Higher funding costs, a repricing mismatch, rising loan defaults and a recession will cause profit to fall at the top six listed Turkish banks this year, according to estimates, although the sector proved resilient during a challenging 2018.
The health of the Turkish economy has implications for large European banks such as Banco Bilbao Vizcaya Argentaria SA, the majority shareholder in Türkiye Garanti Bankası AŞ with a 49.85% holding, and UniCredit SpA, which holds half of the total stake in Yapı ve Kredi Bankası AŞ's parent company. Arabian Gulf lenders with exposure to Turkey are also affected, and at a macroeconomic level, the performance of the Turkish economy has consequences for Germany, as it is the second-largest foreign investor in Turkey, whose biggest trading partner is the EU.
To halt the slide in the Turkish lira's value, the central bank hiked its monetary policy rate to 24.0% from 17.75% in September 2018. The currency slump coupled with the trade dispute with the U.S. curbed economic growth, which came in at 2.6% in annual terms for 2018 versus 7.4% in the previous year. The economy remains a key focus for President Recep Tayyip Erdoğan, whose platform for local elections on March 31 consists of promises of populist stimulus measures.
The lira's volatility is both a cause and a reflection of the country's economic woes, with the currency slumping to its lowest level in at least 10 years against the dollar in July 2018. The lira has since bounced back, but its decline has wreaked havoc on banks' loan books, as has rising inflation and reduced consumer spending power.
The top nonstate banks — Akbank TAŞ, Garanti and Yapı ve Kredi — and the major state-owned banks T.C. Ziraat Bankası AŞ, Türkiye Halk Bankası AŞ and Türkiye Vakıflar Bankası TAO dominate the sector. The other significant player is Türkiye İş Bankası AŞ, which is majority-owned by the bank's pension fund and the CHP, the opposition social-democratic political party. Of 50 Turkish banks reviewed in a Garanti presentation, the aforementioned lenders hold 70% of assets, 72% of loans and 75% of deposits.
"The competitive dynamics have weakened with margin contraction because of slower business growth, deleveraging in real terms, higher funding costs, higher credit costs," S&P Global Ratings Associate Director Magar Kouyoumdjian said on an analysts call, in which the ratings agency forecast Turkey's economy would shrink 0.5% in 2019. "Overall, this could weaken banks' performance and ultimately weaken the industry's stability."
Unfavorable pricing dynamics
Industry data shows that so far this year, state banks are growing, while foreign and private banks continue to deleverage, said Umut Kovancı, assistant director of research at Oyak Securities in Istanbul. Kovancı predicts lenders' performance will depend on funding costs — banks pay 19% to 20% on lira deposits, while the average loan yield of commercial loans is around 23%. Annual inflation was around 20% as of December, down from October's 15-year high of around 25%.
"This margin isn't enough to absorb the potential cost of risk and additional costs," he said.
"Banks are reluctant to lend, but if inflation falls to around 15% to 16% and interest rates are lowered — the market has already started to price in a cut of 500 to 600 basis points — this will reduce lira funding costs, improve banks' spreads and make expanding their loan books a more attractive prospect."
Banks hold inflation-linked bonds in which they earn more income when inflation is high, which massively supported margins in 2018, especially in the fourth quarter. Yet a lira shortage has forced banks to pay a premium on deposits to attract customers.
"Elevated funding costs and a repricing mismatch have been problematic — lira funding facilities are repriced far faster than lending. For example, deposits have an average maturity of 40 days, while loans average about one and a half years," Kovancı said.
"The pricing dynamics have not been favoring the banks."
'This year will be tough for banks'
Turkey's economic woes in 2018 have had a material effect on lenders' asset quality. Garanti, whose Spanish parent BBVA took €365 million of provisions relating to its large customers in Turkey last year, posted a 2018 net profit of 6.71 billion lira, up 5% year on year. But its NPL ratio rose to 5.10% in 2018 from 2.54% in the prior year, according to S&P Global Market Intelligence data.
AK Bank's 2018 net profit dropped 5% to 5.71 billion lira as its expenses jumped by one-fifth, while its NPL ratio ticked up to 3.79% in 2018 from 2.06% in 2017, and it has guided for around 6% this year.
Yapı ve Kredi missed its guidance on its NPL ratio, with its toxic loans coming in at 5.33% in 2018 up from 4.11% in the prior year, but net profit was up 29% on year.
"This year will be tough for banks. We forecast a 5% decline in banking sector profits, but banks are well-prepared," Kovancı said. "The first quarter will be the toughest in terms of revenue generation. Core revenues will be under pressure but starting from Q2 we expect banks to slightly recover by the end of 2019 and into 2020."
The lira rebound has helped improve banks' capital ratios, which are sensitive to currency fluctuations, but the weak lira continues to weigh on banks' asset quality.
Problem loans to hit 20%
S&P's Kouyoumdjian said so-called problem loans — which include impaired, stressed and restructured loans — were already around 10% to 15% and could hit 20% by year-end.
The main cause of rising NPLs is the sustained plunge in the Turkish lira and a sluggish Turkish economy.
"Whichever indicator you look at, it shows a massive slowdown in economic activity — be it unemployment, PMI, negative credit growth or property prices," said an analyst who declined to be named.
As of March 22, US$1 was equivalent to 5.73 Turkish lira.
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