No more Buys: US charges on Halkbank raise the prospect of a sustained period of negative headlines impacting one of Turkey’s largest lenders. There is a risk that this may continue long after Turkey’s current operation in northern Syria – Operation Peace Spring – comes to an end. We acknowledge that there have been concerns about potential charges on Halkbank for some time – we have discussed this ourselves in previous reports. However, the bank’s former deputy general manager was released from prison early and there were reports of several high-ranking government officials and other individuals on both sides, including Turkey’s President, seeking to avoid such charges. The charges mean that, at least for now, our hitherto constructive stance on Turkish bank bonds is much harder to justify. As a result, we have downgraded all Buys to Holds.
What bonds hold up best? Before the US charges were announced, indicative mid prices on about 95% of the Turkish bank bonds we track were already down versus the levels recorded just before Operation Peace Spring began. Based on percentage changes in mid prices, Akbank and Garanti subordinated bonds had declined the most. In a previous report, we discussed performance of Turkish bank bonds in 2018, highlighting that in relative terms, securities including the Vakifbank EUR-denominated covered bond and Kuveyt Turk (KFINKK) bonds were more resilient. Having said this, we stress that past performance is not always indicative of future results – this time may be different.
More on the indictment: The indictment contains six charges – conspiracy to defraud the US, conspiracy to violate Iran-related sanctions, bank fraud, conspiracy to commit bank fraud, money laundering and conspiracy to commit money laundering. Further, US authorities state that in mid-2014, ‘the then-Prime Minister of Turkey and his associates […] instructed Halkbank to resume the [sanctions-evasion] scheme, and Halkbank agreed.’ The US also state that the scheme ‘would artificially inflate Turkey’s export statistics, making its economy appear stronger than it in fact was.’ The US authorities stress that these are ‘only allegations.’ However, it is hard to understate the seriousness of the charges in the indictment, given the potential implications on Halkbank. The bank has issued a statement saying the indictment ‘appears largely to repeat allegations used during the Atilla trial.’ Hakan Atilla is the former deputy general manager of the bank who was released earlier this year and who has launched an appeal against his conviction. Halkbank sees the decision to indict as ‘unprecedented legal overreach’ as the bank does not have branches or employees in the US, and therefore falls outside the US Department of Justice (US DoJ) jurisdiction. In addition, Halkbank highlights extensive investigations it has had carried out and says that the US authorities have received finds from these independent investigations showing the bank’s innocence. Halkbank also states that discussions with the US DoJ are ‘ongoing’. Importantly, the bank has formally linked the charges to sanctions imposed on Turkey as a result of Operation Peace Spring.
HALKBK eurobonds in focus: We note that Halkbank has been absent from the eurobond primary market for some time. Based on Bloomberg data, the bank now has just three USD-denominated bonds totalling US$1.75bn and maturing in 2020 and 2021. Management previously stated that the bank has enough liquidity to repay upcoming maturities, and in today’s statement, Halkbank says it is ‘determined to fulfil all financial liabilities.’ We are not changing our Hold recommendation on the Halkbank bonds in this report, though we acknowledge that these charges may undo much of the progress achieved by the bank in the second quarter.
Punitive sanctions vs. large fine: Punitive sanctions (similar to restrictions initially imposed on UC Rusal), which could impede the bank’s ability to make payments on bonds or otherwise restrict Halkbank from carrying out USD transactions, may be a concern. Such sanctions may have the intended consequence of changing the bank’s behaviour, but may also have unintended consequences, such as impacting US investors negatively and/or compromising financial stability in Turkey and elsewhere. Some reports suggest that, at least for now, a fine may be what is considered. While such a fine could be quite significant (we note the indictment states that Halkbank ‘illicitly transferred approximately US$20 billion worth of otherwise restricted Iranian funds’ and further alleges that ‘at least approximately US$1 billion was laundered through unwitting US financial institutions’), we think it would be much more preferable to any sanctions affecting investors’ ability to hold and/or receive payments on existing eurobonds.
Consider meetings and state support: There are noteworthy meetings involving very high-level government officials coming up. As examples, the US Vice-President is due to meet President Erdogan on 17 October, and the White House has disclosed that President Trump and President Erdogan are scheduled to meet in the US on 13 November. The Halkbank case may well be discussed at these meetings. Separately, as the indictment repeatedly highlights, Halkbank is majority-owned by the Turkish State. Like other state-owned lenders, Halkbank has benefitted from significant support in recent quarters. We cannot exclude the State offering more support to the bank, to mitigate the impact of the US charges.