Turkish sovereign and bank assets – bonds, equities and CDS – have moved broadly in parallel with the capitulation of the Turkish lira. Emerging markets are nervous and susceptible to news, factoids, half-truths, rumour and inference. Vague media reports of Single Supervisory Mechanism concern about the Turkish exposure of a handful of European banks, adopted as hard fact by the market, may have added to the sense of alarm but market reaction around European banks seems overdone.

"Banking in emerging markets can be very rewarding but it will be subject to ups and downs. Macro and political volatility are part of the game," said Marco Troiano, executive director in Scope’s bank team. “Both BBVA and UniCredit see Turkey as a strategic growth engine. They are not adventurers in the country. They have teamed up with established local players and have operated in the country for several years. Turkey may seem a headache right now, but over the longer run the revenue diversification it adds is a positive feature”.

Scope, which placed Turkey’s sovereign ratings under review for downgrade on July 26, yesterday published an update highlighting five major threats to Turkey’s sovereign creditworthiness.

As for the large European banks with presences in the country, the extent of unhedged foreign-currency loan exposure and delinquency rates will need careful scrutiny; as will exposure (including of locally-owned subsidiaries or affiliates) to sovereign bonds and impacts on capital. Ten-year domestic sovereign yields have blown out by 1,000bp since the start of the year to beyond 21%, for instance. But on the basis that most foreign bank lending in Turkey is in TL and funded by TL deposits, the impacts on parent groups will be more geared to Turkey’s broader economic fortunes.

The banks under the spotlight – BBVA (49.85% of Garanti Bank), UniCredit (40.9% of Yapi Kredi Bank); BNP Paribas (72.48% of Turk Ekonomi Bankasi), and ING (rebranded from Oyak Bank) – have all suffered sharp share price declines (10%-12+%) since the beginning of August, regardless of decent solvency, asset-quality, profitability and efficiency metrics at the local level, and the limited size of Turkey businesses relative to the parent groups.

“The Turkey meltdown, just like Italian populist uncertainties before it, Brexit, or Donald Trump’s trade war, is having a clear impact on EU banks. But what the latest turmoil shows yet again is that the goal of de-linking sovereign and bank risk, pursued for years by international regulators – most visibly through the creation of the European Banking Union – remains wishful thinking,” said Sam Theodore, team leader for bank ratings at Scope.

BBVA
Turkey accounted for 16% of BBVA’s revenues at the first-half stage. On the results call, BBVA said it expects GDP growth to moderate after over-heating in 2017 but management believes in Turkey’s long-term potential and in the quality of Garanti Bank. That stake has a book value of EUR 4.4bn but as risk-weighted assets are in TL, the currency impacts mostly offset each other.

"Garanti is an efficient bank and very advanced when it comes to digital banking. As the cycle turns, the bank will likely see impacts on its asset quality and higher provisions, but that should be manageable in the context of the BBVA group,” said Troiano.

In constant FX, profit in Turkey saw a small increase of 7.6%. In terms of the future outlook, provisioning levels will rise to 150bp a year as NPLs continue to grow but revenues are outpacing costs, creating a buffer to absorb them. The TL book grew 15% in H1 18; guidance for the cost of risk in Turkey for 2018 is 150bp, and this is included in IFRS9 impacts.

The strategy for Garanti is prudent given the macro environment; BBVA management is comfortable with its stake in the bank, stressing the risk-mitigating measures taken over the last few quarters: reducing FX loan exposure (now only 22% of total assets), diversifying funding sources, extending maturities (especially on the foreign-currency side), and increasing the quantity of CPI linkers in the ALCO portfolio (to 50% up from 37% three to four years ago). Management expects this natural hedge to positively impact net interest margins in coming quarters.

