Ben Aris in Berlin -

Has Turkey's banking sector already turned the corner? While the rest of the world wallows in misery, Turkey has remained relatively steady and its banking sector in particular looks like it has already come out the other side of the crisis.

Turkey has been doing surprising well compared to its peers in the region. It came in at the top of the class in the IMF's Global Stability report released in April, scoring "concern" in only two of the six categories that worry the IMF (external debt is too high at 110% of reserves and with net external provisions at -11.9% of GDP, this debt is not adequately covered). Still, on both counts Turkey is still streets ahead of the other countries of concern to the IMF. If the country can finally agree an IMF's stabilisation loan, even these worries should drop away (see related piece).

In mid-May, Turkish banks reported their first-quarter financials and most beat expectations. Profits at the top eight banks came in at TRY2bn (€940m) in the quarter, which was down only around 10% on year. Of particular note was that non-performing loans (NPLs) were in the 3-5% range, which is low by regional standards, and come despite a severe downturn in the real economy, which is likely to see GDP contract 4-6% in 2009.

The main advantage of Turkey's bank sector is that it went through such a nasty crisis at the start of this decade, meaning that most banks and the regulator were cautious during the recent boom years. The result has been high capital adequacy rates of 18% (the amount of cash banks keep on hand to pay out to depositors), prudent borrowing abroad and a focus on stability over triple-digit growth rates. For example, the Turkish banking sector's total syndication repayment in the next 12 months is only $9.7bn and banks have enough cash on hand to repay half this amount, with the rest likely to be rolled over. "We have long argued that Turkish banks are not facing systemic risks. Banks' capitalisation is strong and their solid deposit franchises allow them to weather the global liquidity squeeze rather comfortably. They do not have any exotic assets buried in their balance sheets and do not carry any meaningful short forex positions. Therefore, the sector's problem is primarily NPLs," says Deutsche Bank's Kerem Tezcan in a recent report.

A flat loan book and a modest increase in deposits over the last few months have allowed the banks to manage their NPLs. Turkey seems well on track to hit the total of 6% of NPLs by the end of the year, well below the level that most emerging European countries are expecting to see.

If NPLs do come in at 6%, then turkey will emerge from this crisis as a real star. Deutsche Bank estimates that, because of the big cash cushions that Turkish banks hold, NPLs would have to rise above 22% before the capital adequacy ratios fall below 8% and start destroying a banks capital, forcing the government to step in with bailouts.

The kindest cuts

The central bank has acted decisively and cut rates in an effort to spur lending and get the economy moving again. The rate cuts have eased the pressure on banks, but they haven't fed through into an increase in lending yet. Instead, the banks have used their extra cash to bet on things like bonds, made profitable by the interest rate cuts. As a result, almost all Turkey's banks put in strong bottom line growth in the first quarter of this year compared with the same period a year earlier.

That said, there were early signs of life in the lending markets in April, when the total amount of loans grew by 0.6% and some analysts like Deutsche Bank's Tezcan remain confident that total loan growth in 2009 will reach 9% by the end of this year. A return of lending is going to be a lead indicator of reviving economic fortunes and Turkey's positive lending numbers is almost unique in the region where most banks are cutting back as hard as they can in an effort to build up provisions to cover the growth of NPLs. "[Lending] grew in all sub-segments except auto loans during the month, while general purpose loans registered the highest growth in this period. As a result of weak domestic auto sales, auto loans contracted by another 1.5% in February, implying 11.5% slid since the beginning of the year," says Sevda Sarp of Ata Invest in a recent report.

Another encouraging sign is that not only are deposits returning, but Turks have stopped moving their money sidewise inside banks, shifting them from Turkish lira-denominated accounts to dollar accounts as a hedge against a possible devaluation.

The government is also taking steps to keep NPLs down to a manageable level with a proposed "Credit Guarantee Fund," which would provide credit relief for the hardest hit by the crisis, SMEs in particular. "Although there is no precise description of the fund and its methodology, it is also reported that the treasury will bear 60% of the risk, when a loan turns to NPL. We believe this effort of the government is positive for the banks, and could lower the NPL growth towards the second half of the year. We expect the NPL ratio to reach 6% by the end of 2009," says ATA Invest's Sarp.

All this (relatively) good news has already fed through into listed banks' share prices, which have soared in recent months. "The current rise in equities was not a bear market rally. Although short-term profit-taking is on the cards, we believe [the Turkish stock market index] ISE is at the early stages of its mid-term recovery with increased global liquidity, rising risk appetite and signs of bottoming in global and domestic economic activity. We continue to favour exposure to Turkish equities despite the possibility of some pullbacks in upcoming months," wrote Halil Abrahim Kahve of Ata Invest in Instanbul in the first week of May.

These are bold words indeed. A rally on Central and Eastern European stock markets has gone on longer and stronger than anyone expected. Thanks to the relative health of the Turkish bank sector, the country's bank stocks have been outperforming and rose by just under a third in April after the first-quarter results started coming in. Garanti and Halkbank did best of all, seeing their shares rise by 46% and 54% respectively over the month of April, easily outperforming the market.

Still, few think Turkey is out of the woods yet. NPLs are still rising and lending remains anaemic, while the bank sector remains extremely sensitive to interest rate changes; the timing, the size and the strings attached to the IMF deal could make a big difference to the bank sector's prospects going forward. Deutsche Bank's Tezcan highlights the size of the first tranche in particular will have a big impact on whether banks switch from investing in bonds and start making loans again. Tezcan estimates that an IMF loan on the order of $25bn is needed to open up the lending sluice gates again.

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