Turkey 2007: Scramble for Turkey
Turkish banks are very much in demand. The last 18 months have seen a clutch of M&A transactions that have brought international banking expertise onto the Turkish high street. That foreign investment is likely to continue, but the focus is also on how banks are adapting to the changing economic circumstances. Paul Farrow reports.
Go back a few years, and foreign direct investment in Turkey languished at US$1bn–$2bn a year, below the level in smaller economies in Eastern Europe. Economic and political instability kept investors away, while the economies of the former Communist bloc appealed.
Now things are very different. In 2005–2006 FDI soared, and much of that money went into the banking sector. The list of acquisitions is long, and the origin of the acquirors varied.
Since 2005, Fortis has acquired Disbank for US$1.2bn, National Bank of Greece has bought 46% of Finansbank for US$2.3bn, Dexia bought 75% of Denizbank for US$2.4bn, and Bank Turan Alem of Kazakhstan has acquired 34% of Sekerbank for US$300m.
Greece’s EFG Eurobank bought Tekfen, Banca IMI bought into Yapi Kredi in a partnership with the Koc Group, Citigroup acquired 20% of Akbank for US$3.1bn, GE Capital bought 25.5% of Garanti Bank for US$1.55bn, and BNP Paribas bought 42.125% of TEB. As a result of this M&A, according to Merrill Lynch, foreigners own 18% of banks by assets.
What has been the effect of this M&A frenzy on the banking sector? Fazil Zobu, head of research at local broker Dundas Unlu, thinks that the prices paid in these deals have been based on market share, not profitability, and that is has influenced banks’ market tactics. As a result, there are negative spreads on some mortgage loans, for example.
Moody's noted in a recent report that: "Accelerated business growth is a phenomenon that we have noted in a number of Central and Eastern European markets, where foreign-owned banks have been particularly aggressive" – a function of a higher risk appetite, and willingness to acquire market share.
But the general impression among locally-based bankers is that the foreign entrants have not made what was already a highly competitive market more competitive. “Finansbank was known for its ultra-competitive stance before its acquisition. The arrival of NBG didn’t change that,” said one.
"Banks continue to operate irrationally from a competitive viewpoint,” concluded Merrill analysts in a recent report on the BRIC economies and other emerging markets. “The arrival of more foreign banks may help, but any student of the margin decline in the past three years will understand that the burden of proof remains with the banks.
“They should be able to do better. We understand that the lira deposit market remains tight, but there are simply too few conversations with Turkish banks that do not include reference to ‘irrational competition’ for our liking."
Against such a background, Dundas Unlu’s Zobu sees 2007 as a lower margin year for banks. “Competition will keep lending rates lower than they should be given the increase in funding costs,” he said.
As for further deals, Alternativ Bank is in talks with Greece’s Alfa, and Oyak Bank has been in talks with Calyon and Standard Chartered, though these seem to have failed. In the state sector, the privatisation of Halk Bank remains in the programme and of the big four banks only Is Bank looks set to remain independent. The CHP party’s 30% shareholding in the bank – a bequest from the country’s founding father, Kemal Ataturk – is seen as an insuperable hurdle.
“It would be easier to change the constitution of this country than for the CHP to sell those shares,” ventured one banker.
In addition, Tunc Yildirim, head of sales at Dundas Unlu, suggests that there may be scope for some banking sector consolidation 2008–2009, especially if some of the recent entrants have second thoughts.
“Will some of the new entrants be having second thoughts by then?” he asks. It certainly seems curious that Dexia, fundamentally a public sector bank, has opted for a retail operation in Turkey.
While all this M&A activity has been going on, banks have had to deal with a large increase in interest rates that complicated the last year’s operations.
In May 2006, in response to a period of emerging market volatility that left the Turkish lira 28% lower, the Central Bank jacked up interest rated by 425bp. The resulting fall in government bond prices hit the sector. On average Turkish banks still have one third of their balance sheets invested in government bonds, and Mina Toksoz, country risk analyst at Standard Bank, estimates that the sector lost about 10% of its equity as a result, although the subsequent recovery in bond prices has allowed them to make up those losses.
"It hasn't affected their profitability either, as the banks focused on consumer credit growth, the profit numbers coming out at the moment for 2006 look very good," she added.
But Is Bank’s treasurer Erdal Aral agrees that the larger banks were able to manage their positions rather better than that. Furthermore, he estimates that about half of the system’s book was invested in FRNs, so the impact of the rate hike was mitigated by that as well.
