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Wednesday, 18 October 2017

Waiting for take off

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Turkey’s local currency bond market has undoubtedly had an impressive year, but the country is still a very long way from having a fully functioning market. From a standing start, borrowers have started to come to the market. But without a deep and liquid investor base, the country looks set to remain dominated by bank funding. Nick Lord reports.

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Turkey’s local currency bond market is either an abject failure, or an exciting success, depending on the timescale in which you assess it. In 2010 there was TL1.85bn of issuance while in the first four months of 2011 issuance grew exponentially to TL4.7bn. However in the overall context of Turkey’s non-governmental borrowing activity, this is a mere drop in the ocean.

Outstanding corporate bond issues in Turkey account for less than 1% of GDP, according to figures prepared by the World Bank. By comparison, South Korea has outstanding issues worth up to 40% of GDP, while in Malaysia it is 30%.

Turkey does have a working bond market in place; the problem is it is dominated by one borrower – the government. The bond market in total represents just 12% of the total financial market in Turkey, but 99% of this is taken up by government issuance. Of that 1% non-bank issuance is tiny: Issuance figures for 2010 and year to date 2011 show that just 4.5% of the TL6.55bn of issuance has come from non-bank corporate issuance. Clearly, Turkey’s corporates are borrowing their money from banks, not from the bond market.

“The local currency bond market has been relatively shallow,” said Muge Eksi, head of capital markets at Unicredit in Istanbul. “We did do six private placements last year and as the public markets take off we are looking to do many more public deals.”

For many issuers the bank market is just still too liquid and cheap for the local bond markets to compete, explained Eski. Only factoring and consumer finance companies are regular non-bank financial issuers in the local market. Corporates are still largely absent.

Light at the end of the tunnel

And yet, behind the paucity of issuance there is cause for hope, driven largely by a change in attitude at the top of Turkey’s capital markets. The government and the regulatory bodies have taken the view that the lack of a functioning local currency bond market presents a macroeconomic risk to the country. On April 26 the Capital Markets Board of Turkey convened a high level workshop looking at the priorities and challenges of developing the local currency bond markets further.

Representatives from the World Bank, IFC, IMF, S&P and local investment bank Is Investment made presentations, all of which largely made the same point: the two biggest issues facing the development of the market were the strength of the local bank market and the lack of a deep domestic institutional investor base. It was not necessarily the lack of borrowers.

The strength of infrastructure that supports the government bond market and recent changes in regulations will undoubtedly make the market more amenable to borrowers going forward. Recent activity shows that where these changes have been, borrowers have emerged.

This is perhaps best seen by the rapid growth in issuance from the local banks. Issuance took off at the beginning of December 2010 when one of Turkey’s largest banks – Akbank – sold its inaugural local currency bond deal. At TL1bn it was easily the largest domestic corporate issue ever sold in Turkey. It had a short tenor at only 6 months, and priced at 60bp over the relevant government security to yield 7.28%.

Akbank’s issue was followed quickly by other issuers, notably Isbank and Garanti Bank. In the first four months of this year, Isbank has issued TL1.8bn of securities, through three issues, two of which had a tenor of 6 months and one of 13 months. Garanti Bank also took hold of the market issuing two deals worth a total of TL1.75bn, with tenors of six months and one year.

In terms of pricing, there has been a steady decrease in spreads over the relevant government securities. Akbank’s initial 6 month deal spread of 60bp came down to 50bp for Isbank and Garanti’s next 6 month deals, with Isbank’s final 6 month deal coming in at 40bp over.

However total yields have steadily moved out from 7.28% for Akbank’s first deal to 8.41% for Garanti’s April transaction. This is largely due to the increase in the yield for the underlying Turkish government market which has suffered from the generally worsening credit conditions as 2011 has progressed.

What makes these issues interesting is not the money that has been raised but the way they are slowly allowing Turkey’s banks to lengthen out the maturity profile of their funding. These deals are slowly eating away at the yawning asset liability mismatches suffered by banks. The vast majority of banks funding comes from 3 month deposits. Deals sizes in the bond market of TL500m might make only light dents in that, but they are gradually lengthening out their liability profile in aggregate.

Small banks also welcome

Also taking advantage the new local market for bank bonds are Turkey’s smaller banks, which have smaller deposit bases and greater need for funding. Sekerbank has been most active, issuing four deals, with maturities of one year, 18 months and two years. Paying between 9.73% and 10.20% for its funds may seem expensive, but this is in line with the rates offered on local deposits and as such represents competitive financing. Sekerbank is an SME focused institution, where deposits are less readily available than for retail focused mega banks. Therefore accessing the local bond markets in such as large way makes real business sense.

Another bank that has embraced the market is Aktif Bank, an investment bank that is therefore unable to take any deposits. It had previously relied on bilateral loans from development banks and other interbank markets. It arguably can be said to be the progenitor of the Turkish bank lira bond market, doing its first private placement back in September 2009. It has since then issued TL600m and has approval from the CMB for a further TL1bn.

“We really initiated the corporate bond market in Turkey,” said Alper Nalbant, director of financial institutions at Aktif Bank in Istanbul. “As an investment bank we cannot rely on deposits and international borrowing was not enough. However, the market is now hungry for a product like this, especially as these are liquid instruments.”

Nalbant also points out that the tax authorities have now created an incentive for borrowers to issue bonds rather than taking out bank loans. Income from deposits earned by institutional investors is subject to a 10% income tax, but coupons from bonds are only subject to a 5% levy. This means that borrowers can actually offer a net yield pick up over deposits for the institutional investor base.

“The banks are diversifying their sources of funding and the market is getting much more comfortable with their bond deals,” said Eksi. “I think the market is developing well and it is fantastic that volumes have increased so much. I think going forward it will snowball into something very big.”

And yet despite all the work the regulators are doing - shortening registration periods, lowering taxes and such like - until Turkey’s big corporate start to access the market it will not fully develop. Only a handful of corporate issues came out in 2010 and in 2011 none have materialised in the public sphere at all. The banks are just too liquid.

However, if the government were able to engineer a rapid deepening of the local investor base, as well as encouraging pension funds and life insurance companies to actually reduce their duration risk by buying long dated bonds, demand for such issues would increase and pricing might make it more attractive.

Much has been done to make the local currency bond market attractive to local borrowers but much more is still to be done. The last year has been exciting. But coming years could be even more so.

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