Running with the Bulls

2010 was a transitional year for Turkey’s capital markets. What are your expectations for 2011?

The year 2011 will be an interesting one for Turkey, and yet another key year for the Turkish debt capital markets. In 2010, Bank of America Merrill Lynch led the first private sector Eurobond issuance out of Turkey with Akbank’s inaugural $1 billion five-year transaction. This was a milestone transaction as it demonstrated the ability of Turkish banks to successfully diversify their source of hard currency funding and their capability to extend their historically short-term debt maturity profile. As Turkey grows, and as the loan books of banks grow and increase in duration, Turkish banks become increasingly keen to term-out their funding base and diversify sources away from the syndicated loan market and short-term deposits.

Many of the legislative uncertainties around the issuance of Eurobonds were also clarified following this landmark transaction. For example, the rules around the withholding tax impact of issuing a Eurobond directly as opposed to utilizing a loan participation note structure were not yet clear when Akbank launched its inaugural Eurobond in July of 2010. There was also a less than clear view on whether Turkish investors could buy and trade the notes in the secondary market.

By the end of 2010, the government and the tax authorities put in place a framework that specifically addressed the uncertainties, whereby it was announced that direct Eurobond issuances by Turkish firms would attract 0% withholding tax provided that the term is five years or longer and that Turkish investors can buy and sell the notes in the secondary market without becoming liable to pay any withholding tax.

This was a significant development as it means that the cost of borrowing in the international debt capital markets became more palatable for Turkish firms and, as importantly, that the ability of Turkish investors to freely trade the notes will ensure that a healthy level of secondary market liquidity can be established.

Therefore, we start 2011 with a much clearer terrain for prospective issuers than 2010, and expect that it will be a busy year, where financial institutions group (FIG) borrowers in particular will be active in tapping the international debt capital markets with their inaugural or secondary Eurobond issuances. These borrowers will also be contemplating issuing in Turkish lira, which will likely be a follow-up to their inaugural issuance—expected to be denominated in US dollars.

Overall, I see 2011 as a year to lay the foundations for the future growth of the Turkish debt capital markets. In that respect, one shorter-term milestone that I forecast for the end of 2011/start of 2012 is for Turkish banks to start establishing their Euro Medium-Term Note (EMTN) funding programs, which will allow the prospective issuers to utilize different buckets and pools of demand in different currencies across an international investor base, whilst reducing the length of the execution phase as well as signaling investors of their intentions to become relatively frequent borrowers in the debt capital markets.

How do you assess investor demand for Turkish debt?

International debt investors are extremely bullish on Turkey and Turkish firms. Although the sovereign and private sector firms are still sub-investment grade, the levels at which these issuers can borrow underlines that investors perceive most of these credits to be the at the same level as investment grade issuers, where notably the Turkish sovereign has proven its ability to borrow in the international debt capital markets at levels associated with those of significantly higher rated countries.

Having said this, the debt capital markets of Turkey are still in the early part of their development phase, with the Turkish sovereign having been the only significant issuer until 2010 and Akbank, Yapı Kredi, İş Bank, Garanti Bank, and Finansbank having been the only major private sector firms to have issued until now.

Within Turkey a number of major Turkish private sector firms are seen as very close proxies to sovereign risk. However, as these firms are executing or are on the verge of launching their inaugural Eurobonds, they do not yet have a significant track record in the international debt capital markets. This in turn translates into a relatively higher level of spread over the Turkish Treasury than levels local Turkish investors would demand.

This disparity is natural at this stage in the development of a country’s debt capital markets, and I foresee Turkey following the likes of Brazil in the short to medium term. In this regard, 2011 will be a key year for these issuers—likely to mainly be banks—when they will have the opportunity to lay the foundations of their international debt funding strategy via issuing their inaugural or secondary Eurobonds, which will act as an anchor for future issuances.

Do you expect Turkey to hit investment grade in the near future, and what would be the impact of this rating change?

I believe Turkey will reach investment grade. Our house view is that Fitch is likely to upgrade Turkey to investment grade in the second half of 2011. We believe Moody’s and S&P will put through one-notch upgrades in 2011, which will still leave Turkey below investment grade. However, we believe all three ratings agencies are likely to have Turkey at investment grade in 2012.

As mentioned before, Turkey is pricing at much tighter levels than its rating implies. But being sub-investment grade has its limitations. A number of investors are unable or restricted in their ability to invest in sub-investment grade debt, which currently is a limitation for Turkish issuers. Once this barrier is removed, the amount of investor demand toward Turkish paper will increase significantly. This will positively affect pricing through tightening credit spreads and will incentivize a wider base of Turkish corporates to tap the international capital markets.

How would you gauge general investor interest in Turkey from the UK perspective?

It is extremely positive. Turkey is one of the top emerging market countries in terms of possessing a highly pro-business mindset, with well established laws and regulations, relatively transparent legal framework, and a well capitalized and strongly regulated banking system. Investor perception toward the country has been continuously improving since 2001, when Turkey had its very own banking crisis, with the country having witnessed increasing political and economic stability. As a result, many investors are bullish on Turkey and would like to see more Turkish debt being issued both from the sovereign and FIG/corporate borrowers.