The three bank hobbyhorses of the US sub-prime apocalypse – a return to conservative asset values, rising debt pricing and a global liquidity downturn – could complicate Turkey's recently announced post-election acceleration of its privatization programme.

With the economy at a critical fuel point in its IMF-backed resurgence (economic growth of 7.2% for the past five years), Turkey is vulnerable to a growing current account deficit ($30 billion in the first nine months of this year) that is linked to the rising cost of energy imports and, until recently, no political will to up tariffs to reflect rocketing oil prices worldwide.

Foreign direct investment, much of it from privatization, has been the primary offset to that deficit, financing around 60% of it. And FDI continues to increase – potentially up to $30 billion next year.

But Turkey is faced with a privatization balancing act – a need for strong asset values for its power distribution/production and transport infrastructure, to maximise its medium-term ability to manage its current account deficit in the build up to EU accession; and the necessity of getting the private sector – which faces rising EPC and bank debt costs – into those core industries to maximise efficiency and bring production costs down to a level that no longer require the state to maintain tariffs (energy or infrastructure) at an artificial level.

The equation is further complicated by an overvalued lira, which will put weakened dollar investors at a disadvantage in tenders next year and potentially slim down the number of bidders, depending on asset valuations.

Power distribution for sale

Initial signs are that prime minister Erdogan's re-elected AK Party government will take a pragmatic approach and will be increasing electricity tariffs next year, a politically unpopular move but a necessity if developers are going to take on the inefficiencies of the electricity distribution system: Network loss ratios are 18% on average and up to 62% in some parts of eastern Turkey (the OECD average is 6.5%).

Winning bidders will be expected to spend significant sums at the beginning of the concession to upgrade the existing systems to meet future power demand, expected to rise by 7% annually until 2020 and requiring around $130 billion of investment in both distribution and production.

First on the sales block will be three of Turkey's most economically viable distribution networks – Istanbul Anadolu Yakasi Elektrik Dagitim. Baskent Elektrik Dagitim and Sakarya Elektrik Dagitim.

The three initial 40-year concessions are the lowest risk – Ayedas supplies 1.9 million customers in east Istanbul, with 6315 gigawatt hours (Gwh) and a 7% share of the Turkish market; Baskent has 2.8 million customers and supplies 8041 GWh in the centre west of Anatolia; Sedas supplies 1.3 million customers in the north of Anatolia region with 4134 GWh and has a 4% market share, and, although the smallest in terms of output, is probably the most attractive, since it supplies Turkey's largest and growing industrial area.

The sale will involve a transfer of operating rights with the network assets remaining with stated-owned electricity distribution company TEDAS. The privatized electricity distribution companies will act as regional monopolies licensed and regulated by the Energy Market Regulatory Authority (EMRA).

In 2006 EMRA approved the end user tariffs and revenue requirements of each distribution company for the transition period until 2010 when full power market liberalization kicks in. Unfortunately for bidders the tariffs post-2010 are difficult to predict – although the recent government announcement of an increase is good news.

The four basic tariff components are retail sales, distribution, retail services and transmission; which are regulated in an unbundled fashion. The retail sales tariff has a price cap set at the average price of the energy purchased by the distribution company. Distribution and retail services have revenue caps that cover operating expenses and investment requirements related to distribution and retail services. Transmission tariff is a complete pass-through of transmission costs as charged by state-owned transmission system operator TEIAS.

Around 25 bidders pre-qualified for the auctions in January: Sabanci, Zorlu, Koc, Ciner, Dogan-Dogus-Anadolu Group, ENBW, Habas Sýnai, Limak, Akenerji, Nurol Holding, Iberdrola-Calik Enerji Sanayi, Park, Eren, Hema, Yuksel, Barmek, AES, Novosibirskenergo Energy, Eksim-Kuveyt Turk Katilim Bankasý Ortak Girisim Grubu, Ic-Ictas ?nsaat Sanayi, Prisma Energy, Gama Enerji-General Elektrik Ticaret ve Servis, Ortak Girisim Grubu, Suez-Tractebel, E.ON, Enel and Enka.

The winners are expected to be local consortia in joint ventures with internationals. But it is difficult to predict how the sale and subsequent financing will be structured, given the relative lack of hard data available on loss ratios (the most recent figures available for the first three sales are from 2005 and range from 10-12% loss ratio) and future tariffs.

Turkish renewables boom

Turkey's hydro-power development programme is also accelerating. Enerjisa, a joint venture between Sabanci and Verbund, very recently mandated Akbank, the IFC and Westlb for up to $1.5 billion in debt to back construction of a portfolio of hydro projects. The 10 projects will have a combined output of 928MW.

Financing plans have not been finalised but may comprise a $200 million IFC A loan, a $600 million B loan for syndication internationally by Westlb and a $600 million domestic Turkish tranche for syndication by Akbank. An additional $25 million may take the form of a semi-equity tranche. Clifford Chance is advising the lenders with White & Case counsel to the sponsors.

The deal is the first in spate of hydro financings near or in the debt market. AES-owned IC Energy Group has mandated Yapi Kredit to arrange $175 million of debt for phase 1 in a 15-hydro development between now and 2011. Akbank and Isbank have already joined the deal, which initially involves three projects.

