CGF Overview

CGF (Credit Guarantee Fund) Note that all data are per September 22, 2017 closing

Research Director Analyst Sertan Kargin Kerem Mimaroglu Research Director Banks and Quant +90 850 201 94 48 +90 850 201 94 84 sertank@global.com.tr keremm@global.com.tr

September 25, 2017

1

CREDIT GUARANTEE FUND (CGF) HISTORY AND PURPOSE OF CGF % OF LOANS GUARANTEED UNDER CGF

The Credit Guarantee Fund was founded in 1993 to

improve access to credit for SME, farmers, merchants, craftsmen and self-employed entities that do not have sufficient collateral to

qualify for a loan. By providing guarantees to help

the borrowers qualify for loans, the fund acts as a

joint guarantor.

The Treasury guarantees non-performing loans if

the NPL ratio of the CGF book does not exceed

7%, the NPL risk over and above this level will be

passed to the banks. Within the 7% threshold, the

Treasury guarantees 100% of certain export loans,

90% of SME loans, and 85% of commercial loans.

DEFINITION OF SME CGF LOAN SYSTEMS AVG. SIZE AND YIELD OF CGF LOANS

An SME (Small & Medium Sized Enterprise) is

defined as an enterprise with less than 250 employees and either revenues or balance sheet

size not exceeding TRY40mn.

CGF credit can be provided via the Portfolio Guarantee System (PGS), where banks conduct credit evaluation, or via the Portfolio Limit System (PLS), where the CGF does the evaluation internally. Banks are required to provide 80% of their CGF loans under the Portfolio Guarantee System (PGS) system and 70% of these loans should be directed to SMEs. The Portfolio Limit System (PLS) is primarily used to grant commercial loans.

The average size of CGF loans is TRY520.7k. On

average, CGF loans carry 15.12% yield. Currency

distribution of CGF loans is 86.6% TRY, 8.8% EUR

and 4.6% USD denominated as of 31.08.2017.

SIZE AND ELIGIBILITY OF CGF LOANS MATURITY OF CGF LOANS

On 10.03.17 with the cabinet decision, the size of the fund was increased from TRY2bn to TRY25bn, provided by the Turkish Treasury, acting as a collateral for up to TRY250bn of guarantee vs. previous amount of TRY20bn. SMEs, commercials, and exporters are eligible borrowers for CGF loans. The maximum amount that can be guaranteed per beneficiary is TRY12mn for SME and TRY200mn for commercial loans.

Working capital loans have a maximum maturity of 5 years, with a 1-year grace period. Investment capital loans have a maximum maturity of 10 years, with a 3-year grace period. Average loan maturity under the CGF scheme is 39.6 months. Average maturity for working capital loans, investment loans and non-cash loans is 39.4, 65.1 and 31.1 months, respectively as of 31.08.17.

2

Credit market : All guns firing Turkish banks have maintained a steady foot on the gas pedal and pressed on with the process of expanding core business…

In total lending, banks put emphasis on commercial installment (+32.4% QoQ), SME (+8.4% QoQ) and consumer (+4.4% QoQ) segments in Q2, while cutting back on corporate lending (-7.5% QoQ). Turkish lenders also advanced in FC lending, posting a 3.3% QoQ growth in USD terms mainly driven by business loans in Q2.

With the beginning of 3Q17, sector loan growth gradually slowed down and shifted to 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.

… 1H17 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 on March 10 with fresh TRY250bn (c.USD70bn) in credit line. 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.

Treasury’s risk will be capped at 7% of the total credit facility, amounting to TRY17.5bn during 2017-2019. Treasury guarantee will likely help banks partially off-load NPLs from SMEs onto the public budget whereas lowering risk weights of SME loans signficantly.

Front-loaded CGF utilization likely to slow down in Q3 onwards…

Some 331K clients have utilised TRY192bn of the overall CGF limit of TRY250bn and obtained TRY214bn cash loans so far. There should be some additional CGF utilization in Q3 and Q4; but not as strong as it was in Q2.

