Turkish banks have long been trading near historical troughs, with foreign institutional investor interest at record lows. We believe that this has been driven mainly by three factors. First, concerns about the Turkish lira amid the Central Bank’s policies, weak reserves and the overall regulatory environment. Second, record-high credit growth despite the pandemic-related economic lockdowns raising concerns about asset quality and margins. Third, the weak sentiment toward global financials. We believe that the worst for the Turkish lira is over and that the authorities have made several steps toward normalisation, from interest rates to swap limits and asset ratios.
For many institutional investors, it might have been difficult to justify having exposure to Turkey due to the above, and other, concerns, but we expect that this sentiment will gradually turn into being difficult to justify not having exposure to Turkish banks, trading at their historical low valuations and foreign investor ownership.
Time to pay more attention to valuations
Turkish banks trade at 2.7x 2021F net income on our estimates (3.1x per the Bloomberg consensus as of 2 October). This puts the sector at a 60% discount to GEM and a 67% discount to EMEA financials. Our P/BV vs. ROE-COE and P/E vs. interest rate correlation charts indicate a two-fold multiple re-rating by 2021-2022.
Strong earnings outlook
Our major concerns about Turkish banks have been asset quality and margin outlook. In 2020, Turkish banks have provided more provisions than required, enjoying a strong margin outlook in 9mo20.
For the next 12-month period, we see margins being under pressure, but this time the normalisation of provisions (and only partially from 300bp to 200bp net cost of risk) is to support the earnings growth on our forecasts. We expect a 36% CAGR in net income in 2019-22.
Revisions made in this report
With this report, we revise our macro forecasts for Turkey, and cut our net income forecasts for Turkish banks 16% and 14% for 2020F and 2021F, respectively. We also cut our 12- month Target Prices 19% on average. Still, our average upside to the 12-mo TPs is 59%, versus the consensus expected upside of 34%. Our top pick is Garanti, with a 76% ETR.
We are not negative on lira
As we highlighted in our Turkish Equities Monitor of 3 September 2020, we believe the worst is over for the lira. To summarise our justification here, we believe i) there is not much foreign portfolio money left in Turkish assets; ii) the worst in trade deficit dynamics is over; iii) dollarisation and gold imports have reached a peak already; and iv) with lira interest rates rising, the foreign borrowing roll-over ratios are likely to increase from 60-70% levels. Last but not least, there have been several deregulation measures recently which we believe will go some way to curing the negative sentiment surrounding Turkish regulators. To name a few: i) the Turkish Central Bank increased the policy rate by 200bp; ii) foreign swap limits increased; iii) the asset ratio was reduced further and became ineffective; iv) taxes on FX transactions reduced; v) state banks’ subsidisation of the real sector stopped; vi) withholding tax on lira deposit interest income reduced.
Risks to our investment case
Turkish banks trade at historically their most attractive valuation levels, and thus the potential rewards for investment are substantial. However, great rewards can come with high risks. In fact, we have analysed in this report the worst case scenarios and could not justify a downside from current levels.
Nevertheless, there are still risks worth mentioning, as we summarise below.
Policy mistakes re-emerging
There have been several market-unfriendly measures taken by the Turkish authorities in the recent past, such as keeping Central Bank rates too low, imposing an asset ratio to fuel excessive credit expansion in the banking system, intervening in the FX market at the cost of burning the country’s FX reserves of the country, limiting foreign swap transactions, taxing FX transactions of local investors and so on. Most of these measures have been reversed, eased or abolished in the very recent past, which we see as part of the ‘normalisation’ of Turkey’s economic policies. Nevertheless, the reemergence of over-regulation and excessive free market intervention would pose a risk to our investment case, as that would continue to prevent foreign capital coming back to Turkish assets, in our view.
Excerpt from VTB Capital banking report
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