Turkey: Outlook Revised to Stable at S&P

Standard & Poor’s revised its outlook Turkey to stable from negative and affirmed its BB+ FC and BBB- LC sovereign credit ratings after the close of the market on Friday. The action was a positive surprising as it came amid concerns around Turkey’s political outlook taken to a higher level with the ouster of PM Ahmet Davutoglu. The credit rating agency downgraded sovereigns such as Poland, citing risks related to institutional stability.

The change at the top of the government should not be a game changer for Turkish politics in the short-term since Davutoglu had mostly felt into line with President Erdogan during his tenure. Still, this would keep Turkey’s governance mechanism open to dispute and harm Turkey’s accession process to the European Union while negotiations over visa-free pass going on which was supposed to mark a milestone in the history of country. Also, one would expect that steps toward a constitutional reform are to be taken faster than expected.

Turning back to the upside revision of S&P, the action has been primarily driven by a change in S&P’s assessment for Turkey’s debt burden as the credit rating agency believes that risks to the roll-over of its external debt have moderated. Having said that, the economic performance of the country has proven to be resilient by posting a higher-than-expected GDP growth of 4% despite to a number of challenges including, the busy electoral calendar in 2015, the end of the peace process with the PKK, heightened regional instability, and weak investor sentiment toward emerging markets.

Interestingly, S&P does not see eventual constitutional reform leading significant policy changes such as intensification of intervention in the independence of Turkish central or nationalization of private sector banks. Since, we don’t even have any draft that frames a new constitution, it is hard to predict the implications for the economy. But for instance, in case of a completed transition towards a presidential system, most certainly only the President will be in charge of assigning the Central Bank Governor. This the most controversial point made in the S&P’s Turkey release.

Putting it in a nutshell, below is the comparison of the estimates of the credit rating agency in November 2015 and May 2016 which, in our view, is useful to understand the underlying dynamics of S&P’s rating process.

Turkey - S&P EstimatesThe next report will be released on November 4, 2016.

Prospects of A Liquidity Shortfall

In a country where average maturity of deposits is very short, liquidity risk management for financial instructions is of paramount importance. Most particularly, in Turkey, a country seeking high growth where the consumption is the engine of the economy, the liquidity balance become even more important.

In a previous post we expostulated the deterioration in liquidity adequacy ratios in Turkish banks and warned that banks would be crippled by a liquidity crunch. With the loans to deposit ratio over 100%, it was obvious that banks in Turkey would have some challenges to meet the liquidity requirements adopted by Turkey’s Banking Regulation and Supervision Agency (BRSA). Strictly speaking, Turkish banks have done well in having the necessary assets on hand to ride out short-term liquidity disruptions. But as seen in the liquidity adequacy ratio data released by the BRSA, the trend is simply not pretty.

The first chart above shows Liquidity Adequacy Ratios in Turkey’s banking spectrum overall as the latter only focuses on commercial banks (in other words excludes investment and development banks). The ratios clearly have moved towards the threshold of 100% since the global financial crisis and it is worth to note that the BRSA fines banks when they post a figure below the threshold in two successive weeks.

LCR for Turkish Banks

LCR for Commercial Banks

Things just get stranger and stranger when it comes to analyze liquidity ratios of state-owned commercial bank trio – Halkbank (BIST:HALKB), Vakifbank (BIST:VAKBN), and Ziraat Bankasi. Remember that they used to outperform all other banks in Turkey in terms of liquidity adequacy in 2011.

LCR for State Owned Banks

Apparently at least one of the banks mentioned right above the chart has failed to meet the liquidity requirements. As preparatory to answer the question of which bank(s) has done so, I’d like to show how loans and deposits grew in the meantime.

Loans to Deposit for State Owned Commercial Banks

L/D spread for Halkbank, Ziraat and Vakif were 103%, 96%, and 120%, respectively. Furthermore, for full 2014 fiscal year the average one-month liquidity adequacy ratios for Halkbank and Ziraat were 116% and 112%. Interestingly, no clear information about the liquidity ratios was given in Vakif’s annual reports, however, it was 103% according to my calculation. Most probably Vakif has been posting below-than-requested liquidity ratios for the asset and liabilities with a duration of one-month in 2015.

In broad strokes, despite the fact that current liquidity levels are sobering, Turkish banks with some exceptions are not to face liquidity shortfall in the near term. Nevertheless banks may have to manage their liquidity levels more proactively with the Basel III rules phased in.