The underlying asset quality of Turkish banks will weaken due to the coronavirus (COVID-19) pandemic but this will be more apparent in their income statements than in their reported asset quality metrics in 2020, Fitch Ratings said on September 9.

Asset quality is a key sensitive rating parameter for Turkish banks, alongside foreign currency liquidity, while it is closely linked to the lenders’ operating environment and the macro-economic backdrop, which have weakened this year due to the coronavirus crisis, it added.

However, reported non-performing loans (NPLs) will be “flattered by regulatory forbearance and loan growth”, Fitch complained.

A relaxation of loan classification requirements in Turkey, scheduled to last until end-2020, means that Stage 3 loans are now classified as 180-days overdue rather than 90, and Stage 2 loans as 90-days overdue rather than 30.

Together with Turkey's loan deferral scheme, which enables customers to defer interest or principal payments for three months, this will delay reported NPL increases until around Q1 2021, according to Fitch.

It should be observed that Turkey has been delaying the reporting of NPL increases since 2016.

While the share of restructured loans in Stage 2 loans could rise, many large corporate exposures were already restructured following the August 2018 lira crisis. This could limit new restructurings in the near term, Fitch said.

Largely a function of stimulus

Rapid loan growth driven by local currency lending (total sector loans grew 16%, foreign-exchange-adjusted, in H1) has largely been a function of government stimulus policies.

Demand for foreign currency loans has remained weak.

Fitch calculated that loans made under the umbrella of the state’s Credit Guarantee Fund (CGF) rose to 10% of total sector loans at end-June from 6% at end-2019.

By early August, CGF loans had contributed 44% of the increase in sector loans since end-March.

Unsecured retail lending also contributed a growing share of recent loan origination, partly to meet pent-up credit demand post-coronavirus lockdown and following  a sharp reduction in policy interest rates, while state banks also moved to boost mortgage lending.

However, new CGF lending has been limited since end-June, while rising effective interest rates and regulatory measures, including the easing of the asset-ratio requirement and the lowering of the maximum maturity for certain retail loans, signal slower loan growth in H2.

If Turkish GDP growth recovers in 2021, this could offset some of the hit to asset quality caused by the earlier slump, and support loan collections and recoveries, according to Fitch.

Treasury guarantees limit the asset quality risk from small and medium sized enterprise (SME) loans under the CGF and Fitch’s discussions with banks suggested that new loan deferral requests since end-June had fallen sharply.

But the economic impact of the pandemic and the range of sectors affected will damage underlying asset quality, the rating agency concluded.

Exacerbated risks

Banks' pre-existing balance sheet risks, notably from foreign currency lending, exacerbate the risks, particularly given that the lira has come under more pressure against the dollar in recent weeks, Fitch warned.

Unsecured retail lending is also sensitive to a sizeable fall in employment, while recent rapid loan growth against a challenging macro backdrop brings seasoning risks, it added.

Fitch expected that loan impairments would continue to weigh on profitability as banks provision for increased risks in accordance with IFRS 9, in part due to weaker GDP and employment inputs, irrespective of the easing of loan classification under forbearance.

The banks' ability to absorb losses through income statements, which has generally remained reasonable, could weaken as growth slows, margins tighten and effective interest rates rise, it said.

Fitch anticipated that the banks' cost of risk this year would remain high and that interest receipts relative to interest accrued could also fall in the short term due to payment deferrals and grace periods on loans.

The rating agency rates Turkey at BB-/Negative, three notches below investment grade.