Turkish bank subordinated bonds plunge, as investors sift good from bad

15 August 2018

Among the selloff in Turkish bonds over recent days, lenders’ subordinated bonds have fared the worst, as fear mounts the securities could be written-off if the unfolding economic crisis is not resolved swiftly, said market participants.

 

The lira’s downward spiral has resulted in deteriorating capital levels at Turkey’s banks, while a surge in non-performing loans (NPLs) – large corporates such as Yildiz, Dogus and Gama have recently, or are currently being, restructured – continues to erode asset quality.

 

The subordinated bonds of even the largest Turkish lenders have now dropped to levels usually indicative of severe stress, albeit on incredibly thin trading, noted a buyside analyst.

 

Isbank’s USD 500m 7% 2028 subordinated notes plunged 24 points since last Wednesday (8 August), to be indicated at 42.5-mid, or a yield of 21.6%, yesterday. Akbank’s USD 400m 6.797% 2028 subordinated notes slid from 70-mid to 53.5-mid, or a yield of 16.675%, in the same period.

 

But the peculiarity of Turkish Tier 2 subordinated bond documentation – which, unusually, does not feature a capital ratio bail-in trigger – is leading some to question whether such severe drops are justified.

 

Instead, the bonds only feature a “non-viability” bail-in trigger, meaning the notes should only be written off if the issuing bank ceases to be a going concern or loses its license, both of which are ultimately determined by the regulatory authorities, said a sellside analyst.

 

Given the relative strength of top tier Turkish banks, and expectations that the regulator would be unwilling to allow them to collapse given the systemic risk this poses, these bonds may have dropped below fair value, the analyst continued.

 

“I think people are aware of this facet of the language [in the documents], but the panic regarding the lira means the bonds have just been quoted down and down regardless,” the sellside analyst said.

 

They don’t make ‘em like they used to

 

Beyond this particular quirk of the Turkish market, there are also several ‘old-style’, or Basel II-compliant, Turkish subordinated bank bonds outstanding, which do not even feature the "non-viability" language in the documentation.

 

The ‘old-style’ subordinated notes still in the market are Vakifbank’s USD 400m 6% 2022s, indicated yesterday at 59-mid to yield 21.2%, Isbank’s USD 1bn 6% 2022s, indicated yesterday at 49.75-mid to yield 26.6%, and Yapi Kredi’s USD 1bn 5.5% 2022s, indicated yesterday at 59-mid to yield 20.2%.

 

Given the difficulty of bailing these ‘old-style’ notes in, any attempt at a write-down would be both aggressive and highly antagonistic to bondholders, noted the buyside analyst.

 

There is, however, precedent. In Russia, ‘old-style’ notes were bailed in alongside new-style Basel III-compliant debt, a move that has sparked threats of legal action by bondholders. However, Turkey is perceived as being a more investor-friendly environment than Russia, the analyst continued, where issuers generally prioritise repaying creditors.

 

This nuance appears to be having little impact on indicated prices. “There is no pattern in how the bank bonds are trading, the only differentiation people are making is between subordinated and senior debt,” said a second buyside analyst.

 

“Nobody is looking at specific credits, or the difference between Basel II and Basel III subordinated notes - it's just indiscriminate selling of anything Turkish,” the analyst continued. It is, he argued, nonsensical that leading lender Isbank’s old-style USD 1bn 6% 2022s are quoted today at 51/58, while relative unknown Odeabank’s new-style USD 300m 7.625% 2027s are quoted at 50/55.

 

Pricing in sanction risk is also difficult, as funds tend to “sell first and ask questions later”, said the sellside analyst. For example, Russia state-owned lender VTB’s perpetual notes were quoted in the 50s last year at the peak of the sanctions crisis, despite the fact the viability of the lender was never seriously in question.

 

President Trump announced the US would impose a 50% and 20% tariff hike on Turkish steel and aluminium, respectively, last week (10 August), as disputes centred around the continued detention of a US pastor and the purchase of a Russian-built missile system continue to drag on diplomatic relations. Ankara countered yesterday, imposing its own boycott on US-made electronic goods.

 

Propping up the second-tier

 

Furthering the thesis that bail-ins of subordinated debt are not yet on the cards, the sellside analyst noted that, many of the second-tier issuers are either backed by foreign owners or by strong local financial institutions, which could stand behind their subsidiaries in a worst-case scenario.

 

For example, since late 2016 Alternatif Bank has been owned by Commercial Bank of Qatar (CBQ). Turkey is a long-standing ally of Qatar, and the emir, Sheikh Tamim bin Hamad Al-Thani travelled to Turkey today to demonstrate support. Meanwhile, TSKB, a specialised infrastructure lender, is majority held by Isbank (50.65%), with Vakifbank also being a significant investor.

 

Although it has not issued subordinated debt, QNB Finansbank is backed by Qatar National Bank. Meanwhile Odeabank is majority owned by Lebanon’s Bank Audi (76.42%) with development finance institutions EBRD and IFC also being significant investors.

 

However, the situation described above is, in the words of the first buyside analyst, the “rosy scenario” - one which many argue is too optimistic.

 

A US-based portfolio manager explained why her fund is avoiding investments in all but the strongest banks: “There is a lot of US dollar-denominated debt there, and we just can’t imagine there won’t be failures among the second-tier banks. Then you’re taking a gamble on which ones will get shareholder support, which we don’t want to do.”

 

Banks particularly exposed to the sectors President Erdogan has been artificially supporting by encouraging access to cheap credit – construction and real estate – are also being given a miss.

 

Liquidity is king

 

The biggest problem that could arise, the first buyside analyst continued, is not deteriorating capital adequacy ratios or NPL rates, which can be massaged through regulatory forbearance and creative accounting. Instead, the banks could find they “go over their skis” if liquidity suddenly runs out.

 

“You could walk in after the weekend and guess what - all the corporates have withdrawn their deposits. The show will be over before you’ve had a sip of your coffee,” he said. 

 

A run on the banks, something which the Turkish people have so far shown little inclination toward, could prove the catalyst for a full-blown banking crisis. As such, ensuring enough liquidity remains in the system has been one of the Central Bank of the Republic of Turkey’s central priorities in recent days. The spectre of capital controls continues to loom large.

 

With bond prices in disarray, and investors scrambling to identify where the pockets of value lie, at least some Turkish lenders are seeking the initiative.

 

Vakifbank yesterday announced it would buy back up to USD 100m of its bonds at the current depressed prices. Bargain hunters may need to act fast as – given thin trading – a few trades like this, and Turkish bank bonds will be back at par, according to the analyst.

 

By David Graves and Laura Gardner-Cuesta