Turkey's stop-start IMF-backed privatisation process has picked up in the past two years with the government selling stakes in steelmaker Erdemir, oil refiner Tupras and interests in mobile and fixed line operators Turk Telekom and Telsim.

More is planned. The first three concessions in Turkey's power distribution network will be on the block in January (see box) and a range of infrastructure concessions in the port, airport, road and rail sectors are expected to be tendering or closed before the next presidential election in May 2007 and, more significantly, the general election on 4 November 2007.

But more planning than doing has been the trademark of the Turkish privatisation programme to date. Despite the successes over the last 16 months, many planned sales have still been cancelled or ended up in the courts. Most recently tenders for the Bor, Eregli, Ilgýn and Kayseri sugar plants were cancelled at the last minute despite having already been postponed. The sale of state bank Halkbank is also taking longer than expected to launch, and the privatization of Izmir port has been postponed for the third time, and will now launch in 2007.

But even if only some of the planned sales end up in the market next year, there is a conservative $4 billion of project lending to be met before the end of next year – small compared with developed markets but at much higher lending margins (100bp-plus for corporate debt and around 240bp average pricing for project debt).

Lending competition picking up

On the downside for local banks, but good news for borrowers, that level of pricing has attracted an influx of foreign lenders and margins are already beginning to fall. HVB, WestLB, Citigroup and Credit Suisse have developed a high-profile presence in the project market, SG is sniffing around the corporate debt market and HSBC is making its mark in the capital markets.

Infrastructure funds are also showing interest. Deutsche's RREEF, Orix and Babcock & Brown are said to have been looking at acquisitions and a fund financing is expected in the next three months.

Both investment trends could eventually cut into local project lending business. Local project banks – Garanti Bank, AKBank, Yapi Kredit, Isbank, Vakif Bank and Halkbank – face a higher cost of capital under Basle 2. That, combined with cheap international debt, private equity funds arranging their own equity finance, and the fact that local banks cannot take stakes in non-financial institutions, which bars them from topping up project margins by taking equity stakes, could eventually sideline local banks from MLA roles on the major transactions – as has happened in the Gulf.

For the moment such a scenario appears a long way off. To date the Turkish banks have had MLA roles on most of the significant concession and privatization deals (notably those without Turkish government guarantees) and although cost of capital is an issue, many have sold strategic stakes to foreign lenders, thereby gaining access to a source of internationally competitive long-term lending.

Furthermore, both the lending market and the Turkish government are pushing the boundaries of what is possible in terms of structuring project and acquisitions debt. Tenors have stretched to 10-12 years on recent non- and limited recourse facilities – symptomatic of banks being more comfortable with the long term prospects for the Turkish economy, which has both stabilised and experienced lower inflation, albeit not to forecast levels – and the government has both started to accept step-in rights and is looking at dollar-based energy tariffs (see box) in an effort to give lenders even more comfort.

New benchmarks set

For the market to really take off, tenors need to go out to around 16 years, which appears unlikely in the short term. That said, the flagship deals of 2005-6 clearly demonstrate progress. Vodafone paid $4.55 billion for Telsim and funded the deal off its own balance sheet. But Turk Telecom, Tupras and Erdemir spawned hybrid financings that gradually pushed the envelope of what was bankable.

Turk Telcom was the first successful syndication of a financing package supporting a Turkish privatisation. Saudi Oger won the tender for a 55% stake in Turk Telekom in July 2005 (the Turkish government has retained 45% which will be sold through an IPO) with a $6.55 billion bid, and in November ABN Amro and Citigroup signed a $1.4 billion 15-month guarantee facility for Ojer Telekomunikasyon, the special purpose vehicle set up to acquire the stake.

Saudi Oger is paying in instalments. The second $1.5 billion payment was due November 2006, while the third is due in November 2007. The sponsor currently has ABN Amro and Citigroup syndicating $3 billion of debt, which is rumoured to be oversubscribed and priced at around 250bp over Libor.

The Tupras sale – an important deal in the government privatisation programme since Tupras meets more than 80% of total demand for refined oil products in Turkey – followed Turk Telecom and was won by a consortium led by Turkish industrial conglomerate Koc Holding.

Koc mandated six banks to arrange a $1.8 billion 10-year limited recourse loan to back the bid, as well as JP Morgan to arrange a corporate loan of up to $2.5 billion.

Both facilities incorporated elements that were new benchmarks for the Turkish project and corporate debt markets. The corporate tranche was unfamiliar to lenders – three-year Turkish corporate debt with tickets of $100 million. And the limited recourse tranche, although not unfamiliar in terms of tenor or documentation, was unusual in terms of the amounts involved. It showed that local banks could put up large takes of $300 million-$500 million each, and that small groups of Turkish banks can do $1 billion-plus project deals.

