Dancing to Turkey's tune

Opportunities in real estate

AT THE END of August, GE Consumer Finance agreed to pay $1.56 billion for a 25.5% stake in Turkey’s third-largest privately owned bank, Garanti Bank. The deal, struck with Dogus Holding, Garanti’s parent, is expected to close in the fourth quarter, valuing Garanti at $6.1 billion.

“A truly historic day” UK foreign minister Jack Straw congratulates Turkish counterpart Abdullah Gul after the opening of negotiations for Turkey’s EU membership is agreed

Under the agreement, GECF will also pay $250 million in cash for 49.2% of Garanti’s founders’ shares. The agreement stipulates that the two parties will form an equal partnership.

GECF’s decision to take a strategic stake in Garanti is indicative of the growing international interest in Turkey’s banking sector but it also typifies the style of partnership that foreign players are entering.

“The most important development in the banking sector in 2005 was the increase in direct or indirect investments by foreign investors in the banking sector,” according to research from the BDDK, Turkey’s banking regulation and supervisory agency.

However, Turkish owners have been reluctant to relinquish full ownership, unlike the situation in eastern Europe, where western European and US banks stormed in during the mid-1990s, buying 100% or majority stakes in leading banks.

Botan Berker, managing director of Fitch Ratings’ Istanbul office, attributes this to the way in which the Turkish banking sector evolved. “Turkish banks are looking for joint ventures,” she says. “Unlike in eastern Europe, Turks are not willing to sell 100% of their banks. Turkey’s banking sector is already developed. The private sector has been involved in banking since the establishment of the republic [in 1923]. In eastern Europe, the state had owned everything and, after the Iron Curtain fell, the state banks were sold to the banks’ employees through vouchers.”

This, she says, means that Turkish bank owners have longstanding interests to protect. Their banks also have a relatively highly developed retail infrastructure, modern technology and broad branch networks, as well as a wide range of products. As a result, Berker does not expect to see foreign banks invited to buy majority stakes in Turkey’s banking sector.

Moody’s analyst George Chrysaphinis agrees. “It appears that where the bank’s original owner is a Turkish business group, the foreign bank has only been able to buy a 50% stake,” he wrote in a research report earlier this year. “The improved banking sector prospects have made current owners reluctant to leave the business and have made them realize that a strong foreign partner can help develop the bank’s real banking franchise.”

The only exception was Disbank, Turkey’s seventh-largest privately owned bank. New legislation precludes media owners from holding interests in the banking sector as well. Disbank’s owner, Dogan Holding, which has newspaper, internet and TV interests, chose to sell the bank in its entirety to Belgium’s Fortis.

Fortis paid A880 million for an 89.34% stake, valuing the bank at A985 million. Fortis is also to make a public bid for the remaining 10.66% of Disbank’s shares.

The difference between the Turkish banking sector and that in eastern Europe means that pricing levels differ. “There is less that is attracting buyers, while sellers are also less willing as they are able to stay in the system,” says Berker at Fitch. “The best thing is to have strategic partners.”

Some analysts argue that as the banking environment stabilizes further, it will become easier for domestic and foreign institutions to negotiate deals. “Greater earnings visibility will also lead to a convergence in the valuations that owners and purchasers might attach to Turkish banks, making it easier to strike a deal,” Chrysaphinis explains.

Retail loans as a percentage of GDP

This year, as well as the GECF/Garanti deal, a 57.4% stake in Yapi ve Kredi Bankasi was sold. Koc Financial Services – a joint venture between Turkish conglomerate Koc Holding and Italian banking group UniCredito – finalized the deal in September to buy the stake in Yapi Kredi from the troubled Cukurova Group. The transaction, which was originally agreed in May, is worth $1.4 billion.

This has enabled Cukurova to pay $1billion of the debt it owes to Yapi Kredi. The total debt, incurred when it lost control over the bank as a result of excessive group lending, is $2.3 billion.