Banking sector loans segment distribution

Source: BRSA Weekly Figures

Banking sector loans currency distribution

Source: BRSA Weekly Figures

490 524 565 640 656 607

400 404 405 422 448 486

309 316 319 338 352 368 198 202 199 213

252 334 93 97 100

101 103

105

1Q/2016 2Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017

Corporate loans SME Consumer Commercial inst. loans Credit card

1,490 TRYbn

1,542 TRYbn

1,588 TRYbn

1,714 TRYbn

1,811 TRYbn

TR

Yb

n

1,899 TRYbn

1,025

TR

Yb

n

1,05

9 T

RY

bn

1,08

4 T

RY

bn

1,128

TR

Yb

n

1,212

TR

Yb

n

1,30

0 T

RY

bn

46

5 T

RY

bn

48

4 T

RY

bn

50

4 T

RY

bn

58

7 T

RY

bn

60

0 T

RY

bn

59

9 T

RY

bn

163

US

Db

n

167

US

Db

n

169

US

Db

n

167

US

Db

n

166

US

Db

n

171

US

Db

n

1Q/2016 2Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017

TL loans exc. financial sector

FC loans exc. financial sector

FC loans exc. financial sector (USD)

3

Credit Guarantee Fund : A game changer Credit Guarantee Fund (CGF) mainly utilized through new users; refinance and re-structure tapping remained relatively small

As of 8M17, main utilization of the CGF was directed to new customers (55.8%), followed by additional lending to existing customers (30.7%). 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. Refinance, re-structuring and renewals occupied a relatively smaller portion of the fund (4.5%) whereas CGF loans attributed to previous periods formed 8.9% of the total volume.

… predominantly TRY lending by the CGF…

With loan portfolio reaching to TRY214bn in mid 9M17, the c.TRY185bn (c.87% of CGF) of the funds were granted as TRY loans. However, FC front remained below 15% of the funding scheme with TRY18.8bn EUR and TRY9.8bn 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. As of 8M17, the SME share under this facility reached TRY160bn (75% of CGF). The majority of the remaining portion (25%) has been granted to non-SME entities.

c.77% of the TRY250bn guarantee limit has been tapped

Following the 10.03.17 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. As of mid 9M17, the limit utilization for the guarantees has reached 76.8% to TRY192bn. Additional c.TRY60bn of guarantees remain untapped for the time being translating into c.TRY65bn of potential lending.

Details about CGF utilization

Source: CGF

CGF guarantee and credit

Source: CGF

55.80% 30.70%

4.50%

8.90%

First time credit line

Additional credit line

Refinance / Re-Structure / Renewal

Preivous period

TL USD EUR

86.6

0%

8.80

%

4.6

0%

SME NON-SME

74.7

0%

25.3

0%

CURRENCY OF CGF LOANS PURPOSE OF CGF LOANS

TARGET OF CGF LOANS

TR

Y6

.7B

N

TR

Y8

.7B

N

TR

Y18

.8B

N

TR

Y4

7.1B

N TR

Y10

1.7B

N

TR

Y13

5.6

BN

TR

Y15

5.8

BN

TR

Y16

9.5

BN

TR

Y18

0.9

BN

TR

Y21

3.5

BN

TR

Y9

0.B

N

TR

Y12

0.7

BN

TR

Y13

9.B

N

TR

Y15

1.4B

N

TR

Y16

1.8B

N

TR

Y19

1.4B

N

12M16 01M17 02M17 03M17 04M17 05M17 06M17 07M17 08M17 09M17

CGF Credit CGF Guarantee

CGF limit raised to

TRY250BN

4

CGF utilization areas, average loan size, and percentage of guarantee… Dominant portion of the CGF fund was consumed by trade and services, and manufacturing sectors

As of 8M17, leading utilization of the CGF came from trade and services sector, employing 44.1% of the total fund. Production and construction sectors forming 30.3% and 12.9% of the CGF loans, respectively, are other sectors where concentrated fund utilization is visible. The remaining portion of the facility is distributed among transportation and tourism sectors, and a minor portion is allocated to health, mining and education domains.

