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A comprehensive analysis of factoring companies calls for an assessment of the economic environment for the period 2008-2010 as well as an understanding of the sector’s regulatory framework. With these objectives in mind, this section summarizes the fundamental developments experienced in the Turkish economy in the last three years.

Economic Contraction

As illustrated in Figure 20 the Turkish economy entered into a severe contraction in mid-2008. The impact of the global crisis resulted in a 4.7% GDP contraction in 2009, with manufacturing industries hit particularly hard. Following a steep contraction in 2009, consumption and investments recovered in 2010 and entered into a rapid growth trend. The increase in capital investments in 2010, 29.9%, was in stark contrast with the decreases of 6.2% in 2008 and 19.1% in 2009.

Figure 20 – Quarterly GDP increase/decrease (%)

5.9

Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1-2007 Q2-2007 Q3-2007 Q4-2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3-2009 Q4-2009 Q1-2010 Q2- 2010 Q3-2010 Q4-2010

Inflation

Inflation (based on the consumer price index) slowed to 6.5% from the 10% level of 2008 and 2009 largely due to lower domestic demand.

Table 46 – Annual Increase in the Consumer Price Index

2005 2006 2007 2008 2009 2010

Consumer Prices 7.72 9.65 8.39 10.06 6.53 6.40

Lower Interest Rates

The decline in inflation has been instrumental in bringing about a significant decline in interest rates. The gradual fall in interest rates since 2002 was accelerated by stringent fiscal and monetary policies. As a result of the reduction in the Treasury’s borrowing requirement and the Central Bank’s lowering of interest rates by 15% between November 2008 and the end of 2010. The Central Bank’s interest rate policy enabled the Treasury to borrow at a lower cost and banks to charge lower interest rates on consumer and commercial loans.

Figure 21 – Cost of Turkish Treasury Borrowing Figure 22 – Deposit Rates on 3-month Deposits

2003 2004 2005 2006 2007 2008 2009 2010

13.00

2004 2007 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10

Figure 23 – Interest Rates on Loans and Deposits

16.6 11.6

Average Interest Rates on Credits Average Interest Rates on Deposits

Figure 24 – Yields of Interest Yielding Assets and Cost of Interest Bearing Liabilities

14.2 9.6

Average cost of interest bearing liabilities Average yield of interest earning assets Source: BRSA

Figures 23 and 24 illustrate the cost of interest bearing assets and the yields of interest bearing liabilities including securities based on data from the BRSA’s reports. The downward trend since 2003 is very clear.

Yet despite this downward trend, there was high volatility with the interest rate margin which narrowed and widened significantly at certain periods. In the second half of 2009, in particular, banks were able to readily reflect the Central Bank interest rates in their deposit customers’ rates and widen their interest margins, resulting in a 50% increase in their net income that year.

The volatility experienced in the banking sector may be responsible for diverting some banking customers to the factoring companies.

The Impact of Falling Interest Rates on the Factoring Sector

The fall in interest rates also affected factoring companies. We note that funding costs have come down to 6.9% in 2010 from 13.3% in 2007. The average yield of interest bearing liabilities, on the other hand, eased to 11.6% from 22.6% in the same period. Consequently, the net interest margin was down from 12.4% in 2007 to 5.4% in 2010, impacting profit margins (Graph 13 and 14). Competition among factoring companies was further fueled by excessive price cuts to valued customers at a time when interest margins were already declining. Diminishing interest earnings had to be offset by doing much larger volumes of factoring business. In 2010 net interest margins remained around 4-5%, and factoring companies that were bank subsidiaries, in particular, turned to financially stronger companies and tried to increase their profits with much higher turnovers.

Despite having focused on generating more commissions with higher turnover under lower interest margins, the factoring sector’s overall net commission income in 2010 could only come close to the 2008 level. There has been a severe competition in the last three years leading to the weakening of commissions’ income. Compared to TL32.5 billion turnover in 2008, turnover was TL76.0 in 2010 but commission earnings remained low.

The impact of lower interest margins on profitability is also seen on the rates of return on assets and equity.

ROAA and ROAE have been 3.1% and 16.3%, respectively, in 2010 – almost half of the 2007 levels.

