FINANCIAL INSTITUTIONS ISSUER IN-DEPTH 16 JULY 2015 RATINGS Turkiye Vakiflar Bankasi TAO Long Term Rating Baa3 Baseline Credit Assessment ba1 ST Issuer Level Rating P-3 Outlook Negative Subordinate (foreign) Ba2/ Ba3(hyb) ANALYST CONTACTS Simone Zampa 44-20-7772-1425 VP-Sr Credit Officer [email protected]Firat Bayraktar 44 20 7772-1087 Associate Analyst [email protected]Irakli Pipia 4420-7772-1690 VP-Senior Analyst [email protected]Henry MacNevin 44-20-7772-1635 Associate Managing Director [email protected]Yves Lemay 44-20-7772-5512 MD-Banking & Sovereign [email protected]Banking - Turkey VakifBank Faces Capital and Profitability Pressures in the Competitive Turkish Market Summary State-owned Turkish lender VakifBank (Baa3/Neg, ba1 1 ) is facing a number of challenges that could weaken its creditworthiness. The bank’s capital and profitability, which are weaker than those of peers, are key concerns, leaving the bank vulnerable to intense competitive forces and ongoing macro-economic challenges that are squeezing the sector’s profit margins and putting pressure on asset quality. VakifBank’s market share, at 7.9% of total assets, is hotly contested by numerous similarly sized competitors such as Halkbank (Baa3/Neg, ba1) and YapiKredi (Baa3/Neg, ba1), and threatened by larger players such as Akbank (Baa3/Neg, ba1), Garanti (Baa3/Neg, ba1), Isbank (Baa3/Neg, ba1), and Ziraatbank (Baa3/Neg, ba1). In its efforts to maintain good market share, VakifBank is consuming capital to expand its lending but it is not generating sufficient profit to maintain good capitalisation. This, combined with our expectations for a challenging economic and investment climate in Turkey over the next 12 to 18 months, are among the key factors underpinning our negative view on VakifBank’s Baseline Credit Assessment (BCA) and the negative outlook on its ratings. Turkey's inconclusive election result in June 2 has increased political uncertainty and will likely delay economic reforms. That, in turn, could impact economic growth and - just as critically – affect investor confidence, since the Turkish economy and banks depend on foreign capital to fund their imbalances. However, VakifBank’s liquid assets more than cover the short-term risks associated with refinancing problems that may appear during market turbulence. Finally, the high foreign-currency (FX) content in the loan books of Turkish banks, including VakifBank, creates considerable capital and asset quality risk in a period of sharp currency weakening. The Turkish lira has fallen around 21% against the US dollar (at July 2015) compared to same period last year 3 .
VakifBank Faces Capital andProfitability Pressures in theCompetitive Turkish MarketSummaryState-owned Turkish lender VakifBank (Baa3/Neg, ba11 ) is facing a number of challenges thatcould weaken its creditworthiness. The bank’s capital and profitability, which are weaker thanthose of peers, are key concerns, leaving the bank vulnerable to intense competitive forcesand ongoing macro-economic challenges that are squeezing the sector’s profit margins andputting pressure on asset quality.
VakifBank’s market share, at 7.9% of total assets, is hotly contested by numerous similarlysized competitors such as Halkbank (Baa3/Neg, ba1) and YapiKredi (Baa3/Neg, ba1), andthreatened by larger players such as Akbank (Baa3/Neg, ba1), Garanti (Baa3/Neg, ba1), Isbank(Baa3/Neg, ba1), and Ziraatbank (Baa3/Neg, ba1).
In its efforts to maintain good market share, VakifBank is consuming capital to expandits lending but it is not generating sufficient profit to maintain good capitalisation. This,combined with our expectations for a challenging economic and investment climate inTurkey over the next 12 to 18 months, are among the key factors underpinning our negativeview on VakifBank’s Baseline Credit Assessment (BCA) and the negative outlook on itsratings.
Turkey's inconclusive election result in June2 has increased political uncertainty and will likelydelay economic reforms. That, in turn, could impact economic growth and - just as critically– affect investor confidence, since the Turkish economy and banks depend on foreign capitalto fund their imbalances. However, VakifBank’s liquid assets more than cover the short-termrisks associated with refinancing problems that may appear during market turbulence.
Finally, the high foreign-currency (FX) content in the loan books of Turkish banks, includingVakifBank, creates considerable capital and asset quality risk in a period of sharp currencyweakening. The Turkish lira has fallen around 21% against the US dollar (at July 2015)
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.
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Company profile
State-owned VakifBank enjoys a good franchise and brand recognition in the highly competitive and fragmented Turkish market. Itis a domestically-focused, universal institution, with strong links to Turkey’s corporates. The bank’s indirect government ownershipfacilitates business with public-sector entities and their employees.
