Inflation Tarnishes Polish of Bargains Among Turkey Bank Stocks

  • Istanbul Banks Index rises 18 percent since start of 2016
  • Return on equity at lowest on records dating back to 2002

An 18 percent surge in Turkish bank shares since the start of the year may lose steam as a worsening inflation outlook hinders the country’s central bankers from delivering on policies that would ease a squeeze on profits.

By some measures, Turkish lenders offer a bargain even after the rally. Their share prices trade below the value of their net assets, making them the cheapest after South Korea among peers across 25 developing countries included in the MSCI Emerging Markets Index.

Analysts looking beyond these depressed valuations point to risks to the industry’s profitability from slowing loan growth and more costly regulatory requirements. Return on equity fell to 11.3 percent in 2015, the lowest according to the banking regulator’s records dating back to 2002. A projected pick-up in inflation, already more than 2 percentage points above official targets, is curtailing the central bank’s room for maneuver in cutting interest rates.

“Despite tempting valuations, that’s not a buy signal because the profitability of banks is low and the cost of equity is high,” said Fatih Tugrul Topac, a banking analyst at Teb Investment, BNP Paribas SA’s Turkish unit.

Stock Rally

Since the central bank unexpectedly lowered its overnight lending rate on March 24, Turkish banking shares have risen 8.4 percent on expectations that looser liquidity, and cheaper wholesale funding costs would benefit the industry by boosting profits. When monetary policy eases, lenders are able to cut back the interest they pay to depositors faster than they ease the rates charged to borrowers giving a lift to margins, at least in the short term.

"If rate cuts continue, deposit and loan rates also are likely to come down, eventually, though the drop in deposit rates is expected to decline faster than the loan rates," said Ovunc Gursoy, a senior banking analyst at Seker Investment in Istanbul.

In this scenario, banks with a higher proportion of lira-denominated deposits stand to gain the most, Gursoy said.

That puts Turkiye Vakiflar Bankasi TAO in the best position as it holds more than twice as much in lira deposits than in foreign currency, the highest proportion in the industry, according to company statements to the end of 2015. For most Turkish lenders the opposite is true, with hard currency accounts dwarfing lira holdings, data from the industry regulator show.

Vakifbank shares have risen 36 percent in the past three months, outpacing the 10 peers included in the Istanbul banks index.

False Dawn

Yet the conditions that prompted hints of looser monetary policy this year are expected to turn. Turkish consumer prices will rise to 8.5 percent for 2016, compared with 7.7 percent the previous year, according to the median estimate of 24 analysts polled by Bloomberg. Adding to pressure to keep liquidity tight is the need to counteract the impact of the Federal Reserve’s plans to take rates higher, which often triggers outflows from emerging markets because better returns are available in less risky dollar assets.

“Inflationary pressure and a need to defend the Turkish lira against the dollar as the Fed raises rates is unlikely to give room to the central bank to ease liquidity conditions,” TEB Yatirim’s Topac said.

Under these conditions Turkish valuations look "reasonable," said Cagdas Dogan, a banking analyst at BGC Partners in Istanbul. "A significant drop in cost of equity may trigger re-rating, however that would be possible with a permanent decline in headline inflation."

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