Turkish Banks 18' SECTOR UPDATE. Favouring selective exposures

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1 SECTOR UPDATE I Turkey Banks 08 January 2018 Turkish Banks 18' Favouring selective exposures Turkish banks (XBANK) trade at a 38% discount to MSCI EM banks on trailing P/E of 5.5x and a 32% discount on P/BV of 0.77x going into publication. Also, our coverage banks are trading at 5.9x 2018E P/E and 0.73x 2018E P/BV compared to MSCI EM peers average of 8.9x and 1.13x, respectively. Risks to stock prices remain skewed to upwards rather than downwards as banks have already priced in most of potential headwinds. Attractive valuations are not the only catalyst, but re-rating of 2018 macro backdrop in context of moderate growth, tamed inflation and eased regulations looks promising for core banking revenue expansion despite the strained international relations slowly boiling over to the economy. All this being said, we model 2018E ROAE at 15.1%, 2018E C/I at 38.6% and 2018E specific CoR at 0.99% for our Tier I coverage. We however don t rule out potential idiosyncratic risks which leave us to favour selective exposures this year. While so many crosswinds blow currently, those who are well positioned in Turkish banks had a good year in 2017 with a return of 32.3% YoY, outperforming the MSCI EM Banks Index by 3.7% owing to risk/reward carry trades going into the new year. The 2017 performance has been mainly attributable to i) the Credit Guarantee Fund (CGF) driven acceleration in TRY loan growth, ii) strong emphasis on fee and commission, iii) lower provisioning burden owing to loose regulations and RWA optimisation via the CGF facility and iv) strong contribution from CPI-linkers to NI; not to mention robust GDP. We work with FY2018 earnings growth forecast of c.15% for the banking sector mainly against the backdrop of core banking revenue expansion. Despite relatively limited NIM contraction, we delivered upward revision to our NI estimates on the account of a pick-up in fee growth and slight deceleration in trading losses. With an anticipated TRY100bn (3% of GDP) CGF utilisation in 1Q18, the lending business should prove to be chief catalyst, while OPEX and hefty LLP burden continue to pose headwind to NI. Also, funding costs should remain the weak link given the TRY liquidity squeeze continuing, LDR edging up to historic highs, and inflation remaining the black sheep in the macro pack. We model a 13bps YoY decline in annualised ROAE to 14.63% for 2018E, assuming 15.7% YoY book value expansion through organic capital generation. We project CoE at 17.6%, 300bps above ROAE in That said, risks remain skewed to upwards rather than downwards as banks have already priced in most of potential headwinds at P/BV trading 32% discount vs. MSCI EM banks going into publication which leaves the door wide open for decent return opportunities in tranquil times. While this is not a done deal due to possible continuation of defensive trades amid (geo)political risks and heavy financing costs, Turkish banks should compare well to EM peers, especially profitability metrics, owing to well-defended NIM evolution, solid lending business, and steady operating efficiency. As for capitalisation, the subordinated debt issuances and exchange transactions to Basel-III compliant Tier2 bonds built some buffer for solvency metrics against market volatility; not to mention strongly accumulated provision buffer to meet IFRS-9 directives. Thus, we project CAR at 16.1% on average for Tier1 in 2018E with a close-to-flat YoY progression. Against this backdrop, we made upward revisions to our FV estimates to below mentioned names by c.8% on average; offering c.12% upside for Tier 1 banks on average at the valuations on January 03, 2018 close. Specifically, we delivered decent upward revisions for AKBNK, GARAN and VAKBN. We now favour GARAN and VAKBN as top pick banking stocks for 1H18. Company (Ticker) Rating Price Mkt Cap Fair Value Akbank (AKBNK TI) REVISION! Buy TRY9.94 USD10.6bn/TRY39.8bn TRY10.90 Albaraka Turk (ALBRK TI) Hold TRY1.51 USD361mn/TRY1.4bn TRY1.40 Garanti (GARAN TI) REVISION! Buy TRY10.72 USD11.9bn/TRY45.0bn TRY12.20 Halkbank (HALKB TI) Hold TRY10.92 USD3.6bn/TRY13.6bn TRY13.75 Isbank (ISCTR TI) Hold TRY7.00 USD8.4bn/TRY31.5bn TRY7.65 T.S.K.B. (TSKB TI) Buy TRY1.46 USD931mn/TRY3.5bn TRY1.70 Vakifbank (VAKBN TI) REVISION! Buy TRY6.79 USD4.5bn/TRY17.0bn TRY8.00 Yapi Kredi Bank (YKBNK TI) Hold TRY4.42 USD5.1bn/TRY19.2bn TRY4.75 x Jan 2017 Apr 2017 Jul 2017 Oct 2017 Jan Performance 1M 3M 6M 12M Absolute 14% 5% 1% 36% Relative 2% -6% -13% -10% Relative $ 20% -1% -6% 28% All share price data as at close on 3-Jan Source: Global Securities, Company Data, Bloomberg Research Director Analyst Sertan Kargin Kerem Mimaroglu sertank@global.com.tr keremm@global.com.tr Global Securities Global Securities Research contact for general inquiry research@global.com.tr XBANK Price Performance XBANK Relative to BIST 100 TIER I BANKS P/BV & 2Y STD Yesilce Mah. Eski Buyukdere Cad. No: 65 Kat: Istanbul Turkey Global Menkul Degerler Relative to BIST Jan 2016 May 2016 Sep 2016 Jan 2017 May 2017 Sep 2017 Jan Mean Std Dev(-2) Std Dev(-1) Std Dev(+1) Std Dev(+2) P/BV 95 90

