20 May 2015

Andreas Kuehrer Research Analyst  (65) 6818 7294  [email protected]

Turkish Banks Turkey | Banks

Recommendation: PLEASE SEE TABLE BELOW

Macroeconomic View Turkey is a complex but interesting economic story, which has strong underlying long term credit strengths, but also some key short term challenges which if not properly managed could also weigh on the long term outlook. 

A strong single party government, in power since 2002, has proved adept at setting a clear overall economic development agenda and strategy, and in general has been pro-market and business friendly.



Strong underlying growth drivers, as reflected in favourable demographics – a young, growing population, and much scope (priority target for government) to boost the labour force by improving female participation rates which are low by international standards.



A relatively diversified/flexible export structure – both geographically, and also by content, which has proven a source of resilience in recent years, and for example helped by a state-supported/driven reorientation of trade towards Africa and the Middle East from Europe with the onset of the Eurozone crisis, and then back to the EU as security concerns intensified in Iraq, Syria and also Ukraine/Russia.



Prudent fiscal policy has been a cornerstone for the AKP government – with the maintenance of moderate budget deficits (1-2% of GDP) and primary surpluses, enabling the ratio of public sector debt/GDP to be reduced from over 90% in 2002 to around 35% at present, less than half the EU average, and still on a downward trend and targeted to drop to 30% by 2017.



A strong Western-standard banking sector, benefitting in many ways from reforms instigated after the 2000/01 crisis. The sector is liquid, profitable, well capitalised, with moderate NPLs (much lower than the regional average) and well regulated and supervised.

The above strengths had put Turkey at the top end of the regional growth pack in 2013, with the economy growing at solid clip of over 4%, and double the rate of major peers such as Poland and Russia. However, by late 2013 the strains were already beginning to show, and were a reflection of some underlying weaknesses and some newly emerging vulnerabilities, which are set to be new challenges going forward. The theme of "rebalancing" was certainly the key theme in 2014, and appeared to get added impetus into 2015 by the marked drop in oil and commodity prices - each USD 10 a barrel drop in the oil price is generally expected to cut the current account deficit by around 0.4% of GDP, with a similar cut in the inflation rate. Hence oil down at USD 50 a barrel earlier this year suggested perhaps as much as two percentage points off inflation and the current account deficit from levels in 2014.

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The policy debate is clearly being shaped by the close proximity of parliamentary elections - and the hope is that the vitriol being used against the Central Bank of the Republic of Turkey is merely political posturing to secure extra votes in the nationalist, socialist and Islamist sections of the electorate where banging Western investors always tends to go down well - but if it isn't it would suggest something much more worrying, and a much different direction of reform than that which investors and markets have become used to. The AKP is expected to easily win the elections in June, but the party needs to not only win an absolute majority but also a two thirds parliamentary majority to ensure delivery on President Erdogan's agenda of introducing constitutional reform to move to an Executive presidency.

Banking Sector The Turkish banking sector is the second largest Central and Eastern Europe banking system after Russia with an asset size of USD 778 billion as of YE 2014. Currently, there are 51 banks in Turkey of which 34 are deposit taking including the three state-owned (Vakifbank, Halkbank and Ziraat Bankasi) and the top four privately-owned domestic banks (Isbank, Garanti, Akbank, and Yapi Kredi Bank) account for 42% of the total assets in the system as of YE 2014. The banking sector is well-capitalized (CAR of 15.7% and Tier-I ratio of 13.3% as of YE 2014) and underleveraged (7.8x compared to 8.5x in CEEMEA and 12.3x in Eurozone as of YE 2014). High liquidity, deposit-heavy funding structure and solid asset quality (NPL ratio of 2.8% compared to 9.5% in CEEMEA and 11.4% in EU as of YE 2014) are among some other strengths. The NPL for mortgage loans is at a quite low level of 0.5%. Deposit-taking Turkish banks’ total balance sheets have grown at a significant compound average growth rate (CAGR) of 18.3% from 2006 to 2014, driven by loan book expansion and customer deposits growth, which increased by a CAGR of 23.8% and 16.2%, respectively. Despite strong growth of loans and customer deposits since 2006, the Turkish banking sector remains significantly underpenetrated compared with the banking penetration in the Eurozone. Loans/GDP and deposits/GDP ratios of the Turkish banking sector were 62.8% and 56.2%, respectively, as of 30 September 2014; whereas the Eurozone’s banking sector had loan and deposit penetration ratios of 105% and 110%.

