: “Garanti issued in light of its funding requirements. It didn’t want excess liquidity”. 

A slight concern that was raised after the Garanti bond sale was that it attracted less investor demand than the Akbank bond, with the book closing at around TL1.1bn. However, that may have been a result of timing and with the issuer’s pricing strategy, with European credit markets in retreat after the unexpected result of the Italian election.

Price vs size

“When Akbank printed the deal in January everybody was in risk-on mode, whereas in February the market tone had changed,” said Nick Darrant, head of CEEMEA syndicate at BNP Paribas, a joint bookrunner on the deal. “Garanti’s prime focus was price, not size and with Akbank trading at around 7.44% in the secondary market they were happy to pay 7.5% inclusive of new issue premium.“

Between the Turkish deals came Sberbank, which bought Turkish financial DenizBank from Dexia last year, becoming the first Russian bank owner in Turkey. Sberbank raised TL550m in a deal which priced 20bp outside where Akbank traded in the secondary market and which failed to shine following launch, perhaps due to the complexity of a Russian underlying combined with the Turkish currency, analysts said.

Books on the trade were “mildly oversubscribed”, according to the leads, suggesting the size and price was pushed as much as they could be. Sixty-six investors participated.

Turkey’s banks are relative newcomers to the Eurobond market, and US$9bn of Eurobonds were sold in 2012, up from US$2.6bn in 2011 and US$1.75bn in 2010, according to Barclays data. Turkish bank Eurobonds outstanding totalled around US$14bn or 1.8% of total banking assets as of December 2012. That is low compared with Russian banks, for which the dollar Eurobonds percentage of total assets outstanding stood at around 4% in 2012.

Still, bankers said the pipeline for Eurobond deals remains strong, with some predicting as much as TL40bn of issuance over the next couple of years, as funding costs decline. Several new Turkish issuers have announced their intentions to tap the market during 2013, including Ziraat Bank, BankPozitif, Sekerbank and DenizBank. While a few banks are rumoured to be considering benchmark Eurolira deals, the issuance calendar may be hostage to market sentiment.

One of the drivers of issuance is credit expansion. Barclays expects loan growth in Turkey of 16%–17% this year, against projected customer deposit growth of 10%–11%. On that basis banks would be looking to issue around TL44bn of bonds, around half of which may be expected to be in local currency for the domestic and international market.

Turkish debt has outperformed in the recent period, with spreads compressing by 200bp–250bp in 2012, largely outperforming the emerging market bank space. This year they have been relatively flat.

Compelling comparison

With that in mind, the timing of the new Eurolira issuance makes sense. From an issuer point of view the pricing achievable in lira is compelling when set against the dollar market. Lira-denominated Eurobonds have to date priced 100bp cheaper than their dollar counterparts, if the cost of the cross currency swap is taken into account.

Meanwhile, Turkish banks pay more than 7% interest on deposit tenors of less than a year domestically, making five-year funding at the same rate seem like a very good deal.

“Five-year dollar-lira swaps are around 5.9% and dollar bond coupons are in the 3.5% area, so it makes a lot of sense for banks to issue lira at 7.5%,” said Antoine Yacoub, an emerging markets credit analyst at Barclays based in the UAE. “From the issuer point of view they also get to tap a new investor pool, diversifying their sources of funding and pay less for it.”

Local market conditions mean Turkish banks do not issue longer-dated lira-denominated bonds in the local market, and tenors are usually three, six and nine months. There is little natural demand from international investors for local bonds, perhaps due to the fact they are governed under local law and are not Euro clearable.

While the issuer rationale for Eurolira issuance makes a lot of sense, the case from an investor point of view is more complex. Not only may the fact that banks are paying less than they would in dollars be a discomfort, but the currency risk associated with the lira may also be significant.

“The investor base comprises those that were taking a view on the lira as well as those who were taking a view on their own local currency and its potential for depreciation,” said Yacoub. “Either way they would probably not be looking to swap out of the currency exposure.”

UK accounts bought 38% of the GarantiBank deal, perhaps reflecting demand for non-sterling assets. By mid-March the pound had fallen 8.1% against the dollar and 6.3% against the euro this year.

The outlook for the Turkish currency is mixed, said analysts. On the one hand the economy is on a solid footing, and Finance Minister Mehmet Simsek said in January he expected growth this year of around 4%, with lower inflation. 

Widening deficit

The World Bank, however, warned in January that the country was facing a widening current account deficit, which may reach 7% of national output this year from 6.8% in 2012.

“The current account deficit fell last year because economic growth collapsed from the levels seen in 2011, but it is now rising again, even with mediocre growth,” said Thierry Apoteker, CEO of emerging markets consultancy TAC Financial. “We have seen a 20% deterioration in the value of the lira against the dollar since early 2011 and there is a substantial risk of further depreciation in the medium term.”

In issuing in lira on the international market rather than dollars, Turkish banks are in effect transferring currency risk from themselves to investors, Apoteker said.

“We see a strong technical driver arising from fund flows into emerging markets currency funds, which have been very material since the middle of last year”

“For investors that buy with a view to trading out the currency risk that may not be a problem, and it is less of a concern if you plan to hold the bonds to maturity, but if you are somewhere in between you may be in trouble,” he said.

Certainly, the Eurolira market has some way to go before it establishes a new benchmark. That was shown in March when Isbank was rumoured to be considering a dollar-denominated offering, despite being widely flagged as the next potential contributor to the lira-denominated curve.

Perhaps surprisingly given the low level of liquidity outstanding, bankers report a decent secondary market for the Turkish Eurolira bonds, and both Garanti Bank and Akbank were trading above par in mid-March. 

And while uncertainty over currency exposure is an inherent risk in the bonds, investor demand is unlikely to dry up anytime soon.

“We see a strong technical driver arising from fund flows into emerging markets currency funds, which have been very material since the middle of last year,” said Marc Giesen, head of CEE and Turkey debt capital market origination at RBS in London. “That means the overall technical driver is strong.”

Between January 2011 and the first quarter of 2013, cumulative local currency fund net inflows exceeded cumulative hard currency inflows by 9%.

“For currency investors it’s pretty tempting to get the yield pick-up against the sovereign, especially when you factor in the high correlation between the sovereign and the local currency issuers that we have seen coming to the market,” said Giesen.

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