2 A snapshot of the Turkish Banking Sector There is little attention left to consider anything else other than Turkey s (geo)political wrestling with the United States-led Western block. The strained relations with the West may be slowly boiling over to the Turkish economy and financial system albeit with some easing after the recent resolution for the visa spat with the U.S. and some constructive statements by leading EU countries. While so many crosswinds blow currently, those who were well positioned in Turkish banks had a good year in 2017, with a return of 32.3% YoY as of Dec 29, 2017, slightly outperforming the MSCI EM Banks Index by 3.7% owing to risk/reward carry trades going into the new year. The 2017 performance has been mainly attributable to i) the Credit Guarantee Fund (CGF) driven acceleration in TRY loan growth (credit volume effect), ii) strong emphasis on fee and commission (cross-selling effect), iii) lower provisining burden owing to loose regulations and RWA optimisation via the CGF facility (regulatory effect) and iv) strong contribution from CPI-linkers to NI (securities yield effect). On the flipside, though, Turkish banks have traded at a c.32% discount to EM banks on 12 trailing P/BV of 0.77x going into publication. Exhibit 1 : Trading P/BV and bond Z-spread levels for banks in our coverage P/BV DETAIL MIN MAX AVG CUR AKBNK GARAN HALKB ISCTR VAKBN YKBNK TSKB ALBRK 2,722 2, MIN MAX AVG CUR Z SPREAD DETAIL Source: Bank Financials, Bloomberg, FINNET, House Calculations More specifically, our Valuation Multiple & Z-Spread analysis currently shows that Turkish Tier I banks weighted P/BV multiple has approached support at 2Y P/BV STD-1 level where stocks are being priced at slightly above pre-cgf levels (early March 17 ) as if the CGF facility never had happened. Exhibit 2 : MSCI EM Banks vs. XBANK in USD terms x Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 MSCI EM BANK Index (MXEF0BK) (USD) TR BANK Index (XBANK) (USD) Source: Bloomberg Page 2 of 78

3 Herein, it proves not to be difficult to say that the current valuation multiples leave the door wide open for potential renewed rally for XBANK in tranquil times, although this is not a done deal due to possible continuation of defensive trades amid the increased (geo)political risks and strained relations with the U.S. over the ongoing court cases in the United States against a staterun Halkbank former executive, Mehmet Hakan Attila, on charges of violating the U.S. sanctions on Iran and Iranian entities. Exhibit 3 : Tier I banks average P/BV evolution with 2Y standard deviation Jan-16 May-16 Sep-16 Jan-17 May-17 Sep-17 Jan-18 Mean Std Dev(-2) Std Dev(-1) Std Dev(+1) Std Dev(+2) P/BV Source: FINNET, Bank Financials, House Calculations Coupled with a sustainable ROE of 15.1% remaining 143ppts below CoE of 16.5% in 2017, the current valuation multiples indicate that while some tailwinds emerge, there are some headwinds too. We think that ROEs should continue to stay below CoE in the forthcoming period and we see modest return potential over the next 12 months for our coverage universe. Herein, it s worth taking a quick look at latest financial results before sharing our view on the sector outlook and earnings estimates for banks under our coverage. Q3 readings are not so much different from what we saw in Q2 when the TRY funding squeeze became major headwind for Turkish lenders given the TRY loan-to-deposit (LDR) ratio climbing to c.148%. NII regressed by 2.3% QoQ in Q3 after the two consecutive months expansion in Q1 (+12.9% QoQ) and Q2 (+0.1% QoQ). The disappointing NII readings mainly stemmed from continued decline in securities yield (- 6.7% QoQ in Q3 and -2.9% QoQ in Q2) and narrowing in core spreads (3Q17: -23bps QoQ to 4.60% and 2Q17: -19bps QoQ to 4.83%). Hence, NIM worsened by 21bps QoQ to 3.88% in September on top of 13bps narrowig in Q2 primarily driven by compressed securities yields and subdued loan yields. Deposit costs (3Q17: +63bps QoQ to 6.46% and 2Q17: +54bps QoQ to 5.83%) showed more visible increases compared to moderate loan yield expansions (3Q17: +40bps QoQ to 11.06% and 2Q17: +34bps QoQ to 10.66%), resulting in narrowed core spread performance. Herein, it s worth noting that TRY deposits saw even bigger rate increases due to the CGF driven funding squeeze (3Q17: +93bps QoQ to 9.96% and 2Q17: +104bps QoQ to 9.03%) along with the CBRT s tight policy stance to fight inflation pressures. While the overall impact on core spreads was somewhat eased owing to close-to-flat rises in FC deposit costs, Turkish lenders failed to fully reflect the increased funding costs to loan pricing until late Q3 due to i) duration gap and ii) on-going anti-interest rate voices from the government circles. Page 3 of 78

4 OPEX rose c.15% YoY pace in accordance with low double-digit inflation. While Turkish banks have remained committed to disciplined cost management and increased efficiency (i.e. product digitisation) to normalize OPEX in the forthcoming period, and thereby reiterated their medium term guidance for OPEX growth, the 2017 OPEX growth targets seem to be missed to some extent. For the privately owned banks, higher than expected inflation remains as the usual suspect, while state-run banks basically suffer from the government's self-imposed promotion payments to retiree salaries. Note that a certain amount of this expense will continue to be booked in 2018 and 2019, hindering C/I ratio in staterun Halkbank and Vakifbank as well. The sector s core revenues fell by 2.1% QoQ due to weak NII (-2.3% QoQ, +12.7% YoY), following a close-flat to rise of 0.2% QoQ in Q2 on top of the robust increase of 12.9% QoQ in Q1. Against this backdrop, we saw bottom-line expanded in Q3 on the back of noncore activity such as bulky dividend gains mainly booked by state banks (3Q17: TRY599mn) and eased provisioning expense (-1.8% QoQ and -3.6% YoY), while NII contracted by 2.3% QoQ due to missing securities income (3Q: TRY7,950mn; -6.7% QoQ) and shrinking NIM (-21bps QoQ), as mentioned. Trading loss however rose further (3Q17: TRY3,033mn, +2.7% QoQ) due to hefty swap costs. Exhibit 4 : 3Q17 Banking sector net income evolution Income accounts Expense accounts TRYbn Net int. income Fee income Dividend income Trading loss Other income Provision expense Operating expense Tax expense Net income Source: BRSA Monthly Figures The good news was that Q4 started with decent results with net income rising 2.2% MoM (+25.6% YoY) to TRY3.98bn in October and 1.3% MoM (+35.4% YoY) in November to TRY4.0bn on the back of impressive core revenue performance (Oct: +6.7% MoM and Nov:+4.3% MoM) and moderate provisions expense (Oct: -0.2% MoM and +4.2% MoM). Exhibit 5 : 11M17 Banking sector YtD net income evolution Income accounts Expense accounts TRYbn Net int. income Fee income Dividend income Trading loss Other income Provision expense Operating expense Tax expense Net income Source: BRSA Monthly Figures Page 4 of 78

