Turkey sukuk struggles after Gulf over-allocation
Dubai, October 13, 2012
Turkey's first sovereign sukuk issue was a public relations triumph but it's been a financial disappointment so far in the secondary market, showing the risks of over-allocating debt deals to a single region.
The $1.5 billion Islamic bond, maturing in 2018 and issued at a profit rate of 2.803 percent, dropped to about 98 cents on the dollar in the secondary market soon after issue in mid-September and has stayed below par since then.
Traders say bids have ranged between 99 and 99.5 cents in the past few days. It was bid at 99.5 cents on Thursday to yield 2.9 percent, according to Thomson Reuters data.
As Turkey's first official foray into Islamic finance, the sukuk issue was closely watched by investors around the world, drawing 250 separate orders totalling over $7 billion. The successful sale paved the way for Turkey to raise 1.62 billion lira ($905 million) with a local currency-denominated sovereign sukuk two weeks later.
The historic nature of the dollar sukuk, however, may have blinded some buyers to risks such as a last-minute upsizing of the issue and an overwhelming allocation to a single region, the Middle East.
"Whilst we are comfortable with Turkey as a credit, we avoided the issue as there was no clarity on the size or pricing until the last minutes of the deal," said Mark Watts, head of fixed income in the asset management group at National Bank of Abu Dhabi.
"When buying any asset, clarity of price and size of supply are key. Turkey priced aggressively, a good deal for them, but it left little on the table for investors and slipped below its issue levels after a short period."
Turkey, rated BB by Standard & Poor's, was initially expected to raise between $500 million and $750 million from the issue, or up to a maximum of $1 billion, several regional investors who attended roadshows told Reuters.
But the issue was expanded to $1.5 billion in the closing hours, even as price guidance continued to tighten - in contrast to the usual pattern of a substantial upsizing causing some widening of the pricing.
Another surprise was the huge allocation to the Middle East. Traditionally, Gulf investors have focused on their own region, where yields are relatively high relative to credit ratings. So an allocation of well under half of the Turkish sukuk to the Middle East would have seemed reasonable.
But the Turkish sukuk was sold 58 percent to the Middle East, 13 percent to Europe, 12 percent to Asia, 9 percent to Turkey and 8 percent to U.S. investors. The small Asian allocation was particularly shocking, since Malaysia is one of the biggest sources of demand for sukuk globally.
Many major investors in the United Arab Emirates, both Islamic and conventional, have told Reuters they did not put in orders for the Turkey deal. They cited various reasons, including unusually tight pricing for a first-time, sub- investment grade issuer.
The implication is that a relatively small number of investors in the Gulf ended up with considerably more of the sukuk than they had expected.
In most deals, investors bid for more of a bond than they think they will be allocated, on the assumption that actual distribution of the bond will be proportional to their share of the total bid. In this case, Turkey seems to have skewed its allocation in favour of Middle Eastern bids.
"It was quite expensive and over-allocated. A lot of bidders went in with conditional orders, above a certain spread, 200 (basis points over midswaps) mostly," said a regional trader who declined to be identified.
Turkish government officials declined to comment on their motivations for the allocations, but many market participants think they may have had political and strategic motives.
Turkey decided to allocate a big chunk of its maiden sukuk to the Middle East in an effort to develop a new investor base and help cement growing business ties with the Gulf, these market participants say.
The sukuk prospectus said negotiations for a Free Trade Agreement between Turkey and the six members of the Gulf Cooperation Council were underway. Meanwhile, Turkey's Islamist-rooted government wants to develop Islamic finance, for which the Gulf is a principal centre.
And a congress of Turkey's ruling AK Party this month made clear that the country was focused on expanding ties with the Middle East and the Islamic world, rather than the West, which was barely mentioned.
"From a sociopolitical perspective, Turkey is looking East rather than West," said a regional debt capital markets specialist.
Although some Gulf investors ended up holding more of the sukuk than they had expected and now want to sell, there was also interest in the issue among strategic investors in the Gulf, bankers said - which suggests the sukuk may not have much further downside in price.
Gulf investors have been increasing their investment in Turkey in areas such as private equity and real estate. Bankers said some of these investors saw the Turkish sovereign sukuk as a way to hedge against their private sector risk in the country.
"You have to look at it as hedging. Gulf investors have invested massively in Turkey in the last 12 months, so buying into the sukuk is a way of hedging Turkish exposure," said a Gulf-based banker.
There is also speculation that some of the Gulf's sovereign wealth funds may have put in big orders for the Turkish sukuk, which could account for part of the heavy allocation to the Middle East. Supranational institutions and central banks took 10 percent of the sukuk globally, according to the breakdown of investor types.
Sovereign funds are generally conservative investors which do not normally invest in non-investment grade instruments, and have shown little interest in sukuk.
However, several regional capital markets sources said they understood Turkish officials held one-on-one meetings with regional sovereign wealth funds in Qatar and Saudi Arabia before the issue.
The deal was lead-managed by Citi, HSBC and Liquidity House, a unit of Kuwait Finance House. Qatar's Barwa Bank, in which Qatar Holding, the investment arm of the Gulf state's sovereign wealth fund, owns a 12.1 percent stake, was added as co-lead manager late in the process.-Reuters