Proving resilience

Turkey has a long-established reputation as an opportunistic issuer and it displayed its famed sense of good timing by hitting the market with two quick-fire deals that dodged the tumultuous early months of 2016 on the one hand and appeared to anticipate an oncoming political crisis on the other.

The sovereign traditionally rings in the New Year with a benchmark international bond issue, but 2016 proved to be an exception to that as it sat on the sidelines for the first two months while emerging markets credits continued to take a beating.

It marked an extended hiatus from a country that, wracked by a year of political instability and the Syrian refugee crisis, had last tapped the bond markets in April 2015.

That was just before it was plunged into turmoil by an election result that appeared to spell the end for President Erdogan as the ruling AK Party lost its parliamentary majority.

However, five months later, when Erdogan gambled on resurgent support and called fresh elections, he secured a thumping mandate that sparked a relief rally – the lira climbed to three-month highs against the US dollar and the euro, while equity markets surged.

The victory shocked the country’s secular powers but ended political uncertainty.

“Turkey was preparing to go to the market post-election but the dislocation in emerging markets put its plans on hold,” said one DCM banker.

Bankers say that Turkey was not unduly hampered by restricted access to the international capital markets despite its reliance on external funding to fund its budget deficit. Its opportunistic approach to funding had served it well as it exploited strong conditions in 2014 to pre-fund.

“Following a peak in international funding in 2014, Turkey has a smaller requirement in 2016 consistent with 2015, so it has been able to take time to choose the optimal issuance window whilst also committing to maintaining a market presence,” said Susan Barron, head of CEEMEA DCM/RSG at Barclays.

Patient approach

Its patience paid off. Following a tumultuous end to 2015 that continued into the first two months of 2016, conditions have improved as the US Federal Reserve looked to soothe markets rattled by its rate rise at the end of last year.

Meanwhile, the expansion by the ECB of its QE programme, coupled with a more stable global economic backdrop, meant that when the storm clouds that lingered over global markets – the impact of the Fed’s rate rise, a slowing Chinese economy, a plummeting oil price – lifted in late February, Turkey returned to the markets and proved its resilience with two deals in as many months.

The EMBI+ index, used as a market proxy for the performance of emerging market bonds, stands around 30bp tighter since the start of the year and the recovery has been led by quality sovereign names that proved highly attractive to investors when they reverted to risk-on mode.

“When Turkey returned to the international markets, it proved its status as the star performer in CEEMEA,” said Barron.

The sovereign made its belated bow and printed its first deal of 2016 on March 3 – a US$1.5bn offering that came with a 4.875% coupon and attracted investor orders totalling US$4.47bn.

The strong demand enabled Turkey, which is rated Baa3 by Moody’s and BBB– by Fitch, to take out more than some investors were expecting, with lead managers Bank of America Merrill Lynch, Citigroup and Deutsche Bank printing the trade inside guidance of 5.05%–5.10% at a yield of 5%, or a spread of 329.7bp over mid-swaps, which constituted a new issue premium of around 10bp–15bp.

US investors accounted for 34% of the paper, followed by the UK at 22%, Turkey at 20%, other Europe at 11%, Asia at 8% and others at 5%.

The deal’s strong reception was a vindication of Turkey’s defensive approach – issuing in the belly of the curve and choosing dollars, reflecting the strength of demand among US investors, with its well-established curve making the currency a natural choice.

Turkey returned to the dollar market on April 28, this time with a tap of its outstanding 2045s, and it again took home US$1.5bn, doubling the overall size of that issue.

Lead bookrunners, BNP Paribas, Goldman Sachs and JP Morgan began marketing the deal at 5.50% area before pricing at 5.40%. US investors were again in the vanguard of the allocation process, snapping up 40% of the bonds, followed by the UK with 32%, Turkey with 8%, other Europe 11% and others 9%.

Sources close to the transaction said that during the pre-deal roadshow the escalation of the Syrian refugee crisis was not at the forefront of investors’ minds when assessing the credit.

“Turkey is a regular, well-recognised and repeat issuer,” said Barron. “It has benefited from the broader rally in emerging market credit offerings but it also offers investors an opportunity to invest across the curve – including the long end – relative to similarly rated sovereigns.”

It also enjoyed from a flight-to-quality bid as emerging markets rebounded.

“Turkey’s new dollar 2026 bond received strong support,” said Zeynep Kerimoglu, director in emerging markets syndicate at Citigroup. “Investors were showing a preference for index-eligible names versus non-index names at the beginning of the year and Turkey also has benefited from that trend.”

The 2045 tap brought the amount of funds Turkey has raised from international capital markets this year to US$3bn, out of a 2016 Eurobond issuance programme of up to US$4.5bn.

Good timing

But the two dollar deals also proved to be well timed for another reason.

At the beginning of May, the country was plunged into fresh political uncertainty as Ahmet Davutoglu stepped down as prime minister after losing a long-running power struggle with Erdogan about his management of the economy, the flow of war refugees from neighbouring Syria and the broader question of Turkey’s relationship with the European Union.

Davutoglu’s resignation sent bonds tumbling, with the yield on the five-year government note jumping 25bp to 9.73% on May 5, the biggest increase since January. The cost of protecting the country’s debt against default climbed to a one-month high and equities fell for a fifth day running.

Davutoglu had argued for more orthodox policies, which Erdogan blamed for the country’s high interest rates and slowing growth. Davutoglu was also an advocate for Turkey developing a closer relationship with the EU, while Erdogan’s preference is for it to forge closer links with Asia and the Muslim world.

Moody’s said the development was credit negative and warned that the ousting of Davutoglu was likely to “diminish investor confidence at a time when the country remains highly dependent on external capital to finance its sizeable current account deficit.”

There are fears that the resignation of Davutoglu could threaten a deal he struck with Germany aimed at staunching the flow of migrants from Turkey into the EU.

While political risk will remain high until Erdogan’s successor is announced, bankers argue that the government remains strong and that the sovereign will continue to be judged on how the economy is managed, while the fact it has already almost met its funding target for 2016 means it can bide its time.

The country has also been one of the rare beneficiaries of the steep fall in oil prices, given it status as a major importer of crude, a situation that helped its current account deficit decline to 4.5% of GDP in 2015.

“Turkish growth continued to be meaningfully higher than the European average and, more importantly, fiscal discipline was maintained despite some of last year’s headwinds,“ said Igor Milosavljevic, associate, CEEMEA debt capital markets at Citigroup.

How the most recent political instability will impact future funding plans remains to be seen. While much of its issuance history has centred on the US dollar market, Turkey has also pursued a diversification strategy, last printing a Samurai trade in 2014. It also has an established dollar sukuk programme and printed a debut 10-year in 2012.

From a cost of funding perspective, the euro market, where it also has an established curve and where it last issued in 2014, could also be an option, given the level of spread-tightening since the European Central Bank extended its QE programme.

“It usually starts with dollars and it could do euros later in the year, but the current political uncertainty will likely give it pause for thought,” said one DCM banker.

No one, however, should doubt the sovereign’s resilience.