We have been closely monitoring the banking sector in Turkey as the industry is usually at the focal point for investors looking at the country. Previously we analyzed the declining earnings in the industry and our finding suggested that the monetary policy framework causing higher uncertainties around FX and interest rates was the main culprit.
Turkish banks’ ROAE dipped in mid-2015 when the profitability metric was slightly higher than 10% across the board. That also marked the end of the downtrend as the industry started to post higher earnings since.
Turkish bank’ ROAE stood at 13.3% in October according to the official data, which also suggest that industry as a whole deserve to be valued below book value since the estimated cost of capital remain in the 15%-16% range. That said, we see the Visa sale proceeds being accretive to the earnings, as core revenues growth records a 16% despite the surge in net income.
Turning back to October results, banks managed to grow their interest income and fees 19.5% and 11.7%, respectively, on a trailing twelve-month basis, while opex only increased by 3% as the continuation of the single-digit growth that has in place for the past five months run-up to October. That said, provisions built being lower 23% demonstrated the intact asset quality, and along with the solid cost control, left their marks as the improving key fundamentals. However, we saw the adjusted quarterly net income declining by 4%, making it hard to convince that the current earnings growth rates are sustainable and a deceleration is very likely once base effects of the one-off items fade away.
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.
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.