Nicholas Watson in Prague -

Reports in March that 10 bidders are interested in buying a 20.85% stake in Turkish lender Garanti Bank confirms the huge interest that foreign investors have in the country's banking industry. And a look at the sector's latest financial results shows just why.

The fourth quarter rounded off what proved to be an exceptional year for Turkey's banks. Garanti Bank posted a 151% annual rise in fourth-quarter net profits; Akbank, in which Citigroup holds a 20% stake, saw its profits rise 230%; and Isbank recorded a 184% rise. For the full year, state-owned Ziraat Bankası posted the highest net profit in 2009 with a record TRY3.5bn (€1.7bn); by contrast, the entire banking sector's total profit in 2005 was TRY5bn.

Such profits helped Turkey's index of banking stocks soar by 116% during 2009. Garanti's share price outdid even that, rising 143% over the year. Based on where the Garanti's shares were trading at the end of February when General Electric announced it was looking to offload its stake, the price that an investor would have to come up with for the 20.85% stake would be about $3.3bn. In 2005, GE paid just $1.8bn for a 25.5% stake in Garanti from its parent, the Dogus Group, which bought back a 4.65% stake in 2007.

The reason for the surge in the banking sector's profits was primarily the Turkish central bank's series of rate cuts from November 2008 to November 2009, which took 10.25 percentage points off the benchmark borrowing rate, giving banks access to cheaper funding while they kept the cost of borrowing high to businesses and consumers. At the same time, government bonds, which banks have large portfolios of, rallied as interest rates were aggressively cut.

The banks' growth was also built on the solid foundations laid after the last big banking crisis in Turkey at the start of the decade. This meant that when the global financial crisis struck, they were less exposed to high-risk consumer credit and had little to no exposure to the toxic sub-prime lending that hurt so many western banks. "One conclusion of the past 18 months of global crisis is that Turkey's 2000-2001 banking reform has stood the country in very good stead to ride through the global crisis," says Tim Ash of Royal bank of Scotland. "[Non-performing loans] have risen, but at about 5% they are comparable with those in Central Europe, rather than the 15-35% being experienced across the [Commonwealth of Independent States]."

The big question for investors interested in Garanti - a list that purportedly includes Russia's Sberbank, Spain's Banco Santander, Italy's Intesa Sanpaolo, and the UK's HSBC and Standard Chartered - and other Turkish banks is whether the sector can continue to prosper in 2010 and beyond.

Lending a hand

While most experts concede it would be hard to match 2009's level of profit growth, they reckon most banks will still manage to grow their earnings in 2010, which Jacob Grapengiesser, the portfolio manager of East Capital's Turkey fund, says would be a remarkable performance given such a fantastic previous year. "You would expect a year of consolidation or even contraction in profits," he says.

What he and others are looking for is a change in the way that Turkey's banks do business as the country enters a new interest rate environment of rising rates toward the end of 2010. "Where previously investors had bought Turkish banks because of their positions in government bonds and how they thought those government bonds would perform, now they will invest based on how the real banking business will develop," Grapengiesser says.

Selim Yazıcı, an analyst with Istanbul-based brokerage TEB Investment, says in the "significantly different environment of 2010," he is looking for banks to pursue opportunities in the lending business, especially in the consumer segments, as banks shift out of government bonds. "We expect total lending year-on-year growth of 23% in 2010 as compared to 5% in 2009."

Such growth isn't a surprise when one considers that Turkey has Europe's youngest and fastest-growing population, which is now clamouring for mortgages and car loans in Turkish lira that have become attractive due to the low nominal interest rates. "Although we expect real interest rates to rise to more sustainable levels in the long term, they will remain low throughout the year making borrowing look attractive," says Yazıcı. "Individual demand for longer-term consumer lending will be strong even after rates start to increase, as this will officially mark the end of easing cycle, triggering pent-up demand especially in the mortgage market."

TEB Investment picks Yapi Kredi and Garanti Bank as the greatest beneficiaries of this lending boom, which it says stand out in terms of their technology, appetite and innovative approach to consumer banking. The battle for GE's stake in Garanti promises to be a fierce one.