5 22% 20% 18% 16% 14% 12% 10% 08% 06% 04% 02% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 3.80% 3.60% 3.40% 3.20% 3.00% 2.80% 80% 79% 78% 77% 76% 75% 74% 73% 72% 71% 70% Remarkable core revenue expansion mainly stemmed from strong NII (Oct: +6.8% MoM and Nov: +4.7% MoM) and continuation of fee income generation (Oct: +5.3% MoM and Nov : -1.0% MoM) whereas flattening core spreads (Oct: +23bps MoM to 5.01% and Nov: -33bps MoM to 4.68%) and particularly sustained progression in securities yield (Oct: +69bps MoM to 9.78% and Nov: +234bps to 12.1%) confirmed profitability metrics in 4Q17. In accordance with continued earnings growth, the sector s ROAE rose 18bps MoM to 14.73% following 9M17 figure of 14.55%, whereas solvency metrics deteriorated with CAR declining by 13bps MoM to 16.43%. On the other hand, the sector has failed to escape a number of headwinds to net earnings such as i) trading loss increasing (Oct: TRY1.1bn +39.6% MoM and Nov: TRY1.3bn +14.8% MoM), and ii) OPEX accelerating (Oct: +3.7% MoM and Nov: +3.8% MoM) to TRY5.7bn. All this being said, the October-November results displayed somewhat improved core revenues going into end-2017 amid the CGF driven strong lending business, while elevated trading loss and hefty provisions expense remain as a hurdle. Exhibit 6 : 11M17 Banking sector detailed picture PERFORMING LOANS (TRYbn) DEPOSITS (TRYbn) NET INCOME (TRYmn) , ,944 1, ,954 1, ,994 1, ,046 1, , , , , , ,713 9,085 3,689 8,737 4,232 9,165 3,900 9,785 3,979 10,244 4,029 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 TL loans FC loans Total loans Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 TL deposits FC deposits Total deposits Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 NII Fee income Net Income NET INTEREST MARGIN NON-PERFORMING LOANS SPECIFIC COST OF RISK 4.64% 76% 77% 78% 78% 78% 78% 78% 78% 78% 79% 80% 80% 79% 2.27% 4.01% 4.20% 4.23% 3.81% 4.18% 4.05% 4.09% 4.08% 4.12% 3.97% 3.94% 3.79% 3.25% 3.24% 3.19% 3.26% 3.21% 3.20% 3.19% 3.10% 3.10% 3.12% 3.05% 3.01% 2.94% 1.12% 1.27% 1.14% 1.27% 0.96% 1.03% 0.99% 0.93% 0.86% 1.00% 0.82% 0.79% Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Adj. NIM NIM Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 NPL ratio Coverage ratio Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Specific CoR LOAN YIELD 13.60% 13.68% 13.96% 13.97% 14.17% 14.14% 13.14% 13.28% 13.67% 13.82% 14.38% 13.88% 12.33% 10.77% 10.67% 10.90% 10.97% 11.07% 11.26% 11.65% 10.81% 11.14% 11.11% 11.13% 6.27% 6.00% 10.40% 6.19% 5.34% 5.36% 5.27% 4.80% 5.01% 5.33% 5.50% 5.83% 9.32% 4.98% 3.95% Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 LOAN DEPOSIT SPREAD 13.96% 13.97% 14.17% 14.14% 13.60% 13.68% 13.67% 13.82% 14.38% 13.88% 13.14% 13.28% 12.33% 3.98% 3.96% 4.24% 4.63% 4.17% 4.06% 3.95% 5.03% 5.47% 5.34% 5.56% 4.82% 4.89% 10.19% 10.18% 10.14% 9.33% 9.50% 9.75% 9.93% 8.11% 8.13% 8.34% 8.40% 8.46% 7.44% TL loan yield TL deposit cost 6.27% 6.00% 6.19% 5.83% 5.34% 5.36% 5.27% 5.33% 5.50% 5.01% 4.80% 4.98% 3.95% SECURITY YIELD 14.60% 15.39% 12.94% 12.11% 12.13% 11.65% 11.54% 11.62% 10.95% 11.05% 10.71% 9.89% 8.44% 12.12% 11.63% 10.25% 7.67% 9.57% 9.64% 9.77% 9.23% 9.13% 9.42% 9.78% 9.09% 8.38% 5.44% 5.91% 5.73% 5.54% 5.74% 5.13% 5.16% 4.64% 4.92% 4.68% 4.90% 5.01% 5.35% Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 TL Securities yield FC Securities yield Securities yield TL loans yield FC loans yield Loans yield 4.26% 3.43% 3.92% 2.31% 3.40% 2.98% 3.25% 3.02% 3.20% 2.91% 3.42% 3.90% 3.64% 8.75% 7.80% 11.28% 10.97% 9.34% 7.61% 6.57% 7.55% 10.46% 9.16% 8.98% 6.56% 7.18% DEPOSIT COST 10.19% 10.18% 10.14% 9.33% 9.50% 9.75% 9.93% 8.11% 8.13% 8.34% 8.40% 8.46% 7.44% 6.60% 6.58% 6.64% 6.01% 6.12% 6.32% 6.45% 5.63% 5.51% 5.59% 5.51% 5.45% 4.84% 2.01% 1.92% 2.08% 1.96% 2.02% 1.64% 1.82% 1.99% 2.13% 2.29% 2.07% 2.08% 2.19% FC loan yield FC deposit cost 11.65% 10.77% 10.67% 10.90% 10.97% 11.07% 11.26% 10.81% 11.14% 11.11% 11.13% 10.40% 9.32% 4.66% 5.15% 5.16% 5.31% 5.46% 5.05% 4.57% 5.01% 4.70% 4.78% 4.68% 4.95% 4.48% Trading 7.75% 9.59% 9.35% 9.32% 11.24% 12.13% 9.10% 9.69% 10.02% 9.43% 8.51% 9.22% 9.94% AFS 12.71% 12.23% 7.39% 9.58% 8.87% 10.35% 9.27% 10.11% 10.91% 9.40% 8.13% 8.85% 9.37% 2.01% 1.92% 2.08% 1.64% 1.96% 1.82% 2.02% 1.99% 2.13% 2.07% 2.08% 2.29% 2.19% 5.63% 5.51% 5.59% 4.84% 5.51% 5.45% 6.01% 6.12% 6.60% 6.58% 6.32% 6.64% 6.45% Loan yield Deposit cost HTM Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 TL deposits cost FC deposits cost Deposits cost PROFITABILITY CAPITAL ADEQUACY ASSETS & EQUITY (TRYbn) 12.8% 10.5% 15.6% 19.9% 19.7% 17.0% 14.6% 16.4% 14.1% 16.1% 14.5% 14.7% 14.7% 15.3% 15.6% 15.2% 15.9% 16.0% 16.4% 16.7% 16.9% 17.0% 17.2% 17.2% 16.9% 16.4% 2,997 2,990 3,054 3,168 3, % 2.03% 2.04% 1.78% 1.60% 1.72% 1.71% 1.54% 1.49% 1.56% 1.55% 1.51% 1.10% Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 ROAE ROAA CAR Total Assets Equity Source: BRSA Monthly Figures, House Calculations Page 5 of 78