AKBank, Halk Bank, Garanti Bank, Isbank, Standard Bank and Vakifbank signed the $1.8 billion limited recourse loan backing the Tupras bid in January, while JP Morgan provided $1.5 billion of its $2.5 billion facility on a bilateral basis in the form of a $950 million seven-year facility and a $550 million loan with a 732-day maturity and a 366-day extension option.

To syndicate the remaining $1 billion, JP Morgan brought in Calyon and WestLB as bookrunners and launched a senior syndication at the beginning of February, offering banks a $100 million ticket paying 90bp in fees. The loan paid a margin of 100bp over Libor. Banks that committed to the facility included ABN Amro, Bank of Tokyo-Mitsubishi UFJ, Citigroup, Fortis Bank, HSBC, Natexis Banques Populaires and Standard Chartered.

The retail phase, during which lenders were offered a top ticket of $50 million for a fee of 70bp, was launched towards the end of March and secured commitments from Alpha Bank, Banca Intesa, EFG Bank, ING and Mizuho. The facility was signed at the end of April.

The $1.8 billion limited recourse facility, which came with no shareholder guarantees, was structured on the basis of cashflows, in the form of dividends to be paid by Tupras to an SPV – Enerji Yatirimlari. It was this SPV, which is a partnership of Koc Holding (75%), Aygaz (20%), Opet (3%) and Shell (2%), which acquired the 51% stake in Tupras. The 10-year facility – arranged by Halkbank with Garanti Bank, AKBank, Isbank, Standard Bank and Vakifbank as MLAs – has a grace period of 2.5 years, and an average maturity of seven years.

The novelty value of the total package meant that even banks with a long track record in Turkey had to spend a long time in credit, and for the corporate tranche it became clear that a lot of banks did not have credit lines for that kind of deal.

Oyak Group adopted a similar full and limited recourse funding strategy to back its purchase of a 46% stake in Erdemir, for which it agreed to pay $2.77 billion in an auction held in October 2005.
Oyak mandated ABN Amro, Citigroup and HVB to arrange a $1.62 billion 10-year limited recourse loan and a $1 billion two-year corporate facility (arranged by Citi and ABN only).

The limited recourse deal paid a margin of 140bp over Libor during years one to three, 210bp during years four to seven, and 240bp thereafter. The deal found strong domestic support, with Calyon, Fortis Bank, Garanti Bank and Isbank joining as mandated lead arrangers before launch.

The corporate deal closed later and paid a margin of 90bp over Libor for a $100 million ticket and a fee of 45bp. Lead arrangers could lend $50 million for 35bp, arrangers $25 million for 27.5bp and co-arrangers $10 million for 20bp. The deal came in oversubscribed, partly because of Oyak's quasi-sovereign status – Oyak is the Turkish armed forces pension fund.

Pricing contrasts

The contrast in pricing between all these deals and what went before them is stark. In May 2005 the 12-year Ankara Airport concession debt – which comprised a small Eu149.5 million ($177 million) commercial bank piece, a Eu28.5 million ECA facility and a Eu8.0 million working capital loan – priced at 350bp over Euribor during construction, 325bp post-completion, and then ratcheted up to 375bp over the life of the loan.

The deal was no great risk and subsequent airport deals have come in at around the same mark as the hybrid privatisation facilities – 250bp. Although Ankara was the first to go to a 12-year tenor, the 100bp difference in pricing is a clear signal that Turkish lending margins have become more competitive very quickly. Another similar drop this year and they will be down to the same kind of level as PPP deals for new EU member states.

The next big sale will be energy distribution (see box) for which around $2 billion-plus of project debt will be needed. But if the privatisation agency can get agreement with the competition board over how to push the port privatisation programme forward, a number of port deals could close in quick succession.

Infrastructure privatisation in 2007

The ports of Izmir, Mersin, Iskenderun, Derince, Bandýrma and Samsun – all operated by the state railway administration TCDD – were included in the privatisation programme in 2004. What has held the programme back is the insistence that no operator hold two complimentary concessions so that competition between ports that are next to each other is kept strong. The winning bidder for Mersin Port was PSA, which also has the concession for the next port along the coast at Iskenderun. Consequently the award has been challenged in the courts.

The situation becomes more muddled because the runner-up in the Mersin bid, and therefore the next winner if the competition board does not favour PSA, was Dubai Ports, which has also won the Izmir concession. Consequently no bid can go to financing until a decision on one of them is made. The only port deal that appears to be moving is the $250 million Mamara Port acquisition facility, for which around $200 million in debt is expected to close before year-end.

