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Sunday, 22 October 2017

Turkey 2007: Commodity constraints

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Country-specific factors including EU accession, IMF relations and domestic politics have diminished in importance as Turkish markets take their lead from general changes in risk appetite. But while the country continues to benefit from the ongoing EM spread tightening trend, its high-beta status means that it remains EEMEA’s primary casualty during times of volatility. John Weavers.

Amostly favourable fundamental macroeconomic backdrop has reinforced Turkey's continuing spread narrowing, but another record current account deficit and high Eurobond issuance have ensured further underperformance against LatAm high beta countries.

Booming commodity prices have translated into large external surpluses that have allowed several LatAm countries to accelerate debt buyback programmes, and many governments have internalised their debt, switching their borrowing to local currency Eurobonds that served to boost foreign currency bond prices.

This structural disadvantage compared with other EM borrowers is here to stay. Memduh Aslan Ackay, director-general of Turkey's Foreign Economic Relations, accepts that the country's relatively low commodity output means it is in no position to follow the LatAm model.

"Countries like Brazil, Venezuela and Russia greatly enjoyed the rises in the oil prices and used these excess revenues to pay their debt before its original maturity. To be frank, we are not in the same camp with these countries. We are still producing a relatively high current account deficit," he explained.

On the subject of Turkish lira-denominated Eurobonds, Ackay notes: "When you look at the countries issuing local currency bonds abroad, you see that to some extent there are some impediments on access to their local markets. But in our case, the story is different. We have a well functioning and deep domestic market which is open to foreign investors. And also from a cost perspective, the current rates are not very encouraging to extend duration in local currency. Therefore for the time being, issuing a local currency bond abroad does not seem to be too beneficial."

Turkey has a mixed year-to-date record in the international Eurobond market as it seeks to raise US$5.5bn from foreign currency issuance for the third year running.

This year started off disappointingly, as the sovereign raised US$500m from each tap of outstanding 7.0% 2016s and 6.875% 2036s on January 9, with both deals priced below initial guidance as market conditions deteriorated.

The additions' fixed reoffer prices of 101.875 and 95.875 were 1/8 and 1/4 less than initial price talk, providing yields of 6.732% and 7.215%, equivalent to 207bp and 247bp over US Treasuries. Expectations had centred on bumper supply of US$1.5bn–$2bn at the start of a potentially problematic year for the Republic with presidential and parliamentary elections falling in May and November. However, with the market so soft the Treasury opted for US$1bn, in spite of attracting a US$3bn book.

“Because the market in general expected an issuance type in line with our strategy, we had expected more than US$1bn, though not as much as US$2bn. That morning the market was fine, then it turned negative, which affected demand,” said Akcay.

Turkey got its issuance strategy back on track later in January with an above expectations €1.25bn 12-year Eurobond, the country's second-largest deal and biggest non-dollar issue. The Reg S issue pays a 5.875% coupon and was priced at 99.106 to yield 5.977%. That was equivalent to 168bp over mid-swaps and 193.4bp over Bunds, at the tight end of initial guidance set at 170bp over mid-swaps area with unusually strong demand seen from Italy.

The Treasury then made its third visit to the Eurobond market in February with a US$750m addition to the existing 2020s that took that issue up to US$2.0bn. The bond pays a 7.0% coupon that with a tap price of 100.95 yielded 6.888%, 2bp inside initial guidance of 220bp over 10-year Treasuries.

As of early April, the sovereign had raised US$3.35bn equivalent, around two thirds of the year's target, and the Treasury appears relaxed about the timing of next issue.

EM origination managers expect Turkey to return when a suitable window appears with a US dollar or, more likely, euro transaction given the large amount of euro redemptions falling this year (€2.5bn).

“However, the liquidity in the euro market is well below that in dollars,” Akcay pointed out.

In addition to meeting its annual Eurobond target Turkey can be expected to carry out some traditional prefinancing.

“We never say that we won’t tap the market and pre-fund. In 2006 we did so for US$300m, but it is often in the range of US$500m–$1bn. However, our essential aim is to complete the year’s programme, with some variation. Targets must be meaningful,” Akcay stressed.

The Treasury also continues to put a lot of emphasis on its investor relations programme. The office was established in 2005, and there are around 1,000 investors on the regular mailing list. This has proved successful in terms of new areas of demand.

