Turkey Bank Hazard Revealed in Shoe Boxes With $4.5 Million

Apr 01, 2014 10:27 am ET

(Updates with today’s clashes between protesters and police in ninth paragraph.)

April 1 (Bloomberg) -- When Turkish police raided the Istanbul home of Suleyman Aslan in December, they found $4.5 million stashed in three shoe boxes and hidden in bookshelves.

Aslan, then chief executive officer of the country’s second-largest state-owned bank, said in court that the money was donations collected for his alma mater in central Turkey and to help build a university in Macedonia. When asked why the funds weren’t deposited at the bank he ran, he said that would mean declaring their origin and registering them officially, according to accounts of his testimony in local newspapers.

Dozens of phone conversations purported to be police wiretaps and leaked over the Internet in recent weeks instead paint a portrait of a banker helping a businessman smuggle gold and transfer hundreds of millions of dollars to Iran, evading U.S. sanctions. Surveillance photos said to be taken by police show similar boxes being delivered to Aslan’s home. The money was intended as bribes to ensure his cooperation, police allege.

In a separate investigation, Huseyin Aydin, CEO of Turkey’s largest government-owned bank, was overheard by police approving loans to businessmen who said they were under orders from Prime Minister Recep Tayyip Erdogan to buy a media company. Aydin hasn’t been charged with wrongdoing.

Even after Erdogan’s party maintained control in local elections over the weekend, state-owned banks face the prospect of a weakening economy, surging bad debt and a repeat of the 2001 financial crisis when they lost $28 billion and were bailed out by the government.

‘Badly Mismanaged’

“What has come out in recent months is definitely raising concerns that maybe we’re back to the old days when these institutions were badly mismanaged,” said Alyssa Grzelak, a Washington-based senior economist for banking risk at research firm IHS Inc. “After the 2001 crisis, they were supposed to be cleaned up and no longer doing the bidding of politicians, but that seems to have been reversed.”

The ruling party’s candidates for municipal governments won 45 percent of the vote nationwide, according to unofficial results reported by CNN Turk television. While that put Erdogan’s party ahead of all opposition groups, it’s less than the 50 percent it received in the 2011 general election to win a third consecutive majority in parliament. The results shouldn’t comfort Erdogan, who faces elections for president in August and parliament in 2015, because the impact of a slowing economy has yet to be felt by voters, according to William Jackson, an economist at Capital Economics Ltd. in London.

‘Political Uncertainty’

“The sharp slowdown in economic activity that we’re expecting this year will hurt support for the ruling party in August and next year,” Jackson said. “Economic growth always feeds into election results, even if there’s a lag sometimes. The weekend’s result might look good for Erdogan, but it definitely doesn’t mean the end of political uncertainty.”

Protesters blaming the government for rigging election results clashed with police in the capital Ankara today. Police used tear gas to disperse crowds gathered in front of the national election authority, NTV television reported. Anti-government demonstrations have erupted around the country in the past 11 months. Dissidents accuse Erdogan of having become autocratic and disregarding democracy.

Credit Binge

Aslan, born in 1970, and Aydin, born in 1959, rose to the top of their respective banks in the 11 years since Erdogan became prime minister. While each has more than two decades of banking experience, the top executives of Turkey’s state-owned lenders have long been political appointees who help carry out government policies.

State-owned banks, which accounted for 26 percent of total lending in 2013, helped fuel a credit binge in Turkey that enabled businesses run by Erdogan supporters to win lucrative infrastructure contracts, beating the country’s largest companies and sometimes global firms in bidding wars.

While all Turkish banks have taken part in the credit boom, government-controlled lenders may have played a more prominent role, according to transcripts of phone calls and police records released on Twitter and YouTube.

Turkiye Halk Bankasi AS, the Istanbul-based bank Aslan ran until his arrest in December, expanded its assets by 30 percent last year to $66 billion, twice what they were in 2010. Another government-controlled lender, Turkiye Vakiflar Bankasi TAO, increased its assets 29 percent in 2013 compared with an average of 26 percent for all Turkish banks. Ankara-based TC Ziraat Bankasi AS, led by Aydin, rose 27 percent.

Leaked Recordings

In leaked recordings of phone calls allegedly made in October, Aydin can be heard talking to businessmen who say they have been ordered by Erdogan to buy Turkey’s Sabah newspaper and ATV television network. The calls were taped as part of a string of investigations that came to light on Dec. 17, when scores of people tied to Erdogan’s government were arrested or detained on charges including gold-smuggling, bribery and bid-rigging.

Transcripts of the conversations along with thousands of pages of documents have been leaked by unidentified people since the government dismissed and replaced police chiefs and prosecutors involved in the investigation, which Erdogan has said were part of an effort to undermine him in advance of the elections. While each sound recording is labeled and subtitled, the police reports include transcripts of conversations that haven’t been released and couldn’t independently be verified.

