Turkish project sponsors and lenders have long argued that their costs of borrowing have been artificially high because their country rating does not reflect the real strength of the Turkish economy. Fitch appears to agree, and upgraded the country’s sovereign rating to investment grade in November 2012.

But there is still as little agreement among the ratings agencies about what grade Turkey should be. So while Fitch now has Turkey at BBB-, Moody’s rates Turkey a notch below investment grade, Ba1with a positive outlook. Standard & Poor’s puts Turkey two notches below investment grade, at BB with a stable outlook.

S&P’s cut in Turkey’s outlook from positive so enraged the Turkish government that it stopped paying S&P for a rating. Moody’s, on the other hand, concedes that in 2011 Turkey had debt as a percentage of GDP that was more in line with investment grade countries than its sub-investment peers.

And there is also little agreement on what effect an investment grade rating from all three agencies would have on Turkish borrowing, with some bankers arguing that cost of borrowing for Turkish banks already assumes an upgrade from the trio.

But while the ratings agencies (the same agencies that still had Greece as investment grade in early 2010), analysts and economists argue the official rating, the perceived strength of the Turkish economy is already evident in debt markets, with Turkish banks making significant headway in cutting their cost of borrowing.

In August 2012 Akbank set a new borrowing benchmark low, when it managed to reduce the pricing on a loan to 135bp and pulled in an oversubscription from lenders. Garanti followed in November with 125bp, and now Akbank is back again with a dual-tranche $1.2 billion equivalent one- and two-year deal with pricing of 100bp and 125bp all-in, respectively.

With sub-100bp borrowing by Turkish banks looking possible in the coming year – particularly if, as expected, Moody’s joins Fitch in bestowing an investment grade rating on Turkey – project sponsors in Turkey could benefit from a follow-through cut in debt pricing, although the problem of mismatch between bank short-term borrowing and long-tenor project lending means any cut will not be as significant as sponsors are hoping for.

An upgrade could also significantly improve the chances of a project bond market developing for Turkish projects. A bond was originally a possibility for part of the financing of the upcoming Gebze-Izmir toll road, while at least one other international issuance is under consideration for another major Turkish project and has already received a positive preliminary rating, and UniCredit, RBS and Bank of America Merrill Lynch are out to market with a less exciting, but substantial, $500 million corporate international issue for Sabiha Gocken International, operator of Sabiha Gocken airport, whose sponsors are GMR, Limak and Malaysia Airports Holding.

With a Turkish sovereign rating at investment grade, and given that the Turkish government provided guarantees on many of the major PPP projects tendered since the implementation of Turkey’s new BOT law in June 2012, a bond package would likely be met with considerable international lender appetite. Bonds would overcome the obstacles caused by the mismatch between the short-tenor bank borrowing and long-term bank project lending.

Despite a raft of infrastructure project tenders and some high-profile sales Turkey’s privatisation programme, which has been successful but glacial in its progress, the international borrowing market for Turkish projects has contracted significantly since 2008, and the cost of borrowing from local banks has climbed by around 250bp in the same period to between 700-800bp.

Active lenders, but fewer of them

International lenders remain active, although far less so than during the pre-2008 period, and few still have a footprint in Turkey. UniCredit owns 50% of Yapi Kredi and maintains a presence in its own right. WestLB, once a major arranger in the Turkish project market, has folded. ING and SG also remain in the local market. And Dexia sold its profitable Deniz Bank to Sberbank in September 2012, though Deniz expects to remain an active local project lender.

But of those banks on the ground, only UniCredit, through Yapi, was an active project lender in 2012. And when international banks do come into a deal they are normally alongside export credit agencies and development banks, as happened on the Eurasia Tunnel project (see Project Finance’s February 2013 issue), or projects with a very strong non-Turkish sponsor, as in the Enerjisa deals, where Verbund was, and now E.ON is, 50% owner. Banks would prefer both to be the case.

Local lenders have, to date, bridged the gap left by the retreat of international lenders. Local bankers initially saw that retreat as an opportunity, but now recognise that the market needs some international lenders willing to assume commercial risks. The sheer size of the debt requirements of projects coming to market in the next two years alone is likely to stretch the local banks.

For example the total for just two roads deals – the Gebze-Izmir toll road and the most recent roads privatisation is around $15 billion of long-term debt. In December a consortium of Koc Holding, Gozde Girisim and UEM Group won the latest roads package, which includes the Edirne-Istanbul-Ankara motorway, the Bosphorus and Fatih Sultan Mehmet bridges in Istanbul and 1,975km of toll roads.

Sponsors also want more international lending to put pressure on local banks, which, according to Kadri Samsunlu, CFO of Akfen, “are not yet passing on their lower cost of funding.” The problem for sponsors is that even when international lenders look at taking local project risk they will not offer more than five- to seven-year tenors. In addition, some international banks have been pitching soft miniperms (long-term deals with major pricing increases after around six years that are designed to force a refinancing) to Turkish sponsors. Both lenders and sponsors in Spain and Portugal bought into that concept early in the last decade and have since deeply regretted using the product because of their inability to refinance those deals in the current market.

What price debt?

While financing options remain constrained for all but the best project credits – either because of cost of debt or length of tenor – Turkish government is launching privatisations and tenders for greenfield projects in energy, transport and social infrastructure at a prolific rate, though in some instances using circuitous routes.