And Moody's claimed that the improvement in the sector over the previous few years meant that the turbulence had little or no systematic effect.
"We note in particular Turkish banks' significant probability and capital cushion, improved credit risk profile, better funding profiles, low exposure to direct foreign exchange risk and moderate exposure to interest rate risk," said the ratings agency.
Thanks to the low open foreign currency position (considering both on and off-balance sheet data) of Turkish banks, they are no longer significantly affected by the depreciation of the TL. This is one of the clear benefits of the closer regulation of the sector since the 2001 crisis. Concern over open FX positions is focused on the corporate sector these days.
In terms of capital adequacy, Merrill Lynch concluded in a recent report on emerging market banks that Turkish banks have plenty of capital to support the expected lending boom in that country when rates come down, while the relatively low value embedded in their deposit bases is evident in the low market cap/deposits ratio. In addition, on valuation metrics, they said that Turkish banks were cheaper than their BRIC rivals in terms of P/E and price/book ratios.
However, the determination of the BRSA (banking regulator) to keep banks’ capital adequacy high means that some may be pushed to issue capital securities. The BRSA has said that it will not allow banks with less than 12% capital adequacy to open new branches, and Yapi Kredi, one of the country’s big four banks, has a ratio of only 12.3%.
According to Is Bank’s Aral, Turkish banks need international funding given the lack of sufficient deposit growth. In 2007, the total increase in bank assets was roughly US$30bn but deposits accounted for only US$20bn of liabilities, the remainder being financed mostly through the capital markets.
Garanti completed its first Tier 2 deal in January, through Merrill Lynch and Deutsche Bank, as a 10 non-call five with a step-up after five years. The book was twice covered on the US$500m deal. As a result the bank’s capital adequacy ratio rose from 14% to 15.5%.
“Tier 2 provides us with the opportunity to leverage our equity in a growth environment,” said Tolga Egemen, head of corporate banking at Garanti.
Kubilay Cinemre, CEO of Merrill Lynch’s investment banking operation in Turkey, agrees. “Turkish banks are going to need Tier 2 capital. Currently almost all their capital is Tier 1, which is simply inefficient,” he said.
Loans and deposits
Meanwhile the banking sector continues to expand in loans, deposits and branches as the economy has continued its recovery from the crisis of 2000–2001.
Banking sector loans grew by 51% in 2005, to US$110.7bn equivalent according to Moody's, following growth of 40% in 2004 and 35% in 2003. As a percentage of assets, loans totalled 37% in 2005, up from less than 15% in 2002, and that percentage has increased further.
NPLs have fallen as a percentage of gross loans, from nearly 18% in 2002 to about 5% in 2005, though the rate of NPLs on credit cards is higher. At Garanti, NPLs are running at 6% for credit cards, well above consumer loans where the figure is less than 2%.
Also on the revenue side, fee income continues to play a big role – up to half of fee income comes from credit cards and mutual funds, and falling interest rates may give scope for some surreptitious fee increases.
Turkey has one of the most highly developed credit card industries in the emerging markets. One third of adult Turks have a credit card, and these account for half of all consumer debt. Anecdotal evidence suggests that Turks are happier about borrowing on a credit card than arranging a loan in a bank branch, although the latter would be cheaper.
The main driver behind Turkish banks’ big ticket lending in 2006 was LBOs, privatisation and medium to long-term investment loans. Turkish banks are seeing good interest from SMEs – Garanti now runs SMEs as a separate business line.
However, there has been a slowdown in demand for housing loans. Although these grew at 81% in 2006 for the sector, that was well down on the 353% rate of growth in 2005, and bankers report that demand slowed further at the end of 2006.
In housing loans the main demand is in the five to 10-year sectors, which account for 73% of total housing loans. Demand is lengthening out to 10 years given the shape of the yield curve. Given the high level of interest rates, even a 20-year loan has a duration of less than five years. Turkish banks are financing their housing loans with FX currency swaps. (See separate article on the new Mortgage Law.)
On the deposit side, there has been an increase in FX-denominated deposits banks, which some bankers take to be a characteristic note of caution ahead of two elections – see the article in this report on the political and economic background.
And in the quest for stable deposits, branch openings continue, especially in smaller, underbanked towns in inland Anatolia. However, the number of branches in Turkey is still not up to pre-crisis (1999) levels.