Average CGF loan size has been on the rise…

Certain limits apply for beneficiaries of CGF guarantees. Clients under SME definition can utilize up to TRY12mn/beneficiary of guarantees; for clients named as non-SME, the limit is raised up to TRY200mn/beneficiary.

The average CGF guarantee size as of 8M17 is TRY520.7k. Taking into account c.90% on average guarantee percentage per loan, we calculate the average size of the CGF loans to be c.TRY580mn for the aforementioned period.

Average CGF guarantee (as percentage) also on the rise…

The CGF facility guarantees the principle and interest, participation or lease payment of the granted loan; however, limits remain highly flexible based on the type of borrower.

For borrowers under SME definition 90%, for non-SMEs 85% and, for certain exporters and FX earners up to 100% guarantee can be allocated.

As of 9M17, the average guarantee percentage for the CGF loans reached c.90%. Even though the non-SME portion forms c.25% of the fund, the exports loans which abide to the 100% guarantee credentials increases the average guarantee percentage of the fund to 90%.

Sectoral distribution of CGF loans as of 8M17

Source: CGF

Average CGF loans size and percentage of guarantee

Source: CGF, Global Securities Analysis

Trade and services

Production

Construction

Transportation

Tourism

Other

44.1%

30.3%

12.9%

4.9%

2.8%

5.0%

TR

Y4

44

k

TR

Y55

6k

TR

Y6

18k

TR

Y6

33k

TR

Y57

8k

TR

Y57

8k

TR

Y6

51k

75%

77%

82%

86%

89% 89% 89% 89% 89% 90%

68%

73%

78%

83%

88%

270.0

320.0

370.0

420.0

470.0

520.0

570.0

620.0

670.0

720.0

12M16 01M17 02M17 03M17 04M17 05M17 06M17 07M17 08M17 09M17

Avg. CGF loan size

% of CGF Guarantee

5

Credit guarantee fund puts weigh on financing side, though… The flip side of CGF lending is the cold-reality of financing costs…

While Treasury-backed credit guarantee has supported asset quality profile and profitability, the CGF driven acceleration in TRY loan growth has put pressure on local currency liquidity and thereby resulted in increased cross-currency swap utilisation to fund some part of loan book expansion. Hence, the funding side of the loan generation under the CGF facility has brought some negative implications on NI figures through heavy swap costs.

Despite TRY funding squeeze remaining headwind for Turkish lenders, banks pressed on with the process of expanding core business alongside with the CGF scheme. Hence, TRY loan growth significantly outpaced TRY deposit growth, bringing TRY loan-to-deposit (LDR) ratio to c.148% as of 2Q17. While banks were in rush to expand their loan book in H1, 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.

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, resulting in some NIM compression so far this year; (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 unless the long-awaited easing in deposit rates materialises.

Banking sector TL and FX loan to deposit

Source: BRSA Monthly Figures

Banking sector funding distribution

Source: BRSA Monthly Figures

1,312 1,341 1,454 1,518 1,578

364 369 418

432 425 285 293

300 317 331

216 218

237 259

276

155 154

138 96

87

100 102

116 121

131

2Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017

Deposits Funds borrowed

Shareholder's equity Other liabilities

Repo transactions Securities issued

Money market borrowing

TR

Yb

n

140.2%

133.0% 133.9%

144.1% 147.8%

90.8%

99.8% 99.1%

91.2% 88.4%

119.7% 120.1% 119.3% 120.6% 121.6%

2Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017

TL loan to deposits

FX loan to deposits

Blended loan to deposits

6

The CGF scheme has taken a toll on margins 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 btw deposits and loans.