Italy was a good source of interest for the latest euro issue; Scandinavia, especially retail investors from Denmark, is proving interesting, while there has also been interest from investor bases as different as Austria and Brazil.

The sovereign is also interested in currencies outside the big two. All the Republic’s Samurais have matured, but the country’s sub-investment grade status is a problem in that market.

As for sterling, there seems to be interest from the investor base helped by the low yield environment. Turkey has done a sterling issue before, but there is also the question of continuity, according to Tekin Cotuk, head of fundraising at the Turkish Treasury.

On the subject of Islamic bonds, Ackay appeared to play down speculation of a debut deal in the near term, pointing out that: “The country is already getting a lot of investment from Gulf countries through asset sales and FDI. In addition, the sukuk market does not seem to be booming.”

Turkey finally executed its long awaited debut international liability management exercise in September 2006. It launched a US$1.5bn 10-year Global bond made up of US$1.17bn exchanged from seven high-coupon, short-dated bonds and US$330m of new cash. The bond has a 7.0% coupon and was launched with a 99.152 reoffer to yield 7.12%.

Citigroup and Goldman Sachs were joint dealer-managers for this, the country's inaugural international bond exchange. Turkey does have a successful record in domestic exchanges, however, including 2001's US$8.4bn-equivalent TL bond exchange into US dollar index bonds.

At the time of the exchange, Ibrahim Canakci, Undersecretary of the Treasury, said that all targets had been met for a successful debut exchange. "The size of the transaction exceeded the minimum size of US$1bn, reaching US$1.5bn, establishing this alongside our other most liquid benchmark securities," he noted.

An EM origination manager away from the deal was surprised by the exchange's relatively low take-up rate, at less than 20% for the new bond.

"Initial expectations had centred on a substantially bigger issue given the normal, 30%–40%, participation rate at exchange auctions. The results suggest locals were reluctant to give up their high coupon bonds, despite the tax breaks on offer," he suggested.

The manager stressed that this was an important, progressive exercise for Turkey as it further normalised the dollar Eurobond curve. But he was doubtful that a euro liability management exercise would follow.

"Turkey has fewer euro-denominated bonds, which tend to be even more tightly held, especially by German accounts. It may take quite a sizeable premium to secure a decent take-up rate in this market.

“We did a US dollar exchange in 2006. It was our first liability management exercise on the external debt side and was a good experience for us. Forthcoming exchanges might be both on the dollar and euro markets. We don’t have a concrete decision on these issues yet," Ackay explained.

Non-sovereign Eurobond issuance remains the exception rather than the norm in Turkey where banks in particular prefer the well developed and cheaper loan and ABS markets for the vast majority of their financing needs. Nevertheless, a couple of well received deals have come to the market that should encourage further growth.

Calik Holdings (B+ Fitch) attracted an impressive book approaching US$800m for a debut Reg S Eurobond launched in February 2007. Such strong demand enabled sole bookrunner Merrill Lynch to increase the issue to US$200m, extend the maturity to five years and tighten guidance three times from the initial 9% area. The bond pays an 8.50% coupon and with a 99.510 reoffer price yielded 8.625% at launch, equivalent to 355bp over US Libor and 400bp over Treasuries.

Calik has assets totalling US$2.4bn, making it one of the 10 largest companies in Turkey, and its inaugural offering represented a welcome alternative to the stream of CIS bank issues that have dominated the EEMEA pipeline.

Julian Trott emphasised the pricing achieved in comparison with the Yasar Holdings (also rated B+ by Fitch) €150m five-year bond that was launched in July 2006 at par with a 9.50% coupon and much wider to the sovereign and swap curves.

Garanti Bank had launched a US$500m 10-year non-call five lower tier 2 bond a month earlier at 165bp over US dollar Libor. Deutsche Bank and Merrill Lynch were joint bookrunners for the Reg S 144a subordinated issue that was priced at par with a 6.95% coupon. The deal was notable for the support of political risk insurance (PRI), which ensures that the notes will be rated Baa1, above the issuer's B1/BB–/BB (positive) senior unsecured ratings. The PRI covers against transfer and convertibility restrictions, and will last for 18 months after such an event.

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