JEDDAH — The Turkish operating environment remains challenged to say the least, senior credit analyst Aabid Hanif of Indosuez Wealth Management said in its latest “Credit Pulse” report.
The precarious economic position of Turkey is putting a significant strain on its banking sector, he noted. Downside risks to macro-economic stability have intensified owing to twin deficits (budget and current account deficits, the latter growing rapidly), more challenging external financing environment, a jump in inflation, and the impact of the plunge in the exchange rate on the private sector which holds significant foreign currency-denominated debt. In this context, how delightful are Turkish banks looking, he asked. Not so delightful, he said. Turkish banks face increased risks to performance, asset-quality, capitalization, as well as to liquidity and funding profiles following the recent period of market volatility. Additionally, the increased risk of a hard landing for the economy coupled with reduced investor sentiment are negative for the sector. At least one positive aspect is that these risks come at a time when most banks (the larger both foreign and state owned ones) feature solid domestic franchises, moderate non-performing loans (NPLs), reasonable liquidity and capitalization buffers and, in most cases, track-records of stable profitability.
Although headline NPLs have remained broadly stable at around 3% of gross loans at end-1H18, asset-quality risks for banks have risen given the weakening growth outlook. A significant portion of banks’ lending is in foreign currency (equal to about 37% of sector loans) and the potential impact of local currency depreciation on weakly hedged borrowers' ability to service debt is negative for the health of banks’ balance sheets. Higher interest rates, which also negatively impacts local currency borrowers' debt-service capacity, could also affect loan performance. Other sources of risk for asset-quality include high borrower concentrations and large exposures to the construction and energy sectors.
Profitability for the Turkish banking sector has been improving over the past few years with a return on average of equity of 15.48% at end-2017. However, looking ahead to the second half of 2018 and 2019, the outlook for profitability is negative as funding costs increase, credit growth slows, and impairment charges seem destined to rise. In addition, refinancing and access to foreign funding-markets may become increasingly restricted which also raises liquidity pressures. The Turkish lira has depreciated by some 25% against the euro and 28% versus the US dollar year-to-date. The hikes in the key policy rate to 17.75% were insufficient in the context but they also add to refinancing risk, as does the tighter financing conditions globally, notably the higher interest rates in the US.
“However, if we are looking for some good news, Turkish banks do have a track record of accessing external funding even in adverse market conditions. Banks also have sufficient foreign currency liquidity to cover their short-term (12 months) foreign currency wholesale funding maturities. Foreign-owned banks may also be given support in foreign currency by their parent, making refinancing risk less pronounced.
Nevertheless, capital ratios are facing significant pressure from the lira’s depreciation due to the inflation of foreign currency risk-weighted assets and higher interest rates which result in negative mark-to-market of government bond portfolios. Potential worsening of asset-quality poses a further risk to banks’ capital positions and ratios, but strong pre-impairment profit provides most banks with a buffer to absorb credit losses,” Hanif pointed out.
Given the increased risk of a hard landing for the economy and reduced investor sentiment, the outlook for the sector for the time being remains negative, he noted. — SG
