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Western EuropeOctober 4 2009

Capital markets thrive on adversity

Despite the downturn, share prices on the Istanbul Stock Exchange are soaring on the strength of the country's banks, as global liquidity and optimism return. Writer Metin Demirsar
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Capital markets thrive on adversity

Turkey's capital markets, led by the Istanbul Stock Exchange (IMKB), are flourishing, despite the country's worst economic downturn since World War Two. On September 11, the IMKB-100 Index closed at 46,864 points, an increase of 73.4% from the beginning of the year, and 112% up from March, but still far short from the 55,539 points closing on December 31, 2007.

The Istanbul bourse has been one of the world's best performing stock markets this year, drawing international and Turkish investors amid growing optimism that the global recession had bottomed out. Yet Turkey's gross domestic product dropped 10.6% in the first six months of the year, in the worst half-year result since 1945, while industrial output fell 22.6% in the first five months.

But there are signs that Turkey's economy has begun to pull out of the slump. Record low interest rates, a drop in inflation and unemployment, a boom in project finance loans, a flurry of mergers and acquisitions, a lively derivatives market, and major investment plans announced by dozens of air transport, automotive and energy corporations point to a bright future.

On the up

Turkish Airlines (THY), one of the world's most profitable and fastest growing carriers and a stellar performer on the IMKB, has been a leading investor during the economic crisis. THY plans to spend $6bn to acquire 105 new aircraft by 2023, including 18 wide-bodied jetliners in 2010, and add 15 to 20 new destinations for regular flights from Istanbul in the next two years - many in the Far East.

"We aim to become Europe's number one carrier with new flight destinations and new jetliners," says Temel Kotil, president and chief executive officer of THY. "There should not be a single point left on the map where Turkey isn't connected," adds THY chairman Candan Karlitekin.

"The worst of the crisis is over. Economic growth in Turkey is expected to begin in the fourth quarter. But recovery will take a long time," says finance minister Mehmet Simsek, echoing business leaders' sentiments.

Nevertheless, overall consumer spending fell so dismally low at one point this summer that a group of advertising and broadcasting associations enlisted Sakir Yaman Törüner, former governor of the Central Bank of Turkey and one-time president of the Istanbul Stock Exchange, and Akin Öngör, ex-chief executive officer of Turkiye Garanti Bankasi, to appear in TV commercials to encourage spending. One ad portrayed the avuncular Mr Törüner as a toy shop owner urging children to buy toys to help restore to health the ailing Turkish economy, while Mr Öngör played the role of an elderly street hawker asking pedestrians to buy his pastries.

Confidence returns

Some bankers cite the growing confidence among international investors as the main reason for the rapid rise in Turkish share prices - three-quarters of all trading on the Istanbul exchange is carried out by foreign institutional investors. Bankers also note that some of the liquidity injected into the US and European economies by the US Federal Reserve and the European central banks has begun to filter down to emerging economies such as Turkey.

"As in other markets, share prices on the Istanbul Stock Exchange reflect more international developments and the positive recovery of global risk appetite than macroeconomic and local activities," says Ziya Akkurt, the new chief executive officer of Akbank, a large commercial bank.

But brokers say there is a more focused influx of new money pouring mainly into bank stocks, government bonds and Treasury bills (T-bills).

"Turkey's banks have outperformed manufacturing companies on the stock market three- to four-fold," says Serdar Pazi, director of Ata Asset Management, a major Turkish asset management company. He believes investors are persistently acquiring bank shares rather than equities in Turkish industrial companies, which still face an uncertain future because of a nosedive in exports to the EU, Turkey's main export market. "Banks and industry in Turkey live in separate worlds," he adds.

Others agree. "Banking is the locomotive sector in the stock market. Its superior performance should not be seen as odd," says Ersin Özince, chief executive officer of Turkiye Is Bankasi (Isbank), Turkey's biggest private bank, and president of the Banks Association of Turkey.

The figures certainly stack up. In the first six months of 2009, Turkey's 42 banks posted a total net income of Tl10.09bn ($6.59bn), according to the Banking Regulation and Supervision Agency (BDDK), Turkey's supreme banking authority. All of Turkey's banks reported healthy profits.

There have been no bank failures in the country during the global financial crisis. This is partly because Turkish banks have not carried the kind of toxic assets that devastated some of their peers in the US and the EU. The Turkish banking sector also held a high average capital adequacy ratio of 19.7% in mid-year, more than twice the amount required internationally. Regulators have also closely supervised the banks to prevent mismanagement of funds and bank fraud.

Istanbul stock exchange / ISU 100 index

Istanbul stock exchange / ISU 100 index

The Heavyweights

Although only 13 of the 314 companies listed on the Istanbul Stock Exchange are banks, banking assets are heavily weighted, accounting for 50% of the total assets on the bourse.

A large slice of the profits of Turkish banks stem from their acquisition of average two-year government bonds at 25% yields in 2007 - the benchmark bond interest rate is now fluctuating about 10%. The consequent capital gains on these bonds have resulted in huge profits for the banks in 2009.

In the first half of 2009, bank investments in government bonds totalled Tl236.70bn, or 53% of the banks' deposits (Tl444.99bn) according to the BDDK.

However, Turkish banks have been criticised for investing excessively in high-yield government bonds during the economic crisis for leverage, just as they did during the double and triple-digit inflationary period during the 1980s and 1990s. This potentially reduces the amount of lending available to the private sector, but leading bankers have dismissed the criticism.

