Turkish Non-Financials: This Is Not Your Ordinary Cycle

MENA & Turkey Financials

Ercan Uysal

Thematic (Sector/Industry)

Turkey Banks / Thematic (Sector/Industry)

The Turkish household debt has increased exponentially in the past 15 years, registering the third largest annual growth rate (28% CAGR) within the EM universe in 2003-2018 after Argentina (35%) and Russia (30%).  After peaking at 20% of GDP in 2013, the Turkish household leverage as measured in total household debt-to-GDP has declined to 15% by the end of 1Q19 (vs. EM median of 20%) largely due to a sharp rise in lending rates, higher unemployment and to a lesser degree macroprudential measures that aimed at curbing excessive consumer borrowing.Although the headline leverage indicator does not seem to be alarming at the aggregate level, the micro level analysis paints a more somber picture. According to a recent survey published by ING Bank, Turkey has one of the highest household debt penetration levels in the world where 65% of the households in Turkey had some type of formal debt (80% if informal debt is included) in 2018 compared to the EU avg. of 45% (55% incl. informal debt). On the other hand, given high-income inequality, we believe the debt-to-disposable income ratio of those households that hold some type of formal is a more relevant metric in gauging household leverage. Using micro-level data, we estimate the average debt-to-disposable income of indebted households in Turkey at 60% (v.s EU avg. of 70%), which is disproportionately high for an upper-middle income country.Despite a protracted slowdown in consumer credit in 2015-2019, which has led to a sharp fall in household leverage, we estimate that household debt service-to-disposable income ratio has increased to 25% in 2019 from 20% in 2013 largely due to higher interest rates, shorter loan maturities, and stagnating incomes. Coupled with rapidly rising unemployment (15% as of Feb 19) and inflation (i.e. lower real wages), we believe debt servicing capacity of the Turkish households is already severely impaired, which should continue to exacerbate the banking sector’s asset quality problems.Although the headline gross NPL ratio seems reasonably low at 4%, Turkish banks have been increasingly pushing problem consumer loans into the Stage-2 category, which amounted to TL 40bn, corresponding to 8.5% of total consumer loans, as of the end of 1Q19 (vs. 5.5% in 2017). We also note that Turkish banks have been aggressively selling consumer bad loans to third-party collection firms, which helps improve the headline bad loan ratio. The consumer NPL sales have amounted to a face value of TL30 bn in 2007-1Q19 (or 5% of gross consumer loans), where the average sales price has been as low as 4-5% of the face value.Given the low recovery rates on unsecured consumer bad debt stock, we believe Turkish banks will likely incur significant losses, but not as much as corporate bad loans. Among the listed large-cap banks, Garanti BBVA reported the largest Stage-2 exposure (17% of its consumer loan book), corresponding to 24% of CET1 capital as of the end of 1Q19, while HSBC, ING, QNB Finansbank, Sberbank Deniz and TEB Paribas also had high exposures to problem consumer loans vis-à-vis their CET1 capital levels (avg. 25% of CET1). Last but not least, the state-owned banks (Ziraat, Halkbank, Vakifbank) have been very slow in recognizing potential consumer bad loans (4% of CET1) largely due to regulatory forbearance, in our view.

The Turkish household debt has increased exponentially in the past 15 years, registering the third largest annual growth rate (28% CAGR) within the EM universe in 2003-2018 after Argentina (35%) and Russia (30%).  After peaking at 20% of GDP in 2013, the Turkish household leverage as measured in total household debt-to-GDP has declined to 15% by the end of 1Q19 (vs. EM median of 20%) largely due to a sharp rise in lending rates, higher unemployment and to a lesser degree macroprudential measures that aimed at curbing excessive consumer borrowing.Although the headline leverage indicator does not seem to be alarming at the aggregate level, the micro level analysis paints a more somber picture. According to a recent survey published by ING Bank, Turkey has one of the highest household debt penetration levels in the world where 65% of the households in Turkey had some type of formal debt (80% if informal debt is included) in 2018 compared to the EU avg. of 45% (55% incl. informal debt). On the other hand, given high-income inequality, we believe the debt-to-disposable income ratio of those households that hold some type of formal is a more relevant metric in gauging household leverage. Using micro-level data, we estimate the average debt-to-disposable income of indebted households in Turkey at 60% (v.s EU avg. of 70%), which is disproportionately high for an upper-middle income country.Despite a protracted slowdown in consumer credit in 2015-2019, which has led to a sharp fall in household leverage, we estimate that household debt service-to-disposable income ratio has increased to 25% in 2019 from 20% in 2013 largely due to higher interest rates, shorter loan maturities, and stagnating incomes. Coupled with rapidly rising unemployment (15% as of Feb 19) and inflation (i.e. lower real wages), we believe debt servicing capacity of the Turkish households is already severely impaired, which should continue to exacerbate the banking sector’s asset quality problems.Although the headline gross NPL ratio seems reasonably low at 4%, Turkish banks have been increasingly pushing problem consumer loans into the Stage-2 category, which amounted to TL 40bn, corresponding to 8.5% of total consumer loans, as of the end of 1Q19 (vs. 5.5% in 2017). We also note that Turkish banks have been aggressively selling consumer bad loans to third-party collection firms, which helps improve the headline bad loan ratio. The consumer NPL sales have amounted to a face value of TL30 bn in 2007-1Q19 (or 5% of gross consumer loans), where the average sales price has been as low as 4-5% of the face value.Given the low recovery rates on unsecured consumer bad debt stock, we believe Turkish banks will likely incur significant losses, but not as much as corporate bad loans. Among the listed large-cap banks, Garanti BBVA reported the largest Stage-2 exposure (17% of its consumer loan book), corresponding to 24% of CET1 capital as of the end of 1Q19, while HSBC, ING, QNB Finansbank, Sberbank Deniz and TEB Paribas also had high exposures to problem consumer loans vis-à-vis their CET1 capital levels (avg. 25% of CET1). Last but not least, the state-owned banks (Ziraat, Halkbank, Vakifbank) have been very slow in recognizing potential consumer bad loans (4% of CET1) largely due to regulatory forbearance, in our view.

Turkish Consumer Debt: Payback Time