6 Balance sheet aggregates: Loans and Deposits Turkish banks put a steady foot on the gas pedal and pressed on with the process of expanding core business in In total lending, banks put more emphasis on corporate (+4.2% QoQ) and consumer loans (+4.7% QoQ) in Q3, while also expanding in SME (+3.3% QoQ), commericial installments (+2.5% QoQ) and credit card (+5.5% QoQ) segments. Turkish lenders also advanced in FC lending, posting a c.1.8% QoQ growth in USD terms mainly driven by business loans in Q2. Exhibit 7 : Tier I banks & sector segmental distribution details Source: Bank Financials, Bank IR, House Calculations With the beginning of 3Q17, sector loan growth gradually slowed down and shifted to corporate, consumer and credit card segments. As the credit guarantee fund (CGF) provided much needed liquidity to the economy, the transfiguration to consumer and credit card lending seems natural for the system. Exhibit 8 : Banking sector loans segmental break-down 1,542 1, , ,811 1,899 1, TRYbn Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017 3Q/2017 Corporate loans SME Consumer Commercial inst. loans Credit card Source: BRSA Weekly Figures Page 6 of 78

7 Q3 loan growth: mainly driven by the credit guarantee fund (CGF) Treasury-backed collateral facility aiming to give financing access to SMEs with insufficient collateral base went into force early March Following the cabinet decision, the guarantee size of the CGF was raised to TRY250bn from TRY25bn, previously. The sector has been enthusiastically utilizing the Treasury-backed lending facility ever since. The CGF facility was particularly aimed at SMEs to ease their TRY40bn cash flow problem whereas the new fund also helped the banking system accelerating the overall credit growth. The latest boost is however cyclical, not structural. Some 347K clients have utilised TRY196bn of the overall CGF limit of TRY250bn and obtained TRY219bn cash loans so far. Exhibit 9 : CGF guarantees and credits* TRY6.7BN TRY8.7BN TRY18.8BN CGF limit raised to TRY250BN TRY47.1BN TRY101.7BN TRY90.BN TRY135.6BN TRY120.7BN TRY155.8BN TRY139.BN TRY169.5BN TRY180.9BN TRY192.4BN TRY219.1BN TRY151.4BN TRY161.8BN TRY172.2BN TRY196.4BN CGF Credit CGF Guarantee 12M16 1M17 2M17 3M17 4M17 5M17 6M17 7M17 8M17 9M17 10M17* *Figure as of Mid 10M17 Source: CGF Website Credit Guarantee Fund (CGF) mainly utilized through new users; refinance and re-structure tapping remained relatively small As of 9M17, main utilization of the CGF was directed to new customers (55.1%), followed by additional lending to existing customers (31.9%). In this regard, we saw that some banks were inclined to deleverage their SME books by transferring some portion of non-performing commercial loans to the CGF facility. That said, refinance, re-structuring and renewals occupied a relatively smaller portion of the fund (4.7%) whereas the CGF loans were attributed to previous periods formed 8.4% of the total volume. Exhibit 10 : Purpose, currency and target of CGF loans PURPOSE OF CGF LOANS 8.40% 4.70% 9M17 CURRENCY OF CGF LOANS TL EUR MID 9M17 USD 86.60% 8.80% 4.60% 31.90% 55.10% TARGET OF CGF LOANS SME NON-SME 9M17 First time credit line Additional credit line Refinance / Re-Structure / Renewal Preivous period 74.60% 25.40% Source: CGF Website Page 7 of 78

8 % 83% 78% 73% 68 % predominantly TRY lending by the CGF With loan portfolio reaching to TRY219bn as of mid 10M17, the c.try157bn (c.87% of CGF) of the funds were granted as TRY loans. However, FC front remained below 15% of the funding scheme with TRY14.5bn EUR and TRY9.0bn USD loans in circulation. The FC portion of the CGF was mainly utilized as export loans. As previously stated, the CGF aims to improve access to credit for SME, farmers, merchants, craftsmen and self-employed entities. In details, some 50% of the credits were given to trade (38%) and construction (13%) sectors, while 30% went to manufacturing. As of 10M17, the SME share under the TRY219bn CGF sponsored loan portfolio reached TRY164bn (74.6% of CGF). The majority of the remaining portion (25.4%) has been granted to non-sme entities. On the other hand, c.92.4% of the loans was used for working capital needs while only 2.5% were for investments. Exhibit 11 : CGF average loan size* and CGF segmental distribution 89% 89% 89% 89% 89% 89% 90% Production 86% 30.3% Construction 82% 77% 75% TRY444k TRY556k TRY618k TRY633k TRY578k TRY578k TRY580k TRY631k Avg. CGF loan size % of CGF Guarantee 12M16 1M17 2M17 3M17 4M17 5M17 6M17 7M17 8M17 9M17 10M17* Trade and services 44.1% 12.9% 4.9% 2.8% Transportation 5.0% Tourism Other *Figures as of Mid 10M17 Figure as of 8M17 Source: CGF Website c.79% of the TRY250bn guarantee limit has been tapped As of mid 10M17, the limit utilization for the guarantees has reached 78.6% to TRY196bn which produced TRY219bn loan exention under the CGF scheme so far in This has made up nearly c.12ppt of the c.18% YtD loan growth whereas the rest of the loan growth (non-cgf led portion) has been mainly driven by consumer (+14.7% YtD) and corporate loans (+5.62% YtD) as of mid 10M17. From a quarterly perpective, Turkish banking sector expanded its loan portfolio by 5.5% QoQ in Q1, c.42% (c.2.3ppts) of this expansion was facilitated by the CGF scheme. In Q2, banking sector loan growth slightly decelerated to 4.9% QoQ and this growth figure was single-handedly achieved through the CGF facility. In Q3, the CGF scheme continued to dominate the lending business, which grew by 3.9% QoQ. Herein, it s worth noting that additional c.try50bn of guarantees remain untapped for the time being translating into c.try55bn of potential CGF lending in the forthcoming period. Also, note that loan growth was at c.6% YtD as of mid 10M17, when excluding the CGF support. Tier1 banks benefited significantly Tier1 banks CGF lending book reached c.try100bn as of 3Q17. ISCTR, GARAN and AKBNK were the first banks to start granting CGF loans. In fact, these names led the CGF growth in 1Q17. With the beginning of Q2, the rest of the Tier I names effectively joined the scheme. Coupled with ISCTR, the state-run lenders VAKBN and HALKB led the CGF expansion in 3Q17. Sector loan expansion weighed dominantly on the CGF facility, and for most of the Tier I names, the CGF growth surpassed total loan growth in Q2. As of 11M17, based on our talks with Tier1 banks IR departments, the CGF growth is still on the table albeit with a much lesser degree. In the 3Q17, Page 8 of 78