Commercial banking activities (including SME, corporate and commercial lending) represent the largest share of the bank’s loan bookat 68%. Consumer lending dominates its retail banking operations, with overall retail banking at 32% of the loan book (see Exhibit 1).
Exhibit 1
VakifBank loan book composition versus the average for the system as of Q1 2015
Source: Company data (bank only), Turkish Banking Regulation and Supervision Agency (BRSA)
VakifBank’s market share by total assets was at 7.9% at end-March 2015 (see Exhibit 2), similar to Halkbank (7.6%) and not toodistant from YapiKredi (9.5%). The larger market players are Akbank (10.3%), Garanti (10.9%), Isbank (11.9%) and Ziraatbank (12.7%).
Exhibit 2
VakifBank competes with numerous similarly sized peers
Source: Company data (bank only), The Banks Association of Turkey (TBB)
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Fast lending growth is a point of concernVakifBank’s fast loan growth is in line with the banking system average, but is a point of concern because it is consuming capital andmay lead to asset quality problems (see Exhibit 3). Although loan growth is lower than during 2011-2013, we expect it to remain highas the bank seeks to protect its market share in the highly competitive Turkish market.
Exhibit 3
VakifBank loan book growth versus the average of the system
Source: Company Data, BRSA, Moody’s Investors Service
Capital ratios are lower than peers and vulnerableVakifBank lags peers in terms of capitalisation, constraining its potential for risk-absorption and sustainable growth. The bank’s Tier 1capital ratio was 10.8% at the end of the first quarter of 2015 (year-end 2014: 11.4%), which compares unfavourably with the sector-
wide average of 13.3% (year-end 2014:14%)4 . Its total capital ratio is closer to the average, suggesting that it holds a higher proportion
of lower-quality capital (see Exhibit 4)5 .
Eliminating discrepancies with other banks in the way risk-weighted assets are calculated, the non-risk weighted Tier 1 leverage ratio(Tier 1 capital/Total Assets) shows capitalisation at 8.7%, considerably weaker than the average for the Turkish banking sector.
Exhibit 4
VakifBank capital ratios versus the average for the system as of Q1 2015
Q1 2015 Vakifbank SystemTotal Capital Ratio 14.2% 15.5%Tier 1 Ratio 10.8% 13.3%Tier 2 Ratio 3.4% 2.2%Tier 1 Leverage ratio 8.7% 11.4%
Source: Company data, BRSA
The weaker capital position places the bank at a disadvantage to most of its peers which have greater leeway for future sustainablegrowth and market share expansion.
Higher non-performing loans than the sector is offset by higher provision coverage
VakifBank has higher non-performing loans (NPLs) than the average for the Turkish banking sector. This is largely due to its position asa state-affiliated bank. State-owned banks are proscribed from selling NPLs at a discount as other Turkish banks do, because these areconsidered state assets.
The bank’s NPLs made up 3.57% of total loans in Q1 2015, improving slightly from 3.67% at end-2014. The slight improvement
was due to the bank’s rapid loan growth (at 7.8% quarter on quarter) which expanded the base and diluted the delinquencies6 . Thiscompares with average banking sector NPLs of 2.8%.
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VakifBank follows a more conservative policy than most of its competitors in terms of loan-loss provisions, however - a credit strength.Provisions stood at 91.4% of NPLs at Q1 2015, compared with 73% for the sector as a whole (see Exhibit 5).
Exhibit 5
VakifBank NPLs and provisions trend
Source: Source: Company data (bank only), BRSA
The volume of non-performing loans rose at a quarterly rate of 4.9% in Q1 2015 at VakifBank, slower than the 6.2% rate for the sector.We expect the rate to increase, however, as problems start to arise in the pool of new loans on the balance sheet after the rapid loangrowth that has stretched back over five years. We expect this will increase VakifBank’s NPLs ratio by 50 basis points or more over thenext 12 to 18 months, as a combination of the higher interest rate environment, the depreciation of the Turkish lira and the economicslowdown tests these new borrowers. Loans to consumers (32% of the loan book) and SMEs (26% of the loan book) will likely bear thebrunt. Corporate and commercial loans (42% of the loan book), which have so far proved resilient in the economic slowdown, will alsobe vulnerable now, given the exchange-rate volatility and the predominance of foreign-currency lending in this segment (see Exhibit 6).
Exhibit 6
VakifBank loan composition by currency versus the average for the system as of Q1 2015
FX Content of the Loan book TL FX TotalVakifbank 71% 29% 100%System 70% 30% 100%
Source: Company Data (bank only), BRSA
Lower profitability, facing downside risksVakifBank is somewhat less profitable than the system-average. The bank has seen gradually declining profitability over the past fouryears, when measured by the return on average assets (ROAA). ROAA declined to 1.1% at Q1 2015 (annualised) from 1.5% at year-end 2011. Sector-wide profitability has been also decreasing during the same period to 1.3% from 1.7% (see Exhibit 7). Importantly,VakifBank’s faster loan growth than the system average in Q1 2015 has not translated into higher profitability.
