Strong strategies, good growth: As banks expand their financial practices, the sector benefits

While some peers have struggled following the global economic crisis, Turkey’s banks have grown rapidly in recent years. Moreover, they remain healthy, liquid and well capitalised. Profits declined in 2011, particularly at the larger banks, as interest margins fell due to competition for loans and increased funding costs. However, there is still plenty of room for sector expansion, with a growing population that is increasingly turning to banks to finance their purchases of consumer goods, cars and homes.

MARKET SIZE & STRUCTURE: As of March 2012, total assets in the Turkish banking sector were close to reaching TL1.2trn (€510bn), according to data provided by the sector’s regulator, the Banking Regulation and Supervision Agency (BDDK). This figure has experienced a steady rise over the last several years, increasing from TL732.5bn (€311.3bn) as of the end of 2008 to TL834bn (€354.5bn) in 2009 and TL1trn (€425bn) as of December 2010.

There are currently 29 commercial banks operating in Turkey: three state-owned, 10 private and 16 foreign (including six branches of banks established outside of the country), plus four participation banks, Turkey’s version of Islamic lenders. The top five players account for around 60% of assets, and their market shares have remained relatively stable over the last few years. According to data from company filings and the BDDK, İş Bankası and state-owned Ziraat Bankası each held around 13% of total assets as of the end of 2011, followed closely by Garanti Bank (12%), Akbank (11%) and Yapı Kredi (10%). The two smaller state-controlled banks – Halkbank and Vakı fbank – each accounted for about 7% of assets. The top banks tend to act in parallel: if one bank introduces a new product or changes interest rates, it is typically not long until they all follow suit.

Ziraat, Halkbank and Vakıfbank are all state-owned institutions, although the latter two have free-float shares that are traded on the MKB Borsa Istanbul ( MKB). Public ownership confers certain advantages, such as less expensive and more stable deposit funding, thanks to the perception that these banks are less risky. For many years, state banks maintained lower loan-to-deposit (LTD) ratios than their private-sector counterparts, which allowed them to grow more quickly over the last several years.

Foreign banks present in Turkey include Citibank, DenizBank (Dexia Group), Finansbank (National Bank of Greece), HSBC and ING. International players interested in establishing a local retail presence find that one of the easiest methods to enter the market is to purchase an existing bank. For example, ING acquired Oyak Bank in 2007, prior to which it had been providing mainly top-end wholesale banking to foreign and major local companies. Similarly, in 2001 HSBC expanded its retail presence in Turkey by purchasing local troubled institution Demirbank.

Alternatively, over the last several years, foreign banks have acquired significant ownership positions in local lenders. In 2005 French bank BNP Paribas purchased a 50% stake in TEB Mali Yatırımlar, the principal shareholder of Türk Ekonomi Bankasi (TEB), acquiring a 42.1% indirect stake in the Turkish bank.

TEB further expanded in 2010 by purchasing the local unit of Europe-based Fortis Bank, with the two banks now merged under the name of TEB.

Also in 2005, international financial institution UniCredit Group purchased a 50% stake in Koç Financial Services, which subsequently merged with Yapı Kredi, giving UniCredit an indirect 41% stake in the combined entity. In 2007 Citigroup acquired a 20% stake in Akbank, while in 2010 Spanish bank BBVA purchased 24.9% of Garanti’s shares from US conglomerate, General Electric. As part of the latter deal, BBVA also acquired an option to raise its ownership by an additional 1% and gain a majority of board seats after five years’ time.

ROOM TO GROW: While there has been a rise merger and acquisition activity in recent years, there still remain a large number of small and medium-sized banks, suggesting that further consolidation of the market could occur, particularly as profitability in the sector has declined. However, Zeki Önder, the executive vice-president of Şekerbank, told OBG that it is unlikely that this will occur soon. “With a growing market there is room for everyone, as long as they have the right strategies. Smaller players can win new business if they position themselves well,” he said. This statement was echoed by Martin Spurling, the chief executive of HSBC Turkey, who highlighted that Turkey has a rapidly growing population and that the country is by no means overbanked.

However, Spurling noted that the one area in which there could be merger and acquisition activity is among the foreign banks, as their owners look to retrench in the face of growing woes in the eurozone. For example, DenizBank, one of the best-performing units of troubled Franco-Belgian bank Dexia, has been up for sale since late 2011. The owner has struggled to find a buyer, but as of May 2012, Russia’s Sberbank was said to be interested, joining Qatar National Bank as a potential bidder. Alternatively, Vakıfbank and Halkbank could be targets for acquisition, should the state decide to fully privatise them. However, there has been speculation regarding this possibility for several years, and it seems unlikely to occur in the short to medium-term future.

