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Morningstar | European Banks: Little Delight From Turkey

Turkey's rapid economic growth was fuelled by a surge in credit, and the recent collapse in the value of the lira threatens to topple this house of cards. Banco Bilbao Vizcaya Argentaria, Unicredit, ING, and BNP Paribas respectively derive 14%, 10%, 5%, and 3% of their profits from Turkey, which is at risk.

Our base-case scenario is that the Turkish economy goes through a phase of painful rebalancing during which it weans itself from its reliance on foreign funding. Turkish banks' profitability will be under substantial pressure over the medium term, and they might require capital and funding support. We recently cut our fair value estimates for BBVA and Unicredit by 20% and 18%, respectively, partially because of the lower contribution we anticipate from Turkey over the medium term.

We believe it is extremely unlikely that a Turkish affiliate of a European bank will fail (which would require the parent to write off its exposure), as the Turkish affiliate banks can count on liquidity and capital support from their European parents. However, it is exactly this implicit support that drives our downside scenario. We are concerned that the European banks will support discounted capital calls to keep their Turkish affiliates afloat and safeguard their full Turkish exposure.

We highlight our concern that the Turkish banking sector asset quality is already not what it may seem. Restructured loans are meaningful to Turkish banks' balance sheets, and we believe nonperforming loans could be understated as banks have significant latitude to restructure problem loans, not impairing them as nonperforming and raising provisions against them. Therefore both the nonperforming loan ratio and the coverage ratio might be understated.

European banks that provide significant liquidity and funding support to their Turkish affiliates will have even less of an option to walk away from their investments, given the magnitude of their exposure. Unicredit especially stands out in this regard: While its equity participation in Yapi Kredi is equal to 5% of its consolidated equity, we estimate that funding and liquidity support increases its full Turkish exposure to as much as 20% of its equity. ING and BNP Paribas also provide meaningful funding and liquidity support to their Turkish affiliates, with their full exposure equal to 10% and 3% of their respective consolidated equity numbers. BBVA does not currently provide liquidity and funding support to Garanti, and its equity participation is equal to 9% of its consolidated equity.