Turkey debate: Turkey works to bridge its funding gap

Executive summary • Turkey has a fast growing economy with many funding needs • Foreign investment must be encouraged • Centralized, more streamlined, approval process required for PPPs • Infrastructure needs are substantial. The number of projects in need of finance points to a potential funding gap • Turkey remains a very attractive investment opportunity over the next 10 years

Turkey debate: Participants

Elliot Wilson, Euromoney How can we close the gap between Turkey’s aspirations – the amount of money that needs to be raised to build the country – and the reality, which sees capital raising constrained by issues including underdeveloped capital markets and legal uncertainty over concessions?

AY, Akbank Turkey’s infrastructure needs funding, but it’s easy to forget that this is a fast-growing economy with many funding needs. Turkish corporates’ funding needs are growing, and that requires financing.

There’s a lot of privatization going on as well in infrastructure, creating some overlap in the demand for funding in areas like energy, transport and other sectors. On top of that, infrastructure deals tend to be more than your average banking transaction, requiring longer tenors. With so many claims on their time and funding, it is natural for banks to need to find some sort of balance. It wouldn’t be right for banks to focus only on infrastructure. Nor would it be right for banks to focus solely on working capital transactions with shorter tenors. For the right deal, local banks still have strong balance sheets, allowing them to channel funding into big construction projects.

Look at the infrastructure projects out there: you have stage one of the Gebze-Izmir motorway fully financed, and the third bridge over the Bosporus under construction. Now there is the third airport, where authorities are in the early stages of putting together a financing and construction package.

These are among the largest infrastructure deals ever attempted in Turkey, and if they were all squeezed into a six-month period, it would be hard to locate all the requisite funding. We bid for many of these projects, as well as for many of the public-private partnerships (PPPs) that continue to spring up in the education and health sectors. The only time there was a failure in terms of closing a big transaction was just over two years ago, during the electricity distribution privatization process, and that was because valuations weren’t acceptable to everyone, rather than a lack of liquidity in the market.

There are two things that banks need to be satisfied about to complete any given transaction: first, their own capital adequacy levels; and second, the strength of the deal itself. In capital adequacy terms, Turkish banks historically had a lot of balance sheet to play with. That will inevitably ebb as each new major deal is completed. Just as important is the industry’s loan-to-deposit ratio, which has risen from 80% a few years ago, to 110% today. There is less liquidity available, so if new mega-sized infrastructure deals emerge now, Turkey’s banks may need more help in terms of being able to fund them. There is still talk of the Kanal Istanbul waterway linking the Black and Marmara seas, but I believe it will require more due diligence to come to market.

Euromoney How can Turkey engage foreign investors and convince them to commit more infrastructure capital to the country? Can the country corral the hundreds of billions of dollars it needs for new infrastructure funding?

BT, Akbank We have seen some mega-projects that require funding from all parties, such as Gebze-Izmir and now the third airport. Once upon a time, international banks as well as multilaterals and local lenders could all be relied on to find optimum ways to structure mega-projects, making them work for everyone. That was always difficult and challenging, not because all those parties had disputes but because they had naturally different expectations and priorities. And discussions within a crowded group takes time, so over the past few years we have seen Turkish sponsors increasingly lean toward preferring deals funded and closed wherever possible by local banks, due partly to the need to meet very aggressive schedules set out by state authorities.

We think these schedules should be stretched to take into consideration the needs of the market. We want to see multilaterals involved in PPPs and other infrastructure projects: we appreciate their knowledge and what they bring to any structure. Their presence is a boon to local banks and it strengthens a sponsor’s negotiating powers. In that sense, we would love there to be more contact between multilaterals and local banks.

Euromoney How can we get those vital institutions to reconnect in Turkey?

HÖ, EBRD Certainly we agree that with the exception of a few banks such as UniCredit, we don’t see international lenders in the mix on deals any more. IFIs [international financial institutions] are active, and the EBRD is responding to this by investing in the vicinity of €1 billion each year in Turkey. It isn’t always easy to corral and structure deals, so there has been talk of bringing in more funds through ECAs [export credit agencies], Islamic banks and even talk of tapping international capital markets, either through Eurobonds or local currency bonds, or even through sukuk. Turkey’s infrastructure needs range from €75 billion to €300 billion, depending on which study you read, crossing sectors including transport, energy, municipalities, healthcare and education. How are all those projects going to be financed? In the four years to end-2013, EBRD provided financing to 116 projects worth €3.5 billion. Turkish banks are providing a lot of the funding as well, but their stamina only stretches so far, and we would like to see more IFIs getting involved as well as more international commercial banks reentering Turkey. After 2008, international commercial banks disappeared, and only a few have come back in any major way. Alternative sources of funding are very important, not just for greenfield projects but also for brownfield operations, where capital markets can be tapped into as well. We saw the first infrastructure bond completed in Turkey last year, which included both EBRD and IFC as anchor investors. We want to see more of those over the next couple of years, which would increase the funding base for sponsors.

