The aftermath of investment grade

The much awaited investment grade has finally arrived… Fitch upgraded Turkey’s FX credit rating to investment grade (BBB-) with a stable outlook, citing well known positive factors such as favorable medium-term growth, declining government debt burden, rebalancing in the economy, the sound banking system and the relatively wealthy and diverse economy. Investment grade (IG) rating is perhaps not a real game changer but is certainly important as easy access to credit makes life easier for every       ne. In fact, a number of large Turkish banks and industrial companies have already started to issue corporate bonds either to fund new investments or to refinance existing debt. The key point to remember here is that the maturities of the new loans are longer and the cost is relatively lower than before. Investment grade should also support the privatization of state assets that have previously been canceled primarily due to lack of available long term financing.

Managing the inflow of capital should be critical… Other emerging countries have typically experienced large quantities of short and long term capital inflow right after being upgraded to investment grade. While inflow of capital promotes economic growth, it results in the appreciation of local currency and could potentially lead to deterioration in current account deficit too. The Central Bank of Turkey is certainly aware of the vulnerabilities imposed by capital inflows and is also well equipped with a wide range of tools to prevent TL from appreciating sharply. We project TL to trade between 2.0 and 2.1 against the basket in 2013.

From banks’ perspective, investment grade status should improve FX funding, reduce the level of domestic competition for deposit rates and result in more resilient net interest margin. At the same time, the corporate sector should find it easier to access capital markets and raise foreign currency loans with longer maturity and lower cost while by-passing commercial banks. In response, banks are likely to increase exposure to profitable SME and consumer segments. Ultimately, easy access to foreign funding supports banks’ growth but the system’s risk profile should also increase given the potential rise in “on-balance-sheet” net short FX position and relatively riskier loan portfolio. From non-financials’ perspective, TL and FX denominated corporate bonds should gain importance as their reasonable cost and extended maturities are hard to ignore. We do not expect a sizeable appreciation in TL given CBT’s stance in tackling excess capital inflows and would also not bet on a consumption boom as loan growth should be closely monitored not to upset the delicate rebalancing in the current account.

Equity market implications…The urban legend of “pension funds waiting at the door to splash money once the IG status is obtained” may not prove right, but IG certainly bodes well for Turkish financial assets particularly given the prevailing high global liquidity. The first implication is the sustainability of the decline in long term TL yields, in our view. 10-year Turkish local currency bonds currently trade at 7.7%. Hence, we reduce our risk free rate assumption by 50bps to 8.50% and raise our 12-month target level for ISE-100 to 85k from 74k, offering a 18% upside potential from current levels. Turkish equities have had a phenomenal year in 2012 .They have risen by 50% YTD, outperforming MSCI-EM by 36%. The solid performance raises the question of whether all good news have been priced in or not as Turkish equities currently trade at 11.4x on our 2012E and 10.3x 2013E earnings forecasts, representing 14% premium to its 5-year average. While the future still appears to be bright given the declining interest rate environment, solid earnings growth in 2013 and improved access to international funding, short lived profit taking could rule in the near term in light of recent outperformance, in our view. As for banks vs non-financials, we maintain our overweight stance in banks in the near term as banks continue to be the prime beneficiaries of IG.  Among banks, we like Garantibank and Vakifbank. Among non-financials, we like Boyner, Dogus Otomotiv, Koza Anadolu Metal, Teknosa and Tupras.

 

BGC Partners