REGULATION: In the wake of a severe financial crisis in 2001, the country’s banking regulations were overhauled and the independence of the central bank was established. The system that has been in place since then has been widely credited with keeping the country’s financial institutions from taking overly risky positions. Thanks to its strong regulatory system, the sector was well-positioned to face the global economic challenges of 2008 and 2009, V. Derya Gürerk, the CEO of Türkiye Finans, told OBG. “Turkey was prepared for the global financial crisis, having entirely reformed the regulatory environment following its own 2001 downturn, and the ongoing uncertainty around the globe is not being felt by the banking sector here,” he said.

Since 2001, the Central Bank of the Republic of Turkey (CBRT) has held a dual mandate to ensure both price and financial stability by using short-term interest rates as its primary policy instrument. The CBRT makes funding available to the country’s banks through several channels, including one-week repos (the cost of which has been considered the country’s policy rate since May 2010) and overnight lending schemes. The CBRT also has the ability to set reserve requirement ratios for both lira- and foreign exchange-denominated assets and liabilities held by the banks. The central bank was active in 2011, taking steps to cool the economy and ensure a so-called soft landing, while at the same time intervening to reduce volatility in the value of the lira.

Meanwhile, the BDDK oversees the banking system, making sure that it remains stable and intervening to protect the interests of consumers. Among the regulator’s responsibilities are establishing and enforcing rules regarding capital adequacy ratio (CAR) requirements. Capitalisation rates are generally strong in the sector, although they have steadily fallen over the last two years, as banks have increased their lending activities and reduced their holdings of zero-risk-weighted government securities. As of March 2012, the sector-wide CAR stood at 16.6%, well above the BDDK’s minimum of 12% to continue opening branches, but down from 19% and 21% at the end of 2010 and 2009, respectively. The BDDK has also in recent years limited dividend payments for banks with low CARs.

The implementation of Basel II, which will go into effect in July 2012, will put further downward pressure on CARs. Kutluğ Doğanay, a banking analyst at İş Investment, told OBG that he expects capitalisation rates to fall by an average of 130-150 basis points once the new rules come into effect, although CARs will remain well above the regulatory minimum. However, he added that the impact is expected to vary from bank to bank. For example, lenders that hold large amounts of foreign exchange reserves and Eurobonds and have lower levels of collateralised loans will need to set aside additional capital. On the other hand, risk weights for mortgages and loans to small and medium-sized enterprises (SMEs) will be reduced. Akbank in particular has been identified by Doğanay and other banking sector analysts as a bank that could in fact be positively affected by the introduction and new mechanisms of Basel II, due to the fact that it currently uses a 100% risk weighting for its mortgages and SME loans.

LENDING: As noted above, the recent decline in CARs in large part reflects a fundamental transition in Turkey’s banking sector, as it has shifted from using deposits to purchase government securities to a system in which lending plays a far greater role. Indeed, according to the “Turkey Article IV Staff Report” from the IMF, loans as a percentage of total assets for the sector as a whole rose from 38.4% in 2005 to 54.5% as of September 2011. This been facilitated by historically low real interest rates in 2010 and 2011, as well as competition for banks to win market share, which has kept lending rates low.

This transformation is also apparent in observing the rise in the volume of loans over the last several years. BDDK data shows that the value of total outstanding loans in December 2009 amounted to TL392.6bn (€140.1bn); by December 2010 this had reached TL528.9bn (€224.8bn), rising further to TL682.9bn (€292.2bn) by December 2011 and TL699.1bn ( €297.1bn) by March 2012. This is equivalent to 33.9% growth in 2010 and nearly 30% in 2011. The expansion in credit occurred across the board, but was strongest in lending to SMEs and consumers.

Indeed, the share of loans accounted for by SMEs has increased over time, growing from about 21% to nearly 24% between December 2009 and March 2012. According to Doğanay, this figure is still relatively low compared to the pre-crisis level of 27% between 2006 and 2008 as well as international standards, particularly given that SMEs represent a large part of the economy. Historically, the state-owned banks – particularly Halkbank – have focused on lending to small businesses. However, over the course of the last decade, private lenders have increasingly focused on this segment. One important player in this area of the market is Şekerbank, with SMEs accounting for about 60% of its loan book. However, as Önder told OBG, there is still significant room for growth in this area, as it remains a largely under-banked segment. Loans to SMEs also represent an attractive opportunity because they are better collateralised than credit card loans and lending to larger commercial borrowers, Cenk Karacaoğlu, vice-president at Bank Asya, told OBG.