In the roads sector the financing of the $1.45 billion Eurasia Tunnel was Turkey’s first major PPP to close with all the state guarantees that the new BOT law facilitates. It benefited from major multilateral and ECA support, and its funding was in place before Fitch’s Turkey upgrade. Its 18-year debt priced at an annual 350bp over Libor, with a 220bp upfront lenders fee. These numbers will give an indication of the margins to come for any international debt on the $10 billion Gebze-Izmir, and to a lesser extent the roads privatization debt package.

The first phase financing for Gebze-Izmir is expected to reach financial close in March. The 22.5-year concession comes with the same revenue and debt guarantees as Eurasia Tunnel, and its lead arrangers are UniCredit, Credit Agricole, Mizuho, NCB, IDB, Akbank, Isbank, Yapi Kredi, Garanti, Finansbank, BIIS, Ziraat Bank, Vakifbank, Halkbank, Citibank, IFC and EBRD, with ECA support from JBIC/Nexi and Sace.

The project has been split into two financings – the first for the Izmit Bay Bridge and Gebze-Bursa section and the second for the Bursa-Izmir section. The Izmit Bay Bridge accounts for the majority of the annual guaranteed traffic income under the concession model – $511 million of a total $683 million, once the whole project is operational in 2019. Consequently, financing for the second part of the scheme may either be a top-up loan or, more likely, a total refinancing, given that the bridge is likely to be operating when the deal comes to market. Phase 1 construction is expected to take 45 months, followed by a further 42 months for phase 2. No revenue is assumed in the five months from end of bridge construction until the end of phase 1 construction.

Because of the size of Gebze-Izmir’s debt requirement Turkish banks will have to play a much larger role. Whilst on Eurasia Tunnel the Turkish bank roles were limited to providing guarantees on a $200 million EIB guarantee facility, Gebze-Izmir will require a large locally financed tranche priced at local levels, rumoured to be around 650bp, and at a local tenor, which, to date, has been 15 years maximum.

Progress and problems

While Gebze-Izmir will dominate the Turkish project finance market in 2013, other major projects are also progressing. In the airport sector, bidders are already showing interest in Istanbul’s third airport, the bidding deadline for which is 3 May. The 25-year BOT concession is for a facility with an annual 90 million passenger capacity (expandable to 150 million) airport and local developers Limak, Alarko, Sabanci, and IC Holding have been linked with the tender.

In addition, in December, TAV Airports signed a Eu250 million ($334 million) 15-16 year loan package for Izmir’s Adnan Menderes Airport. The deal comprises a Eu70 million A loan and a Eu75 million B loan, with UniCredit and Siemens Bank providing Eu40 million and Eu35 million respectively. DenizBank also lent Eu65 million and Black Sea Trade and Development Bank Eu40 million.

In the energy sector the long-anticipated $5 billion Star Refinery project – sponsored by SOCAR (81.5%) and Turcas (18.5%) – is also out to the project market, after holding roadshows in Istanbul and London earlier this month. UniCredit is financial adviser on the scheme, which is expected to have EBRD, IFC, JBIC, Kexim and US Ex-Im support in the form of covered and direct loans. A formal request for proposals is expected in the second quarter of 2013 after the sponsors have digested feedback from the roadshows.

Other sectors in Turkey, particularly the social infrastructure sector, are making slow progress, despite Turkey’s PPP legislation, which is in place, though likely to be subject to additional changes. The hospital sector, for which there are plans for 18 integrated health facilities across the country, is still waiting on financial close of its first concession – Kayseri, whose sponsors are YDA and INSO. And although other concession continue to go out to tender – most recently final bids went in from Akfen and a consortium comprising Sila Dan/Ronesans/ Sam Yapi/Assigna for the 25-year concession for the 600-bed Isparta hospital – the hospital projects are struggling to prove their bankability.

The hospitals have been tendered as build-lease-transfer concessions and come with VAT exemption and 25-year concession contracts. But lenders are struggling with issues such as compensation payments in force majeure situations, difficulties over determining pricing per patient and the fact that minimum patient number guarantees are in Turkish Lira. Sponsors will need to decide to deal with the Lira revenue stream by either paying for cross-currency swaps on non-Lira borrowing or going local, with the risk of an expensive corporate deal in an untested market.

Impact of an upgrade?

The key issue, particularly for the corners of Turkish project market that only appeal to domestic banks, is the cost of risk transfer. For smaller project deals with local rather than international sponsors the options are limited to local debt, and in many instances the cost of local debt is too high to make a project viable.

An upgrade to Turkey’s sovereign rating is not going to move that pricing overnight. But the perception of long-term stability for Turkish bank borrowers will allow them to borrow longer term at lower rates, thus cutting the mismatch between tenors on borrowing and lending. Turkish banks’ ability to pass on their current lower borrowing costs should ease some of the problems that domestic sponsors face. In addition, an upgrade would attract more equity to the infrastructure sector, where projects typically have 20% equity requirements, and in which projects the size of Gebze-Izmir have an uphill task in equity raising.

Changes to PPP and BOT regulation are also having a positive impact on Turkey’s flagship infrastructure projects, although whether state minimum revenue and debt assumption guarantees will go onto the state balance sheet is unclear. If they do, their use will certainly be limited to all but key projects.

A potential sovereign upgrade from a second rating agency, enhanced lender security because of changes to PPP laws and a deal pipeline valued at $60 billion over the next five years – if the Turkish project sector was ever worth consideration from international lenders it is now.