Bridging the gap

IFR IMF Special Report 2011
11 min read

Turkey’s capital markets have suffered as much as any other country’s during a brutal first half of 2011. But it did not have to be that way - many of Turkey’s market woes are self-inflicted.

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Despite its rapid economic growth, Turkey’s capital markets are struggling to draw foreign inflows. International investors have been deterred by questionable macroeconomic decisions and IPO pricings are perhaps unrealistically high amid the current global volatility. Moves to tackle the nation’s burgeoning deficit and stabilise its currency, as well as a substantial privatisation programme should go a long way towards providing a more attractive environment for foreign investors.

The country’s capital markets are hard to love at the moment. Despite having the fastest growing economy in the world in the first quarter of 2011, the performance of its international financial markets has been anaemic. By early August the stock market had fallen by 14% from its highs in mid-May, although it has recovered 6% by the end of the month. The Turkish lira is the worst performing of any major emerging market, down by 10.8% against the dollar and 15.6% against the euro year to date. Even yields on government bonds are widening as are spreads on Turkish sovereign eurobonds.

This disconnect has many causes: much can be attributed to the global market downturns. But there is also some inverse alpha at work: Turkey has actually made life more difficult for itself. As a result there are a number of chasms that Turkey needs to bridge if its markets are to regain their standing in the international financial markets.

These lacunae cover many parts of the business: the valuation gap between domestic sellers and foreign buyers is too wide; the country sits awkwardly between a sub-investment grade rating and investment-grade pricing; and macroeconomic policies are proving a deterrent to international investors.

This last point centres around the Central Bank’s controversial decision to cut interest rates while forcing the banks – through the banking regulator – to hike their reserve rate requirements. While this is meant to stave off hot money and a rapid rise in the value of the lira, it has had the effect of blowing out the current account deficit (CAD) by rapidly diminishing the value of the currency. The CAD was only US$13.8bn at the end of 2009, but it rose rapidly to US$42bn by the end of 2010 and now is up to US$68bn in the first half of 2011. This ballooning CAD is causing many international observers to worry that Turkey could be heading to another of its self-inflicted crises.

“Under stable global growth and financial market conditions, this [CAD] is manageable,” wrote RBC emerging markets research analyst Nick Chamie in August. “But given the scale of the recent widening in the CA deficit, if there is a sustained deep flight from risk assets and/or tightening in global credit conditions, Turkey is highly exposed as it could have a much harder time financing its CA deficit, potentially triggering a disorderly balance of payments adjustment.”

Macroeconomics have a deep influence in Turkish capital markets. In particular all three ratings agencies use the CAD as a reason not to upgrade Turkey to investment grade. The sovereign nestles one notch below investment grade at Ba2 by Moody’s, BB+ by Standard & Poor’s and BB+ by Fitch.

“If they upgrade Turkey to investment grade, then there will be many more opportunities for foreign finance to come here,” says Birgul Denli, executive vice-president of Vakif Bank in Istanbul.

Stuck in no-man’s land

Turkey’s international bond market is now in a no-man’s land: stuck between non-investment grade rating and investment-grade pricing, Turkish issuers don’t offer enough yield to attract emerging market bond investors, nor do they offer the credit rating necessary to bring in the developed market investors. As a result, the sovereign and Turkey’s leading companies have visited the international bond markets only rarely this year.

Turkey’s banks have, however, been active. And yet again it is those banks that are doing the hard work of internationalising Turkey’s financial markets, despite the best efforts of the regulators to rein them in. The first half of the year saw a number of first time eurobonds from Turkey’s leading banks – Akbank, Garanti, Isbank and Yapi Kredi. In the second half of the year, deals are expected from some of Turkey’s smaller institutions, DenizBank, Halk Bank, Turk Eximbank and Vakif Bank.

“In the eurobond space, there were new issuers to the market along with follow-on issuance by banks who continued to build out their yield curves,” says Muge Eksi, head of capital markets at UniCredit in Istanbul. “The promising trends of longer tenors – up to 10 years – reverse enquiries and issuance by large and mid-sized banks will continue. Corporate issuance, which has been slow to develop, offers great potential for growth.”

