Turkey 2005 - Convergence setback
After months of spread tightening and a string of positive news items, the wheels came off Turkish bonds in March following a reverse in the US Treasury market. With over half its 2005 international funding in the bag, the sovereign isn’t worried, but this move seems to have upset hopes for non-sovereign issuance. John Weavers reports.
The downward grind of Turkey’s EMBI+ index performance came to an abrupt end in March as emerging markets retreated in face of tumbling US Treasuries, triggering a sharp correction across the entire emerging markets asset class. With US 10-year yields climbing more than 50bp from 3.98% on February 9, Turkey's EMBI+ soared to over 300bp by the end of the month, from a record low of 230bp on March 8.
Like other EM sovereign bonds, Turkey has become a hostage to US debt movements, and the key question in the secondary market now is how it will fare relative to other EMs. Turkey underperformed most EEMEA bonds (notably Russia and Ukraine) during the first two weeks of the market retreat, but it held up better than several high-beta Latin American credits, including Brazil.
EU accession hopes and expectations of a new US$10bn IMF accord had served as the two main anchors for Turkey bonds in recent months. Investors have been cash rich, while EU convergence funds moved away from recent EU entrants and the next wave of members (Romania and Bulgaria) towards the longer-term candidates, such as Turkey and Ukraine.
Any negative noise about Turkey’s EU accession prospects – or the lack of an agreement with the IMF – was shrugged off, but this may no longer be the case, especially if the new, more cautious and defensive approach to EM bonds takes hold.
Certainly there are reasons for caution about any further spread tightening if investors are prepared to look. There are signs of reform fatigue in Ankara, while Brussels' anger at the aggressive police response to the Women's Day protests in early March showed that the EU is no push-over. Even a start to EU accession talks on October 3 is not inevitable, with Martin Schulz, the socialist leader in the EU Parliament, stressing that unless movement is seen in Turkish reforms “there will be no start to entry negotiations".
The postponement of Croatia's EU accession talks is another potential problem, since some central European nations (such as Austria) have hinted that they may seek to delay Turkey's start date talks in retaliation. Another key issue is France's EU constitution referendum on May 29. With some polls predicting a No vote, general concern about the EU could translate into a harder political stance and demands that Turkey fulfil every condition.
The other anchor in Turkey’s success in recent months had been expectations of a US$10bn IMF stand-by agreement. That is expected to be realised in April or May, despite concerns over the government's slow progress in carrying out the required changes. IMF managing director Rodrigo Rato will travel to Istanbul on April 28–29 and Turkish Economy Minister Ali Babacan has said that the government will sign a letter of intent with the Fund. So far investors have been more than sanguine about the delays, but that may no longer be the case.
However, even if the current market retreat continues, analysts are not predicting a reverse of the progress made in recent years in public finances,
Serhan Cevik, EEMEA economist at Morgan Stanley, thinks that as far as risk aversion to Turkey is concerned, the crux of the matter lies there. He argues that fiscal adjustments have already reached a critical mass, leading to a substantial drop in the debt-to-GNP ratio (to 82.3% in 2004 from 2003's 91.3%) and in the risk premium that investors demand on government bonds.
And Global Securities’ head of economic research, Cem Akyurek, does not foresee any problems for the government in rolling over its debt given the involvement of a variety of buyers – local banks, retail investors and foreigners. Assuming that the sovereign’s financing continues on the same track, he says, “in three years Turkey could be out of the woods”.
The Republic has around US$31bn of outstanding bond issues, and borrowing in the medium term (2005–2008) could total about US$15bn, though this is not confirmed by the Treasury. This year, Turkey managed to get away two bumper issues before clouds descended upon the EM universe: a 20-year US$2bn bond that was the largest ever Turkish sovereign issue, and a 12-year €1bn deal.
Around 350 investors participated in the dollar deal, which launched on January 13 into a volatile environment. “It is our preference to tap the market with a long-dated benchmark sized deal as the first transaction of a given year, if the market is available. Although we are flexible in terms of currency, the frequency of dollar issues has outweighed that of euros,” said Tekin Cotuk, department head at the Treasury.
February’s euro deal was the largest yet for the sovereign in that currency, and attracted over 300 accounts, including many European central banks, and resulted in a book of €5.5bn.
With those two deals in the bag, the Republic has raised US$3.3bn out of a 2005 plan of US$5.5bn. The sovereign usually pre-funds towards the end of year, although market conditions will determine the timing and size of any such move.