"If the Turkish banking system is pulling through the present economic crisis with ease, the banks have been managing their risks well. The banks should be congratulated, not criticised," says Mr Akkurt at Akbank. "Acquiring government bonds also posed considerable risks for Turkish banks," he adds.

Undersized stock market

One reason why the banks carry so much weight on the IMKB is that the bourse still is very shallow. In the first eight months of 2009, the market value of companies listed on the exchange stood at a mere $214.55bn, a rise from $119.69bn at the end of 2008, but down from $289.98bn at the end of 2007, according to the Association of Capital Market Intermediary Institutions of Turkey. At the end of 2008, the nation had just 997,677 individual investors in Turkish securities, or 1.3% of its 75 million population.

The 314 companies listed on the Istanbul exchange is miniscule compared to bourses in other emerging markets. On the Korea Stock Exchange, for instance, 1793 companies are listed. On the Bursa Malaysia, shares of 917 companies are traded. Even the Cairo & Alexandria Stock Exchange has more listed companies than the IMKB.

Although the volume of shares traded on the Istanbul exchange in 2008 reached $261bn, ranking the IMKB as the world's 26th busiest bourse, only 129 of Turkey's 500 biggest corporations in terms of sales revenues are listed. Family-owned institutions still form the backbone of Turkey's business world. Some 99.5% of the industrial companies in Turkey are small- and medium-sized enterprises employing fewer than 150 people and having sales revenues less than $30m.

"Listing requirements are an expensive and difficult proposition for most companies," says Alpaslan Budak, deputy secretary-general of the Association of Capital Market Intermediary Institutions of Turkey (TSPAKB), a trade group composed of 103 brokerage houses and 42 banks.

Companies listed on the Istanbul Stock Exchange are required to supply annual and semi-annual externally audited financial reports to the IMKB, according to principles approved by the Capital Markets Board (SPK), a regulatory agency supervising the bourse. All financial statements must include provisions for deferred taxation. These financial statements have to be published in national newspapers as information for potential investors.

The capital market reforms passed in May 1992 extended the SPK's supervisory powers, making its functions and powers comparable to those of the Securities and Exchange Commission in the US.

Istanbul Stock Exchange officials suggest the government should reduce corporate tax by 5% on companies which go public. Hüseyin Erkan, chairman of the exchange, has travelled throughout Turkey since he became head of the bourse in November 2007 to explain the workings of the IMKB and urge companies to go public. More than 60 Turkish companies have actually applied to the SPK to go public but are waiting for improved economic conditions to list their shares.

Government dominates debt

The country has a lively bond market, dominated by government debt instruments, including bonds, T-bills, repurchasing agreements (repos) and reverse repos. According to TSPAKB, the total fixed income trading volume was $2810bn in 2008 on the IMKB and the over-the-counter market, nearly 11 times bigger than the trading volume of equities on the IMKB.

Some 88% of the T-bill trading and 81% of the repo trading in 2008 was carried out by banks. The remaining portion was carried out by brokerage houses, some of which are subsidiaries of banks. Only brokerage houses can trade in equities.

A private sector debt market is non-existent in Turkey, crowded out by government securities. Private companies can only raise money by either going public or borrowing at rates charged and maturity dates set by the banks.

"If private companies could issue bonds, they could raise funds at lower rates and maturities they dictate themselves," says Mr Budak of the TSPAKB.

Project finance is increasingly available, but Mr Özince at Isbank points out the need to develop new financing methods for the mortgage market and real estate. "Developing a real estate market and registering and securitising all building activities, including construction of roads, drinking water and sewage systems, and other infrastructure, will make the economy more transparent and will increase the government's tax base," he says.

Mortgage loans, he notes, account for 80% of gross national product in western European countries. But in Turkey, there is plenty of room for growth, as housing credits only represent 5% to 7% of GNP. Mr Özince proposes a mortgage clearing house, similar to the US Federal National Mortgage Association. But this has been looked upon with scepticism by the Finance Ministry because of the difficulties encountered by Fannie Mae in the US.

cp/62/Ziya Akkurt 2.jpg

Ziya Akkurt, the new chief executive officer of Akbank

Attracting retail investors

Investors have been snapping up mutual funds, of which Turkey had more than 245 at the end of 2008. Launched mainly by banks and operated by affiliated brokerage houses and asset management companies, the mutual funds are separate corporations in accordance with the country's capital market laws.

The Turkish mutual fund market was valued at $19.36bn at the end of July 2009, according to the TSPAKB. Is Asset Management, a subsidiary of Isbank, for instance, operates 18 separate investment funds issued by the bank that are either low-risk, low-yield funds based on government bonds, T-bills and repurchasing agreements, or high-risk, high-yield securities based on equities or securities that contain a mix of the two. Investors earned anywhere between 3.91% and 44.91% return in the first seven months of the year from these funds.

In 2008, when shares on the bourse came tumbling down, Ak Asset Management and Yapi Kredi Asset Management introduced capital-protected funds. The bank used equity options to offer a guarantee to investors, with a return of more than 7% earned from a mix of government bonds and higher-risk equity assets.

More exotic stock market funds, real estate development trusts and venture capital funds already exists, but their total assets were valued at just $7.27bn as of July 2009.

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