Mark Bentley
Jun 09 2018

‘Unethical’ Moody’s forewarns second wave of Turkish crisis

A decision by Moody’s to cut the credit ratings of Turkey’s biggest banks is a timely precursor of the troubles pending for an economy wracked by currency weakness and high interest rates.

Mehmet Ali Akben, the head of the country’s banking watchdog, characterized Moody’s downgrade of 17 top Turkish banks on Thursday as “unethical”, saying that the firms were well capitalised with few bad loans.

But the Moody’s decision, which follows a similar ruling by Fitch earlier his month, goes to the heart of Turkey’s economic and financial troubles.

While the Turkish central bank has staved off a meltdown in the lira by raising interest rates by 425 basis points to 17.25 percent since May, the belated moves to shore up the currency -- which slumped to a record low of 4.92 per dollar last month -- threaten to spark stage two of a mini economic crisis that has rocked Turkey over the past three months.  

At the centre of the troubles are the country’s banks.

On Friday, Akben pointed out that the banking industry is strongly capitalised – capital adequacy ratios exceed 15 percent. The proportion of bad loans to total loans is also very low, showing that the lenders are managing their finances well, he said.

However, capital adequacy, which measures a bank’s ability to sustain losses without becoming insolvent, is on a downward trend. The ratio for the sector was 16.8 percent at the end of 2017, according to data from the Akben’s team. On the other hand, the ratio among European banks, pummeled by years of financial crisis, exceeded 18 percent at the end of last year compared with 17.3 percent a year earlier, according to the European Central Bank.

Capital adequacy ratios are expected to decline further going forward as lira depreciation increases the value of foreign currency-denominated risk-weighted assets.

More pertinent for Turkey, however, is the deterioration in the asset quality of banks. Akben highlights that bad loan ratios in the sector are low – they amounted to 2.9 percent of total loans at the end of 2017 compared with 4.9 percent in Europe. But the figures bely three important factors.

Firstly, Turkish banks have a growing propensity to sell off bad loans to credit collection companies at big discounts to keep their books relatively clean. For example, Yapi Kredi, Turkey’s fourth-biggest listed bank, sold 500.8 million liras ($112 million) of non-performing loans (NPLs) to debt collectors including Hayat Varlik in April at just 5.6 percent of face value; a big markdown compared with global averages.

Secondly, non-performing loans among Turkey’s small and medium-sized companies were almost 5 percent of total loans to SMEs at the end of 2017, according to banking watchdog figures. NPLs are set to increase markedly as the economy slows – an economic downturn traditionally results in lower sales and customers delaying payments for goods and services. And many firms may struggle to repay their foreign currency-denominated debts after the lira’s sharp depreciation.

Large sales of NPLs – there is no official data that gives the total size of such transactions – are producing a fast-growing secondary market, but prices are falling. Blanket sales, possibly caused by a sharp dip in economic activity, would further depress prices and magnify the gap between the book and market value of banks’ NPLs. The result would be significant losses and further erosion of banks’ capital.  

Thirdly, banks are reporting big increases in restructured lending, in which customers renegotiate loan terms to ease repayment difficulties. For example, Akbank, one of Turkey’s top three banks, said loans under close scrutiny, which include swathes of restructured loans, almost tripled at the end of the first quarter from six months earlier to 22.3 billion liras, or almost 10 percent of total loans.

As Moody’s points out, “the sharp deterioration of the Turkish lira against the U.S. dollar is expected to lead to an increase in problem loans coming from the significant number of Turkish companies that have borrowed in U.S. dollars and are not hedged.”

Unhedged, foreign currency loans of non-financial companies amount to $226 billion, or about 30 percent of gross domestic product, Turkish central bank data shows.

Large Turkish conglomerates such as Yildiz Holding, the maker of Godiva chocolates and McVities biscuits, have already applied to local banks to improve the terms of well over $10 billion in borrowing. Data for small and medium-sized companies is not available, though requests to renegotiate such credits are sure to increase markedly as the economy slows and interest rates rise.

Moody’s predicted that Turkey’s economy will grow 2.5 percent this year and 2 percent in 2019, compared with a credit-fueled 7.4 percent in 2017. Its prediction for 2017 indicates a contraction, perhaps in the third quarter of the year. The government expects first-quarter GDP of more than 7 percent.  

Moody’s also foresees inflation in Turkey increasing to 16 percent from 12.2 percent in May and 10.9 percent in April on the back of lira depreciation and higher oil prices.

Faster inflation means higher interest rates. Loan rates for businesses are already nudging above 20 percent annually, according to loan supermarket portal hangikredi.com.

Garanti Bank, Turkey’s third-largest listed lender, is offering SMEs a 500,000 lira, three-year loan at a monthly compound interest rate of 1.72 percent, according to the portal. The cost of borrowing for the firms is poised to rise further as a result of the central bank’s rate hikes, which will translate into higher interest rates on deposits, forcing banks to increase loan rates to maintain their profit margins.

Moody’s and Fitch also point out that the ability of the Turkish government to bail out banks in times of stress is diminishing as the country’s credit profile deteriorates and central bank reserves decrease.

Central Bank Governor Murat Çetinkaya has just $26 billion of net foreign currency reserves at his disposal for potential bailouts, meaning he may be more reluctant or selective in providing financial support to banks through the money markets.

The country’s worsening current account deficit – currently about 6 percent of GDP -- coupled with a decline in foreign investment and portfolio inflows into stocks and bonds means the central bank’s foreign currency reserves could deplete further as policymakers are forced to dip into its coffers to finance the shortfall.

Whether those reserves will be enough to deal with any financial stress on the industry without reverting to an external bailout, possibly from the International Monetary Fund, remains to be seen. 

Finally, the sector is faced with a potentially huge fine from the U.S. Treasury Department as it investigates state-run Halkbank for its role in breaking sanctions on Iran.

Mehmet Hakan Atilla, a senior executive of Halkbank, is already behind bars for his role in the scheme. The fine against Halkbank could run into tens of billions of dollars, analysts say, and there is a risk that other banks may be included in follow up indictments by the U.S. courts.