9 HALKB maintained steady foot on gas pedal extending TRY8.4bn new CGF loans. AKBNK and VAKBN granted TRY5.0bn and TRY4.0bn, respectively; while other Tier1 names CGF utilization cruised behind these figures. Private segment was quick to respond to the newly introduced loan scheme and led the market share in the first quarter of the facility in order to utilize the first mover s advantage. ISCTR was one of the leading names since the beginning of the CGF scheme. However, state-run banks have been currently leading the market with HALKB and VAKBN owning 10.9% and 9.7% market share, respectively, followed by ISCTR at 9.0% by the end of 3Q17. This indicates that loan growth was fuelled more at Vakifbank, Isbank and Halkbank through the CGF, relative to others, as the Treasury backed loan facility has lifted their lending capacity by an average 10%. Front-loaded CGF utilization slowed going into the end of 2017 During Q3 earnings results, Tier1 banks managements cited that they still have some limit available after having heavily utilised the CGF facility. Specifically, Tier1 banks utilised the CGF facility in a front-loaded nature given the TRY53.6bn facility remaining available vs the overall limit of TRY250bn as of mid 10M17. Hence, we think that the CGF lending has become subtle going into the new year. In tandem, we expect loan growth to decelerate towards 22.1% YoY by end of 2017 from 23.9% YoY in Q3 and to normalize in 2018 at around 15% YoY, as a new CGF scheme is not on the government s agenda. Rather, the current CGF mechanism will be made permanent to counteract liquidity shortages and sustain recovery in the Turkish economy. The permanency of the CGF scheme means that Treasury will allow the banking sector to re-lend the amounts to be redeemed by corporates in the forthcoming period without allocating new limits. It s bearing in mind that the CGF was extended in a hurry and in abundance, as a lifeline to the corporate sector suffering losses from large FC mismatches and sector-specific shocks, such as tourism and transportation in This means that the repayment capacity of the sector - particularly in a scenario of sub-par growth - constitutes a major source of uncertainty. Meanwhile, the authorities say NPL ratios in the CGF loans are low, but it is too early to tell, as the average maturity of CGF loans is slightly above 3 years. The picture may change significantly over the next 12 months. Loan growth: The onus remains on GDP performance As corporate sector has found a life-line with the CGF facility, private consumption drove the GDP growth while investments continued to remain lagging factor. In the forthcoming period, banks expect investments to take the driver seat at some point, and lead the growth going-forward. True, the robust growth in 2017 may require manufacturing sector to begin inventory restoking which could pose a catalyst for private investments for the forthcoming few quarters; but this motive remains insufficent to achieve a secular boost in investments given the long-lasting structural issues. In fact, the million dollar question now is whether or not above-trend growth momentum will last in The answer still remains unknown as the Turkish economy has followed a roller-coaster ride in the past several decades. Following an anaemic performance with severe imbalances in the 1990s and financial crisis in 2001, Turkey enjoyed five years of rapid economic growth, with GDP per capita (new series) increasing at almost 8% per annum accompanied by structural changes, productivity growth and a broadening base of economic activity. From about 2007 onwards, however, economic growth slowed significantly and productivity growth stagnated in all metrics. Then, Turkey's experience was just another example of the well-known stopand-go cycles so typical of emerging economies. Page 9 of 78

10 Exhibit 12 : Banking sector loans currency break-down TL loans exc. financial sector FC loans exc. financial sector FC loans exc. financial sector (USD) 484 TRYbn 167 USDbn 504 TRYbn 169 USDbn 587 TRYbn 167 USDbn 600 TRYbn 166 USDbn 599 TRYbn 171 USDbn 621 TRYbn 175 USDbn 1,059 TRYbn 1,084 TRYbn 1,128 TRYbn 1,212 TRYbn 1,300 TRYbn 1,351 TRYbn 2Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017 3Q/2017 Source: BRSA Weekly Figures With entrenched structural constraints i.e. low savings rates, declining total factor productivity and labour market inefficiencies in Turkey, constrained household incomes, an ageing work force and over-dependence on external financing (external financing needs: USD200bn plus p.a.), sluggish investment will likely suppress the potential growth in the absence of targeted structural reforms. Needless to say, the growth-inflation paradigm is still doing badly mainly due to heightened inflation risks while Turkey s CAGR GDP of 6% during apparently contradicts with the seasonally adjusted increase in unemployment rate to 10.6% from 8.8% over the same period. Against this backdrop, tight money/loose fiscal policy mix would be ultimately growth negative should the sugar-rush stage of the CGF facility fade into the rear view mirror. Exhibit 13 : Global Securities macro forecasts Growth E* 2018-I** 2019-P*** GDP (TRY mn)-nominal prices 1,569,672 1,809,713 2,044,466 2,338,647 2,608,526 3,100,937 3,564,174 4,032,934 GDP (USD mn) 871, , , , , , , ,791 GDP per capita (USD; at market rate) 11,588 12,480 12,112 11,014 10,807 10,638 11,181 11,953 GDP growth rate(%; y/y) Unemployment Rate (%) Inflation & Rates E* 2018-I** 2019-P*** CPI (y/y; end of period-%) CPI (y/y; annual average-%) The CBRT f/cast for CPI (eop; %, last Revision) Benchmark Rate (2yr; oya-%) Benchmark Rate (2yr; end of period-%) O/N Borrowing rate (end of period-%) Week Repo Rate (end of period-%) O/N Lending rate (end of period-%) Interbank Repo Rate (end of period-%) GDP Deflator (oya-%) Foreign Currency E* 2018-I** 2019-P*** Depreciation (USD - oya; %; nominal) Depreciation (USD - eop; %; nominal) USDTRY (average; market Bid Rate) USDTRY (end of period; market Bid Rate) EURTRY (average; market Bid Rate) EURTRY (end of period; market Bid Rate) *Estimate **Indicative ***Projection Source: BRSA Weekly Figures Page 10 of 78