Dutch bank Rabobank also received the blessing of the BDDK in September for its proposed acquisition of a 51% stake in Sekerbank, which largely serves farmers and consumers in small communities.

The prospect of Turkish EU membership is the main driving force for this increasing interest from western banks. BNP Paribas paid $216.8 million for a 50% stake in TEB Financial Investments from Turkey’s Colakoglu Group in February, giving it a 42.2% stake in medium-size bank Turk Ekonomi Bankasi (TEB).

Joint benefits

Such joint ventures are favourably viewed by the rating agencies. “We believe that banks that are partnered by significant foreign banks will benefit from the transfer of know-how and from improved transparency and corporate governance,” argues Moody’s Chrysaphinis. “A well-handled partnership will leverage local knowledge with the technical and financial resources of the foreign bank and is likely to put positive pressure on the bank’s ratings.”

And for foreign banks, these partnerships offer the best way to get market access. “Given the well-established franchises and local know-how of domestic banks, we do not believe that a foreign bank can make significant inroads into the Turkish banking system without acquiring an existing Turkish bank,” says Chrysaphinis.

Few of Turkey’s privately owned banks are thought to be opposed to a strategic partnership with a foreign player if the price is right. Shareholders at Akbank, Turkey’s largest private sector bank, have let it be known that they would welcome an appropriate partner, Turkish analysts say. Akbank is majority owned (66.35%) by the Sabanci Group, one of Turkey’s largest and most diverse industrial-financial conglomerates.

With EU accession now more likely than ever, albeit 10 years or more down the line, few major players can afford to ignore the potential that the Turkish market offers. Citigroup is one of the players rumoured to be looking at the market, along with French and German institutions.

With Turkish banking assets today making up less than 80% of GNP, and a population of almost 70 million to sell products to, it is little wonder that foreign banks are keen to get involved. For example, mortgages in Turkey make up only around 1% of GNP, compared with penetration levels of 30% to 40% in Europe.

Berker says all the large banks are looking at the property finance market. “Some financial institutions from the West are already trying to penetrate the Turkish mortgage market,” she says. “They have been coming to conferences, talking to banks and establishing their own mortgage companies.”

The switch to mortgage lending, along with other fast-growing areas such as lending to small and medium-size enterprises and microfinance, is a result of falling interest rates in Turkey, which has forced banks to look beyond simply holding high-yielding government securities.

EU ambitions

Developments in the banking sector have been taking place in the shadow of Turkey’s EU aspirations. Last December EU political leaders fixed October 3 as the date for Turkey to begin negotiations. But on the eve of the historic development, Austrian foreign minister Ursula Plassnik refused to sign up to the draft framework for entry talks.

Thirty hours later, the Austrians fell into line and Turkey’s foreign minister, Abdullah Gul, belatedly took off for Luxembourg for the opening ceremony after Turkey agreed to the EU’s terms. Crucially, Austria’s demand that Turkey be offered an option short of full membership was dropped.

Jack Straw, UK foreign minister and chair of the meeting, referred to the opening of the accession talks as a “truly historic day for Europe and the whole international community”.

Analysts have said all along that the accession process is more important for Turkey, because of the economic and political transformation it will promote, than the actual accession. This means that now Turkey has officially embarked on negotiations, the time that these take to complete is relatively unimportant.

The EU process has long been priced into Turkish sovereign debt spreads, to the extent that on that Monday, while frantic discussions were taking place to convince Austria to fall into line, spreads only moved within a 1.5 basis point corridor.

On news that the deal had been concluded, though, shares on the Istanbul stock market leapt by as much as 7% over a two-day period, to record new highs.

The number of Turkish banks has fallen from more than 60 in 2001 to 48 today, yet amid the flurry of strategic partnerships being formed there is little sign of domestically led consolidation. This comes back to the same point about the domestic market being self-sufficient in terms of capital, making mergers unnecessary for the banks’ future development. “The ownership motive is strong in Turkey,” Berker argues.

