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Western EuropeOctober 3 2004

Turkish upward trends

Turkish borrowers have been enjoying improved conditions this year, as economic growth moves the country beyond the effects of the deep recession and currency crisis that struck in 2000 and prepares it for EU entry.
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With the help of an anticipated new loan programme from the IMF, and with investors optimistic about the decision on membership of the European Union, Turkey has become a favoured credit, and recent sovereign bond offerings have all met with heavy demand.

The Turkish Treasury estimates that it will issue roughly $5bn-worth of bonds on the international markets during 2004. In January, it sold $1.5bn-worth of 30-years bonds in a deal led by Citigroup Global Markets and UBS. In February, it launched a e1bn offering of 10-year bonds, led by Credit Suisse First Boston and Dresdner Kleinwort Wasserstein. And in June, there was a $750m offering of seven-year bonds led by JPMorgan Securities and Lehman Brothers.

Emerging market

“Turkey has been the best-performing emerging markets sovereign asset this year, with the underlying theme being economic progress, and also the move towards getting a date for EU accession negotiations,” says Jonathan Brown, global head of emerging markets syndicate at JPMorgan in London, which not only led a sovereign Turkish offering in June, but also subsequently lead managed a corporate bond offering for Petrol Ofisin, an oil products distributor.

“In addition to strong international demand, there is a lot of domestic appetite for Turkish sovereign bonds, and 25%-30% of a typical sovereign bond offering might go to these domestic retail or bank books, and these investors provide some sort of shock absorber for the market if conditions are volatile,” Mr Brown explains.

“The buyers of the Petrol Ofisi corporate bonds were a subset of emerging market sovereign bond buyers,” he adds. “This was the first corporate bond offering out of Turkey since 2002, and we expect to see more corporate issuance as the economy continues to improve.”

Petrol Ofisi was privatised in 2002 and is now part of the Dogan Holdings conglomerate. Its $175m five-year Eurobond was launched in July, carrying a 9.75% coupon, and was rated B by Standard & Poor’s (S&P) and B+ by Fitch Ratings.

The euro-denominated sovereign offering in February, which was sold at a spread of 246bps over Bunds, also met with strong demand, on the back of the improving Turkey story.

“It was well distributed across Europe, with a good mix of bank investors, dedicated funds, retail investors, and a limited number of hedge funds,” says Petri Kivinen, managing director in the emerging markets global debt origination team at Dresdner Kleinwort Wasserstein in London.

“There has traditionally been a considerable German and Austrian retail bid for Turkish bonds, and that is still there, though to a lesser extent now that the spreads are getting tighter,” Mr Kivinen explains. “There is also usually a very strong bid out of Turkey itself for Turkish sovereign issues. The banks are very liquid, and they want to play in both dollar and euro transactions. Demand could be anywhere between 20% and 30%, though the final allocation is usually less than this, and that strong domestic bid helps support the secondary market.”

Rating agency response

In August, S&P upgraded the Republic of Turkey long-term foreign currency sovereign rating to BB- from B+, noting that “the sovereign upgrade reflects the progress Turkey is making toward durable economic stability, and the country’s expected adherence to a strict macroeconomic programme beyond 2004”.

Turkey has also benefited from indexed investors buying more bonds. In August, JPMorgan raised its allocation for Turkish sovereign bonds to marketweight from underweight. Turkey now makes up around 8% of the JPMorgan Emerging Markets Bond Index.

However, shortly after the upgrade by S&P, Moody’s indicated that any upgrade from Single B by itself was not imminent, leaving the credit in the split rating category, and dampening the rally which had seen the 10-year dollar sovereign bonds trade in to around 350bps. Fitch Ratings has Turkey on a positive outlook but still at Single B.

“The credit rating for Turkey is on an improving track rather than a deteriorating one, and that has led to an increased appetite from investors,” says David Spegel, emerging markets debt analyst at ING Financial Markets in London. “We have seen a 65-70 basis points compression on spreads since July, so Turkey is now trading largely in line with its rating. Moody’s statement regarding Turkey’s worrying current account deficit suggests that a matching move from that agency will not be forthcoming anytime soon.