Overall NPL ratio YE 2014

Capital – Tier 1 ratio YE 2014

Source: Company Material

The main challenge for the Turkish banks in the long term remains the country’s low savings ratio of around 12%, which has been underpinned by a young and consumption-driven population. Given the banks’ aggressive lending appetite in the past few years, deposit growth did not match and incremental growth above the country’s savings rate was funded through market sources. As a result, the banks’ loan-to-deposit ratio increased to 110% at end-2014 from c.70% in 2007.

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Akbank – (Baa3/ BBB-) Credit Direction: (=) Akbank is the fourth largest bank in Turkey by total assets as of Q4 ‘14. It was founded in 1948 as a private bank to provide funding to local cotton growers. Akbank’s core banking activities consist of consumer, commercial and SME, corporate and private banking services. Loans are primary focused on the corporate and SME sectors, but retail (consumer and credit cards) also make up a sizeable portion. Akbank’s strategy is to move away from credit cards into SMEs and general purpose loans. The bank has a strong franchise with a broad deposit base. The issuer has the best asset quality with an NPL ratio of 1.7% and at the same time with a Tier 1 ratio of 13.8% the strongest capital position among Turkish banks. The bank remains in a very strong shape after it announced the Q1 ‘15 numbers and as a result we expect the bank’s outstanding debt to trade tightest among private banks in the Turkish Eurobond sector.

Tier 1 & CAR ratio YE 2014 % 19 17 15 13 11 9 7 5 2011

Loan book breakdown YE 2014 31% SME 37%

Corporate

2012 Tier 1

2013 CAR

2014

Retail 32%

Source: Company Material

Garanti – (BB+/ Baa3/ BBB-) Credit Direction: (=) Garanti is the third largest bank in Turkey by total assets as of Q4 ‘14.The bank was established in 1946 as an integrated financial services group in most segments of the banking sector including corporate, commercial, SME, payment systems, retail, private and investment banking together with its subsidiaries in pension and life insurance, leasing, factoring, brokerage and Asset Management. The bank has an extensive network with 994 branches. The Dogus group, a Turkish industrial conglomerate, is the largest single shareholder in the bank. After March 2016, BBVA has an option to increase its stake in Garanti by 1%, effectively assuming management control. We think Garanti remains in a strong position and see the recent increase of BBVA’s ownership as a credit positive. Garanti’s year end results were relatively robust therefore we view the outstanding debt as relatively tight and upside is limited relative to other names.

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Tier 1 & CAR ratio YE 2014

Loan book breakdown YE 2014

35%

Retail Corporate & SME

65%

Source: Company Material

Halkbank – (Baa3/ BBB-) Credit Direction: (=) Halkbank is the sixth largest bank in Turkey by total asset as of Q4 ‘14. It was established by the state in 1938, with a special mandate to provide loans to small businesses and to support growth in underdeveloped areas. The bank is still the only provider of state subsidized loans to the SME sector. Halkbank is not listed for privatization and currently all board members are nominated by the government. Halkbank operates a wide network of 886 branches throughout Turkey. The bank is 51.1% government owned and is likely to benefit from sovereign support. Halkbank’s profitability has been sound due to the large share of SME lending. The bank has exclusive right to provide government subsidized SME loans, which tend to perform better from an asset quality angle. Total loan growth reached 18.5% in 2014 and the issuer is expecting growth in the same range for 2015. The NPL ratio increased to 2.9% and the bank’s coverage ratio dropped to 73.8%, however the bank’s capital position remained solid at a Tier 1 ratio of 13.9% YE 2014.

