Under the ratings cosh

The coup attempt in Turkey on July 15 failed to usurp the government but it did put the sovereign in the sights of the ratings agencies and froze the financing plans of the country’s banks.

Moody’s is due to complete its review on Turkey’s Baa3 rating by mid-October, and that is a black cloud hanging over the country that could have a significant impact on its capital market plans.

“Market expectations of a rating downgrade have come down … but are not going away, in my view,” Delphine Arrigi, portfolio manager at Old Mutual Global Investors, told IFR.

“Turkey is back on [the] track of an unsustainable growth model solely driven by domestic demand and high current account deficits. [It’s] a model that has traditionally led to boom-and-bust cycles.”

Trouble bubbling

One EM sovereign analyst at an investment fund said that despite domestic tensions calming and the Turkish lira recovering after the coup attempt, trouble lurks on the horizon.

“What really worries me is that the fundamentals look rather shocking,” he said, “particularly the external finances. Whichever way you slice and dice the numbers, Turkey has a massive external financing requirement. The net reserves of US$34bn are nowhere near sufficient if things go badly wrong.”

A Moody’s downgrade would mean two of the three ratings agencies have Turkey as junk – S&P rates the country BB – which will further chip away at a crucial pillar of technical support at a time when the fundamentals are struggling.

Hanging over the edge of a junk rating could see money pour out of Turkish debt, as it threatens the country’s eligibility for investment-grade indices, although the principal driver for inclusion in the EMBI Global index is the Index Income Ceiling based on World Bank GNI per capita data.

“The mechanism of index-eligibility provides a support floor for Turkey,” said a London-based syndicate banker. “Turkey is a big constituent of EMBI indices and the US Global Aggregate indices and, as a result, you always tend to see a number of reluctant buyers. From a fundamental perspective you could be concerned, but the fundamentals become almost secondary to the technicals.”

Selling pressure

If Turkey were to have a median non-investment-grade rating, then there would be forced selling, in particular from US investors who follow the US Global Aggregate indices, according to the syndicate banker. However, some market participants suspect the impact could be limited, particularly when compared with other countries that have been shunted into a junk rating.

“If there’s a downgrade, you will see a sell-off, although not as massive as Russia or Brazil,” said Thibaut Nocella, an analyst at Insight Investment.

Whatever the outcome, bankers are growing impatient with the ratings agencies, as they expect a rise in deals if Turkey is found to be worthy of an investment-grade rating.

“It would be good if Moody’s got off the fence and did something,” said another syndicate banker. “If [Fitch and Moody’s] both keep as is and clean up things and move on, Turkey could be hot again.”

As it stands, much of Turkey’s financing needs were front-loaded, with any potential future issuance from the country on hold awaiting the agency decisions, according to a CEEMEA analyst.

“Would they want to see the conclusive [ratings agency] decisions affirmed first? I think likely, if only to be seen to treat their investor base in the most professional way,” said the strategist. “I still think this is important for the Turkish Treasury. So they may prefer to wait till later in the year, say October [or] November.”

But even if Turkey is dumped into sub-investment-grade territory in the meantime, not everyone is convinced it will be cataclysmic for the country.

“Historically,” said an investor, “whoever bets against Turkey loses.”

Bank casualties

Yet even without a downgrade, the coup attempt at the end of July severely dented Turkish issuers’ capital markets plans.

Yapi Kredi yanked a proposed US$550m 4.50% July 2023 deal the day the notes were due to settle – and a week after they had priced.

The decision to cancel the bond issue divided bankers, with some questioning the advice the lender was given and others arguing that canning the deal was a sensible call.

While the cancellation of a bond deal between pricing and settlement dates is not unprecedented, it is rare. Earlier this year, Bahrain pulled a transaction following a downgrade of the sovereign, while Panama’s Tocumen Airport took the same action in the wake of money-laundering allegations against the owners of its largest duty-free shops.

Yapi’s case was different, with the decision to cancel based not on specific credit concerns about the issuer itself but because of the political crisis in the country.

The attempted coup and its aftermath triggered a wave of selling in Turkish assets, with the lira hitting a record low against the US dollar and bond spreads ballooning.

No MAC

While these events did not trigger a material adverse change clause, Yapi decided the prudent decision was to cancel the deal. It cited “the recent negative developments and the ensuing market volatility” in a statement.

Yapi’s move followed discussions between lawyers involved in the transaction who believed that the disclosures in the original offering memorandum no longer accurately reflected the risks.

As such, for any deal to go through, a supplementary document detailing the new risks would have had to be sent to investors. Once sent, investors would have the right to reconfirm their orders for the transaction – or pull out. In the circumstances, it was considered likely that many investors would have walked away.

Bank of America Merrill Lynch, Deutsche Bank, HSBC, ING and UniCredit were the leads.

Some bankers away from the deal, however, questioned the decision. “I don’t think this is the right thing to do,” said one, who believed the whole thing left a bad taste.

Another banker agreed the deal did not have to be pulled. “The key question is whether this is a MAC (material adverse change)-type event. I’m not necessarily convinced they had to cancel it,” he said.

But he felt that Yapi took “the pragmatic decision” as it is a regular issuer, adding the bank’s actions “were very considered for the market”. He said bankers within his firm felt it was “the right thing to do”.

A third banker agreed the decision to pull was correct but said that while “you can’t really fault anyone, it was still embarrassing”.

Underperforming

Adding to the controversy was the fact that the bonds were underperforming even before the coup attempt on July 15 and then widened significantly afterwards. “Investors will be quite happy with the result,” said an asset manager who did not participate in the deal, “they saved five points.”

But other market players will be less pleased. “Net it is a small positive for the credit and investors got their money back,” said a trader. “But some dealers had been shorting [the bonds]. So it would have been a real disappointment for them to see [the deal] torn up.”

Even though the notes were cancelled, any trading losses or gains will be crystallised. “The key issue is if you are trading to balance net positions. That’s where you have issues, as there’s nothing you can do,” said the second banker.

Yapi’s cancellation followed a decision by Sekerbank to postpone a roadshow that was due to begin on July 17 for a potential Basel-III compliant Tier 2 deal. At the time, leads said Sekerbank would re-engage with investors at the appropriate time to reschedule the roadshow.

Neither bank has returned to the capital markets yet, some two months after the failed coup.

Any Moody’s downgrade of the sovereign could also have a significant knock-on effect on the banks, despite their being well capitalised.

“The banks look pretty solid and have withstood other volatile periods. However, if the sovereign is downgraded, then the banks will get crushed. It’s all looking a little ugly,” said a DCM banker.