Bondholders Grow Increasingly Fearful About Turkey's Banks

By Steven Levine

Turkey’s banks have generally come under significant pressure and have spurred contagion to other parts of Europe, as the country battles a long list of adverse macro conditions.

Bond investors in Turkish financial institutions have grown increasingly worried about the sustainability of several of the country’s banks’ ability to repay their debt.

Over the past three months, spreads on many banks’ five-year credit swaps (CDS) have mushroomed by anywhere from around 235bps to more than 350bps.

Akbank’s (AKBTY) five-year CDS, for example, has blown out by close to 355bps over the past three months, according to Bloomberg data.

 

While the bank’s borrowings increased around 32.8% year-on-year in the second quarter 2018, much of its debt is denominated in U.S. dollars, which has helped make financing more challenging as the exchange value of the Turkish lira deteriorates.

Consequently, certain of AKBTY’s bonds have fallen considerably, along with its stock.

The bank’s 5.0% notes due October 2022 were recently quoted at a yield of around 11.2%, a year-on-year rise of about 6.8%. Shares of AKBTY have also suffered a decline of more than 70% over the same period.

Another Turkish bank, Turkiye Vakiflar Bankasi (TKYVY), has been under similar pressure. Its 5-year CDS has ballooned by over 380bps over the past three months, while the yield on its 6% notes due November 2022 have risen close to 14% year-on-year to about 19.5%. TKYVY’s American Depositary Receipts (ADRs) have also plummeted to nearly US$5.50 from around US$20.50 over the past year.

 

Credit profile damage and central bank support

In late August, Moody’s Investors Service cut its credit ratings on 18 Turkish banks and two finance companies, citing “a substantial increase in the risk of a downside scenario.”

According to Moody’s analyst Carlo Gori, Turkish banks have around US$186bn in foreign currency-denominated market funds as of June 2018. This level equates to 75% of their total wholesale funds, making the banking system “particularly sensitive to potential shifts in investor sentiment” given the need to refinance these liabilities on an ongoing basis.

In the next 12 months, around US$77bn of foreign currency wholesale bonds and syndicated loans, or 41% of the total market funding, needs to be refinanced, Gori said.

The Turkish banks hold around US$48bn of liquid assets in foreign currency and have US$57bn of required reserves with the Central Bank of Turkey, “which would not be entirely available,” Gori added.

Against this backdrop, uncertainties over effective support from Turkey’s central bank have risen, especially about its level of independence in the wake of the country’s recent presidential elections, leaving widespread concerns about inflation management and potential defaults.

Country at risk

Spreads on Turkey’s sovereign five-year CDS have increased by almost 280bps over the past three months, and according to the Depository Trust & Clearing Corp (DTCC), data as of June showed that an average equivalent of US$325m of notional value has changed hands on the Republic of Turkey’s CDS (across all maturities) on a daily basis.

Furthermore, in addition to Moody’s downgrades of several of Turkey’s financial institutions, the ratings agency also cut the country’s credit rating further into junk status – to ‘Ba3’ from ‘Ba2’ – as well as changed its rating outlook to negative.

Contagion

Meanwhile, the market’s jitters about Turkey’s fiscal and financial health have spurred contagion in other parts of Europe, such as Italy, where uncertainties over exposure to Turkish debt appears to have risen.

Investors have generally become more cautious about Italy’s banks’ and finance companies’ abilities to repay their debt obligations, with several five-year CDS spreads having widened in the area of 35bps to 70bps over the past three months.

The long list of financial institutions include Banca Monte dei Paschi di Siena (BMPS), Banco BPM (BAMI), Intesa Sanpaolo (ISP), UniCredit (UCG) and Banca Italease.

As several of Turkey’s banks’ shares have declined, and its local currency eroded against the U.S. dollar, so has the spread of Italian government bonds widened against German sovereign debt.

 

Italy’s 10-year government bonds were last around 252bps wider against German government notes of similar maturities.

For ETF investors, the value of the iShares MSCI Italy Index Fund (EWI) fell about 13.5% against the iShares MSCI Germany Index Fund (EWG) from late April to around the end of August, only to regain around 3.3% of that loss to date.