Denli at Vakif Bank says she is looking to enter the eurobond arena “when the market settles”. She also points out that as only 8.7% of Vakif’s funding comes from wholesale markets, the bank has a large appetite for such deals. “About 14% of the Turkish banking sector is funded in the wholesale markets, on average,” she says. “So we have a long way to go to get there.”

“SMEs are the rising starts of Turkey’s future and we need to see how we can help them more”

On the equity side, a number of deals were pulled in the first half of the year, despite a strong performance by the underlying index in the first five months of the year. In particular, IPOs for Pegasus Airlines and Finansbank were pulled due to the ever-present gap between the valuations the Turkish sellers wanted and the price international investors were willing to pay.

Deals that did go ahead have also failed to perform: the US$220m February IPO of Bizim supermarket group is now down 25% on issue price. Even the standout deal of 2010 – the US$713m IPO of Emlak Konut Real estate investment trust – now down to just 22% above the IPO price having risen as high as 65%.

“Unfortunately global macro volatility also affected the Turkish market and a number of large-size IPOs were cancelled or postponed,” says Eksi. “It is likely the market will continue to be subdued compared with 2010 for the rest of the year.”

The second half of the year could possibly see both Finansbank and Pegasus come back to market, as well as a potential US$1bn IPO for Hospital group Acibadem and a US$250m IPO for state-owned infrastructure company Gumruk. However, the valuation gap is now worse than it was in the first half.

Focus shift

On the banking and lending side, most of the focus will be on privatisations. The government has been left red-faced by the failure of three large privatisation deals in the last year. The most embarrassing of these has been the failed US$1.2bn sale of Baskent electricity grid – the second time it has failed to complete the sale.

Local consortium MMEKA Holdings comprehensively outbid other international consortia for the asset but then failed to raise the finance to close the deal. The government is likely to look to the secondary public offerings of Turkish Airlines and potentially Halk Bank to restore some credibility in the international markets. Eksi thinks the total volume of these SPOs may exceed that of IPOs by the end of the year.

What is emerging is that new innovations are taking place that will allow financiers to bridge the gap between raising finance and getting it to the companies that need it. In July, mid-sized lender Sekerbank became the first bank anywhere to issue a covered bond backed by SME loans. The TL800m programme placed TL450m worth of bonds with private buyers and is hoping to sell more in the public markets in coming months. The structure is an innovative way of linking Turkey’s SMEs (from where most of Turkey’s economic growth comes), and international finance. “We are building a financial bridge between Anatolian SMEs and the international financial community,” says Dr Hasan Basri Goktan, executive chairman of Sekerbank.

The authorities are making efforts to address the fact that a disconnect lies between Turkey’s vibrant SME sector and the limited number of large companies and banks that can or want to participate in the international markets. At the beginning of the year, for instance, the Istanbul Stock Exchange launched an emerging companies market for SMEs to seek a listing.

“I was recently in the US for a series of meetings and we discussed the financing of our SMEs,” says Professor Dr Vedat Akgiray, head of the Capital Markets Board of Turkey. “SMEs are the rising stars of Turkey’s future and we need to see how we can help them more. The [Sekerbank covered bond deal] is a good model.”

More innovation, lower valuation expectations by issuers, a willingness to tackle the current account deficit, a privatisation programme that brings in long-term foreign finance and less capricious macro policies could work wonders in bridging the gap between Turkey’s short-term problems and its undoubted medium-term potential.

Turkish bonds to date
Issuance dateIssuerAmount (m)MaturityCoupon (%)Issue/reofferSpread (bp)Ratings
05/01/2011Turkey, Republic ofUS$1bn14/01/2041696.63UST+169.7Ba2/BB/BB+
24/01/2011Is BankasiUS$500m01/02/20165.199.132UST+329.1Ba3/BB/BBB–
11/03/2011Turkey, Republic of¥180bn30/03/20215.615100OS+48Ba2/BB/BB+
15/04/2011Garanti BankasiUS$500m20/04/20216.2599.086UST+287.9Ba3/BB/BBB–
15/04/2011Garanti BankasiUS$300m20/04/20163mL+250bp3mL+250Ba3/BB/BBB–
Source: IFR