Rating Action Commentary
ֳ Places Halk on Rating Watch Negative
Mon 21 Oct, 2019 - 9:45 AM ET
ֳ - London - 21 Oct 2019: ֳ has placed Turkiye Halk Bankasi's (Halk) Long-Term Foreign Currency (LTFC) Issuer Default Rating (IDR) of 'B+', senior debt rating of 'B+' and Viability Rating (VR) of 'b' on Rating Watch Negative (RWN).
The rating actions follow the announcement on 15 October by the U.S. Department of Justice that the bank had been charged with fraud, money laundering, and sanctions offenses. The RWN on the Long-Term IDRs, senior debt rating and other support-driven ratings reflects uncertainty surrounding the sufficiency and timeliness of support from the Turkish authorities in case a material fine or other punitive measures are imposed on Halk. The RWN on the VR reflects ֳ's view of the material risk of Halk becoming subject to a fine or other punitive measures as a result of the U.S. investigation, which could put downward pressure on its standalone credit profile.
ֳ expects to resolve the RWN once there is more clarity on the outcome of the U.S. investigations and the implications this may have on the bank. The RWN may be maintained longer than six months if the U.S. investigations are extended for a longer period of time.
Key Rating Drivers
LONG AND SHORT TERM IDRs, SRF, SR, SENIOR DEBT, NATIONAL RATING
Halk's LTFC IDR and senior debt rating are driven by the bank's 'B+' Support Rating Floor (SRF), which reflects ֳ's view of a high government propensity to support the bank, in case of need. This is based on its majority state ownership (51%-owned by the Turkey Wealth Fund), systemic importance, policy role and a record of capital and liquidity support. The bank's SRF is one notch below the sovereign LTFC IDR, reflecting high risks to the ability of the sovereign to provide support in FC given its limited and volatile level of net central bank foreign exchange reserves. The sovereign's greater ability to provide support in local currency drives the higher Long-Term Local Currency (LTLC) IDR at 'BB-', in line with Turkey's LTLC IDR.
The RWN reflects (i) uncertainty about the severity and nature of measures, if any, taken against the bank; (ii) increased geopolitical tensions between Turkey and the U.S., which could escalate and raise uncertainty on the authorities' ability and propensity to provide sufficient and timely support in case a material fine or other punitive measures are imposed on Halk, and (iii) significant (49%) non-state ownership of the bank, which may complicate the prompt provision of solvency support, if required.
VR
Halk's VR reflects concentration of the bank's operations in the high-risk Turkish operating environment, which deteriorated significantly in 2018. The latter is evident in the Turkish lira depreciation (down 28% in 2018 and 9% YtD in 2019) and volatility, a high, albeit falling, local-currency interest rate environment and a weak growth outlook (2019: GDP growth of -0.3% forecasted). Market conditions in 2019 have remained a challenge, exacerbated by ongoing market volatility and political and geopolitical uncertainty.
Halk's VR also reflects the bank's weak performance, only modest capital buffers, reduced access to external funding and ֳ's view of weaknesses in governance and risk controls. The VR also captures the bank's solid market shares (end-1H19: 10% of sector assets, unconsolidated basis).
The RWN on the VR also reflects ֳ's view of an increased risk of Halk becoming subject to punitive measures, including a fine, as a result of the U.S. indictment. Such measures could materially weaken solvency, increase refinancing risks, given potential reputational damage, and weaken the bank's liquidity position or negatively impact other aspects of the bank's standalone credit profile.
Asset-quality risks for the bank are significant and have increased due to the weaker growth outlook, high Turkish lira interest rates and local-currency depreciation (given not all FC borrowers are fully hedged). FC lending amounted to 32% of gross loans at end-1H19, which is below sector and peer averages. However, Halk also has exposure to the more vulnerable SME segment (41% of loans at end-1Q19), although the subsidised SME portfolio typically outperforms non-subsidised lending. Exposures to the troubled construction/real estate and energy sectors are additional sources of risk at the bank.
Halk reported FX-adjusted loan growth of 7% in 1H19, which is above the sector average. We believe loan growth could still fluctuate depending on the government's economic agenda and stimulus packages intermediated by state banks.