“The market is watching the EU accession negotiations, and clearly the question of whether the government will adhere to fiscal targets or not will be closely tied to the prospects of entering the EU,” Mr Spegel adds.

“From a fundamental point of view, the macroeconomic indicators are quite positive, with inflation and interest rates both coming down, and good growth numbers, though some commentators believe that unemployment remains a problem, as well as the current account deficit,” explains Gonca Artunkal, director at Citigroup in London.

“On October 6, we will hear about the EU accession report, and then at the Amsterdam summit in December, we will know the decision of the EU regarding Turkey’s accession, and most investors are factoring in a positive outcome, even though many believe it could be a conditional yes,” she adds.

Banking sector

For the Turkish banks, issuing senior unsecured bonds is generally an expensive way to raise financing, and they tend to go for a mixture of syndicated foreign currency bank loans and securitisation deals.

Along with Brazilian banks, Turkish banks are the best-established global issuers of asset-backed securities (ABS) backed by credit card receivables and electronic remittances. These hard-currency flows – which never enter Turkey – are packaged up by the issuing bank and used to repay the bonds. They are structured to investment grade, giving Turkish banks access to an ABS broad investor base, where spreads of only 240bps for Triple B bonds are typical.

In July of this year, Akbank closed a $270m international credit card receivables securitisation, backed by Mastercard, Visa and American Express payments. This seven-year deal was led by Citigroup, and was wrapped to Triple A by MBIA Insurance Corporation.

Incentives

In addition to tight pricing – plus, in some cases, the cost of the monoline wrap – the big incentive for an institution such as Akbank is the relatively long seven-year term, giving it matched funding for lending to corporate clients, and lending in areas such as project finance.

This was the eighth deal by Akbank since 1998, during which time it has raised $1.8bn on the ABS markets, doing both wrapped and unwrapped deals.

Turkiye Garanti Bankasi has also been a regular issuer of remittance and credit card backed ABS, and there have also been deals over the past 12 months from Turkiye Is Bankasi (Isbank) and Turkiye Vakiflar Bankasi, the latter led by WestLB.

This easy access to the ABS market, plus the availability of syndicated loans to Turkish banks, partly explains the dearth of corporate bonds on the international market.

“The Turkish banks continually roll over these one-year syndicated bank loans, and the domestic banking sector is so liquid that they are shovelling money at Turkish corporates at such competitive rates that the Eurobond market is rarely competitive in terms of cost of funds,” comments one banker.

For example, early in 2004, Akbank signed a syndicated bank loan, which attracted a lot of interest, and was increased in size from $375m to $500m, with 63 banks participating.

It was a one-year facility, priced at Libor plus 55bps.

“There is quite a bit of interest from investors, but at the moment, it is quite expensive compared with alternative sources of funding, and the main reason for a corporate like Petrol Ofisi to do an offering was to push out maturity, rather than the cost of the debt,” the banker adds. Nonetheless, he does expect to see one or two more corporate deals this year.

These would no doubt be welcomed by investors, who have seen only four offerings in recent years. In the late 1990s, Turkcell did two offerings, and there was one deal in 2002 when manufacturer Vestel Electronics came to market.

Phased approach

Clearly Turkey, and its corporate sector, is currently on an upward trend, but – in addition to the next phase of the IMF loan programme, expected to be agreed in September – the next crucial event will be decisions from the EU.

Turkey has external debt of $150bn, and the convergence of spreads that accompanies EU accession is critical to its plans to reduce the burden of its interest payments. Countries such as Bulgaria and Romania have seen spreads tighten by hundreds of basis points as investors have bet on EU entry, and such a pattern would be anticipated on Turkish bonds. In contrast, any back-pedalling from the EU on membership from Turkey would worry investors.

“The market would react extremely badly if there wasn’t a positive response from the EU, and may react negatively if there are suggestions that Turkey has to jump through many more hoops before negotiations can begin,” comments one London-based economist.

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