Via Wolf Street

Big Gamble that was hot for years has gone sour after Turkish lira’s plunge and surge of defaults on bank debts denominated in foreign currency.

By Nick Corbishley, for WOLF STREET:

As the Turkish lira logged fresh record lows against both the dollar and the euro on Friday, and is now down 19% this year against the dollar, attention is turning once again to the potential risks facing lenders. They include a handful of very big Eurozone banks that are heavily exposed to Turkey’s economy via large amounts in loans — much of it in euros — through banks they acquired in Turkey. And the strains are beginning to replay those of the last currency/financial crisis in 2018.

When the Money Runs Out…

Subordinate bonds of Turkiye Garanti Bankasi AS, which is majority owned by Spanish lender BBVA, together with two other local banks — Turkiye Is Bankasi AS and Akbank TAS — are trading at distressed levels (yields of over 10 percentage points above U.S. Treasuries), even though the banks are still profitable and said to be highly capitalized. This is an indication of the amount of confidence investors have in the ability of these companies to repay their obligations.

Three weeks ago, when the lira was trading within a tight band against the dollar — the result of the Central Bank of the Republic of Turkey (CBRT) pegging the lira to the dollar by burning through billions of dollars of already depleted foreign-exchange reserves and dollars borrowed from Turkish banks — no corporate bonds in Turkey were trading at these levels. Now that the CBRT has stopped propping up the lira, which has since fallen 7% against the dollar, the average risk premium demanded by investors to hold dollar-denominated notes of Turkish businesses has soared.

That’s just one of the problems that have emerged in recent days. Turkish banks have also begun charging fees on FX cash withdrawals, according to Reuters. State-owned Ziraat Bank charges a 0.03% commission for withdrawals above $3,000 while Garanti now requires a 0.015% fee for those above $20,000. This came after the banks had lobbied the central bank for months to allow withdrawal commissions on physical FX, citing hard currency shortages.

READ ALSO  2021 Could Be A Much Better Year For Canadian Oil

European Banks’ Exposure

Banks’ physical FX costs have risen due to plunging tourism receipts and reduced cross-border trade. At the same time, many companies are having trouble servicing their dollar- or euro-denominated loans and could end up defaulting. Loans in local currency are plummeting in value along with the currency. If these pressures continue to rise, they could spark contagion effects among banks in Spain, France and Italy. Two years ago, this risk was serious enough to prompt even the ECB to issue a warning on the matter.

Some of these banks have since reduced their exposure to Turkey’s economy, after being forced to write down their assets during Turkey’s last crisis, when the sharply weakened lira left Turkish companies and banks struggling to make interest payments or redeem their overseas debt. But the exposure is still considerable.

Of all non-Turkish lenders Spanish and French banks continue to have the most loans outstanding to Turkey, according to the Bank for International Settlements. Banks in Spain, France, Italy and the UK have an estimated combined exposure of around €118 billion. Spanish lenders (read: BBVA) account for just over half of that (€61 billion) while French (read: BNP Paribas), Italian (read: Unicredit) and British (read: HSBC) banks are respectively due €24 billion, €21 billion and €11 billion.

A Big Gamble that went well for years has gone sour.

These lenders were drawn to Turkey by the country’s record of high-octane, debt-fueled economic growth and its much more favorable demographics than the ageing populations of Western Europe. For a fair while, the bet paid off. Erdogan’s economic miracle, fueled largely by a huge foreign-currency-denominated debt bubble, provided over a decade of juicy lending opportunities and bumper profits for the banks. Then, when the miracle faltered, the bubble went pop, and things went to heck.

Many loans to the energy and construction industries went into default and were rescheduled. The non-performing loan (NPL) ratio surged to 5.5%, its highest level since the GFC. Inflation soared to over 20%, causing the CBRT to hike rates to 24%, until Erdogan fired the CBRT’s chairman and demanded a change of policy. All of this turmoil, coupled with Erdogan’s takeover of the country’s economic institutions, including the CBRT, have prompted some of the banks to reconsider their presence in the country.

READ ALSO  US, Global Corporate Giants Not Amused Mexico Finally Forces Them to Pay the Taxes They Owe

Between November 2019 and February 2020, Italy’s biggest lender, Unicredit, reduced its stake in the Turkish lender Yapı Kredi — not once but twice! It now holds 20% of the bank’s stock, down from around 40% a year ago. ING Groep, the biggest bank in the Netherlands, is also allegedly considering selling part or all of its Turkish operations as is HSBC, though neither bank appear to have taken concrete actions to that end.

But the foreign bank that has taken the biggest loss on its investment in Turkey so far…

One foreign bank that remains optimistic, at least outwardly, about its exposure to Turkey’s economy is the most exposed of all: Spain’s BBVA, which owns half of Turkiye Garanti Bankasi. BBVA has already written off over 75% of its investment in Garanti since buying its first chunk of the lender in 2011, under the combined influence of Garanti’s plummeting shares and Turkey’s plunging currency.

Garanti’s shares that trade in Istanbul closed on Friday at 6.78 lira, or about $0.92. The Garanti ADR, which trades in the US, closed at $0.91 on Friday. This is down 85% from the $6-plus range when BBVA started buying its stake in 2011.

BBVA CEO Onur Genc came to BBVA via Garanti, which he’d joined in 2012 as executive vice president for retail banking, and then moved up. In November 2018, he became CEO of BBVA.

Like many foreign banks, Garanti has extended large amounts of foreign-denominated loans to Turkey’s real estate, construction, energy and tourism sectors, the first three of which are still recovering from the last crisis while the fourth is reeling from the effects of the current crisis.

While most other Western banks in Turkey are thinking about further scaling back their exposure to Turkey, BBVA expanded its total stock of loans by 21% in the first half of the year — the highest increase of any private sector bank, bragged Garanti BBVA’s CEO Recep Baştuğ. “Any eligible business or consumer was granted loans,” said Baştuğ, “leading to record high growth of 28% in corporate lending in the first half.”

READ ALSO  Turkey’s lira sinks to 8 against US dollar for first time

The bank has also allowed borrowers who couldn’t make loan payments to defer them, both interests and amortizations. In other words, extend-and-pretend across the board. The bank continues to show interest income on those loans in deferral, though no payments are actually being made.

Thanks in large part to this, as well as the expansion of lending and the relatively strong performance of the lira in May and June, Garanti earned €189 million in the second quarter of 2020 — despite the loan growth, this was down from €218 million in the second quarter of 2019. And this as as of the end of June.

Conditions have changed in the past three weeks. The lira has sunk to a new low and financing pressures are rising. Once the moratoriums on loan payments and interest come to an end, which one day they must, those pressures will soar as defaults surge. Yet despite that, BBVA believes that Turkey’s economy — and with it, Garanti — will ride out this latest storm reasonably unscathed.

But when it comes to Turkey, BBVA has always been hugely optimistic. CEO Onur Genc said in January 2020 that Turkey had been the biggest positive surprise of 2019. “This year,” he said, it “will be even better.” Prophetic words. By Nick Corbishley, for WOLF STREET.

Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.