MIDEAST DEBT-Turkey's debut sukuk struggles after Gulf over-allocation


* Middle East allocated much more of sukuk than expected

* Secondary market trading below par since soon after issue

* Relatively small number of Gulf investors may have boughtit

* They appear to have ended up with big over-allocations * Political, strategic motives may lie behind allocation By Rachna Uppal and Mala Pancholia

DUBAI, Oct 11 (Reuters) - Turkey's first sovereign sukukissue was a public relations triumph but it's been a financialdisappointment so far in the secondary market, showing the risksof over-allocating debt deals to a single region.

The $1.5 billion Islamic bond, maturing in 2018 and issuedat a profit rate of 2.803 percent , dropped to about98 cents on the dollar in the secondary market soon after issuein mid-September and has stayed below par since then.

Traders say bids have ranged between 99.0 and 99.5 cents inthe past few days. It was bid at 99.5 cents on Thursday to yield2.9 percent, according to Thomson Reuters data.

As Turkey's first official foray into Islamic finance, thesukuk issue was closely watched by investors around the world,drawing 250 separate orders totalling over $7 billion. Thesuccessful sale paved the way for Turkey to raise 1.62 billionlira ($905 million) with a local currency-denominated sovereignsukuk two weeks later.

The historic nature of the dollar sukuk, however, may haveblinded some buyers to risks such as a last-minute upsizing ofthe issue and an overwhelming allocation to a single region, theMiddle East.

"Whilst we are comfortable with Turkey as a credit, weavoided the issue as there was no clarity on the size or pricinguntil the last minutes of the deal," said Mark Watts, head offixed income in the asset management group at National Bank ofAbu Dhabi.

"When buying any asset, clarity of price and size of supplyare key. Turkey priced aggressively, a good deal for them, butit left little on the table for investors and slipped below itsissue levels after a short period."


Turkey, rated BB by Standard & Poor's, was initiallyexpected to raise between $500 million and $750 million from theissue, or up to a maximum of $1 billion, several regionalinvestors who attended roadshows told Reuters.

But the issue was expanded to $1.5 billion in the closinghours, even as price guidance continued to tighten - in contrastto the usual pattern of a substantial upsizing causing somewidening of the pricing.

Another surprise was the huge allocation to the Middle East.Traditionally, Gulf investors have focused on their own region,where yields are relatively high relative to credit ratings. Soan allocation of well under half of the Turkish sukuk to theMiddle East would have seemed reasonable.

But the Turkish sukuk was sold 58 percent to the MiddleEast, 13 percent to Europe, 12 percent to Asia, 9 percent toTurkey and 8 percent to U.S. investors. The small Asianallocation was particularly shocking, since Malaysia is one ofthe biggest sources of demand for sukuk globally.

Many major investors in the United Arab Emirates, bothIslamic and conventional, have told Reuters they did not put inorders for the Turkey deal. They cited various reasons,including unusually tight pricing for a first-time, sub-investment grade issuer.

The implication is that a relatively small number ofinvestors in the Gulf ended up with considerably more of thesukuk than they had expected.

In most deals, investors bid for more of a bond than theythink they will be allocated, on the assumption that actualdistribution of the bond will be proportional to their share ofthe total bid. In this case, Turkey seems to have skewed itsallocation in favour of Middle Eastern bids.

"It was quite expensive and over-allocated. A lot of bidderswent in with conditional orders, above a certain spread, 200(basis points over midswaps) mostly," said a regional trader whodeclined to be identified.


Turkish government officials declined to comment on theirmotivations for the allocations, but many market participantsthink they may have had political and strategic motives.

Turkey decided to allocate a big chunk of its maiden sukukto the Middle East in an effort to develop a new investor baseand help cement growing business ties with the Gulf, thesemarket participants say.

The sukuk prospectus said negotiations for a Free TradeAgreement between Turkey and the six members of the GulfCooperation Council were underway. Meanwhile, Turkey'sIslamist-rooted government wants to develop Islamic finance, forwhich the Gulf is a principal centre.

And a congress of Turkey's ruling AK Party this month madeclear that the country was focused on expanding ties with theMiddle East and the Islamic world, rather than the West, whichwas barely mentioned.

"From a sociopolitical perspective, Turkey is looking Eastrather than West," said a regional debt capital marketsspecialist.

Although some Gulf investors ended up holding more of thesukuk than they had expected and now want to sell, there wasalso interest in the issue among strategic investors in theGulf, bankers said - which suggests the sukuk may not have muchfurther downside in price.

Gulf investors have been increasing their investment inTurkey in areas such as private equity and real estate. Bankerssaid some of these investors saw the Turkish sovereign sukuk asa way to hedge against their private sector risk in the country.

"You have to look at it as hedging. Gulf investors haveinvested massively in Turkey in the last 12 months, so buyinginto the sukuk is a way of hedging Turkish exposure," said aGulf-based banker.

There is also speculation that some of the Gulf's sovereignwealth funds may have put in big orders for the Turkish sukuk,which could account for part of the heavy allocation to theMiddle East. Supranational institutions and central banks took10 percent of the sukuk globally, according to the breakdown ofinvestor types.

Sovereign funds are generally conservative investors whichdo not normally invest in non-investment grade instruments, andhave shown little interest in sukuk.

However, several regional capital markets sources said theyunderstood Turkish officials held one-on-one meetings withregional sovereign wealth funds in Qatar and Saudi Arabia beforethe issue.

The deal was lead-managed by Citi , HSBC andLiquidity House, a unit of Kuwait Finance House .Qatar's Barwa Bank, in which Qatar Holding, the investment armof the Gulf state's sovereign wealth fund, owns a 12.1 percentstake, was added as co-lead manager late in the process.

(Additional reporting by David French in Dubai and NevzatDevranoglu in Istanbul; Editing by Andrew Torchia)

((rachna.uppal@thomsonreuters.com)(+971 4 366 4240)(ReutersMessaging: rachna.uppal.reuters.com@reuters.net))