Tier 1 & CAR ratio YE 2014

Loan book breakdown YE 2014

Source: Company Material

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Isbank – (BB+ / Baa3/ BBB-) Credit Direction: (=) Isbank is the largest private bank and the second largest bank by total assets in Turkey as of Q4 ’14. At YE14 the bank had a market share of 13.2% in total loans and 12.7% in total deposits. Isbank also offers asset and wealth management, capital markets, securities brokerages and insurance services throughout Turkey.It was the country's first private bank. Isbank has the largest branch network among the private banks with over 1,333 branches throughout Turkey. Isbank operates two subsidiaries abroad, in Germany and Russia. The bank is focused on growing profitability and sustaining market share in general. Isbank is focusing on cost savings although it intends to build another 50 branches over the next couple of years. Despite the bank’s expansion course the headcount per branches is falling as the institution is focusing on non-branch channels. The bank’s NPL ratio of 1.6% is among the strongest in its peer group and the bank has a very strong reputation with a robust franchise in all market segments.

Tier 1 & CAR ratio YE 2014

Loan book breakdown YE 2014

Source: Company Material

Vakifbank – (BB+/ Baa3) Credit Direction: (=) Vakifbank is the seventh largest bank by total assets in Turkey as of Q4 ‘14. The bank was established in 1954 to administer the accounts of the country's foundations. It has become a fully-fledged bank since. The bank is largely focused on commercial and SME loans, but there is also a large exposure to the retail sector. Vakifbank is also active in investment banking services. The bank is 58% owned by the Turkish Prime Ministry’s General Directorate of Foundations. Vakifbank is predominantly owned by the Turkish government which will likely benefit from sovereign support. The bank clearly benefits from state deposits which represent a strong funding source. Over the next couple of month the state is expected to transfer 58.5% of shares from the General Directorate of Foundations directly to the Turkish Treasury which we view as supportive for the bank. Vakifbank reported 4Q ‘14 bank-only net profit of TRY 683 million ahead of consensus estimates of TRY 624 million. Capital adequacy improved, with Tier 1 ratio reaching 11.4% at year-end 2014. Gross loans grew by 20% year-onyear, driven mostly by the commercial & corporate segment. This year, management expects strong lending growth to continue at high teens - up to 20% pace.

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Tier 1 & CAR ratio YE 2014

Loan book breakdown YE 2014

Source: Company Material

Participation Banks - Credit Direction (=) The financial institutions whose activities are compliant with the Islamic rules are called participation banks in Turkey. Today there are three participation banks in Turkey which are covered by BOS fixed income research: Albaraka Türk, Kuveyt Turk and Turkiye Finans. Both conventional banks and participation banks are governed by the Banking Law and monitored by the same authorities. Regulated under the same legal framework, participation banks have to launch their own financing models. Participation Banks in Turkey have great potential to embrace a big deal of unbanked people with solid and ethical Islamic Banking arguments. Kuveyt Turk: Kuveyt Turk was incorporated in 1989 and is 62% owned by (Kuwait Finance House) KFH. The establishment process was initiated by the respective governments of Turkey and Kuwait to develop trade between the two countries. The Kuwaiti state owns a direct 9% stake through the Public Institution for Social Security state fund. The bank’s net income rose 23% from TRY 300.3 million in 2013 to TRY 370.5 million in 2014. The bank’s total asset grew 31.3% within 2014 to TRY 34.8 billion. Albaraka Türk: Albaraka Türk is the oldest Islamic bank in Turkey recently celebrating its 30th birthday. It focuses on SME and corporate lending. The majority owner (54.1%) of is Albaraka Banking Group from Bahrain. Albaraka Banking Group is one of the world’s leading Islamic banking group with consolidated assets of USD 24.8 billion at Q1 ’15. In the Q1’ 15 the bank’s net income rose 3.5% from TRY 61.6 million in Q1 ‘14 to TRY 63.7 million in Q1 ‘15. Turkiye Finans: Turkiye Finans is an Islamic bank focused on SME and consumer lending. It has no investment banking or capital market activities. The majority owner (66.3%) of TFKB is The National Commercial Bank of Saudi Arabia (NCB). NCB is the largest bank in Saudi Arabia. It is rated A1 / A+ and belongs to the royal family of Saudi Arabia. The banks net profit grew at 13% between 2010-2014, outperforming Turkish banking sector and Turkish participation banking average.