IT, IFC A number I’ve heard is that Turkish banks are recycling $5 billion to $7 billion in capital back into infrastructure projects every year. That gives you $35 billion out of a total of $110 billion, which leaves a pretty meaningful gap. As balance sheets and Turkey’s economy grow, new money can be injected into the infrastructure space by Turkish lenders, but it’s clearly not enough to fill the gap. So the contribution of IFIs and ECAs and foreign commercial banks is clearly very important. A year ago, Turkey’s economy was worried about the impact of Basle III and how those rules might force foreign lenders to stay away, but it seems now some French, Italian, and Austrian banks are coming back. And we see interest from Korean banks where Korean companies are sponsors, and from Japanese and maybe even Chinese banks, so there is external interest. ECAs remain very competitive where there is a large foreign component, and if Eurobond sales proliferate, and if we can see the domestic bond market develop, all of that could be used to free up new financing sources.

AY, Akbank The presence of multilaterals is beneficial as there is an unhealthy level of competition over some projects among local banks. Some deals get closed, but that doesn’t always mean they have been closed in the ‘proper’ way. These are very long-term transactions and they involve serious risks, so the addition of multilaterals is key. Until now, their presence has been limited to healthcare PPPs and to the Eurasia Tunnel, but until now, we have been overly dependent on using only Turkish players to close these projects.

IT, IFC We have $3.2 billion-worth of projects in Turkey, and infrastructure comprises $1 billion of the total. Most of those are in the power and ports sectors. They are assets that are either not reliant on full concessions, or where we are comfortable with how the concession has been written. Some are where the port or owner-operator has bought the land and the licence. What has held us back from some transport projects has been the structure of the concession in terms of step-in rights, direct agreements and termination payments. Recent government guarantees on projects are helpful, but problems still lurk out there.

AY, Akbank A good example is when the third bridge across the Bosporus was tendered out the first time. It had no takers, as no one thought it was financeable.

HÖ, EBRD The initial scope on that deal was huge. You had 260 kilometres of highway and a vast new bridge, along with land expropriation and environmental issues. No one thought it was a bankable structure, which is why the state decided to limit its scope. And that was back in 2011/12 when international banks were dealing with their own problems in terms of capital adequacy. The government was right to limit the size of project and to create a more bankable structure. Actually our presence in the Turkish market as an IFI is not that limited. We are trying to finance €1 billion to €1.2 billion in annual business volume in Turkey, and this year we hope to reach €1.5 billion, a third of which goes into infrastructure projects, including power and energy. Is this enough? Definitely not, as Turkey is a big country and I think a combined approach, with more multilateral involvement, more international banks and more alternative financing are certainly required. We see a positive movement in terms of each new concession, bringing the structures in line with the best practices applied in Europe and around the world.

BT, Akbank Project documents including concession agreements should meet international standards. There have been considerable improvements in healthcare project agreements, yet we believe that issues relating to many concession agreements still need to be addressed to be more bankable. This will definitely bring more international players, including international investors, on to the scene.

Euromoney Healthcare PPPs are often highlighted as a model of success here. Can we transpose that success to infrastructure projects on a far larger scale?

ED, Akbank There are many potential avenues of fruitful investment in Turkey, but we need to foster investor confidence. The Turkish economy is still growing fast – by 4.3% year-on-year in the first quarter of 2014 – so there is plenty of opportunity here. There are economic and financial risks, of course, but the important thing is that the capital that makes its way here has secured good returns, both in absolute and risk-adjusted terms, so in that sense we have a better policy environment thanks to continuous structural reforms. Both local lenders and international banks, along with IFIs and multilaterals, are increasingly keen and willing to invest in Turkish infrastructure projects.

Euromoney When will international banks again become big participants in key infrastructure projects? How can we make global investors more comfortable?

