Morgan Stanley Says Turkey’s Bank Rally Isn’t Over Yet

History suggests otherwise, but Morgan Stanley says Turkey’s peer-beating banks have room to rally further.

Analysts including Samuel Goodacre increased share price targets for four of Turkey’s biggest lenders by an average 15 percent on Monday, saying a government credit guarantee facility will continue to underpin their earnings. Istanbul’s banks index is climbing even as the country’s borrowing costs rise to the highest in at least six years, defying an inverse relationship between the two that had held for longer than a decade. The gauge is up more than 40 percent this year.

Traders who bet against the nation’s lenders this year on the view that higher interest rates will weigh on earnings have missed out. A 250 billion lira ($70 billion) credit backstop from the government for commercial lenders fueled a lending boom even as the central bank drove borrowing costs higher. There’s more to come, says Morgan Stanley, estimating that the Credit Guarantee Fund will add about 1 percentage point to economic growth and help sustain strong private consumption.

“We don’t think it’s time to take profits,” the London-based analysts wrote in a report, estimating 4 percent to 12 percent higher earnings for the lenders in 2018 than previously. The bank also lowered its cost-of-risk assumption by 25 basis points.

The Borsa Istanbul Banks Index jumped the most in five weeks on Monday, before trimming some gains Tuesday. The gauge has still rallied more than twice as much as the MSCI Emerging Markets Financials Index. That’s even as the yield on the nation’s two-year note, a proxy for short-term interest rates, has climbed 111 basis points in 2017, reaching a high of 11.74 percent on Tuesday.

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Stretched Banks

Not everyone agrees with Morgan Stanley. With bank balance sheets now stretched and the central bank showing no signs of easing liquidity as it confronts above-target inflation, some analysts and traders are beginning to question whether the stocks can prolong their gains without a boost from lower interest rates.

“The banking sector has exhausted catalysts for outperformance,” said Julian Rimmer, a trader at Investec Bank Plc in London, who is underweight the sector. Interest rates can’t “fall that much, owing to the stickiness of Turkish inflation,” and there is a limit to how much support the government can provide, he said.

The government’s support for credit has pushed banks’ lira loan-to-deposit ratios to a record this year and fueled stiff competition to attract customer funds. The difference between what banks charge for lira loans and what they pay depositors to pay for the lending boom narrowed to a four-year low in June, and is still near the lowest since early 2015.

Still, the Morgan Stanley analysts aren’t concerned. They project that return on equity for the Turkish banks its analysts cover will climb to 11 percent to 17 percent over the next two years, a 3 percentage-point to 5 percentage-point increase from a trough seen in 2015. 

“Even in a very tight environment for liquidity, profit expansion remains intact,” the bank’s analysts said.