Compared with other emerging markets, 48 banks is not an overly large number for a population of 70 million. Russia’s 143 million people, for example, have a choice of 1,100 banks; Kazakhstan, with a population of just 15 million, has about 35.

Turkey’s banking sector had total assets of NTL338.1 billion ($249 billion) at the end of July, according to BDDK research. The stock market capitalization of Turkish banks increased from $28.6 billion to $34.8 billion between the end of 2004 and the end of June 2005.

Rescue strategy

O’Connor: GECF’s investment in Garanti is “an excellent opportunity in an important market”

“The far-reaching restructuring of the Turkish banking sector, initiated after the banking crises of late 2000 and early 2001, has had a significant positive impact on the stability of the system, making it more conducive to franchise building,” according to research from Moody’s. “Compared to the pre-crisis operating environment, the current banking system is composed of a smaller number of financially healthier players.”

The reforms had cost the government almost $40 billion by the end of 2003.

And while Turkey’s banks are benefiting from the stability that the AK Party has brought to the country since winning elections in late 2002, few are under any illusions that the banking sector will suffer from renewed volatility should this stability come under threat.

This is why Turkish politicians have been quick to welcome the benefits that stricter regulation for banks under Basle II will bring. “Though we had rules in place in the 1990s, many countries including Turkey could not escape financial crises with devastating impacts on the real sector and widespread contagion in other countries,” Ibrahim Canakci, undersecretary at the Turkish treasury, told a conference earlier this year. “In many of these cases, the main factors to blame were the weak financial systems and poorly managed and supervised banks.”

Turkey’s banking sector will immediately feel the impact of Basle II on capital adequacy ratios, given the proposed changes in the risk weight of assets. But it would appear that the impact of the new rules on the capital adequacy ratio at the consolidated level in the banking sector will remain limited. According to a quantitative impact study carried out by the BDKK, even though banks’ capital adequacy falls to some extent under the Basle II provisions, it should not be seen as significant because of the prevailing high capital adequacy ratio of the Turkish banking sector.

The scale of the BDKK and SDIF reforms means that so far only private sector banks have been attractive to foreign investors. But there are plans to privatize state-owned Vakifbank through an IPO and analysts do not rule out foreign interest in either Haalk Bank or Ziiyat Bank. Haalk in particular, which has a strong position in the growing market of SME lending and microfinance, could be attractive to foreign banks that have similar specializations.

“Microfinance will grow in the future,” says Fitch’s Berker. “For any bank, it is a very profitable sector. Historically there have been non-performing loan ratios of only around 1% in this business. It would make sense for one of the big banks that has expertise in this area.” It is likely to be at least two years, though, before this will become a reality.

Ziiyat’s role as the main intermediary for the agricultural sector means it would need more reform – and would pose more of a challenge – for many international houses to take an interest.

Market opportunities

Turkey’s banks have traditionally been highly reliant on the syndicated loan markets, especially when sovereign spreads were trading hundreds of basis points wide of where they do today.

Strategic partnerships with foreign banks are likely to give Turkish institutions more options when it comes to raising finance.

There is little sign, however, that the country’s banks will turn significantly towards the plain vanilla eurobond markets, although securitization is growing in popularity. Three securitizations of diversified rights payments were launched within one week in June, from Akbank, Vakifbank and Denizbank.

Akbank chose to use full monoline wraps for its $700 million offering, while Vakifbank tapped its securitization loan programme for $750 million and Denizbank sold an unwrapped $300 million deal.

Foreign investors hungry for yield and diversification have been keen to buy this paper, as there is little sub-sovereign plain vanilla debt on offer. Other banks that have already taken the securitization route this year include Is Bank, Finansbank and Garanti Bank.

With the added benefit of GECF’s involvement , which is likely to be concluded by the end of the year, it remains to be seen what Garanti’s next funding move will be.