AY, Akbank Of course any foreign commercial bank wants to be completely comfortable to enter an investment with tenors of five or 10 years, or even longer. The catalyst will come from government authorities realising that current regulations are not set up to raise all the funding that Turkey needs. If that happens, it can force through change. But is the capital load attractive enough for commercial banks to be able to provide financing at tenors of 10 or more years? At the end of the day, these are heavy-duty financing deals requiring a lot of capital and, in most instances, banks can find better ways to allocate their capital than through project finance. In my view, project finance is the most difficult type of financing – it’s like taking equity risk for credit-risk returns, and when you put it like that, there tends to be some national dominance in terms of how these projects get financed. And that’s why we see multilaterals being less ubiquitous in this sphere – the likes of the IFC and the EBRD are not here to provide a few token investments in a tried-and-tested industry. There needs to be effort from government and regulatory bodies to make the environment better, and the stars need to be aligned by way of foreign commercial banks being more wiling to invest in certain types of deals.

HÖ, EBRD We are talking in Turkey of projects with tenors of 10 years, even 15 or 18 years in a few cases. When one considers an investment horizon of decades, boosting short-term investor confidence alone might not be enough. We need to take into account many parameters, including sound and bankable project structures and long-term political stability. Another important point here is that all PPP projects have to be run by the responsible regulatory authorities. We have so many different governmental bodies in Turkey with PPP oversight, including several ministries [meaning that] each authority is responsible for its own PPP structures. Another role the EBRD plays in Turkey is to engage in policy dialogue. We have strong relationships with various state departments, and we manage those relations and try to provide them with examples of our past experiences in other countries of operation. So for example, an argument we would make is that a new law and a central unit that combines all PPPs under one umbrella would be essential for creating even more successful PPPs in Turkey.

Euromoney How can we move toward a more centralized and streamlined approval mechanism for overseeing and regulating infrastructure projects in general and PPP projects in particular?

HÖ, EBRD That needs strong initiative on the part of the Turkish government. The most successful PPP structures depend on excellent communication between the state, the private sector and creditors. That’s the only way that necessary improvements can be made.

BT, Akbank In the long run, it’s vital to create a central unit where all international parties can communicate. It’s also important to have transparency and to have a more international tendering process.

IT, IFC The process of rewarding concessions needs to be less frantic. There tends to be a great rush to award concessions, after which you spend two or three years sorting out the details.

BT, Akbank Turkish sponsors and Turkish lenders know how the government thinks; they know how the bidding process works. Foreign investors don’t know the bidding process as well, and they rarely have enough time to find the requisite financing. These little points might also help increase appetite from international sponsors, which would create a wider range of financing institutions. So bankable deals are very important, as is greater transparency and a longer bidding process.

Euromoney Does Turkish infrastructure require evolution or revolution to take it to the next stage?

AY, Akbank It’s an evolutionary process. Turkish banks aren’t as liquid as they once were. Capital adequacy levels have fallen, and in the future, banks will need to be much more choosy in terms of which projects they want to be part of, and what standards they are using to underwrite those projects. But that evolution will push banks to ask for more rigorous standards in terms of how concessions are structured. Something will happen in one project – maybe a deal will go sour – and everyone will stop and learn from their mistakes.

HÖ, EBRD That is also a result of how projects have been financed until now. We don’t have full nonrecourse project finance structures in Turkey, partly because of how finance deals are traditionally structured. Normal project finance risks cannot be undertaken with many of the existing PPP structures in Turkey in the absence of state-of-the-art termination clauses and step-in rights as well as with the lack of direct agreements, which is why there is always some recourse to sponsors, and the majority of sponsors in these deals are usually the same prominent Turkish names. But it’s evolutionary. If problems do occur, government and banks could sit down together to think of ways to do things differently.

AY, Akbank There are really very few genuine project finance deals in Turkey. They tend to require full or at least partial recourse to sponsors. Turkey is completing some of these deals quickly, and you can also question sponsors’ ability to stand by their commitments in material ways if anything goes wrong.

ED, Akbank Recent studies suggest that success in financing projects increases if it includes collaboration with multilaterals and local financing institutions. It’s not only important for capital needs but also in terms of local monitoring of invested projects.

Euromoney Where is the greatest and most pressing need for more infrastructure capital in Turkey?

IT, IFC There are quite a few deals in the pipeline. You have the third airport, with the financing about to be put out there as an RFP [request for proposal] with the goal of financing it by end of the year, and then we start talking about the next stage of the financing for Gebze-Izmir. There’s lots of activity with funding new power plant production as well.

HÖ, EBRD In terms of smaller transactions there are three or four greenfield port projects underway, as well as at least two privatizations, so the deal pipeline is there.

Euromoney Are there enough deals to keep everyone busy?