Other more traditional procurement financings are making more progress. Upgrade and expansion build-operate-transfer (BOT) concessions are underway for Antalya airport and Istanbul's second airport – Sabiha Gokcen. There is also $1 billion in motorway financings with treasury guarantees in south-east Turkey: on these deals the private sector contractors are paid by the government roads authority and the government, albeit indirectly, raises the debt from the bank market. The $400 million treasury-backed Ankara-Istanbul motorway has been postponed but is expected to return to the market to be financed 50/50 by commercial debt and the Treasury. And the $480 million Istanbul Metro expansion – mandated by Istanbul Electricity Tramway and Tunnel Administration (IETT) to WestLB – has almost reached close.

Commitments are largely in for the deal, which comprises a $310 million commercial tranche and a $170 million Euler Hermes-covered tranche. The municipality of Istanbul is guaranteeing the debt.

Turkey is potentially going to be the next big niche European project sector – although EU accession is still some way off. But it will need to further develop the environment for long-term project debt and foreign sponsor security if it is to attract the kind of foreign capital investment it is hoping for. For all its success in the past two years, it only pulled in $1.7 billion in foreign capital through privatizations in 2005, and the same in 2006.

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Power distribution privatization 2007

In early 2007 three of Turkey's most economically viable distribution networks – Istanbul Anadolu Yakasi Elektrik Dagitim (Ayedas Region 14) Baskent Elektrik Dagitim (Baskent Region 9) and Sakarya Elektrik Dagitim (Sedas Region 15) – will be tendered as 40-year concessions.

It is not the first time the networks have been on the sales block. Turkey tried and failed to privatize them in 2002. But this time there is an unprecedented sense of urgency – so much so that bidders were only given a month to come up with proposals before the September 2006 deadline and were forced to ask the government for an extension to early 2007. The deadline for bid filing is now 19 January 2007.

Electricity in Turkey is expensive – 8 cents/kwh for industry and more for domestic use – because of network loss ratios, which are up to 20%-plus in Eastern Turkey. The sale process is designed to reduce loss ratios on the distribution network, and the winning bidders will be expected to spend significant sums at the beginning of the concession to upgrade the existing systems.

The success of the sale will also be key to further network privatization (there are up to 21 concessions in all). The three initial concessions on offer are the lowest risk Turkey has – 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).

EMRA recently 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 and will be determined at a later date by the distribution companies in accordance with an Electricity Market Tariffs Communique and related regulations but subject to EMRA approval.

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 companies have prequalified for the auction and the winners are expected to be local consortia in joint ventures with internationals (Enel and Enka recently announced a joint bidding venture for all three tenders). But for all the interest the tender is creating, 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 and future tariffs – an issue that Project Finance put to Murat Bilgic, regional manager in the corporate loans department at Isbank.

PF: Isbank was involved in all of the privatization financings last year – what is your take on the power network sale and the information available to bidders and their bankers?
Bilgic: "It's a big competition and we're attempting to stay in touch with everybody. But even for the bidders, solid data for risk analysis is not as freely available as it could be. In the initial talks information on loss ratios on the networks was distributed – but that data was from the first attempt at a sale in 2002 and totally out of date. Consequently all interested parties are trying to get as much new data as they can before committing."

PF: What do you see as the major hurdles the privatisation will have to overcome?
Bilgic: "There are the usual macroeconomic issues – currency risk and inflation (which diverged from target in May and is now above 10%). In the power sector the government is already attempting to minimize currency risk by passing a law to set tariffs in US dollars.
"But there is still the issue of power liberalization in 2010 and no-one is clear on what tariffs will be after that. The uncertainty makes base case financing models beyond 2010 difficult to predict."

PF: Is there a possibility that banks will structure bridges or mini-perms prior to 2010 and then refinance when the tariff regime is clarified?
Bilgic: "Unlikely – the concessions and sums involved are both long and large and any buyer is unlikely to be able to support debt repayments for such a short-term – even with a bullet and subsequent refinancing. These deals will need a minimum of 10-year tenor and possibly more which in itself is a problem given deals to date have not gone beyond 10 years."

PF: Given the government urgency to get these concessions tendered are there any initiatives to make financing these deals easier?
Bilgic: "Isbank already collects receivables for the government on the Sakara regional network, which could easily be leveraged as part of an acquisition financing. Unfortunately at the moment the government does not allow receivables to be pledged – but we are discussing the option with both the administration and bidders.
"A further problem is that any loan will be at an SPV level which will be remote from the target company. For a receivables deal to work the SPV would need to merge with the target company – again something the government is looking at facilitating."