Turkish Financials: Latest Results & Outlook

Turkish banks have outperformed its EM peers on a ytd basis (see the chart below), as MSCI EM Financials index took a huge hit in the first two weeks of this year arising out of a massive sell-out in Chinese markets. Excluding that timeframe, the performances of two indexes has almost been in line to date. Going forward, EM equities are expected to pull out a vapid performance owing to a Federal Reserve not appearing to be relenting on rate hikes anymore. This will most certainly limit the gains in Turkish stocks.

Turkish Banking Stocks v MSCI EM Financials

Time and time again, we reported declining profitability, low growth expectations and asset quality deterioration are key risks that lied ahead that are to weigh on stock market performance. By this means we maintained cautious stance against Turkish banking stocks while we thought Akbank (BIST: AKBNK) could deliver strong returns due its strong capital position, better asset quality, comfortable funding and liquidity profile and improved operational efficiencies. Additionally, we underlined that TSKB (BIST: TSKB) would be a defensive play in case of an emerging market sentiment reversal due to its strong FX net asset position.

Q1 results, in our view, were satisfying with in broad strokes despite the fact Isbank (BIST: ISCTR) missed widely the consensus in earnings. Our high conviction call Akbank reported a quarterly net income above the consensus (TRY1.07 billion versus TRY 965 million, ROAE: 14.9%) which was driven by the continuation of strong operational efficiency, better than expected credit metrics and solid recovery performance. Surprisingly, the growth in loan was below the sector average, however, we are of the opinion that its strong funding capacity and deposit base will support lending activities in the quarters to come. Akbank’s loan-to-deposits ratio stood a 101% which was the lowest figure recorded among Tier 1 banks. Following the Q1 results, we maintain our bullish views for the bank and reiterate our “Buy” rating. The bank has outperformed BIST Bank Index (BIST: XBANK) and BIST 100 Index (BIST: XU100) by 9.3% and 5.7%, respectively since our publication.

Garanti (BIST: GARAN) also beat the estimates but the positive deviation came from “other” income (subsidiaries, provision reversal). The bank also received a NIM contraction that is likely to be a signal of new cycle which will eventually curb the bank’s future earnings as it has been struggling to grow its deposit base to finance growth. Also, the asset quality metrics draw picture full of uncertainties along with criticized assets rising. Above all, Garanti is not the back that returns value to shareholder as its ROE is on a declining. We do not see the current trends are favorable for Garanti.

Halkbank (BIST: HALKB) beat the estimates at the bottom line thanks to some help from non-operational lines. Halk has a strong deposit base as its clients are generally consistent savers such as retired people. Its loans-to-deposit has been lower when compared to other Tier 1 Turkish banks, but in this quarter we saw lending outpacing deposits as the bank has been aggressive on commercial segment. Credit metrics were not favorable, particularly on the commercial lending side. Halkbank has seemed to lose its historical premium ROE, as growth has come at the expense of profitability. What is more, newsflow about its state ownership profile may lead a cost of equity remaining elevated.

Isbank was the only bank that reported a lower than expected net income in Q1 2016 as ROAE was at 11.8%. Despite a loan book decreasing by 1%, the management reiterated its growth rate target of 10% for the full year. The effective tax rate of 12% in the quarter helped the bank fill the gap between consensus and the actual results to some extent. Fundamentals spiral downwards in Isbank in our view.

Vakifbank (BIST: VAKBN) posted a solid set of results that exceed our expectations and the analyst estimates. Volume growth was bright with deposits growing remarkable while funding costs were only 21 basis points higher. This seemed to be supporting the core spread. We very well might see an acceleration in NIM going forward, however are not still convinced that the bank deserves to enjoy a premium valuation as profitability metrics are not up to the mark.

Yapi Kredi (BIST: YKBNK) reported a net income of TRY704 million which was well above the estimates. Key points from the Q1 results were fast lending growth, an expansion of 10 basis points in swap-adjusted NIM, best-in-class efficiency, and strengthening capital position. Yapi Kredi was the fastest lender among the private banks in the quarter. On a negative note, deposit costs saw a pick-up as expected, as the bank still sought for lending growth despite its relative weak funding capacity. Newsflow regarding Unicredit planning to sell its stake in the bank, however, would be able to limit the gains in the stock. Thus, we do not recommend to build positions in Yapi Kredi at this stage.

Eventually, we do not draw positive reviews about Turkish financials with the exclusion of Akbank. We see more attractive opportunities in emerging and frontier Asia, specifically we expect Indian (private) and Pakistani banks to emerge as outperformers in the EM financial sphere.

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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.

State-Owned Banks under Pressure

Considering the fact that poor performance from main bank stocks is more able to drag the whole market down in Turkey than anywhere else, I have been trying to provide comprehensive information about the key themes in the industry in order to measure the changing dynamics. From this point I find analyzing of state-owned banks’ recent performance extremely necessary as it is already seen as the biggest threat to Turkish markets.

Halkbank and Vakifbank are the state-owned banks whose shares also traded in Borsa Istanbul with free-float rates of 49% and 25%, respectively. Their poor performance compared to the peers on a year-to-date basis had been already eye-catching, but, it has been even clearer following the general elections which ended up with no single party majority. As being run by the state share prices of both banks were amenable to the outcome of the elections.

Turkish Banks Stocks Performance 2014 - 2015

Above is the visualized form of year-over-year stock performances of Tier-1 banks in Turkey where two state-owned banks’ are shown in different shades of red. Vakifbank and Halkbank along with Yapi Kredi seem to be underperformers and all three have provided a negative return to investor through this period. Reviewing the stock performance with the fundamental data is here to be a key to fully discover the pricing dynamics and what actually lies behind.

Turkish Banks Key Fundamental Data

According to 1Q15 results Halkbank posted a ROE figure of 15.7% that made it one of the most profitable banks in CEEMEA region, however, this could not have prevented the stock from trading below its book value. On the other hand Vakifbank with a ROE of 13.6% is traded a significant discount of 26% to its book value. In light of this information two stocks are not fairly valued, offer a huge potential upside, and each indeed would be a great buying opportunity for investors who are eager to take hard to predict political risks.

In a previous note about Halkbank, I mentioned that the stock should not have been the conviction call among Tier-1 Turkish banks, and it was not likely benefit from the current trends in the industry. The current valuation is definitely beyond the framework I had proposed. As a matter of fact it is safe to say that political worries could be overblown.

On the other hand, there is evidence that shows Halkbank has always been valued with a company specific risk premium. The following charts show that the bank is traded with modest multipliers when compared to Tier-1 banks. Moreover, now Halk is not exceptionally far from historical averages in valuation terms.

Turkish Banks - Historical Price to Book Value

Halkbank - Historical Price to Book Value

Turkish Banks - Historical Price to EarningsHalkbank - Historical Price to Earnings

With so many upside and downside catalysts it is tough to allocate funds perfectly in emerging markets as the transformation in global monetary policy is likely to a game changer. Most particularly in Turkey it is crucially important to walk on eggs where the stock market is set to navigate in choppy waters. Within this context I believe the short term potential and longer term risks in Turkey’s state-owned banks stocks should be realized.