The increase in TRY deposits 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 5bps QoQ rise in FC deposit costs in Q2. Herein, it’s worth noting that the TRY appreciation helped the bank ending the quarter with lower FC deposit costs. Hence, the bank faced an affordable 54bps rise in blended deposit costs. Particularly, the increase in blended deposit costs compared well to the 367bps hike in the CBRT’s effective funding rate so far this year. More importantly, the widening of blended loan yield (+35bps QoQ) partially offset deposit cost increase of 54bps QoQ, resulting in a 19bps QoQ contraction in the loan-to-deposit spread in Q2.

NIM narrowed down by 14bps QoQ to 4.09% in Q2 despite the contribution of CPI linker income. Worth to mention, the sector’s NIM might further contract by few bps in Q3 due to ‘missing CPI-linker revenues’.

The sector expects potentially slower CGF utilization, which should result in lower pressure on local currency liquidity and thereby softer TRY deposit rates starting from Q3 onwards. Hence, core spread might have bottomed-out in Q3. Swap costs could ease in Q4 should the CGF loan utilization become subtle through the end of the year. Hence, banks expect to run at a flat-to-slightly lower NIM in Q3, followed with an improvement in Q4 owing to likely proactive upward loan pricings from Q3 onwards. However, we don’t rule out that the funding side of the loan expansion under the CGF scheme could bring spread compression through swap costs.

TRY volume and TRY Loan to Deposit Ratio

Source: BRSA Monthly Figures

TRY loan yield and deposit cost

Source: BRSA Monthly Figures

159

186

230

294

34

1 43

4

46

0

520

59

4 66

1 715

845

842 88

3

114

163 217 26

2

288

384

485

588

753

881

1,013

1,13

1 1,214

1,30

4

34%

45%

61%

71%

88% 94%

89% 84%

89%

105%

113%

127% 133%

142%

134%

144% 148%

20%

40%

60%

80%

100%

120%

140%

160%

0.0

200.0

400.0

600.0

800.0

1,000.0

1,200.0

1,400.0 TRY deposit volume (TRYbn)

TRY loans volume (TRYbn)

TRY loan to deposit ratio

13.20% 13.26% 13.31% 13.16% 13.50%

8.90% 8.40% 8.24% 7.99%

9.03%

4.30% 4.87% 5.07% 5.17% 4.47%

2Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017

TRY loans yield TRY deposit cost TRY core spread

7

Details on sector & Tier I banks in the CGF scheme aftermath Tier I banks annualised general CoR evolution

Source: Bank financials

Tier I banks CAR and CGF impact on CAR

Source: Bank financials, Bank IR

16.01pps

17.42pps

13.33pps

15.81pps

14.62pps 14.38pps

0.55pps

0.84pps

0.69pps

0.72pps

1.12pps

0.46pps

AKBNK GARAN HALKB ISCTR VAKBN YKBNK

CAR w/o CGF

CGF impact on CAR

16.56%

AKBNK 18.26%

GARAN 14.02%

HALKB 16.53%

ISCTR 14.84%

YKBNK 15.74%

VAKBN

Capital Adequacy Ratio (CAR) as of 2017/06

17 15 15 12

21

35

20

10

50

15 19

27 24

9

60

13 15

30

8

24 21

41

7 10

8

14 15

24

18

12

AKBNK GARAN HALKB ISCTR VAKBN YKBNK2Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017

bp

s

Banking sector SME NPLs and NPL ratio

Source: BRSA Weekly Figures

Teir I banks SME loan portfolio

Source: Bank Presentations, Bank IR

25.2

37.

5

55.7

41.5

35.

7

21.9

26.8

39

.8

57.9

44

.3

37.

0

23.9

27.4

40

.9

61.9

50.0

37.

5

23.1 28

.8

44

.1

65.

