Do Turkish Banks Add Economic Value?

Time and time again I have been directing sharp criticism for the relatively poor financial performance, and more importantly, for the industry’s lack of focus on low profitability. In September, return on equity, or ROE, for the whole industry, came down to a level that made it even lower yielding than the riskless Treasury bonds (September RoAA was at 10.41% versus average 10Y bond yield at 10.44%). The situation is even more severe once the other elements of costs of equity such as equity risk premium are considered. These all reveals an important finding: Turkish banks are deeply struggling to add economic value.

The chart above shows the return on equity for the industry and the cost of equity. Return on equity is derived from 12-month trailing net income and 12-month average total shareholder’s equity. On the other part, the cost of equity, the threshold for generating positive economic value, is derived from average Turkey 10Y government bond yield, an estimated equity risk premium of 6%, and beta of 1.0x. Importantly, the chart reveals why we have seen lots of discount to book value valuation in the equity market and M&A deals.

Turkish Banks - RoE versus CoE

However, it is also worth to point that October data may be signaling a turning point for banks as RoE and CoE both showed signs of convergence. RoE was up by 4 basis points to 10.45% m/m as well as 10Y bond yield significantly decreased 46 basis points to 9.98%. The industry posted 5.6% and 15.5% growth in earnings and total equity, respectively.

The important part of earnings growth came from the net interest income that were up by 18.5% y/y to 62.8 million liras. The growth is fees was relatively slower with 12.2% increase while expenses grew by 19.2%. On a negative note provisions extended significantly in October.

With banks’ 3Q financial statements and first month of 4Q stats at the table, Akbank (BIST:AKBNK) seems to be a good candidate to be an outperformer in my view, as the bank is poised for fast loan growth due to its strong liquidity and core liabilities.

Economic Growth Fails to Create Jobs

Today Turkish Statistics Office reported a monthly unemployment rate of 9.8% in August, which was higher than market consensus. The rate was at 9.3% in July. Elsewhere, non-farm unemployment rate jumped to 12.3% from 11.8%, while the labor force participation rate dropped by  0.1 pp to 51,6%. Seasonally adjusted unemployment rate remained at 10.1% and kept on visiting its historic high since October 2010.

Seasonally adjusted data signals that the employment gains a strong presence that despite the slightly acceleration in growth dynamics.

Insufficient contribution of services is the key factor for the recent worrisome trend in unemployment. Considering Turkey’s economic dynamics, job creation has mainly driven by the services.

Our thesis that, for a remarkable breakthrough in the labor market, an annual growth rate higher 5% is needed in Turkey. Ongoing macro structure has no ability create a satisfying number of jobs with a moderate pace growth.

Turkey Unemployment & Labor Force Participation Rate

Share of Employment in Turkey by Industries

Private Equity Funds in Turkey: Will We See a Reload ?

Private equity funds are collective investment schemes used for making investments in various equity securities according to one of the investment strategies associated with private equity. They can be can be used to capitalize new technologies, expand working capital within an owned company, make acquisitions, or to strengthen a balance sheet. In the developed countries, they played a fundamental role of bringing together wealthy investors and private companies (especially not traded on a public stock exchange) in need of capital.

In 2000, Turkven Fund launched out into business world, and, concurrently it became the first private equity fund founded in the country. Another success story, Actera Group, which was set up in 2008, made its shining appearance in the market, and has whose assets under management now reached $1.5bn. Up to the present, over 70 private equity funds are on the lookout for profitable opportunities.

Macroeconomic conditions also provide an attractive environment for yield-oriented private equity funds. Following the historical Lehman Brothers’ failure, Turkey constrictedly suffered from the crisis. Moreover, it became the second-fastest growing economy after China with growth rate of 8.8% in 2011. With its economic power, Turkey drew the attention of the funds that are screening emerging markets for investments. Much more that 40 deals completed in 2011 and 2012, but, it looks like the ongoing upside trend line in mergers and acquisitions may be about to finish.

M&A Trend in Turkey - Marketmerger

Comparing to excellent results of 2011 and 2012, the number of deals we saw year-to-date is only 9, according to Marketmerger. As the recovery symptoms in developed world begin to become more clear, we see a sharp decrease in capital inflows towards emerging economies.  As might be expected, this is deteriorating the outlook of the PE market in Turkey. What is more, 2.2% growth rate, $5.8 billion current account deficit, fluctuating currency and the political unrest arising out of both domestic and foreign events are badly influencing the market.

The story of private equity funds in Turkey began perfectly, proceeded distinguishedly, but, recently it entered a rough era with some must-be-faced global challenges. Along with the current temporary inactivity in M&A market, Turkey will be an attractive market for both cross-border and domestic investors.