Impaired loans as a share of gross loans increased to 4.2% at end-1H19 from 3.5% at end-2018, reflecting a sharp rise in non-performing loans (NPLs) in absolute terms following heightened currency and interest rate volatility in 2018. The impaired loans ratio remains fairly moderate, although this should be considered in light of recent rapid loan growth. We expect asset quality to continue to deteriorate given significant macro risks and market volatility. Increasing levels of Stage 2 loans (8% of loans at end-1H19) and restructured loans also suggest the potential for an increase in impaired loans.
Halk's profitability metrics are weaker than those of most large bank peers. Halk's operating profit/risk-weighted assets (RWA) fell to 0.3% in 1H19, reflecting significantly squeezed margins, increased impairments and lower CPI-linked securities income. ֳ estimates Halk would have been close to loss-making were it not for one-off income items in 1H19. The bank's margins came under pressure from a greater reliance on LC deposit funding as the bank has not been actively using cheaper, external funding in FC, partially due to the US investigation and also due to its slower repricing of the Turkish lira loan portfolio (for example, in the SME book and supportive loan packages announced by the authorities).
Lower Turkish lira interest rates may be supportive of Halk's margins as liabilities reprice quicker than assets. However, risks to profitability are high from a potential marked weakening of asset quality.
Halk's core capitalisation has come under pressure from currency depreciation, rapid loan growth in recent years and high interest rates. Its ֳ Core Capital (FCC) ratio was a low 9.2% at end-1H19, below that of peers, and should be viewed in the context of the bank's growth appetite and asset-quality risks. Internal capital generation has also weakened following pressure on margins and asset quality. The Total Capital Adequacy ratio of 14% is higher and is supported by Additional Tier 1 and subordinated debt, with some of these instruments having been provided by the Turkish authorities or state-related entities.
Refinancing risks remain high, as is for the sector, given moderate FC wholesale funding (including interbank deposits), recent heightened market volatility, and uncertainty surrounding the U.S. investigation. Halk has lower reliance on short-term FC funding than peers, however, having reduced its exposure since 2017, due in part to more limited market access. It also has sufficient FC liquidity to cover short-term maturing FC debt (largely comprising Eurobonds, repo facilities and bilateral loans). ֳ expects LC support to be forthcoming from the Turkish state, if needed. Timely and sufficient support in FC from the Turkish authorities may be constrained by modest net central bank reserves.
RATING SENSITIVITIES
IDRs, SRF, SR, SENIOR DEBT, NATIONAL RATING
Halk's support-driven ratings could be downgraded if the bank does not receive sufficient and timely support to offset the impact of any fine or other punitive measures imposed as a result of the U.S investigation. They could also be downgraded and revised lower, if ֳ believes that potential support from the Turkish authorities, even in the absence of disciplinary actions, becomes less reliable.
The RWN on the support-driven ratings could be removed if ֳ believes there is a clear commitment by the Turkish authorities to provide support, in case of need, to the bank to offset potential punitive actions. However, this would be assessed relative to the sovereign's ability to provide support in FC, which is constrained by limited FX reserves.
In common with other state-owned banks, the ratings could also be downgraded if the sovereign is downgraded, or if ֳ otherwise believes that the ability of the sovereign to provide support, in case of need, has markedly weakened.
A reduction in state ownership at Halk, or the introduction of bank resolution legislation in Turkey aimed at limiting sovereign support for failed banks, could also negatively impact ֳ's view of the likelihood of support, although such developments are not expected in the near term.
VR
The VR could be downgraded if the outcome of the investigations results in substantial fines, leading to a material weakening of capitalisation, or if reputational risks result in franchise damage and increased refinancing risks. In common with other Turkish banks, the VR is also sensitive to a weakening of asset quality as the loan book seasons or a marked deterioration of the operating environment.
The RWN on the VR could be removed if there is increased certainty that potential fines would not materially weaken capital, or other aspects of the VR, and if the bank demonstrates that it can effectively cope with the reputational risk linked to the allegations.
ESG Considerations
Halk has been assigned a governance structure relevance score of '5' in contrast to a typical relevance influence score of '3' for comparable banks. This reflects the elevated legal risk of a large fine, which drives the RWN. It also reflects potential government influence over the board's strategy and effectiveness in the challenging Turkish operating environment.
Additional information is available on
PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.