8

53.4

44

.7

25.1

AKBNK GARAN HALKB ISCTR VAKBN YKBNK

2016/09 2016/12

2017/03 2017/06

TR

Yb

n

16.7%

AKBNK

22.0%

GARAN

36.7%

HALKB

23.9%

ISCTR

14.0%

YKBNK

26.8%

VAKBN

% of SME loans in total loans as of 2017/06

17.2 17.3 19.8 21.6 23.0 23.7

4.11% 4.11%

4.66% 4.87% 4.88%

4.66%

3.00%

3.50%

4.00%

4.50%

5.00%

5.50%

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

1Q/2016 2Q/2016 3Q/2016 4Q/2016 1Q/2017 2Q/2017

SME NPLs SME NPL ratio

TR

Yb

n

8

Q2 portfolio expansion directly attributable to CGF The CGF scheme: A major motive behind strong loan growth

Turkish banking sector expanded its loan portfolio by 5.3% QoQ in Q1, c.40% 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.

Tier I banks CGF utilization reached c.TRY100bn as of 8M17

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 2Q17. Sector loan expansion weighed dominantly on CGF facility for most of the Tier I names CGF growth surpassed total loan growth in Q2.

As of 8M17, based on our talks with Bank IR departments, the CGF growth is still on the table albeit with a lesser degree. In the first 2 months of 3Q17, HALKB maintains steady foot on gas pedal extending c.TRY6.5bn new CGF loans. AKBNK and VAKBN granted c.TRY3.5bn and c.TRY2.2bn, respectively; while other Tier1 names’ CGF utilization cruised behind these figures.

State banks now lead the CGF market

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, at this point, state-run banks lead the market with VAKBN and HALKB owning 10.5% and 10.6% market share, respectively, followed by ISCTR at 10.2% as of 8M17.

Tier I banks nominal change in loan portfolio

Source: Bank IR, Global Securities Analysis

Tier I banks CGF loan portfolio volume

Source: Bank IR, Global Securities Analysis

4.0 6.0

1.0

6.1

1.3 3.0

11.0

15.0

12.5

17.1 17.0

10.0

14.5 16.2

19.0 18.5 19.2

12.0

8.0% 9.0%

10.5% 10.2% 10.6%

6.6%

-03%

-01%

01%

03%

05%

07%

09%

11%

13%

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

AKBNK GARAN HALKB ISCTR VAKBN YKBNK

CGF Volume as of 1Q17 CGF Volume as of 2Q17

CGF Volume as of 8M17 Market Share as of 8M17

TR

Yb

n

5.4 3.9

9.1 10.1

5.2 3.8 4.0

6.0

1.0

6.1

1.3 3.0

9.4 9.9 10.1

16.2

6.5 6.8

AKBNK GARAN HALKB ISCTR VAKBN YKBNK

Non-CGF nominal change CGF nominal change Loan nominal change

TR

Yb

n

-5.9 -3.4

0.5

-6.9

-1.6

-5.2

7.0 9.0

11.5 11.0

15.7

7.0

1.1

5.6

12.0

4.1

14.1

1.8

AKBNK GARAN HALKB ISCTR VAKBN YKBNK

TR

Yb

n

2Q17

1Q17

9

What is the impact of CGF on NIM and ROE? CGF impact on NIM and ROE (TRYmn) 1Q17 2Q17 CGF total 47,140 155,800 CGF interest income (Appoximation) 1,782 5,889 CGF Funding expense (Appoximation) 117 1,165 NII 27,570 27,621 IEA 2,701,798 2,784,839 NIM 4.14% 4.03% NII exc. CGF impact 25,905 22,896 IEA exc. CGF impact 2,654,658 2,629,039 NIM exc. CGF impact 3.96% 3.53% CGF impact on NIM +18bps +50bps

CGF loans for the quarter 40,430 108,660 CGF loans total 47,140 155,800 General Prov. for CGF (%1) 471 1,087 Fee income from CGF (0.03%) 12 33 Swap expense attributable to CGF (Approximation) 908 864 CGF net impact (NII + Porv. + Fee - Swap ) 1,357 6,144 Equity 317,312 330,944 NI* 13,236 12,124 ROE 17.76% 15.48% NI exc. CGF impact* 12,527 8,077 ROE exc. CGF impact* 16.75% 10.13% CGF impact on ROE* +101bps +535bps