DEMOGRAPHICS: The growth in consumer lending is partially driven by demographics, given the expanding population that is increasingly affluent. As John McCarthy, the chairman of ING Bank Turkey, told OBG, “Turkey is a strong demographic story: the population is nearly 80m strong, young and growing at 1.2% per year. The economy is worth $800bn; and consumer spending is focused on bigger-ticket items (houses, cars, white goods) that banks can help finance.” Consumer loans are heavily marketed, with many banks advertising instant credit lines that can be approved by phone. Lenders are using increasingly sophisticated data-mining activities, analysing customer profiles to market specific products that might appeal to individual borrowers (see analysis).

Of course, attracting new retail customers to the banking sector has potential downside. As lenders bring on consumers who are not used to having debt, this could push up non-performing loan (NPL) rates. However, between 2009 and 2011 NPLs actually fell, with the sector average declining from 5.16% to 2.71% over this period, as reported by Cross Asset Research, a division of French bank Société Générale. There is some variation across the top banks, with Halkbank having the highest ratio in 2011 (at 3.1%), while Akbank enjoys the lowest at 1.6%. In terms of the downward trend over time, the IMF has attributed this decline in part to a steady amount of NPLs while total lending has increased. Looking ahead, NPLs could go up, but Emre Alpan nan, research manager at the Banks Association of Turkey (TBB), told OBG that the performance of loans will largely depend on how the economy does as a whole in 2012. If growth meets the government target of 4%, the rate of NPLs is unlikely to go up, he said.

SLOW DOWN: Rapid growth in lending in 2010 and 2011 contributed to a rising current account deficit (CAD), as consumers were using their newly acquired credit to purchase imported goods from abroad. This trend was exacerbated by the rising value of the Turkish lira. Not unaware of the link between credit growth and the expanding CAD, the government took steps starting in late 2010 to curb lending, unofficially targeting loan growth of about 25% in 2011. This figure was never formally announced, but it was noted in several official speeches during the final quarter of 2010. As written in the IMF Article IV report, one element of the CBRT’s efforts to ensure financial stability starting in late 2010 was “using moral suasion to target a maximum 25% increase on banks’ annual loan growth”.

“To have a large and unsustainable CAD is a serious problem for the economy and Turkey’s can really only be addressed with micro reforms, because of the huge energy-import component,” Süleyman Aslan, CEO of Halkbank, told OBG. “Controlling it is a difficult process that is working, albeit slowly.”

NEW CONTROLS: Of course, the central bank also can, and did, draw upon its monetary policy tools to slow lending in 2011 (see analysis). The challenge was how to effectively reduce credit growth without raising interest rates, as this would have increased inflows of so-called hot money, which would have further strengthened the lira and raised the price of Turkey’s exports. Instead, the bank chose to initially lower the policy rate in late 2010, while at the same time raising reserve requirements, in what is sometimes referred to as an “unorthodox” approach.

However, the CBRT’s initial efforts were for the most part ineffective at curbing lending. This is in part because the central bank continued to pump liquidity into the economy through its open market operations. Moreover, rather than raise interest rates to cover these higher intermediation costs, the banks instead opted to earn lower margins instead of being the first to raise rates in a competitive environment.

Subsequently, in mid-2011, authorities decided to take a different approach. In June 2011, the BDDK raised provisioning requirements for certain types of consumer loans, as well as increasing the risk weighting for this same set of products. Unlike the earlier efforts by the government, this move had a clear effect, with interest rates jumping almost immediately and growth in the volume of loans slowing in the following months. Moreover, the BDDK imposed further restrictions on credit card lending.

The situation shifted again in late 2011. As the lira continued to weaken, the CBRT took steps to raise its rates, most significantly lifting the overnight borrowing rate from 9% to 12.5% in October of that year. Perhaps more importantly, however, it did so in a way that that left the banks with very little visibility, with the governor of CBRT announcing in October 2011 that it would balance the mix between one-week repos and overnight lending as deemed necessary by market conditions. Banks, being risk-averse institutions, then again pushed up their rates, further slowing lending. While central bank funding stayed at about 7.5% in November and early December 2011, late in the year the CBRT tightened liquidity substantially, with the average cost of financing hitting nearly 12% in early January 2012. However, the situation improved by the end of the month, as the central bank eased its stance, and accordingly lending rates at the bank have also come down.

FUNDING: Just as the composition of the asset side of banks’ balance sheets has changed over the last few years, lenders’ liabilities have also shifted. Historically, deposits were the main funding source for banks, but growth in deposits has not kept pace with the rise in lending. Indeed, the LTD ratio increased from 76% at the end of 2009 to 98% as of 2011 year-end, according to the BDDK. For this reason alone, lending in 2012 may expand at a slower rate than in 2010 and 2011, according İş Investment’s Doğanay. In other words, there simply is less room to grow than there was in previous years.

