Turkish Banks in 2012

Following consecutive regulatory actions, Turkish banks have come under pressure from rising funding costs and deteriorating earnings quality since the end of 2010. As a result of the policy crossfire caused by the Central Bank Turkey (CBT) and the Banking Regulatory + Supervision Agency (BRSA), we have been conservative on banks’ Net Income Multiplier (NIM) evolution, foreseeing a gloomy picture for their profitability, not only in 2011, but 2012 as well.

A base case scenario, had been expecting the CBT to continue its RRR policy amid widening CAD worries, and funding costs continuing to weigh on profitability. However, in tandem with the surprising policy actions taken by the CBT, do we now have a different profitability outlook for Turkish banks for the coming year?

Based on new macro assumptions, Turkish banks are relatively better positioned to benefit from the monetary easing, which translates to an improved earnings outlook, and hence better valuation prospects. Revised estimates now mark 5% growth in net earnings for the banking system in 2012. Looking ahead, as a result of recession related woes; the CBT is now adopting a different policy than it has over the past 12 months. To cope with a potential recession, it is likely to provide liquidity and accelerate growth.

Taking this into account, we can expect to see a revision on its RRR policy in 2012, with ratios being cut by 300-400 bps within the year to curtail the loan market. A lower reserve would provide additional funding, and at the same time lower costs, meaning better than expected net earnings.

So, with recent changes to the macro picture, the main concerns have been removed namely margin compression. Margin compression is not an issue for Turkish banks in the coming quarters on the back of upward movement in loan yields, downward revision to deposit costs and the policy shift mentioned above. To be specific, since the end of June, 2011, local currency deposit rates have declined by 130bp, while loan interest rates have increased by 160bp; which should lead to 30bp improvement in the sector’s spreads in 3Q11. Beyond 3Q11 a combination of a lower base, the possible release of required reserves and the increase in loan interest rates should act positively on margins.

As sector related concerns have been removed with the above mentioned factors, we can now be more positive about Turkish banks. One should note that the banks have fundamental value and are particularly attractive, with a highly-regulated financial system; this in addition to Turkey’s growth potential when compared to Europe Middle East + Africa (EMEA) peers. After outperforming their peers both in terms of earnings and asset growth over the past three years, Turkish banks have shown great resilience during the financial turmoil.

And more importantly, they now trade at 1.3x P/BV and 8.0x P/E for 2012, which is 20% lower than their peak levels. Looking ahead to 2012 we can expect to see Gross Domestic Product (GDP) growth to slow down to 3.5%, which should negatively impact overall loan growth and also lead to higher Non Performing Loan (NPL) generation. With this in mind one would assume the loan growth to be lowered. Besides, loan growth is currently running at 38% y/y, which suggests a higher base for the coming year. As mentioned, one is now more positive on margin evolution.

Due to decreasing deposit costs, and increasing movement in loan yields, together with a possible release of RRR and lower base effect, we now foresee 25bps expansion in the NIM, formerly assumed to be flattish. Asset quality among Turkish banks has made significant improvement so far this year, with the NPL ratio falling below 3%. However, as a result of the economic slowdown, we can expect some deterioration in this area.

One is to believe that Turkish banks are fundamentally strong, comfortable in equity terms, and capable of absorbing a slump. With a better margin outlook, the bottom line growth forecast for the sector is 5% which is parallel with consensus forecasts. One prefers a bank that have higher returns on loans and less reliance on government securities, and that has ample liquidity, with better NPL and fee income prospects with better cost management.

Respectively, Halkbank and Isbank are better-positioned relative to their peer group. Halkbank operates with a low-loans-to-deposits ratio and greater room for fee income generation. Isbank, however, is comfortable in terms of funding. Under new management it has started to focus on profitability, which is expected to improve its efficiency and RoE. Garanti Bank with its strong franchise, improving margins and proven management is one to watch for the future.

For further information please visit www.aydinestate.com or e-mail info@didimaydinemlak.com Burak Altin, Aydin Real Estate.