Moody's Investors Service on June 18 downgraded 18 of Turkey’s banks, cutting their local currency long-term deposit ratings, and their local and foreign currency senior unsecured and issuer ratings (where applicable) by one notch and maintaining the outlooks as negative.
The standalone baseline credit assessments (BCAs) of 16 banks were downgraded by one notch, while the BCAs of the remaining two banks—government-owned Ziraat Bankasi and Turkiye Vakiflar Bankasi (Vakifbank)—were downgraded by two notches.
This rating action followed Moody's surprise downgrade, on June 14, of Turkey's sovereign bond rating to B1 from Ba3, with a negative outlook, which also resulted in the lowering of the ceiling for foreign currency deposits to B3 from B2.
Also in the wake of the sovereign downgrade, Moody’s on June downgraded the ratings of the covered bonds issued by five Turkish banks (Akbank, Sekerbank, Turkiye Garanti Bankasi, Turkiye Vakiflar Bankasi and Yapi ve Kredi Bankasi).
Additionally, Moody’s downgraded to B1 from Ba3 the long-term issuer ratings of the Metropolitan Municipalities of Istanbul and Izmir. The Aaa.tr National Scale Rating on Izmir was affirmed. The rating outlooks on both municipalities were kept on negative.
Higher risk exposure to investor sentiment, depositor behaviour
Outlining its reasons for the downgrades applied to the 18 banks, Moody’s said “the downgrades primarily reflect (1) a significant increase in external vulnerability for the country, exposing Turkish banks to a higher risk of a sudden shift in investor sentiment and depositor behaviour; (2) a higher risk of more extreme government policy measures, which could include restricted access to foreign currency for depositors, reflecting policy uncertainty and weakening central bank's net foreign currency reserves; and (3) a more prolonged deterioration of the operating environment, leading to a further weakening of banks' solvency metrics. Moody's has captured these challenges by lowering the Macro Profile it assigns to Turkey to Very Weak+ from Weak- by increasing the negative adjustment it applies for Funding Conditions score”.
Moody’s said Turkish banks’ high reliance on short-term funding in foreign currency remains a structural weakness, rendering them vulnerable to shifts in investor sentiment and stress scenarios.
It added: “This weakness has been a key negative driver of Turkish banks' ratings for several years. With around 30% of tangible banking assets being funded by wholesale debt, Turkey is one of the emerging countries that is most reliant on market funding. As at April 2019, a sizeable USD64 billion of this wholesale exposure was in foreign currency and maturing in the next 12 months.
“A key mitigating factor is that the banks hold large amounts (USD100 billion) of liquid assets in foreign currency. Moody's notes, however, that only USD21 billion are cash or unencumbered securities, while the rest comprises receivables from the central bank (USD33 billion), receivables from financial institutions (USD30 billion), or compulsory reserves with the central bank.
“Furthermore, retail depositors have also continued to convert a material portion of their local currency deposits into foreign currency (mainly US dollars) to protect their savings from depreciation. Recently, the level of foreign currency deposits reached about USD209 billion, a sizeable 54% of total deposits.”
Moody’s cautioned that against the backdrop of reliance on foreign currency funding, the government has announced a number of economic reform packages since May 2018 with most measures continuing to focus “on the near-term priority of propping up economic activity at the expense of eroding the underlying resilience of the economy and the banking system to external shocks, in part by increasing its fragility to shifts in market sentiment”.
Moody's also observed that the central bank's net foreign currency reserves were limited at around $27bn, and they include an undisclosed amount of swaps with banks that lend foreign currency raised in the wholesale market and borrow lira to lend in the economy.
“In the context of high policy uncertainty, the combination of structural weaknesses, potential market stress, and limited mitigating factors increase the risk of more extreme policy measures, which could include restricted access to foreign currency for depositors in a stressed scenario,” the rating agency said..
Moody's also said that the deterioration of the operating environment for the banks may be more prolonged than it previously expected, leading to higher asset risk and lower profitability.
Moody’s expects Turkish real GDP to contract by 2% in 2019 and to grow only marginally in 2020, at +2%. This represents a material deterioration from previous years. In 2017, real GDP grew by 7.6% and in 2018, despite a sharp deterioration of the Turkish lira that sank into a currency crisis, real GDP expanded 2.6%. Inflation will remain very high at 18.5% in 2019 and 13% in 2020, versus 2018’s 20.3%, while the Turkish lira will remain weak, the rating agency forecast.
Pile of problem loans to grow
Moody's added that it expected “that the macroeconomic challenges will lead to an increase in the stock of problem loans of Turkish banks. A higher inflow of problem loans will lead to higher provisioning costs, reducing the profitability of Turkish banks that is, on average, strong. Some weaker banks will not have sufficient pre-provision profits to offset a spike in loan-loss charges”.
Despite a reduction in profitability, Moody's said it anticipated that capital will remain stable for most Turkish banks, adding: “Nevertheless, due to the still high level of assets in foreign currency, the capital of Turkish banks is still susceptible to a material currency deterioration.”
The larger BCA downgrades applied to Ziraat Bankasi and Vakifbank reflected “the unseasoned risk that the banks have built via recent higher-than-average loan growth”.
The other 16 banks downgraded are Akbank, Alternatifbank, Denizbank, Export Credit Bank of Turkey (Turk Exim), HSBC Turkey, ING Turkey, Nurol Investment Bank, Odea Bank, QNB Finansbank, Sekerbank, Turk Ekonomi Bankasi, Turkiye Garanti Bankasi, Turkiye Halk Bankasi, Turkiye Is Bankasi, Turkiye Sinai Kalkinma Bankasi (TSKB) and Yapi ve Kredi Bankasi.
Istanbul and Izmir closely linked to sovereign
In explaining its downgrading of the ratings of the Istanbul and Izmir municipalities, Moody’s said: “Due to their close institutional, financial and operational linkages with the Turkish government, metropolitan municipalities, including Istanbul and Izmir, cannot act independently of the sovereign and do not have enough financial flexibility to permit their credit quality to be stronger than that of the sovereign. Therefore, Istanbul and Izmir are rated on par with the Turkish government bond rating of B1 negative.
“Moody's assessment of both cities' baseline credit assessments (BCAs) is unchanged at b1, reflecting the two cities' robust operating performance, predictable shared taxes paid by the government and representing the vast majority of their revenue, and their large and diversified economic bases. In Moody's view, these factors counterbalance their limited cash reserves and significant exposure to foreign currency debt.”
Istanbul's B1 rating reflected its large and diversified economy, continuing robust operating performance, high self-funding capacity and valuable asset base, which provides fiscal flexibility to accommodate increasing capital spending and a strong likelihood that the Turkish government would provide support if the city was to face acute liquidity stress, Moody’s said.
It added: “On the other hand, Istanbul's rating is constrained by its relatively high debt burden, which will remain elevated during 2019-20 and facing upward pressure on debt servicing costs given the city's significant exposure to foreign currency debt.”
Looking at Izmir, Moody’s said its B1 rating reflects its very high and stable operating balance, exceeding 50% of operating revenue in 2018. “Izmir's credit profile benefits from the third-largest economic base in the country and a moderate likelihood that the Turkish government would provide support if the city was to face acute liquidity stress,” said Moody’s, adding: “At the same time, the rating is constrained by the moderately high indirect debt of municipal-related entities and the city's high exposure to foreign currency debt.”