Of course, banks do have access to other sources of funding, including the issuance of Eurobonds and syndicated loans from foreign lenders. As the eurozone crisis continues to unfold, Turkish banks could find it more difficult to tap into the international markets, although CBRT Governor Erdem Başç› has downplayed the likelihood of this happening. Speaking to executives in Bursa on January 6, 2012, he said, “even if there is a serious problem with European banks, other banks will still extend credit to Turkey because there is still plenty of cheap financing standing at about 0% interest rate all over the world.”

Alternatively, local lenders have also started issuing lira-denominated bonds, which they have been allowed to do since October 2010, although the BDDK does place limits on the amount of outstanding debt of this type that can be issued. The cap varies by bank size, going as high as TL51bn (€21.7bn) for some lenders. However, at this point, the limit does not impose a constraint on any of the banks, according to nan of the TBB, and moreover, it could be raised in the future, he said.

Banks were quick to enter the local bond market after having gained permission to do so, floating four bond issuances during January and February 2011. Yields on these fixed-income instruments were broadly comparable to the cost of deposit funding, which likely helped alleviate competition in the deposit market, an important factor at a time when yields on banks’ assets were falling. It is interesting to note that the duration of these bonds was quite short (with three of the four maturing within less than a year), but in fact this is not unusual for Turkey, where duration of loans is typically one to two years, with the exception of mortgages, which are still a relatively small part of the market.

Since early 2011, banks have continued to issue debt in the local bond market. For example, Finansbank finalised two six-month lira bond issuances of TL150m (€63.8m) and TL200m (€85m) in October 2011 and November 2011, respectively. In January 2012 both Akbank and Garanti issued local currency bonds. Akbank sold TL650m (€276.3m) in liradenominated bonds at an 11.6% yield, followed a week later by Garanti’s sale of TL1bn (€425m) in local bonds at 11%. While this type of debt remains a small part of the banking sector’s liabilities, it is expected to grow, in part because in February 2012 the BDDK announced that they would allow lenders to add 50% of the local bonds that they issue to their liquidity adequacy ratio.

COVERED BONDS: Turkish banks continue to search for new sources of funding. In mid-2011 Şekerbank introduced covered bonds as a new alternative to the market. Not only was it the first covered bond issued in Turkey, it was also the first of its type globally to be backed by loans to SMEs. Covered bonds are typically secured by mortgage pools, and indeed, the 2007 Turkish legislation that made this issuance possible was originally intended for mortgage loans, although the law allows for other assets to be used.

The total value of Şekerbank’s covered bond programme has been set at TL800m (€340m), which the bank has already tapped a number of times. For its first tranche, the lender sold TL228m (€97m) in bonds to Italian bank UniCredit, Dutch development bank FMO and the Washington-based and World Bank member group, International Finance Corporation. The European Bank for Reconstruction and Development and the European Development Bank were the investors for the second tranche, which totalled TL180m (€76.5m). The pricing of the bond was attractive, at Euro Interbank Offered Rate ( EURIBOR) plus 200-250 basis points, about half the cost of deposits in Turkey, according to Önder. Moreover, he added that other advantages of this issuance include access to new sources of funding and an innovative structure that allows additional issuances as more loans are put into the pool.

Turkey’s participation banks have also started turning to the bond market for longer-term funding, although in these institutions’ case, this has involved tapping into the growing global sukuk ( Islamic bond) market. Issuances of sharia-compliant bonds, which are locally known as “leasing certificates”, have been allowed in Turkey only since April 2010. Lawmakers subsequently amended the tax laws in early 2011 such that leasing certificates of the Ijara type would be exempt from certain taxes, bringing the tax structure for Islamic debt in line with that applied to conventional bonds.

One participation bank, Kuveyt Türk, has already carried out two issuances of sharia-compliant debt, beginning with its August 2010 floating of a threeyear $100m sukuk offering. The lender, which is majority owned by Kuwait Finance House, then held a second sukuk round in October 2011. Bank Asya and Bank Albaraka had both planned to have sukuk offerings before the end of 2012, but they later announced delays due to adverse market conditions.

Finally, while the sukuk are an important first step in increasing funding alternatives for Turkey’s participation banks, they may still operate at a disadvantage when compared to their sharia-compliant counterparts in the Gulf and Asia, according to Gü rerk of Türkiye Finans. “One key challenge facing the segment is access to funding. Sukuk are emerging in Turkey, but funding sources that are available at Islamic banks elsewhere in the world are still lagging behind or missing here,” he told OBG.