11 Putting all the (geo)political mass aside, delaying structural reforms (such as labor market, tax and pension systems) remain as main hurdle for growth prospects. Hence, the economic rebound would unlikely last without key structural reforms. Particularly, reform fatigue has undermined the country s productive capacity which together with volatile/unpredictable currency dynamics and increased reliance to external financing have damaged private sector income statements. Fiscal policy has provided a strong upward drift to demand side. Recall, the government took a range of measures to stimulate the economy early 2017, i.e. providing wage subsidies to firms and postponing the due dates for their tax and social security payments. Ending this support will be difficult since the factors weighing on consumption and investment, such as higher inflation and interest rates and declining productivity, are structural rather than cyclical. We therefore expect the fiscal accomodation to remain operational for a while longer, till at least the 2019 elections. Thus, the presidential office delivered new support package for employment during mid Dec All this being said, our macro team expect GDP growth at 4.3% in 2018 and 4.0% in 2019 after ending 2017 at 7.0%. These growth estimates should translate into lending growth rate of 15.1% YoY for FY 2018E from 2017E 22.1% YoY for the sector (11.3% when CGF impact excluded). Deposits : Scarce financing source TRY deposits marked 12.2% YoY growth as of 3Q17, while FX deposits (USD terms) rose a significant 15.1% YoY. The overall deposit growth (22.0% YoY) somewhat lagged the loan growth (23.9% YoY). We believe banks will be reluctant to further extend their LDRs, which reached c.122% for the sector as of 3Q17. The situation is more acute on the TRY side whose LDR reached c.148% from c.134% in YE16, while FX LDR remains relatively lower at 89%. The CGF-backed loan growth obviously explains the hike in TRY LDR as well as the ongoing dollarization in financial markets. This means some 70-75% of loan growth in 2017 has been met up by deposit growth, the rest coming from external sources. This picture resulted in increased cross-currency swap utilisation to fund some part of TRY loan book expansion via FX deposits. Exhibit 14 : Banking sector TRY loan and deposits with TRY LDR 1,600.0 TRY loans volume (TRYbn) 142% 144% 148% 148% 160% 1, , , % TRY deposit volume (TRYbn) 133% 127% TRY loan to deposit ratio 113% 105% 94% 88% 89% 89% 84% 71% 61% 45% , % 1, , , , % 120% 100% 80% 60% 40% % Source: BRSA Monthly Figures We think overly stretched TRY LDR remains main hurdle against a major slide in deposit rates. And, it is highly unlikely that this basic arithmetic will improve any time soon. Needless to say, the increased Treasury roll-over rate in domestic debt has put further pressure on TRY liquidity and thereby resulted in permanent scarcity in TRY liquidity, which together with extra funding needs due to the CGF driven TRY loan growth, lifted up interest rates. While Page 11 of 78

12 banks were in rush to expand their loan book in 2017, they refrained from competing on costly TRY deposits. Rather, they showed a desire to dispose of expensive liabilities to avert heavy financing costs. Given the scarcity of TRY deposits, banks need to convert excess FX deposits into TRY or access into foreign wholesale markets to fund their TRY loans. Exhibit 15 : Banking sector TRY and FC LDR detail TRY loan to deposits FC loan to deposits Blended loan to deposits 133.0% 133.9% 144.1% 147.8% 147.7% 120.1% 119.3% 120.6% 121.6% 121.9% 99.8% 99.1% 91.2% 88.4% 89.0% 3Q/2016 4Q/2016 1Q/2017 2Q/2017 3Q/2017 Source: BRSA Monthly Figures In such environment, we assume banks will continue to utilize FX deposits to fund TRY loan growth through currency swaps in the forthcoming period. Hence, the funding side of the loan generation (mainly driven by the CGF facility) should bring further negative implications on NI figures through heavy swap costs. Also, currency pressures and accompanying FX passthrough to inflation should pose another risk to interest rates. Herein, the CBRT rate moves should remain pivotal as the Bank has needed to keep tight liquidity conditions to avoid further inflation risk and thereby forced banks to tap their daily liquidity needs from the late liquidity window (LLW) which currently hovers at 12.75%. All told, we factored in an average yield of 10.8% on loans (+24bps YoY) in our 2018 NI estimates. As the sharp TRY loan growth has been mainly funded by FX sources, banks may see some adverse implications on the credit policy as: i) either banks should reduce their appetite to pursue further aggressive loan growth due to the funding constraints, or they will see further deterioration in TRY LDR ratios; ii) while banks have managed not to fully reflect the increased CBRT funding costs to loan pricing, deposit costs have remained the weak link due to heightened TRY liquidity squeeze, keeping NIM evolution under pressure for some time to come; iii) banks should continue to utilise cross-currency swaps to convert FX funding into Turkish liras as long as LDR remains far above 100%; and iv) needless to say, swap costs are mostly influenced by currency dynamics. All these factors should start softening the credit growth at some point in the near future unless the long-awaited easing in deposit rates materialises. Furthermore, deposit costs are mostly conditional on inflation and currency pressures as well as Turkish Treasury s increasing financing needs in the wake of expansionary budget polies. Despite adverse impacts of FX-funded TRY loan expansion on the credit market dynamics, the CGF will be made permanent to counteract liquidity shortages and sustain recovery by revolving TRY90bn CGF loans due in 2018 and deploying fresh TRY50bn to boost investments mostly in 1Q18. With this scheme, the government is planning to inject an additional TRY100bn (c.3% of GDP) CGF loans to the economy by the end of 1Q18. Page 12 of 78