Loan growth is supported by the TL loan book (growing at 15%). The foreign-currency loan book is decreasing (-8.4% YoY) and the slowdown will continue in H2. Net fees rose by over 30%. Garanti is continuing the roll-out of its new digitally-led service model, Garanti Plus, now available at over 600 branches. Management says this is bearing fruit, improving efficiency, customer experience and employee satisfaction.

Garanti’s H1 net attributable profit grew over 25% YoY in constant euros, thanks to strong core revenue growth and a focus on cost control. NII rose 18% principally due to loan growth and successful customer spread management (the latter rose 26bp in Q2 despite higher funding costs). The spread is likely to decrease in H2, but this will be offset by higher income from the uptick in CPI linkers. At the local level, Garanti reported an 18.1% return on average equity at H1 18.

UniCredit
UniCredit highlighted that it is in Turkey for the long run and is willing to stomach the volatility. Yapi’s profit contribution was 27.9% up in constant FX (-3.4% lower in current FX). Yapi Kredi’s return on tangible equity at H1 was 16.4%. Because Yapi Kredi is consolidated using the equity method, only the bottom-line result is included in UniCredit's accounts, which reduces the volatility of the group's results. At EUR 183m in H1 18, Yapi accounts for less than 2% of UniCredit’s overall revenues.

“Turkey is a material part of UniCredit’s CEE business and a risk to profitability, as we have flagged in our issuer research in the past. But capital impacts are manageable,” said Troiano. Indeed, the impact on UniCredit’s group CET1 ratio from the depreciation of the lira is marginal; just -2bp for each 10% depreciation (-6bp on capital; +4bp offsetting RWA impact). Management said the impact from the widening of sovereign bond spreads is also manageable: 1bp for every 100bp widening, Troiano pointed out.

Pro rata regulatory consolidation of Yapi Kredi RWAs is just EUR 25 bn. Yapi’s capital increase (USD 1bn rights issue plus planned USD 500m AT1) had no impact on UniCredit’s CET1 ratio at group level. Most intra-group funding exposure is short-term and is in place to support the group’s GTB and FIG businesses.

BNP Paribas
Turk Ekonomi Bankasi generated a 13.57% return on equity in the first quarter of 2018, with a low NPL ratio (2.89%) and a 73.46% loan/deposit ratio. Foreign currency loans accounted for 21% of TEB’s total; the overall NPL ratio was 2.9%. In terms of marketable securities, 96.5% was TL-denominated, while 39% of deposits were FX.

On the H1 BNP Paribas earnings call, management acknowledged that Turkey had become a point of attention but emphasized TEB’s relatively small market share with a solid management team focused on the products and underwriting the bank carries out. Any repricing on the liabilities side, management said, is accompanied by actions on the assets side but this can take time. The cost of risk is stable year-on-year.

In terms of relative size, outstanding loans at H1 in the Europe-Mediterranean sub-segment of the group’s International Financial Services division where Turkey sits amounted to EUR 36.1bn. Turkey’s share of that was 39% (equivalent to EUR 14bn). Contrast that with outstanding loans in French retail banking (EUR 163bn), Belgian retail banking (EUR 105bn), BNL (EUR 78bn) and BancWest (EUR 60bn).

ING
ING’s EUR 15bn loan book in Turkey was flat quarter-on-quarter based on the change in FX rates. It represents about 2.3% of the loan book at group level. Stage 3 provisioning is at a similar level; 2% to 2.5%.

In terms of the composition of its Turkey loan book, the mortgage book is a little below EUR 1bn and is relatively short-dated. On SMEs, the bank is working with the government in terms of the guarantee it offers for lending, which currently is about EUR 1.5bn. Management wants to limit that so as not to over-extend loans supported by the guarantee because this is subject to a certain level of NPLs and the bank wants to stay within the limits.

When it comes to foreign currency loans (mainly in Wholesale Banking), management seek to match euro or dollar funding with euro or dollar revenues at the client level. Until now, based on its profile, and the cost of risk, it is well under control, management said.

Authored by Keith Mullin