Pi Capital
Date of publication: 06 October 2020
Today we will look at one debt securitiy as investment ideas for this week: Turkey's senior unsecured sovereign Eurobond

IDEA #1: Turkey's senior unsecured sovereign Eurobond

Against the backdrop of growing global risk appetite in 2019, Turkey's senior unsecured sovereign Eurobond due in 2030 rose in price quite actively along with other EMs. However, at the peak of the sell-off that swept the global trading floors in the first decade of March 2020, the yield on the issue soared to near double digits. As the situation on the world markets stabilized by the beginning of June, the yield on the security corrected by the beginning of June 2020 to 6.4%. It would seem that it is high time to go (along with other EMs) to conquer the levels noted on the eve of the pandemic (5.5%), however, this did not happen.

The fact that the paper is trading at levels that, at first glance, are not too far from their dock-like levels, can create a deceptive impression of its relative well-being. Indeed, such a moderate underestimation, for example, could be attributed to the fact that the global demand for risk has not yet fully recovered in individual names. However, it is not the yield of the issue that is more indicative, but its credit spread, which is now at its highs over the past 15 years (see the chart below). The fact is that the current crisis has not only exposed the not very high credit quality of the issuer, but also worsened it. It must be said that investors, presenting an increased demand for risk in developing countries last year, apparently fully realized this, however, in the pursuit of high yields, the market largely turned a blind eye to this. Now, given the not yet fully recovered global appetite for risk, the deterioration of the issuer's credit quality is hard to ignore. In addition, investors have to take into account the geopolitical background around the issuer, which has been quite volatile recently. This led to an increase in the premium for investment in this instrument and its corresponding downward revaluation.

Speaking about the deteriorating credit position of the issuer, first of all, we note the situation with foreign exchange reserves, which have decreased by $ 35 billion since the beginning of 2020. True, this decline was to some extent offset by the growth of gold reserves. However, in the conditions of a stable departure in 2020, the current account balance of the balance of payments in the negative area, Turkey has to spend reserves to maintain the lira, as a result of which its gold reserves have decreased by about 20% ($ 20 billion) over the past six months. At the same time, given, for example, the negative impact of the pandemic on the tourism industry, the current account balance may remain negative, which means further pressure on reserves.

It must be said that Turkey's financial account of the balance of payments is under pressure in 2020. In an attempt to curb capital outflow, the Central Bank even recently took a step that is quite nontrivial in the current global macroeconomic context - it raised the 1-week repo rate by 200 bp at once. p. up to 10.25%. This was argued that inflation exceeded expectations, however, in reality, it looks more like an attempt to contain the currency crisis. As a result of attempts to support the economy with cheap money (the rate was lowered from 12% at the end of 2019 to 8.25% in May 2020) at double-digit inflation rates, the real interest rate in Turkey went into a deeply negative zone (-3.75 p. . P.). In combination with a fairly large external debt and a negative current account balance, this put pressure on the foreign exchange market (the Turkish lira against the dollar has fallen by more than 20% since the beginning of the year), and attempts by the monetary authorities to restrain this process with the help of foreign exchange interventions only led to depletion of foreign exchange reserves. However, even after the sharp increase in the rate, the real interest rate in Turkey remains in the negative zone, which creates risks for financial stability.

The deterioration of the issuer's credit position did not escape the attention of the largest international rating agencies. In August 2020, Fitch downgraded Turkey's rating outlook from stable to negative, keeping it at BB-. On September 11, 2020, Moody’s agency not only downgraded the rating of Turkish sovereign debt in foreign currency to the lowest level since the early 1990s. - B2, but also retained a "negative" outlook for it. Moody’s analysts expect a crisis in Turkey’s balance of payments, which may prompt the government in an attempt to preserve the gold reserves to impose restrictions on the outflow of foreign currency, which, according to the agency, will also affect the interests of holders of the republic’s sovereign foreign currency debt.

The rise in credit risks around Turkey led to a twofold increase in insurance against default (5-year CDS) in 2020 to 550 bp. According to this indicator, Turkey is a kind of leader among the largest developing economies. The current crisis has led to a reassessment of the risk of an issuer default by 3-4 pp upwards. Note, in accordance with the Bloomberg risk model, the main risks for the issuer are concentrated in the period up to 5 years. Thus, the probability of a default by Turkey over the next 5 years is now 23%, while an issue maturing in 2030 will default to a 24% probability.

With the exception of Kenya, Turkey's sovereign curve trades higher on the yield of its rated peers. As for the issue maturing in 2030, it also trades at a pronounced premium (about 1 pp) in yield relative to global bonds with a B + rating.

Thus, due to the growth of both credit and geopolitical risks around the issuer, the Turkey 2030 Eurobond lagged significantly behind the market in 2020. Note that the overall expansion of the issue z-spread from its February levels reaches 250 bp. Of course, for peers - dollar-denominated Eurobonds of developing countries - the z-spread has also widened during the current crisis. Thus, as follows from the chart below, the average z-spread of Eurobonds included in the EMUSTRUU index has expanded by about 100 bp over the past 7 months. In other words, the increase in the z-spread of the Turkey 2030 issue was partly due to the general risks of developing countries - namely, the growth of premiums pledged by investors in profitability when evaluating these assets.

If we talk about the prospects of the paper in terms of its own credit quality, then, for example, Moody’s agency is very pessimistic in this regard, noting that a change in the outlook to "positive" (not to mention an increase in the rating) is very unlikely in the medium term. However, it is noted that the outlook on Moody’s rating may change to "stable" if fiscal and monetary policies become more consistent in preventing further deterioration in the balance of payments. According to the agency, external financial support, as well as a decrease in tensions with the US and the EU, can also help improve Turkey's risk perception.

We also believe that investors should pay special attention to the dynamics of the gold reserves of Turkey, as well as the state of the current and financial accounts of its balance of payments. However, the primary external market remains open for the republic, and the refinancing risks, although far from zero, but at the moment seem to be quite manageable.

To summarize, Turkey's sovereign dollar Eurobond due in 2030 is a rather interesting choice in the segment of high-yield instruments, given its pronounced premium in yield to peers and the prospects for a recovery in global risk demand as the global economy normalizes. Meanwhile, the credit position of Turkey does not show any signs of improvement, in addition, further downward actions on the part of the largest rating agencies in relation to the issuer are not excluded. Now, on this investment instrument, you can fix the yield at the level of 7%, despite the fact that the probability of its default by the end of the circulation period is 24%. Thus, based on the risk / return ratio, this Eurobond could be recommended to investors with high risk tolerance.

Note that the Turkey 2030 Eurobond is a fairly liquid security on the global market. An important feature of the issue is that the minimum lot for it is equal to the face value and is only $ 1,000. There are no options for early withdrawal and / or revision of the coupon level. The coupon is paid twice a year: July 15 and January 15. The issue is being serviced by NSD. We draw your attention to the fact that this Eurobond is a margin bond in the Finam IG, as a result of which its yield can be increased.

Alexey Shternshis
Joint Managing Director
Capital Pi 


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