13 Exhibit 16 : Banking sector funding break-down TRYbn Deposits Shareholder's equity Securities issued ,325 1,431 Funds borrowed Repo & MM funding Subordinated debt ,518 1,578 1,635 3Q/2016 4Q/2016 1Q/2017 2Q/2017 3Q/2017 Source: BRSA Monthly Figures Core spreads under pressure The CGF driven acceleration in TRY loan growth and TRY funding squeeze offered an unpleasant cocktail for local currency costs. Hence, Turkish lenders saw higher financing costs while the sector failed to fully reflect the increased CBRT funding costs to loan pricing until mid Q3. However, this was not unexpected given the maturity mismatch between deposits and loans. The increase in TRY deposit costs was not as bad as initially feared. In fact, the overall burden of TRY deposits on core spreads was more than halved owing to a more moderate 14bps QoQ rise in FC deposit costs in Q3. Hence, the sector faced an affordable 63bps rise in blended deposit costs in the quarter. Particularly, the increase in blended deposit costs compared well to the 444bps hike in the CBRT s effective funding rate in More importantly, the widening of blended loan yield (+40bps QoQ) partially offset deposit cost increase of 63bps QoQ, resulting in a 23bps QoQ contraction in the loan-todeposit spread in Q3. Exhibit 17 : Banking sector TRY and FC yields/costs/spreads TRY loans yield TRY deposit cost TRY core spread 13.87% 13.26% 13.31% 13.50% 13.16% FC loans yield FC deposit cost FC core spread 5.63% 4.98% 5.10% 4.99% 5.24% 4.87% 5.07% 5.17% 4.47% 3.91% 3.37% 3.71% 3.21% 3.05% 3.16% 9.96% 8.40% 8.24% 7.99% 9.03% 1.60% 1.92% 1.90% 1.94% 2.08% 3Q16 4Q16 1Q17 2Q17 3Q17 3Q16 4Q16 1Q17 2Q17 3Q17 Source: BRSA Monthly Figures NIM narrowed down by 13bps QoQ to 4.09% in Q2 despite the contribution of CPI linker income. The sector s NIM saw further contraction of 21bps QoQ to 3.88% in Q3 due to relatively softer CPI linker income and tighter core spreads. With elevated utilisation of cross-currency swaps to fund CGF loans and accompanying additional cost in swap book (TRY1,641mn; +5.4% QoQ), the swap adjusted NIM ratio narrowed by 27bps to 3.27% for the Tier1 banks. Page 13 of 78

14 CGF s contribution to sector s NIM reached c.50bps in 2Q17 The CGF s impact on NIM can be generalized through yield contributions to interest income and funding pressure on interest expense. In our models, we applied 15.1% (stated by CGF as of 9M17) average CGF loan yield and relevant deposit cost for the calculation period. Our calculations suggest that the CGF s contribution to sector s NIM materialized around 18bps for 1Q17 and 50bps for 2Q17, then followed with a subued impact in 3Q17 amid the normalisation of the CGF utilisation. constructive guidance for Q4 NIM While the sector participants, particularly Tier1 banks, have guided a close-toflat increase for NIM figures in Q4 with the expectation of CPI linkers contribution, progressive loan pricing, and potentially easier swap and deposit costs, things may not work out as one calculates. In fact, cost of funding should have the last word. Specifically, the funding side of heavy loan book (c.try2.7tln or c.89% of GDP as of 3Q17) might have brought some additional spread compression in some banks in 4Q17 given the challenging financing conditions. Green shoots have withered prematurely as Turkey s strained relations with the U.S.-led Western Block and the heightened geopolitical risks have left investors between a rock and a hard place. In fact, Turkish banks have been caught in a tug-of-war going on between the strong credit market, with unfavourable knock-on effects on inflation, and uncertainty over how financing will be sustained within the budgeted targets. Hence, given the stretched financing conditions, we don t rule out further NIM compression in Q4 for those that suffer elevated LDR and thereby heavy swap books. In fact, we model c.20ps QoQ expansion in the reported NIM for 4Q17 to 4.08% as a result of CPI contribution and core spread expansion. That said, banks seem to have achieved their flattish to slightly upwards NIM guidance for FY 2017, ending up a 22bps YoY expansion to 4.11%, based on our estimates. Exhibit 18 : Tier 1 Banks reported, trade/swap adjusted and CPI excluded NIMs 5.0% 4.5% Tier 1 Banks' NIM Tier 1 Banks' Trade Adjusted NIM Tier 1 Banks' Swap Adjusted NIM Tier 1 Banks' CPI excluded NIM 4.0% 3.5% 3.0% 2.5% 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 Source: Bank Financials, Bank IR, House Calculations The CGF s impact on sector s ROE presents a mixed bag The CGF facility provides a variety of buffers to the bottom-line, such as NII, fee income and exemption from general provisions. On the other hand, due to overly imbalanced loan-deposit balance, the CGF scheme also encourages additional swap utilization and therefore lifting swap costs for the sector. Based on our calculations, the CGF s net impact on NII amounted to c.try1.7bn in 1Q17 and c.try4.7bn in 2Q17. The excess portion of the CGF which had to be funded through swap utilization led to approximately TRY908mn and TRY864mn swap costs in 1Q17 and 2Q17, respectively. Page 14 of 78