Debt Loads

The money-losing media companies had been put up for sale by an Erdogan ally in financial difficulty. Because the buyer couldn’t borrow the purchase price in excess of $500 million on his own, five construction firms formed a pool to help with the acquisition. Aydin arranged loans of $100 million to each firm, bypassing internal credit limits for some, overlooking their already heavy debt loads and ignoring collateral requirements, according to the recordings and transcripts.

“I’m starting these loans with a two-year maturity so nobody gets suspicious,” Aydin told one of the businessmen in a conversation purportedly taped by police. “But I will turn that to five years, seven years, don’t you worry about that.”

Aslan allegedly accommodated the gold-smuggling business of Iranian-born businessman Riza Sarraf, according to phone conversations leaked in recent weeks. After Sarraf complained that some of Aslan’s subordinates objected to documents submitted in relation to fund transfers, Aslan told him he would tell his associates to be more lenient.

Other Wiretaps

“I’ll go over everything and tell them there will be no further demand for additional documents, and I’ll even reduce the initial requirements,” Aslan said in a July telephone call with a person police identified as Sarraf.

Other wiretaps reveal the involvement of three ministers and their approval of the bank’s actions.

Spokesmen at Halkbank and Ziraat declined to comment for this article. Aslan, who was released from prison after about two months, and Aydin weren’t available to be interviewed, their respective banks said. The court returned the money to Aslan, who remained on Halkbank’s board until yesterday.

Halkbank has said all its money transfers to Iran have been legal because there was no international ban on trading gold with the country until July and the company stopped transferring funds for that purpose after the sanctions went into effect.

Cheap Loans

In a February television interview Aydin defended Ziraat’s lending to the five companies as legal and within bank procedures. Two of the firms at the center of the disputed purchase are among Turkey’s most successful and have borrowed from other banks, Aydin told Bloomberg HT, a broadcast partnership of Bloomberg News and an Istanbul media group.

He said talks with clients about the pricing and maturity of loans, like those captured on the wiretaps, are normal for a bank CEO.

Turkey’s state-run banks have been used before to win political support. In the 1990s, their main business of making cheap loans to farmers and small companies consistently lost money because the banks charged less interest than what they paid for deposits. The institutions ran up losses that equaled 14 percent of the nation’s gross domestic product at the time.

In December 2000, the state banks’ hunger for funds led to an unprecedented spike in interbank lending rates, which reached 1,950 percent at one point. The system collapsed two months later, when the Turkish currency’s peg to the dollar and the euro could no longer be sustained.

Majority Control

After the 2001 crisis, when the economy shrank by almost 10 percent, Turkey promised the International Monetary Fund it would sell all state banks within a few years. Erdogan, while he didn’t stick to the promise, continued efforts to make the lenders profitable. Halkbank and Vakifbank sold shares to the public, forcing them to disclose more financial information, even as the government maintained majority control.

Before the voice recordings started showing up on the Internet in December, analysts such as Grzelak and investors including BlackRock Inc. didn’t express concerns that the state banks were in trouble. Profits were rising, and bad-loan ratios were low. Because other government-controlled firms are required to keep their cash in non-interest-bearing accounts at the three state lenders, the free money boosts profitability.

BlackRock built sizable stakes in Halkbank and Vakifbank. The New York-based company, the world’s largest asset manager, is the second-biggest shareholder in Halkbank, after the government, with a 5 percent stake. It added to that position in January, saying price declines made the shares cheaper. Halkbank and Vakifbank shares dropped more than 30 percent after raids on the homes of dozens of politically connected individuals in December and were down almost 20 percent as of yesterday, compared with a 7 percent decline for the Borsa Istanbul Banks Sector Index, which includes the state lenders.

A spokesman for BlackRock in London declined to comment.

Parliamentary Audit

There were earlier warning signs that lending decisions were being influenced by political connections. In July, a parliamentary audit of Halkbank leaked to local newspapers and also obtained by Bloomberg News highlighted the firm’s $450 million loan to a company owned by Sebahattin Yildiz, an Erdogan supporter in financial trouble.

The bank’s exposure to Yildizlar SSS Holding rose, even though the lender knew the Ankara-based mining and ceramics firm was in default on other obligations and that its collateral for some loans was less than purported, according to the audit. In one instance, the collateral claimed by the firm to be $130 million was worth $8 million, the audit showed.

Energy Regulator

Halkbank responded to the leak by saying that Yildizlar was paying its debt on time and there wasn’t any reason for panic. A few weeks later, the nation’s energy regulator seized a power- distribution network run by the company because it was behind on payments for about $100 million of electricity. The bank still hasn’t categorized the loans as nonperforming. In a February statement, Halkbank said the collateral from the company was fairly valued.

