It has been more than nine months since Sekerbank introduced Turkey to covered bonds, and no one else has followed suit.

At least a couple of other originators are reportedly planning their own deals, but skeptics say the domestic market in non-government bonds is too thin, and the current economics of doing a deal not compelling enough, for a true market to emerge anytime soon.

But several factors point to what some see as the inevitability of this product's appeal. Chief among them are burgeoning mortgage books and a deepening domestic funding base.

Hunger for Housing

While Sekerbank used loans to small and medium enterprises to back its covered bond program - the first of its kind in Europe - players said that follow-up issuers were far more likely to use mortgages. Indeed, they argued that the emergence of a true covered bond culture in Turkey was predicated on the use of mortgages, even though domestic legislation allows for other assets. There are actually two separate pieces of covered bond-related legislation in Turkey: one for covered bonds backed by mortgages and another for those secured by any of a wide range of other collateral.

"We believe covered bonds should be using mortgages denominated in Turkish lira; the bonds should also be in Turkish lira and funded by Turkish investors," said an official at a Turkish bank, adding that without these conditions, a program would end up as a lone deal instead of a building block for a larger marketplace.

Mortgage growth in Turkey has indeed been stellar since about 2004, although the amount in dollar terms has recently dipped a bit on the back of a steep devaluation of the lira (see chart next page). Mortgages remain overwhelmingly denominated in local currency.

The appetite for housing loans has been sustained by economic growth over the past several years as well as the fact that mortgage debt remains at a very low level as a share of GDP, at about 5%. Observers say these factors will continue to provide fuel. Despite the economic malaise of the neighboring eurozone, Turkey's economy has been cruising along since it emerged from a sharp downturn in 2009, provoked by the global financial crisis. The average economic growth of 2.4% a year between 2007 and 2010 raced to 8% in 2011.

The potential for mortgage covered bonds is palpable. A source at a multilateral bank said that at least two Turkish banks are seriously looking at establishing a program, and that most of the top six banks have looked at it. The top seven banks in the country - accounting for a combined 64% of banking assets - are Akbank, Is Bank, Ziraat Bank, GarantiBank, Yapi Kredi Bank, Halkbank and Vakiflar Bank, according to a report by the World Bank.

Akbank has indicated to the press that it is considering a covered bond. An official from the bank did not return a request for comment.

Bahadir Teker, the general manager of non-bank originator Seker Finance, said he wanted the lender to be the first to issue mortgage covered bonds. "Timing-wise and instrument-wise, covered bonds are a good fit," he added. Seker Finance is a unit of Sekerbank.

The originator has its work cut out for it. Apart from not having a rating - Teker says it plans to get one by the end of the year - there is the issue of book size. The originator issued its first mortgage only last year, and its book currently stands at about TL100 million ($57 million). The GM said the figure should quadruple by mid-next year, however.

So far, Seker Finance has received long-term funding from the U.S. Overseas Private Investment Corporation. Its loans have a longer average maturity than the Turkish average, with the lender having originated the first 30-year mortgage in lira last year. Other banks have termed out their mortgages no more than 20 years, Teker said. But the norm is far shorter. The average mortgage term in Turkey is around eight years and the average duration three, according to the Turkish bank official.

Established in 2010 originally as Istanbul Mortgage Finansman, Seker Finance became a subsidiary of Sekerbank in 2010.

Sekerbank's TL800 million covered bond program, which has seen a few taps since its debut in July 2011, is denominated in local currency, but the buyers so far have reportedly been only foreign. Indeed, they appear to be made up entirely of multilaterals. To be sure, the first couple of disbursements from the program have gone to the likes of the International Finance Corp., the Dutch development bank FMO, the European Investment Bank and the European Bank for Reconstruction and Development. UniCredit has handled the program, which is rated 'A3' by Moody's Investors Service.

Unless Seker Finance is able to tap multilateral funding sources as its parent has, the mortgage originator will have an uphill battle drumming up interest from domestic investors in its deal. Indeed, even larger financial institutions with track records in issuing Eurobonds, local paper and structured paper backed by diversified payment rights (DPRs) face serious barriers to selling covered bonds locally.

But the market is growing, which bodes well for covered bond issuance down the road.

Lira Market: Are We There Yet?