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Conclusion & Recommendation Turkish banks outperformed their EMEA peers in 2014, mostly owing to the performance in the second quarter of the year. They underperformed in 3Q ‘14, due to rise in interest rates amid fears on Fed rate hikes in 2015, but then made a decent recovery in 4Q ‘14 on the back of a sharp decline in oil prices and improvement in the outlook for inflation and the current account. The Turkish banks trade as a homogeneous asset class with little credit differentiation. Turkish bank’s Eurobond performance has been under pressure, with spreads around 30bps wider (ytd) as a result of the weak TRY, political pressure and less supportive external liquidity conditions. The direct contagion channels to the banks via weak FX have been muted so far; however, we expect FX-related macro risks to weigh on banks’ profitability. Central Bank of the Republic of Turkey now has limited room for rate cuts, which is likely to put further pressure on the already weak economic growth trajectory and high unemployment trends. The banks’ primary concerns are low GDP growth and high unemployment, which can have a pronounced negative effect on asset quality in the medium to long term. Given recent bond volatility, we think there will be a better entry point after the elections. Our top picks remain Isbank and Vakifbank because of their slightly cheaper valuations versus peers. Among the participation banks we prefer Kuvyet Turk and Turkiye Finans over Albaraka based on fundamentals. The Halkbank 4.75% of 2019, the Isbank 5.5% of 2019 and the Vakifbank 5.00% of 2018 look fairy valued to us, thus we change our recommendation on these bonds to HOLD from BUY. We reiterate our BUY recommendations on the Isbank 5.00% of 2021, the Isbank Tier 2 6.00% of 2022 and the Vakifbank Tier 2 6.875% of 2025. Among the participation banks we have witnessed some spread tightening for the Kuveyt Turk and we change the recommendation on the outstanding Eurobond to HOLD from BUY. Despite slightly weaker credit fundamentals we still see some upside potential for the outstanding debt of Albaraka; therefore we reiterate our BUY recommendations on both outstanding bonds.

Current recommendations under BOS coverage Nam e

Coupon

Maturity

Rating

Ask Price

Recom m endation

Currency

Risk Rating

Akbank

3.875%

10/24/2017

Baa3

101.75

HOLD

USD

3

Akbank

5.00%

10/24/2022

Baa3

101.00

HOLD

USD

3

Akbank

5.125%

7/22/2015

Baa3

100.90

HOLD

USD

2

Akbank

5.125%

3/31/2025

Baa3

98.00

HOLD

USD

3

Garanti

4.00%

9/13/2017

Baa3

102.50

HOLD

USD

3

Garanti

4.75%

10/17/2019

Baa3

102.50

HOLD

USD

3

Garanti

5.25%

9/13/2022

Baa3

103.00

HOLD

USD

3

Halkbank

4.75%

6/4/2019

Baa3

102.00

*HOLD

USD

3

Isbank

3.875%

11/7/2017

Baa3

102.00

HOLD

USD

3

Isbank

3.75%

10/10/2018

Baa3

100.00

HOLD

USD

3

Isbank

5.50%

4/21/2019

Baa3

105.00

*HOLD

USD

3

Isbank

5.00%

6/25/2021

Baa3

101.75

BUY

USD

3

Isbank (Sub)

6.00%

10/24/2022

Ba2

101.25

BUY

USD

5

Vakifbank (Sub)

6.875%

2/3/2025

Ba3

100.50

BUY

USD

5

Vakifbank

5.00%

10/31/2018

Baa3

103.25

*HOLD

USD

3

Albaraka Turk (Sukuk)

6.25%

6/30/2019

BB

102.56

BUY

USD

4

Albaraka Turk (Sukuk)

7.75%

5/7/2023

B

100.55

BUY

USD

5

Kuveyt Turk (Sukuk)

5.162%

6/26/2019

--

104.00

*HOLD

USD

3

Turkiye Finans (Sukuk)

5.375%

4/24/2019

--

104.00

HOLD

USD

3

* Change to Hold from Buy

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