BT, Akbank There’s more than enough for us to be getting on with. Since local elections [in March 2014], several new privatizations and greenfield projects have come through, and the pipeline is full.

Euromoney So is everything normalising after a period of uncertainty last year?

BT, Akbank Yes. Investors had taken a wait-and-see attitude, but now I think the confidence is back, and sponsors and investors are eyeing any number of new projects.

ED, Akbank That’s not surprising. Take the energy sector: current capacity is around 66,000 MWh and should be expected to grow at around 7% a year, or 2 percentage points higher than potential GDP growth rate. At these growth rates we need to build two mega-sized power plants each year, so this gives us a clear view of infrastructure needs just in the energy sector. Turkey’s energy sector is growing fast and we need more infrastructure financing in place.

Euromoney How about the development of infrastructure bonds? Until we get a primary market and a liquid secondary market in place, will the ability to create more capital to fund new projects remain constrained?

IT, IFC Once you get to the point where projects have been in place for two or three years, and which are creating regular cash flows, thereby providing something for the big agencies to rate, you’ll see far more bond creation. Investors are interested in the market. Perhaps if the US Federal Reserve’s tapering process accelerates, some of that interest might wane, but for now the interest is there, particularly in potential Eurobonds. What I’ve been told is that when it comes to bonds issued in Turkish lira, the law is unclear on where that bond would fit within the pecking order of bankruptcy seniority – that it might be treated as equity.

HÖ, EBRD We need to classify which projects are appropriate for debt capital market issues. Right now, with any greenfield projects – power stations, airports, container ports – neither the legislation nor appetite is in place, and the main reason for this is construction risk. We will see a lot more projects financed by bond issuances over the next two or three years, particularly when it comes to the brownfield space. And that will free up a lot of capital for banks, which will be a key facet of financing greenfield projects. Projects financed by banks’ senior loans after they become operational could be good candidates for Eurobond issues. Because if you look at the infrastructure sector, exchange-rate risk is mostly mitigated because revenues are either indexed to hard currencies, or are actually in hard currencies. And as an IFI, it’s within our strategy to foster capital market development, and we will look across the board at almost all the potential bond issues, and if possible invest in them as anchor investors.

Euromoney What about local currency bonds as a source of infrastructure financing?

	HÖ, EBRD We are exploring ways of issuing local-currency bonds.
	IT, IFC We can buy local currency bonds. The issue in Turkey is how bonds will be treated legally if they are placed in a default situation. We aren’t going to pay a bond premium to take an equity risk.

HÖ, EBRD At EBRD we provide long-term local currency financing. Just last year, we completed a transport-sector deal with a 10-year maturity, denominated in Turkish lira.

ED, Akbank Turkey’s corporate bond industry has grown in leaps and bounds in recent years. It is still small compared to emerging-market peers, at around TL30 billion ($14 billion) but it’s a number that will continue to grow. Local banks are likely to be major funders of infrastructure deals in the near future, but increasingly they will not be the only participants.

Euromoney How do you sum up Turkey’s infrastructure potential and challenges?

BT, Akbank We are only in the early stages of building the country, and everything is aiming toward the [premier Recep Tayyip Erdogan’s] Vision 2023 plan. Turkey has enough financial institution capacity to achieve this aim, and more than enough human resources. More involvement from international players will be crucial to meet the ambitious pace of this programme.

ED, Akbank I am a sincere optimist. The Turkish economy produced a current account deficit of $65 billion in 2013. If you exclude energy imports, that number falls to $16 billion, which is negligible. So we can save 4% of GDP by just excising our energy-financing needs. And 4% of GDP adds up to $30 billion, which is a good number for such an investment. And that means that just by changing our current account dynamics, we can fund a lot of infrastructure investments, which in turn will lead to higher productivity.

HÖ, EBRD Turkey’s infrastructure needs are substantial – I think we all agree with that. There is definitely a potential funding gap if we take into account all the projects that need financing. At EBRD, we are increasing our annual exposure to Turkey every year, with ever more capital allocated to infrastructure. We are also fully supportive of the development of the debt capital markets for infrastructure-based projects.

IT, IFC Turkey remains a very attractive place to invest. It can be volatile, but growth rates show it will be a great place to invest over the next 10 years. It’s our second-largest sovereign exposure, and it’s a country we are very happy to support. Infrastructure investment needs are very large, and this will require the commitment of not just local banks but DFIs, ECAs, foreign commercial banks and maybe the involvement of bond markets and Islamic finance.