Deposit and Swap cost calculation (TRYmn) 1Q17 2Q17 Deposit total 1,518,009 1,578,116 Deposit for quarter 64,349 60,107 Loan total 1,830,276 1,919,182 Loan for quarter 95,933 88,906 CGF loans total 47,140 155,800 CGF loans for quarter 40,430 108,660 Non-CGF loans for quarter 55,503 -19,754 Deposit avalaible for CGF loans 8,846 79,861 Deposit cost for period 5.29% 5.83% Deposit interest expense for CGF funding 117 1,165

Tier I banks loans total 1,083,092 1,121,777 Sector loans total 1,830,276 1,919,182 Tier I / Sector loans total 59.2% 58.5% Swap expense for Tier I banks 662 1,557 Swap expense for sector (Projection) 1,119 2,664 Avg. swap cost (Assumption) 11.5% 12.0% Swap portfolio for sector (Projection) 38,911 88,793 Swap funding consumed by CGF (Approximation) 31,584 28,799 Swap expense attributable to CGF (Approximation) 908 864 *General provisions impact excluded from calculations

Source: BRSA Monthly Figures, Bank Financials, Bank IR, CGF, Global Securities Analysis

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 c.15.1% (Stated by CGF) 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.

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 stretched loan-deposit balance, the CGF scheme also encourages additional swap utilization and therefore lifting swap costs for the sector.

According to 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 CGF which had to be funded through swap utilization led to approximately TRY908mn and TRY864mn swap costs in 1Q17 and 2Q17, respectively.

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. From provisioning perspective, 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 to annualized ROE in 1Q17 and 2Q17, respectively.

10

The CGF scheme: A strong catalyst for GDP growth A credit driven recovery in GDP

Domestic credits have been the chief engine of economic activity in Turkey amid the Treasury sponsored credit guarantee fund of as much as TRY250bn (USD70bn). At almost 10% of the country's GDP, the credit guarantee fund (CGF) facility revived credit growth, which domestic banks had projected earlier this year to slow to 11-14% from almost 20% in the past three years. In the week ending Sep 15, total credits of the banking sector reached some TL1.91bn, corresponding to an annual growth of c.23%.

The strong correlation between growth and loan demand has remained relatively steady in Turkey since 2012, averaged about 5x. More specifically, an incremental TRY50bn increase in the CGF size would produce 2-2.5% additional loan growth, according to rough calculations. Against this backdrop, Turkish economy could grow above 5% this year, if this correlation holds and credit growth remains at around robust c.23%. 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. Nevertheless, this is not a done deal given the long-lasting structural issues.

With entrenched structural constraints -- 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 p.a.) -- sluggish investment will likely suppress the potential growth in the absence of targeted structural reforms. Needless to say, the growth-inflation paradigm still doing badly mainly due to heightened inflation risks. Hence, 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.

GDP Growth vs Bank Loans

Source: TurkStat

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 an upward drift to demand side. Recall, the government took a range of measures to stimuate the economy early this year, 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.

0

2

4

6

8

10

12

14

16

-20

-15

-10

-5

0

5

10

15

2005

-03

2005

-09

2006

-03

2006

-09

2007

-03

2007

-09

2008

-03

2008

-09

2009

-03

2009

-09

2010

-03

2010

-09

2011

-03

2011

-09

2012

-03

2012

-09

2013

-03

2013

-09

2014

-03

2014

-09

2015

-03

2015

-09

2016

-03

2016

-09

2017

-03

GDP Growth (y/y; %) Change in Loans/GDP (%; RHS)

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Important Disclosures BASIS FOR RECOMMENDATIONS 12-MONTH RATING DEFINITION

BUY: Buy stocks are expected to have a total return of at least 15% and are the most attractive stocks in our coverage universe on a 12-month horizon.

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Date of completion of this report: 25.09.2017 16:40 UTC+3 Date of email-distribution of this report: 25.09.2017 16:45 UTC+3

12

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