Analysis: Turkish firms face debt-servicing crunch as lira spirals lower

By Claire Milhench and Karin Strohecker

LONDON (Reuters) - Turkey's freefalling lira has cranked up the pressure on Turkish banks and corporates, which now account for the bulk of credit ratings downgrades in emerging markets this year, as foreign and domestic debt servicing costs grind ever higher.

The lira has lost 29 percent of its value in 2018, battered by unorthodox monetary policy, double-digit inflation, Turkey's big current account deficit and large external borrowing requirement.

In addition, a deterioration in relations with the United States means some $1.7 billion of Turkish exports may lose duty-free access to U.S. markets, shutting off vital dollar inflows and raising concerns about what other sanctions may be in store.

"The market is fearing that sanctions could hit the ability of the Turkish corporate sector and the banks to refinance their debt in a worst-case situation if this escalates further," said Jakob Christensen, head of EM research at Danske Bank.

The strains for companies that haven't effectively hedged their forex risk are already apparent. Turkey accounted for 97 net downgrades from January to July, as well as 19 out of 33 of the emerging market's "fallen angels" - investment-grade debt that has since been cut to junk ratings, according to David Spegel at Fundamental Intelligence.

Turkish banks' ability to lend on to the private sector is the first big question mark, and given the scale of lira losses they run the risk of a major crunch.

U.S. bank Goldman Sachs said in analysis on Tuesday that another 30 percent drop in the Turkish lira to 7.1 per dollar could largely erode banks’ excess capital.

Its analysts estimated that every 10 percent drop in the lira impacts banks' capital levels by 50 basis points on average. They calculated that the 12 percent lira plunge since June had left Yapi Kredi with the weakest capital levels of all the main Turkish banks.

On Tuesday, the lira stayed close to the previous day's record low as concerns deepened about a rift with the United States and President Tayyip Erdogan's influence over the central bank. Erdogan wants lower borrowing costs to fuel credit growth and economic expansion, but analysts say the economy is overheated and needs higher rates.

Inan Demir, senior emerging economist at Nomura International, noted signs of balance sheet stress with some companies already asking to restructure loans from their lenders.

"That was before dollar-lira even reached 4. Now within 2-3 months of breaching 4, we breached 5, and the worries can only increase," he said.

He cited examples such as Yildiz Holding, the owner of food brands such as Godiva chocolate and McVitie's biscuits, and conglomerate Dogus Holding.

In July, fixed-line operator Turk Telekom reported a quarterly net loss of $184 million, hit by the cost of servicing its foreign-currency debt.

"If we don't see the lira recover soon, even to July levels, that will trigger more restructuring ... it is quite painful as it costs (companies) so much to service their debt," said Vladimir Miklashevsky, senior economist at Danske Bank.

As of May, Turkish companies had $222.8 billion in long-term loans from abroad, almost all in dollars or euros, central bank data shows.

STRESS SCENARIO

In a July report, ratings agency Fitch identified retailers and consumer goods companies without significant exports as among the most exposed in a stress scenario where quantitative tightening occurs faster than expected and the lira weakens.

Conglomerate Yasar Holding was seen as particularly vulnerable, given its high short-term debt and a significant currency mismatch; "Hard currency debt is around 50 percent of total debt, while most of its revenue is local currency," Fitch said.

It also highlighted bottler Coca-Cola Icecek, with 80 percent of its debt in hard currency, while profits are mostly in lira.

Slabbert van Zyl, an EM equity portfolio manager at Comgest, said Icecek was paying away 50 percent of its operating profit on finance charges or on FX mark-to-market losses.

"That is massive. I would normally expect that to be 10 percent at most," he said. "Their net margin during the good period was 7 percent - now it is 1 percent."

RECKLESS LENDING

While the banking sector has a strong capital buffer, investors are concerned that asset quality issues will erode this after breakneck expansion.

Bank shares have fallen around 33 percent year-to-date, with banks caught between President Tayyip Erdogan's demands for more cheap credit and central bank tightening.

Uday Patnaik, head of emerging market debt at Legal & General Investment Management, who has had a core underweight in Turkey for 1-1/2 years, noted that the average non-performing loan ratio stood at 3.3 percent in the first quarter: "In our opinion these numbers are a bit massaged, to say the least."

He attributed some of the problems in the banking sector to loans to the construction and energy sectors. Turkish banks have helped finance some $89 billion in projects.

"There has been some 'reckless lending' on the way and some of the skeletons are beginning to emerge in the loan books," Patnaik said, noting the loans to deposits ratio had increased from around 80 percent in 2007 to about 125 percent.

He pointed out that some Turkish bank senior debt is now trading wider than issues from Ukraine. For example, Ukreximbank's 2025 eurobond is trading at a lower yield than Yapi's 2023 bond.

He questioned how much longer some Turkish issuers could fund themselves in the international market, if five-year subordinated debt was yielding 15-25 percent: "If this were to continue for another year, you could see issues with some of these banks that are not as systemic."

So far the roll over ratio for banks and corporates is 100 percent, but the latest data is only for May, and the lira has taken several legs lower since then.

Nomura's Demir said banks had "an ample cushion" to withstand a big shock, but he was concerned foreign creditors were getting uneasy about banks' exposure to groaning corporate balance sheets. This could have a knock-on effect on their ability to borrow, hurting their immediate liquidity.

In June Moody's downgraded 17 Turkish banks, saying constrained funding conditions were a challenge given the high reliance on U.S. dollar short-term market funding, which stood at $75 billion, or about half of their foreign currency market funding as of March.

With cross-currency mismatches increasing the further the lira falls, Spegel warned: "The probability of future bailouts of the banking sector has increased significantly … probably within the next 12 months, if things continue on the current trajectory."

(Reporting by Claire Milhench; Editing by Hugh Lawson)