Historically, Turkish banks have been avid buyers of government bonds, eschewing corporate paper. This has pushed the corporate sector to seek funding abroad while stunting the development of a domestic market in bank and corporate paper.

Part of the problem is a relative dearth of non-bank investors that can generate a market for a given financial product.

At the end of 2010, the total investor base - insurance, pension and mutual fund sectors - in Turkey amounted to TL61 billion, or 5.5% of GDP.

The percentage of assets managed by domestic investors in other emerging markets at comparable levels of financial development is significantly higher. In Brazil and Malaysia, for instance, they are over 70% and over 40%, respectively.

Within this investor base, private pensions accounted for 1% of Turkish GDP by the end of 2009. The government hopes to lift that figure to 10% by 2023. Given the country's demographic profile, it could very well achieve that, according to the World Bank report.

All this has translated into a tiny market for lira-denominated bonds outside of Turkish treasuries. Up until very recently, corporate borrowers - in addition to banks themselves - could count on the domestic market only in relatively small doses.

But this segment is growing, and growing fast.

Corps and Banks Hit Their Stride

So far in 2012, banks and corporates have issued TL10.9 billion in bonds, according to the Capital Markets Board of Turkey. This compares favorably to the TL18.5 billion for all of 2011, which was, in turn, a 740% increase from the TL2.2 billion posted in 2010.

A big shift in this market took place in October 2010, when Turkey's Banking Regulation and Supervision Agency allowed banks to issue lira-denominated debt instruments in the domestic financial markets. As a further push, in January 2011 the government slashed the transaction tax on corporate bonds in the secondary market from 5% to 1%. The idea was to level the playing field with local treasuries.

Encouraging a non-governmental bond market is immensely important to an embryonic product such as covered bonds, which could in many ways be seen as the next step in financial evolution from a corporate bond.

Still, even a larger space for corporate and banking bonds doesn't guarantee that covered bonds are next in line, or even make economic sense.

One of the reasons has to do with ratings. When Turkish originators thought they would have to attract foreign investors to local covered bonds, they assumed that the product would have to reach at least single-A on the global scale. And even then, they knew it would be tough to placate foreign buyers who associate covered bonds with the triple-A seal. Sekerbank's covered bond, for instance, was 'A3', and there was never any question that multilaterals would have to be the first buyers.

Now that a domestic market is taking root, lenders say they may not have to depend as much on foreign investors. Unlike their counterparts abroad, local investors are not as concerned with ratings, at least not yet, sources said. This might seem to confer an advantage over foreign investors' grade fixation.

But in reality it is a double-edged sword. On the one hand, originators would not necessarily need to struggle to achieve a certain grade, giving them some breathing room. On the other, investors might scarcely differentiate - if at all - between a covered bond and a plain vanilla one from the same issuer.

This line of reasoning would be most applicable to top-tier banks that already have outstanding plain vanilla debt locally and are able to hit triple-A ratings on the national scale. Across emerging markets, even domestic investors who care a good deal about ratings have often been reluctant to accept tighter pricing on an originator's structured deal in comparison with its vanilla debt if the latter is already triple-A on the national scale.

"We have a developing bond market; that is a positive," said the Turkish bank source. "But investors are not ratings-sensitive from a commercial viewpoint." All the extra work that goes into a covered bond, then, would be difficult to justify.

Domestic bonds for a top-tier bank price at 50-70 basis points over local treasuries. Achieving tighter pricing on a covered bond is not yet possible, the bank source said.

"The question for covered bonds is will the domestic investor reward this higher-quality instrument?" said a source at a multilateral bank. "[An originator] will go to the trouble to do a covered bank only if [they're] confident [they] can get a discount in the market compared to senior unsecured."

So far this does not seem to be the case. But it might turn out true further down the road, particularly for third- and second-tier issuers. Originators higher on the food chain will likely have to find other reasons to justify doing a covered bond, possibly pushing out maturities or diversifying funding.

Getting multilaterals who will accept tighter pricing on board will obviously alter the math as well.

Also, the idea of foreign private-sector investors eventually buying into Turkish covered bonds has not dissipated entirely.

Indeed, they are already in the local treasury market. But players say that their involvement is contingent on a vibrant secondary market, something that does not exist in the corporate and banking bond market.

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