| Inflation in Turkey hit 83% in September and is likely to contribute to further growth in bank's nonperforming loan portfolios. |
Turkish banks are struggling to attract international investors to take on their swelling ranks of nonperforming loans amid differing views on valuations and concerns over economic and political uncertainty in the country.
Sales of Turkish nonperforming loans, or NPLs, have slumped since 2019, while the level of distressed debt in the banking system has continued to grow, according to an S&P Global Market Intelligence analysis. Recent legal reforms have paved the way for more foreign investment in the domestic NPL market but interest has so far remained scarce.
The high risk premium that foreign investors would want to put on any Turkish assets for purchase would not match banks' sale price expectations, Ozan Cığızoğlu, a partner leading financial services consulting in Turkey at PwC unit Strategy&, told Market Intelligence. This would only widen the existing price gap in the Turkish NPL market, which is not likely to kick into higher gear before elections in June 2023 and the macroeconomic outlook improves, he said.
For Turkish lenders, this means souring debt will remain on their balance sheets for longer and potentially increase as borrowers repayment ability deteriorates amid the weak economy and high inflation. More NPLs would require higher provisions from banks, weighing on their profitability, capitalization and their ability to lend to the economy.
Soured debt rising
The level of NPLs and Stage 2 loans — those classified as being at significant risk of default — held by Turkish banks as of June 30, have both exceeded the 2021 full-year totals, Market Intelligence data shows. The total amount of NPLs reached 192.67 billion lira and that of Stage 2 loans rose to 667.48 billion lira, bringing the overall distressed debt total in the system to over 860 billion lira, or more than $46 billion, at June-end. The total amount for full year 2021 stood at 791.48 billion lira, of which 191.18 billion lira were NPLs.
Bank asset quality is expected to deteriorate further in 2023 amid an economic slowdown, rampant inflation and potential further depreciation of the lira, pushing more Stage 2 loans into the NPL category. A weaker lira would erode the creditworthiness of the Turkish corporate sector, which is still highly exposed to foreign currency debt, and hit banks' loan books, S&P Global Ratings said in an Oct. 4 report.
COVID-19 relief measures have boosted economic performance in 2020 and 2021, facilitating banks' NPL collection. Yet that expansion will end this year, with GDP growth expected to drop to 4.7% in 2022 and to 2.7% in 2023, according to World Bank forecasts from Oct. 10.
NPL sales falling
There have been only three NPL sales so far in 2022 — all to local asset management companies — against 11 in 2019, Market Intelligence data shows. These include Yapi ve Kredi Bankasi AŞ's 113 million lira NPL portfolio sale to Efes Varlık Yönetim AŞ, Emir Varlik Yönetim AS, Hedef Varlik Yönetim AS and Denge Varlik Yonetim AS, and two NPL portfolio sales by Banco Bilbao Vizcaya Argentaria SA subsidiary Turkiye Garanti Bankasi AS, each with transaction value of a little over 50 million lira.
Resolving the brewing bad debt crisis in the country would require the restructuring and sale of large commercial and corporate loan portfolios, which has not happened so far, according to market observers. Corporate debt accounted for roughly 80% of Turkish bank loan portfolios in the last five and a half years, Market Intelligence data shows.
The proportion of corporate debt in Turkish NPLs is similar, with consumer NPLs accounting for just 16.7% of total NPLs in the country as of July 2022, data from the Banks Association of Turkey shows.
The Turkish Asset Management Companies Association has estimated the nominal value of NPLs that were sold between 2020 and June 30, 2022, at a little over 10 billion lira, compared to initial expectations for 73 billion lira in the 2020-2023 period made by Strategy&. The main reason for the shortfall is fewer corporate NPL sales, Strategy&'s Cığızoğlu said.
Banks tend to be less willing to sell corporate NPLs or accept price discounts for those portfolios as they believe the likelihood of collecting repayments from businesses is better, Muhsin Keskin, head of the banking, finance and capital markets practices at Istanbul-based Esin Attorney Partnership, said in an interview. Retail NPLs are easier to off-load as banks do not have high hopes to collect in the future, Keskin noted.
Furthermore, commercial and corporate NPL portfolios are harder to handle by domestic asset managers, many of which lack the scale or sophistication to service larger or more complex distressed debt transactions, Cığızoğlu said. While local asset managers are merging or boosting external funding to gain scale and get ready to service larger deals, foreign investment remains crucial for developing the Turkish NPL market, he noted.
Hopes for change
There have been no direct NPL sales by Turkish banks to foreign investors over the past three years. Efforts have been made in recent years to increase foreign investor participation in the Turkish NPL market, with a securitization law amendment in October 2021 named as a crucial step in the process. The law was changed to allow the issuance of asset-backed securities based on NPLs, which previously was permitted for performing loans only.
The law change will play a critical role in drawing more foreign investor interest to the Turkish market, Komninakidis said. "The international investment community is very accustomed to the structure and concept of securitization," he said. Now that this is an option for Turkish NPLs, it provides fertile ground for more soured loan sales in the future, he added.
As the Turkish legislative landscape improves and banks in historically troubled European markets such as Greece and Cyprus make progress in cleaning up their balance sheets, international financial sponsors, credit funds and industrial-scale debt servicers will be looking for new opportunities to deliver the returns they have come to expect over the decade since the global financial crisis, Hyder Jumabhoy, partner in the global M&A and corporate practice of law firm White & Case, said in an interview. "We see Turkey as possibly being one of those new markets," Jumabhoy said.
Yet, the tide will likely take a couple of years to turn given the upcoming election and current macro environment. "Banks are hoping there will be some change in the outlook after the election," Cığızoğlu said. "Everyone is really waiting for the economy to get better."
As of Oct. 21, US$1 was equivalent to 18.58 Turkish lira.