State-owned lenders including Halkbank often issue new loans to troubled borrowers so they can avoid reporting them as restructured, according to two bankers with knowledge of the practice. Regular restructurings -- extending the maturity of a loan or reducing the interest rate -- have to be reported in company filings.

At Turkiye Is Bankasi AS, Turkey’s largest non-government bank, restructured loans have multiplied sixfold in the past three years. They have quintupled at Garanti Bankasi AS, the No. 2 lender. State-owned banks’ undisclosed restructurings probably exceed those rates of deterioration, the bankers said.

Default Rates

Restructured loans have higher rates of default and would be the first to fail if the economy turns sour, according to Mete Yuksel, head of research at TEB Invest, an Istanbul-based brokerage. While disclosed restructurings at non-state banks have been rising in recent quarters, it’s difficult to know how much may be hidden, he said.

“NPL ratios can rise significantly systemwide if the economy doesn’t recover toward the end of this year,” Yuksel said, referring to nonperforming loans.

The Turkish economy is facing headwinds. Last year, the prospect of an end to the U.S. Federal Reserve’s easy-money policies sparked an outflow of funds from emerging markets and hurt the currency. The lira’s slide accelerated after the December raids, which led to the arrests of the sons of three government ministers and revealed an internal struggle within Erdogan’s coalition. The currency lost one-quarter of its value in the 12 months through January, when the central bank doubled interest rates to 10 percent to prevent further outflows. It has stopped falling since.

Slowing Economy

The median growth estimate of economists surveyed by Bloomberg News is 2.3 percent this year, down from a 4 percent expansion in 2013.

Some economists, including Jackson of Capital Economics, predict a recession. The higher cost of imports resulting from the devalued currency and increased borrowing costs will hamper growth, according to Jackson.

Erdogan, who acknowledged the veracity of some recordings, has tied them to a conspiracy by a faction of his governing party that has turned against him. His government swiftly reassigned judges, prosecutors and police chiefs in January and February to muffle the investigations. Since then, all suspects arrested in December have been released from custody.

Even if courts refuse to take action, tapes of wiretapped calls and police reports keep finding their way to the Internet. Last month, Erdogan banned access to the popular microblogging website Twitter and the video website YouTube to prevent new leaks from reaching the public.

Doesn’t Care

Pro-government media portray a nation that doesn’t care about the revelations and continues to support its leader. While thousands protest against corruption and eroding democracy in the big cities, others attend campaign rallies to hear Erdogan.

Much of the support is the result of improvement in Turkey’s economic well-being. Income per capita has doubled since Erdogan came to power in 2003. While that was fueled at first by structural changes and rising productivity, growth in the last few years has been dependent on surging private debt. Corporate and consumer borrowing jumped to 67 percent of GDP in 2013 from 33 percent in 2008.

Almost 90 percent of the country’s corporate debt has been accumulated by closely held nonfinancial companies without any public disclosure of their balance sheets, ownership structures or other basic information, according to data compiled by Burgan Yatirim Menkul Degerler, an Istanbul-based brokerage. Many of those, including Yildizlar and the five construction firms that bought Sabah and ATV, are companies that were established or came to prominence since Erdogan came to power.

Heavily Exposed

They have been winning billion-dollar infrastructure contracts for airports, roads and bridges, buying state assets and racking up debt. While not all of this has been financed by government-run banks, recent revelations have increased the probability that they’re more heavily exposed.

“We know so little about these new firms that have grown so fast thanks to their political connections,” said Nergis Kasabali, Burgan’s head of research. “We don’t know how highly levered they are. The higher the firm’s leverage, the easier they’ll fall apart and start defaulting on their loans during an economic downturn.”

Almost half of the outstanding corporate debt is denominated in foreign currencies, which increases the risk of failures. While some borrowers are exporters, many rely on domestic consumption. The lira’s decline has eroded consumers’ purchasing power and will dent those companies’ sales, making it harder to pay back loans in dollar or euros.

Legal Turmoil

Three Turkish bank executives point to the halt in new projects as a harbinger of what’s to come. The five firms that bought the media company had won a tender to build and run a third airport for Istanbul, offering to pay the government $30 billion for a 25-year lease. The political and legal turmoil, combined with cost overruns before excavation began, have thrown the project’s financing into limbo, said the bankers, who have been involved in the airport-funding effort.

If Erdogan’s power wanes, defaults by some politically connected companies could follow, said the bank executives, who asked not to be named because of fear of reprisal. That would probably lead to increased cover-ups, which could be sustained until either Erdogan is voted out of office in 2015 or the losses spook creditors enough to cause a run on the banks, as they did in 2000, according to IHS’s Grzelak.

“They rely too much on short-term funding from foreign banks,” Grzelak said of Turkish banks. “So loss of confidence could lead to loss of that funding very quickly, like last time. Recalling the role state banks played in that crisis, it wouldn’t be surprising to see them leading the way once again.”