GE Energy Financial Services has also bought a 50% stake in GAMA Enerji which has an interest in the existing Birecik hydro plant and is working on 13 further hydro deals totalling 365MW. And Global Yatirim Holding is in the market with its 22MW Cakit River plant, and has a further six hydros in the pipeline that include the $450 million 350MW Cetin Dam and Hydro Plant.

Wind and geothermal projects are also picking up. GAMA has nine wind projects totalling 490MW in the pipeline and Gurmat Elektirk has mandated Westlb for a $125 million financing to back its development of the 48MW Germencik geothermal reservoir.

All these projects benefit from Turkey's 2005 renewable energy law, which gives a 10-year offtake guarantee and annual tariff reviews by the Energy Market regulatory Authority (EMRA) that cannot go below or above Eu50-55/MWh. Furthermore, projects that start operation before 2011get a 85% discount on land rental from the state and grid connection for 10 years.

Telecoms pioneering

Telecoms has also been one of the big infrastructure success stories in Turkey's privatisation programme – pushing tenors and debt volume to new benchmarks.

Ojer Telekomünikasyon's return to market for a $3.8 billion refinancing in February followed its successful $2.075 billion venture in 2006, which raised over $3 billion in commitments. But the new deal exceeded expectations when it pulled in over $7.5 billion in commitments during the senior phase of syndication. An eight-year facility – the deal was the longest tenor ever for a Turkish corporate loan at that time.

Sponsored by Ojer – a special purpose vehicle set up in 2005 to drive the purchase of a 55% stake in Turk Telekom by a consortium led by Saudi Oger – margins were reverse flexed by 35bp over Libor, bringing pricing down to 240bp from 275bp on the deal, led by ABN Amro, BNP Paribas, Calyon, Citigroup and Fortis Bank.

Telecoms group Avea also launched a $1.6 billion loan in February, arranged by ABN Amro, which raised the whole amount of the loan in senior syndication. In March, Turkcell followed with $3 billion of five-year debt. The facility was led by Akbank, Citigroup, HSBC, Garanti Bank, JP Morgan and Standard Bank and was split into three $1 billionn pieces: tranche 'A' had a three year tenor and paid a margin of 115bp over Libor, and tranche 'B' was a three facility priced at 150bp.

Despite being raised to finance acquisitions with fees payable only on draw down, the deal attracted a lot of commitments in syndication. Ironically, the loan was cancelled at the end of May when Turkcell failed to acquire targets in the Middle East, but the very fact that the banks were willing to sign up to a deal where cancellation meant no fee is a measure of bank appetite for Turkish infra debt.

Transport PPP to break into roads

That appetite bodes well for Turkey's planned road programme. Details are sketchy but the Turkish government has announced a major roads privatization in the wake of the power sell-off.

The Turkish transport market has already spawned strong dealflow in the airports sector, stop-start privatization in the ports sector (although this year the ports market has picked up with the financings of Mersin and Izmir which were stalled by legal challenges pertinent to both projects), and the privatization of the state-owned vehicle inspection chain TuvTurk.

For the moment only two roads have been approved – with Istanbul bridges and the Bosphorus Tunnel PPP divorced from the programme. But a $5 billion package is to be tendered as a whole or in two parts and Macquarie, Brisa and Autostrade have already expressed interest.

Much of the template for the roads programme has already been engineered in the airport and port markets – notably a step-in rights structure that overcomes issues foreign lenders have with Turkish force majeure clauses. Although the step-in rights can be cancelled by the government, lenders are generally secure if every potential breach is outlined in detail.

Such a structure was recently used in the Antalya airport concession financing. Garantibank, WestLB and Unicredit HVB arranged a 12-year Eu600 million ($850 million) financing for sponsors Fraport and IC. The deal priced at 250bp-300bp over Euribor – the standard margin range on most Turkish airport and port deals in the past year.

The next deal to market – the estimated Eu400 million debt financing for the Sabiha Gocken airport terminal in Istanbul – will be an interesting margin indicator of whether the sub-prime issue will affect Turkish infra debt. The deal is being lead arranged by ABN Amro and Yapi Kredit and is just the investment tranche of a 20 year concession awarded to GMR/Limak/Malaysia Airports, which also features a Eu1.93 billion concession fee.

2008 – a year of asset re-evaluation?

Bank consensus is that to date Turkish debt margins have avoided sub-prime fallout – primarily because they are much higher than pricing in the EU, and more particularly new EU entrants. And even compared with a 20bp rise in the general cost of European project debt, Turkish margins look fat.

Furthermore, although investors face a number of hurdles, the Turkish economy is strong. Inflation has declined from 29.7% in 2002 to 7.7% in October of this year. Turkey's annual growth rate has averaged 7.2% since the financial crisis in 2001, when, with the help of the IMF the country instituted a recovery program. Overnight interest rates have fallen from 44% in 2002 to around 16.25%.

Turkish privatization has already wetted international interest, and in the power generation sector demand so vastly outstrips supply that sponsors, if not lenders, may be comfortable going ahead without full offtake agreements.

But asset valuations could become a sticking point in a new lending market ill at ease with high leverage. Turkey's upcoming privatizations – particularly some of the high loss ratio distribution networks – may have a hard ride to market.