EARNINGS: While the volume of loans grew significantly over 2010 and 2011, bank profitability declined over this period. According to the IMF, the sector’s return on equity (ROE) and return on assets (ROA) have steadily fallen since 2009, standing at 13.6% and 1.6% as of August 2011, respectively. This trend has been true across the board: for example, the ROE at İş Bank – the country’s largest private bank – fell from 20.7% in 2009 to 12.9% in 2011, while its ROA declined from 2.1% to 1.4%, according to Cross Asset Research.

While this is a significant drop in ROEs over two years, Spurling told OBG, these figures are still higher than many of the returns that banks achieve in the more developed markets of the West, where ROEs in the range of 8-10% are the norm. Moreover, the drop from 2009 is at least in part due to the artificially high returns earned that year as a result of a one-time event, namely the CBRT’s steep reduction in interest rates between November 2008 and November 2009. Over this period, the policy rate fell from 16.75% to 6.75%. For the banks, which hold large portfolios of government securities (and held even more at the time), this was a windfall, as it widened their net interest margins (NIMs).

Since 2009 and up until the fourth quarter of 2011, margins steadily narrowed for a couple of reasons. First, the CBRT began imposing higher reserve requirements starting in late 2010 and also stopped paying interest on reserves. Second, increased competition among banks for both deposits and loans, particularly during the first half of 2011, kept NIMs low. While margins did start to move up for some banks in the fourth quarter of 2011, the trend on an annual basis is clearly downward. To give just two examples, at Akbank, the NIM fell from 5% to 3.3% between 2009 and 2011, while this figure declined from 5.2% to 3.6% at Garanti.

In response to declining margins, banks have focused greater attention on lowering costs, according to Adnan Bali, general manager of İş Bank. “If we consider the contraction in NIMs, controlling operating expenses is becoming a more important issue for the sector,” he told OBG. A report from Cross Asset Research shows that the average cost-to-income ratio for the six top banks (Akbank, Garanti, Halkbank, İş Bank, Vakıfbank and Yapı Kredi) increased from 35.2% in 2009 to 41.3% in 2011; however the research group anticipates that this figure will fall over the next few years. Moreover, the equities research outfit considers Turkish banks to be among the most efficient of the lenders that they follow, noting that “cost control performance in 2011 in response to lower revenue levels resulting from higher reserve requirements and general provisioning has been good.”

ALTERNATIVE INCOME SOURCES: Banks are looking for new solutions to offset falling NIMs and boost profits, and one such opportunity can be found in the rise in banks’ fee and commission income. Indeed, as was pointed out in the IMF Article IV report, one of the reasons that the banks may have kept their lending rates low in 2011 was to ensure that they maintained their customer base, and therefore safeguarded the opportunities to earn more non-interest revenues from these same people. “A large market share supports fee income – a growing contributor to bank profits,” the IMF report explained.

The fees-to-income ratio actually varies significantly across the major players, according to a March 2012 report from UK-based bank Standard Chartered. For example, at İş Bank in 2011, this ratio stood at 9.8%, while Garanti, Akbank and Yapı Kredi held ratios of 23.9%, 25.6% and 29.6%, respectively. At Vakıfbank, which is majority owned by the state, this ratio was lower, at 12.6%. In general, banks with higher credit card market shares tend to enjoy more robust fee incomes, so it is therefore not surprising that Yapı Kredi – as Turkey’s leader in credit card issuance – has the highest fee-to-income ratio.

In terms of trends over time, this ratio at all five of these banks, with the exception of İş Bank, increased during the 2009-11 period. This is consistent with research done by Citibank (covering Garanti, Halkbank, İş Bank, Vakıfbank and Yapı Kredi), which demonstrated that fee and commission income at these institutions rose between 2010 and 2011 by 6.4% and 15%, respectively. At the same time, interest income declined by 5.7% in 2010, followed by a small rise (0.8%) in 2011.

OUTLOOK: While profits took a hit in 2011, analysts expect NIMs to recover in 2012. This will in part be dependent upon the CBRT’s monetary policy and growth in deposits. Rising fees and commissions, as well as continued efforts to reduce costs, could also play a role in making Turkish banks more profitable in upcoming years. Moreover, with a loan-to-GDP ratio of just 48%, Turkey’s banking sector still has much room to expand. According to TBB’S nan, the sector is preparing for loan growth between 15% and 20% in 2012, adding that the composition of loans will depend on the economy, as retail loans are more sensitive to general economic growth. Nonetheless, given that Turkey’s population is young and growing, it is likely that the country’s banks will continued to enjoy substantial opportunities for lending.