Vakif delivers on covered promise

State-owned VakifBank broke new ground with its €500m five-year covered bond towards the end of April. The best part of 10 years of wrangling over the product was wrapped up in the deal, which made it notable from an issuer point of view. As far as investors were concerned, it printed at a spread that offered considerable pick-up over anything else available in the asset class.

Unlike peripheral eurozone banks, Vakif’s covered bonds are not eligible for the European Central Bank’s bond-buying programme, which meant the issuer was forced to offer the chunky premium.

Added to this was the fact that its success followed a lengthy gestation process. Turkey introduced covered bond legislation in 2007 but the delay in issuance has been down to a number of factors. First, Turkish banks have been able to fund more cheaply through other methods; second, there was no clear buyer base; and third, the country’s covered bond law is now in line with international standards, making investors comfortable with the asset class.

VakifBank had been plotting its covered bond debut for two years and it accelerated plans late last year after gaining approval from the country’s capital markets board regarding Turkish lira swap agreements. This was a crucial element before any deal could be launched, as the company’s existing covered bond legislation did not allow for extensive use of derivatives.

Ozlem Gokceimam, head of structured finance, financial institutions, at Garanti Bank, said: “The market has been held back by the need for potential issuers to introduce swap structures that are essential in order to meet liabilities in Turkish lire.”

After gaining approval from Turkey’s capital markets board regarding swap agreements, Vakif began courting its investor base. It benefited from technical factors that have triggered a rally in emerging market credit after a tumultuous few months following the Federal Reserve’s decision to increase interest rates last year, coupled with fears about the scale of the slowdown of China’s economy.

Following intervention from the ECB in extending its bond-buying programme, investors moved to a risk-on mode, and Turkey’s status as a well-known presence on the international capital markets helped the country to lead the way, with the sovereign hitting the market in late March and late April.

As well as being comfortable with VakifBank as a credit, investors were also happy to avail themselves of the healthy return on offer – with sources close to the deal pointing out a yield of more than 2% on a covered bond is highly uncommon.

Vakif’s deal printed 150bp–160bp back of the bid for the next highest yielding covered bonds from peripheral Europe and around 50bp back of the Baa3/BB+/BBB– rated Turkish sovereign, but 13bp inside the bank’s own senior unsecured 2019s. It was rated A3, three notches above the bank’s unsecured ranking.

The leads were able to tighten pricing from initial price thoughts of mid-swaps plus 280bp area to 250bp at launch, although this still left a hefty new issue premium that was down to the fact that Vakif’s covered bonds are not eligible for the ECB’s bond-buying programme.

EBRD support

The European Bank for Reconstruction and Development also threw its support behind the deal with an investment of €50m.

Noel Edison, director for insurance and financial services at the EBRD, said in a statement: “This well-established asset class in Europe is an excellent new funding tool for Turkish banks and will importantly broaden their investor base. We are pleased to play a role in VakifBank’s debut issuance. We hope that the Turkish banks will embrace the covered bond market, as it gives access to a larger pool of longer term investors with lower funding costs, reducing reliance on deposits and short-term wholesale funding and helping to address the asset-liability mismatch.”

While the EBRD’s involvement was welcome, it was ultimately not needed, as the order book ballooned to €3.2bn.

“It’s clear that the asset class has benefited despite being outside the realm of the ECB’s covered bond-buying programme, while the broader QE initiative has triggered a rally in emerging markets bonds. This deal sets the lead for others to follow,” said Boudewijn Dierick, head of flow ABS and covered bond structuring at BNP Paribas, which was a lead bookrunner on the deal alongside Barclays, Erste Group, Natixis and UniCredit.

Garanti Bank is likely to be next line to tap the market. The lender announced last year that it had established a €5bn global covered bond programme with Barclays and Natixis as arrangers. In October, it gained approval from the country’s capital markets board regarding swap agreements but was subsequently held back by a sharp sell-off in emerging market debt.

Having seen VakifBank’s issue go smoothly, Garanti is committed to making its debut. Gokceimam said: “We established the programme, it is up and running. It’s a just a case of choosing the right moment with the right price to enter the market.”

There are high hopes that covered bonds are an idea whose time has come for Turkey’s banks. As for their western rivals, the market provides them with an opportunity to raise capital to meet Basel III capital requirements while also reflecting a shift in their funding needs. In addition, the asset class provides a flexible and longer term option compared with their traditional approach of funding themselves in three-month windows through customer deposits.

Covered bonds also offer Turkey’s banks a way to tap into a rising housing market and a greater demand for mortgages as they become more widespread.

There is no doubting the potential of the covered bonds as an opportunity for Turkish banks to serve as a welcome diversification their funding from traditional sources.

“This is a prolific funding tool for Turkish banks because it’s the closest to the sovereign curve they can get in terms of cost of funding with a public DCM product. While the covered bond market represents a funding diversification play for banks, it’s also relatively cheap compared with MTNs and Eurobonds, thanks to the strong mortgage cover pool. However, within the European covered bond universe, even relative to Spain and Italy, funding costs still remain high,” said Gokceimam.

The rally in emerging market credit could make covered bonds attractive from a borrower’s perspective at the moment, but that could change and it is likely that the asset class will serve as a diversification play for some banks to put down a marker in the international capital markets rather than a regular source of funding.

Only the most optimistic of syndicate bankers are predicting a flood of issuance for an instrument that remains in its infancy and one where issuers must ensure they get international investors comfortable with their story.

“In the first instance, it’s important to establish a curve so investors can get to know Turkish covered bonds. There is a lot to do in terms of investor education for Turkish covered bonds, so, thanks to the Capital Market Board, the structure of Turkish covered bonds looks very like the Pfandbrief mortgage-backed structure. This is extremely helpful when discussing the structure with the investors,” Gokceimam said.

No ’one size fits all’

Bankers say that the mortgage-backed product is perhaps the only one that has a natural buyer universe for now – but that structure does not suit all of the country’s potential borrowers.

The last mandated Turkish covered bond was from Sekerbank in January 2015, although that deal, which was secured by SME loans and not mortgages, never materialised after the lender received indications of interest in the context of low 300s over mid-swaps for a non-benchmark sized euro-denominated three-year issue. No IPTs were ever announced.

Sekerbank does not offer mortgages, so instead provided an asset pool of SME loans. “While it was a logical move from Seker’s point of view, it was a bit too exotic for an international audience,” said one syndicate source.

BNP Paribas’ Dierick said: “There have been SME-backed covered deals by Turkish banks in the past but they have been more like privately placed club deals. Traditional covered bond investors don’t buy SME deals – there’s a smaller buyer base. The VakifBank deal is a very significant move because it’s the first mortgage-backed benchmark covered bond deal by a Turkish bank on the international stage.”

The rise in Turkey’s house prices has also raised fears of a bubble, but bankers say this is wide of the mark.

“Turkish banks demand a higher amount of equity to support mortgage lending than in many other countries, so these mortgage pools are of the highest quality,” said Dierick.

“The success of this market will depend on the use of proceeds and the cost. If it makes sense for Turkish banks to swap it into Turkish lire to fund their mortgage loan books, then this could become a powerful tool,” said Garanti Bank’s Gokceimam.