15 The legislation allows banks to book 0.03% commission rate for CGF loan originations. Approximately, this should have provided c.try12mn in 1Q17 and c.try33mn in 2Q17 as fee income, while remaining negligible in 3Q17. From provisioning perspective, the CGF loans don't require general provisioning as the loans are already backed by the fund. There should have been a positive impact through this channel; however, Turkish banks appear to have set aside usual amount of general provisions which looks a prudent move. Against this backdrop, we excluded positive impact of this channel from our calculations. Gathering all the elements in our analysis, the CGF facility provided c.100bps and c.535bps contribution to annualized ROE in 1Q17 and 2Q17, respectively. Note that the impact of CGF on ROE remained subdued in 3Q17. Capital ratios saw a technical boost Turkish banks are generally well-capitalised, but currency pressures and Fitch downgrade weighed on capital early Turkish Banking Regulatory and Supervison Authority (BRSA) has since then introduced several measures to mitigate the negative impact. Firstly, banks were given the opportunity to switch to alternative rating agencies for calculating risk weightings (only state-run banks, Halkbank and VakifBank, adopted Islamic Rating metrics and JCR). Then, the BRSA reduced the risk weight of FC reserve requirements under the CBRT s macro-prudential policy to zero. Also, the BRSA halved the provisioning ratio both for performing loans and loans under close watch. In addition to above-mentioned supportive regulations, banks solvency ratios strongly benefited from internal capital generation whereas the exchange transaction to Basel-III compliant Tier2 bonds helped banks to some extent hedging their financials against market risks. Exhibit 19 : Banking sector SHE and solvency figures SHE CAR CET % 17.20% 18.00% 17.00% % 15.49% 15.83% 16.03% 15.57% 16.05% 16.00% TRYbn 14.64% 12.34% % 13.38% % % % % % % % 14.00% 13.00% 12.00% 11.00% Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q % Source: BRSA Monthly Figures Against this backdrop, the sector-wide capital adequacy ratio (CAR) almost fully recovered back to 17.2% in Q3, but slipped back to 16.9% in 10M17. For Tier1 banks under our coverage, CAR showed a 55bps QoQ increase to an average of 17.1% in Q3 whereas bank-only CET1 ratio rose 41bps QoQ to 14.6% in the quarter. Looking forward, the Credit Guarantee Fund scheme should be supportive as loans under the CGF will have zero risk weight. We do not expect CAR to be a major issue for banks in 2018 unless we see a significantly sharper depreciation in the TRY. Page 15 of 78

16 08% 07% 06% 05% 04% 03% 02% 01% 00% Exhibit 20 : Tier 1 Banks CAR, CET1 and T1 figures T1 CET % CAR 15.76% 17.59% 16.68% 16.70% 18.91% 12.67% 12.68% 13.81% 14.06% 14.10% 16.98% 12.76% 12.79% 16.19% 11.15% 11.28% 14.91% AKBNK GARAN HALKB ISCTR VAKBN YKBNK Source: Bank Financials Asset quality worries deferred to late 2018 and beyond As of 11M17, improved economic activity, strong loan growth and heavy restructurings have gradually improved the NPL ratio to 2.94% (lowest figures since 3Q15) since the beginning of the year despite currency pressures. In TRY terms, SME loans which composed of c.25% of loan book as of Q3 remained in the spotlight, as the NPL ratio (4.75%) in the segment remained way above the ratio for the overall NPL book (3.05%) in Q3 albeit with some easing from 4.87% in YE16. Exhibit 21 : Troubled asset figures for the Turkish economy Troubled Assets* Troubled Assets / GDP* (4Q Trailing) 6.4% 7.2% 6.6% * Guesstimate via extrapolation 5.2% 4.4% 4.9% 5.4% 5.5% % 3.7% TRYbn M17 Source: Bank Financials, BRSA Monthly Figures, TurkStat, CBRT, House Calculations Also, FC asset quality has been key focus given corporate balance sheets still remaining under fire amid USD211bn currency mismatch, equivalent to c.25% of GDP, and in turn an estimated overall FX deficit of USD70bn as of Q3. With the glass half full, despite on-going currency pressures, FC asset quality has so far been resilient owing to i) relatively longer maturity structure of FC loans, ii) concentration of FC loans in large corporates due to strict credit policy rules and directives, (iii) fully hedged FX positions, and (iv) Treasury guarantees to mega construction projects mostly financed through longer term foreign currency loans. Page 16 of 78

17 Exhibit 22 : Troubled asset study and detail for the Turkish economy Sector (TRYbn) M17 Perf. loans ,065 1,256 1,513 1,765 2,027 Non-performing loans NPL ratio 3.47% 5.11% 3.56% 2.63% 2.78% 2.63% 2.78% 3.04% 3.18% 2.99% Restructered loans* Write-offs* Protested Bills Bounced Cheques**** NPL in non-bank Financials Troubled Assets* GDP** ,160 1,394 1,570 1,810 2,044 2,338 2,591 2,959 Troubled Assets / GDP* (4Q Trailing) 3.4% 5.2% 4.4% 3.7% 4.9% 5.4% 5.5% 6.4% 7.2% 6.6% Source: Bank Financials, BRSA Monthly Figures, TurkStat, CBRT, House Calculations However, this is not to say that the coast is clear to become comfortable about balance sheet risks. The continuation of the TRY weaknes coinciding with a bulk of maturities could hit those sectors with less hedging capacity. A wave of corporate defaults could turn into a systemic problem given that most of the FC financing is raised via the domestic lenders. Potentially problematic loans (Group 2) was at 3.54% (+12bps QoQ) of the total loan book for Tier 1 banks as of Q3, which continued to leave investors with a bad taste about NPL formation in the coming quarters. Given c.85% of fresh CGF loans booked at 0% risk weight, Turkish banks may sustain solvency ratios by rebalancing fresh loans and loan restructurings. Specifically, Turkish banks should have a great chance to transfer some of overdue SME loans in Group 2 category to the CGF scheme, which should support CoR and keep asset quality intact in pontentially distress periods. Exhibit 23 : Banking sector SME NPL book and ratio 50.0 SME NPLs 5.50% SME NPL ratio 4.87% 4.88% 4.66% 4.66% 4.75% 5.00% % % TRYbn 17 TRYbn 20 TRYbn 22 TRYbn 23 TRYbn 3.50% 0.0 3Q/2016 4Q/2016 1Q/2017 2Q/2017 3Q/ % Source: BRSA Monthly Figures Sovereign ratings under risk again Fitch Ratings said on Nov 23 that investigations by U.S. authorities into a group of Turkish figures accused of violating sanctions on Iran could put Turkish banks ratings under pressure if the situation escalates. Fitch added that if there was a case of reputational damage resulting in diminished access to capital markets or a large fine that wasn t offset by the state support, it could result in negative rating pressure on banks. With the glass half full, Fitch cited that capital buffers in the Turkish banking sector were currently sufficient to absorb moderate shocks, although risks Page 17 of 78