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Exhibit 7
VakifBank return on average assets versus average for the system
Source: Company data (bank only), BRSA
The bank’s consolidated net income dropped 32% year-on-year in the first quarter of 2015, mainly due to additional provisionsrequired at its insurance subsidiary, Güneş Insurance, which were up-fronted for the entire year. This cost was offset in part by anincrease in net interest income (+18%) and significant growth in the net fee and commission income (+55%) resulting from loangrowth and increased contribution from the payment system fees. However, the bank’s net interest margin contracted slightly to 3.11%from 3.31% in the same period, and remains lower than the system-average of 3.35% at Q1 2015 (year-end 2014: 3.53%).
In common with its domestic peers, we expect the bank’s profitability to face downside risks over the coming 12 to 18 months from:
» Ongoing pressure on the bank’s net interest margin due to the likely increase in funding costs, which include currency swaps.
» Turkish courts have ordered the country’s banks to reimburse fees for products and services incorrectly charged to retail customersover the past 10 years. The overall amount is difficult to quantify precisely, but VakifBank has repaid TL53 million in the first quarter of2015 (about 13% of the pre-tax income, excluding the rebate).
» Our expectation that provisioning costs will increase due to gradually rising NPLs in the slowing economy.
Reliance on market funds has been growing…
A low savings culture among Turkish consumers means that all Turkish banks rely to some extent on confidence-sensitive capitalmarkets to finance their lending growth. Reliance on market funds has been increasing for Turkish banks as loan growth has exceededdeposit growth over the past years.
VakifBank’s loan-to-deposit ratio stood at 113% at Q1 2015, which compares favourably against the 119% system average on a bank-only basis (see Exhibit 8). However, the consolidated loan-to-deposit ratio, including factoring and leasing receivables, brings VakifBankin line with the system average.
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Exhibit 8
VakifBank loan-to-deposit ratio versus the system average
Source: Company data (bank only), BRSA
VakifBank’s deposits represent around 63% of its liabilities, in line with the average for the system, but lower than the 69% averagereported by other state-affiliated banks. The remainder is made up of borrowed funds (11%), interbank money market funds (11%)and securities issued (7%), similar to the average of other deposit-taking banks. We note that part of this funding includes Turkishlira bonds (at 11% of the total market funding) which has shown similar stability to customer deposits. The remaining part of marketfunding is exposed to investor sentiment, which could result in higher costs and more limited access in times of market turbulence.
…but short-term risks are more than covered by liquid assetsVakifBank holds a sizeable quantity of liquid assets7 , partly compensating for its riskier market funding. Its liquid assets made up 29%of total assets, above the average for the system of 27% (see Exhibit 9).
Exhibit 9
VakifBank outperforms the sector average in terms of liquidityLiquid assets to total assets compared to the system average
Source: Company data, BRSA
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The maturity profile of VakifBank’s deposits are also in line with the system, with 85% of deposits maturing within three months(see Exhibit 10). However, we note that public-sector deposits represent around 16% of total deposits, compared to the 4% systemaverage. We view state deposits as less cost-sensitive with a higher rollover rate, a credit strength.
Exhibit 10
The maturity profile of VakifBank's deposits is in line with the system averageDemand + 7 daysmaturity deposits
As of Q1 2015, the banks’ total liquid assets stood at TL51 billion, while total market funds stood at TL49 billion. About 72% of thebank’s market funds mature within one year (see Exhibit 11), which includes TL15.7 billion in the form of secured repos. The liquid assetsto short-term market funds ratio stood at 1.4 times as of end-March 2015, which gives the bank some cushion in case of refinancingproblems during market turbulence.
Exhibit 11
VakifBank’s maturity structure of market funding (TL billion)
Source: Company data, TBB
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Endnotes1 The bank ratings shown in this report are the bank’s deposit rating, senior unsecured debt rating (where available) and baseline credit assessments.
2 Please see “Moody's: Turkish election result raises political uncertainty, likely to delay economic reforms”, published 8 June 2015.
3 A central bank survey shows 12% of Turkey’s non-financial companies with FX borrowings have no export revenue to help offset the impact, while another10% have FX debt which is higher than their export revenues.
4 Similarly to the system, the VakifBank marked decline in the Tier 1 capital ratio in Q1 2015 was mainly driven by (i) the depreciation of the Turkish lirawhich triggered an increase in the risk-weighted assets associated with the foreign-currency loans, and (ii) loan book growth.
5 VakifBank issued in February 2015 a Basel III-compliant Tier 2 capital instrument which increased the foreign-currency component of the total capital ofthe bank, thus providing some hedging to the Turkish lira depreciation.
6 Repayment problems do not usually emerge until later in the life cycle of a loan.
7 Mostly cash and equivalents at the Central Bank, and Turkey’s sovereign securities (Baa3, negative).
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