Turkey is one of the main emerging market borrowers, and raised more than any other EM sovereign in the international bond market in 2004 if Mexico is excluded for being an investment-grade credit. “Turkey is a key borrower in the emerging market universe and our improving fundamentals foster our significance as a credit. This phenomenon paves the way to maintain a close dialogue with the banks, as Turkey’s dominance in emerging markets increases,” said Memduh Aslan Akcay, director general at the Treasury, alluding to the fact that these days the sovereign is a bigger fish in a smaller emerging market pond.
In terms of its policy, the Treasury is “looking at managing the curve not just raising funds", in the opinion of Ahmet Tacer, head of credit markets for ABN AMRO in Turkey. He anticipates a bond exchange auction either this year or next. The Treasury has confirmed it is considering an asset-liability management exercise, which would most likely see short-dated, high-coupon bonds exchanged for longer-dated, lower coupon paper. “Our core purpose is to issue longer-dated bonds offering liquidity and duration. The strong fundamentals enable us to reach our goal with ease in comparison to past issues,” said Akcay.
“Although the US dollar still represents the deepest market for emerging market issuers, we project to increase our euro issuance on the back of positive market sentiment surrounding Turkey’s EU prospects. Moreover the euro market represents a cost effective market for us, with relatively less volatility.”
The sovereign also has some gaps in its yield curves. In US dollars, 15 years is one obvious gap. Turkey used to come to the market more frequently, with smaller deals, and as a result lower liquidity. Now the Republic has the luxury of pricing less frequent, more liquid deals.
“We perceive liquidity as an important factor for any issue, given the fact that the size of the issue matches this preliminary target,” Akcay added.
One investment bank syndication head said that he expected a couple more benchmarks (one dollar, one euro) this year as well as another tap. He favours a 15 or 20-year, euro-denominated bond given the low cost (5.50% for the 2017) and thinks that Turkey will look to further extend the euro curve which currently has maturities in 2008, 2009, 2010, 2011, 2014 and 2017.
In the local market, the Treasury is expected to continue extending maturity after February's first five-year lira bond sale, which attracted good demand from foreign investors. However, much may depend on the Treasury's willingness to carry out reforms to make local and international markets more fungible in the way that Hungary has done. At present only big banks are able/willing to overcome these obstacles.
“Turkish lira-denominated issued have become very important”, said Finance Minister Kemal Unakitan, at a New York meeting of investors on March 19. He added that the Treasury Ministry may attempt a 10-year local issue to extend the TL curve, though the size of any longer issue would be limited.
But despite persistent talk of a Turkey Islamic deal, Unakitan is dismissive of Islamic bonds for the sovereign. Asked about the timetable for legal changes that are required before Turkey can continue its discussions with banks for issuing Islamic bonds, the minister replied that this was not an important issue for Turkey.
There has been no corporate bond supply out of Turkey since July 2004, and the tumbling secondary market has clearly exacerbated corporate reticence. As a result, little or no international bond supply is on the near-term horizon.
Petrol station operator Petrol Ofisi (Poas) had asked several banks to present proposals for a new, US$250m Eurobond with seven years the favoured tenor, and according to bankers, the company's board approved the new fundraising in late February.
Poas was the last corporate from Turkey to issue a bond, when it launched an inaugural US$175m 9.75% five-year 144a/Reg S Eurobond through BNP Paribas and (sole bookrunner) JP Morgan last July. That was the first Turkish corporate bond in more than two years, following Vestel Electronics' US$200m five-year bond in May 2002 through ABN AMRO. As that bond matures in 2007, Vestel could seek to refinance it via another Eurobond.
Elsewhere Vakif Bank (B1/B) has mandated ABN AMRO, Citigroup and JP Morgan to arrange a US$300m+, five-year, 144a bond. The bank had planned to issue in the first half of 2005, but given current market conditions it will have to “seriously reconsider its refinancing options”, according to one of the leads.
Even aside from the recent turbulence, the reality is that when they do tap the market, borrowers favour loans and asset-backed deals rather than plain vanilla Eurobonds. Turkish borrowers find Eurobonds expensive while blue chips and corporates can get plenty of cheap funding locally. According to Gonca Artunkal, head of Turkish investment banking and corporate finance at Citigroup, the historic advantage (for borrowers) of international loan pricing over bond pricing has reduced, but loans are still cheaper and the documentation is familiar to borrowers. “However, the bond market can offer advantages including longer tenors, and in the specific case of securitisation, the pricing compared with loans is more competitive,” she said.