Small and Medium Size Companies in Turkey and Payment Channels

A survey of conditions shaping demand for factoring services in Turkey usually opens up the subject of the role of SMEs in the Turkish economy. In 2004 a study on “Macro Credit Sources in the Turkish Economy”

was prepared by Dr. Ercan Türkan, advisor to the Central Bank of Turkey⁴. This report was the result of a comprehensive research covering years 2001-2003 analyzing the various channels of payment and credits.

During those years the credit volume as a percentage of GDP in Turkey was very low, around 20%. The study indicated that there were several sources of unofficial payment and credit channels used by companies in addition to the official bank credits such as suppliers’ credits, post-dated checks and borrowing from international banks. In fact, the study revealed that only 41.3% of total credit sources (i.e.

credits extended by banks and other non-bank financial institutions) of what the author called “Macro Credit

4 http://www.tcmb.gov.tr/yeni/evds/yayin/kitaplar/temkk.pdf

Channels” were “official”. The rest he called “quasi-official” and “not official”. Consequently, the volume of total credit use in Turkey was in fact 2.6 times larger than the volume of bank loans.

Table 47 – Macro Credit Channels

This research was conducted in 2004 based on year 2003 data. We estimate that if it is to be adjusted to the present day, the 2.6 coefficient would decrease to 1.6. We attempted to reconstruct these numbers to date and found that these semi-official payment channels are clearly still in use.

Figure 25 – Credit Channels (2003)

We do know that excluding consumer credits (inclusive of credit card loans) the total volume of bank loans was US$300 billion at the end of 2010. We could add US$15 billion leasing and factoring receivables to that number. Also at the end of 2010 the corporate sector’s use of international loans was US$82.6 billion, suppliers’’ credits were US$20 billion and the credits extended through Turkish banks’ foreign branches was US$30.8 billion. These numbers indicate that the growth of Turkish banking has increased the share of official credit channels. Nonetheless, the widespread use of future dated checks continues.

The Central Bank’s May 2011 Financial Stability Report underlines that the widespread use of commercial bills and post-dated checks continues and that the average volume of transactions over the last five years has been TL200.0 billion. The year 2010 transaction volume was TL228.0 billion (US$150 billion). When checks are sorted by value, we noted that 57.28% were under TL5,000 (US$2,800 in today’s exchange rate), 77.98% were under TL10,000. These numbers are important in explaining to us how factoring companies dealing with a large number of customers financing small ticket checks have built their strategies in response to market behaviour.

Table 48 - Volume of Transactions of Post-Dated Checks in Turkey

2006 2007 2008 2009 2010

Transaction Volume (BilionTL) 188,3 220,5 234,3 200,8 228,0 Kaynak: T.C. Merkez Bankası

Source: T.C. The Central Bank of Turkey and BTM (Interbank Settlement Center) Developments in the Banking Sector

In 2010 banking sector credits increased by 33.9% (6.9% in 2009). Non-performing loans decreased in nominal terms, but the decline in the NPL ratios from 5.6% in 2009 to 3.8% in 2010 was particularly due to the rapid growth in credits. Shareholders’ equity also rose by 21% following the 28% increase in 2009, and capital adequacy ratios were as high as 20%.

While lower interest rates had a negative impact on the factoring industry, the impact was different for

Table 50 – Comparison of Profitabiity Ratios in Banking and Leasing

2006 2007 2008 2009 2010

Factoring Net Profit/Loss (Million TL) 491.0 427.0 439.3 328.8 389.7

ROAA (%) 15.5 6.2 5.7 3.6 3,1

ROAE (%) 27.9 30.0 25.0 15.9 16.3

Leasing Net Profit/Loss (Million TL) 363 348 590 529 463

ROAA (%) n.a. n.a. 2.8 2.8 2.8

ROAE (%) n.a. n.a. 15.7 13.6 9.1

Banks Net Profit/Loss (Million TL) 11,364 14,916 13,422 20,076 21,931

ROAA (%) 2.3 2.6 1.8 2.4 2.2

ROAE (%) 19.1 19.6 15.5 18.2 16.3

http://www.bddk.org.tr/WebSitesi/english/Reports/Financial_Markets_Report/8127FMR_Dec_2009.pdf and Turkrating’s calculations

Table 51 – Financial Indicators of Banks

2007 2008 2009 2010

Total Assets (Million) 581,606 732,536 834,014 1,007,556

Annual Increase (%) 16.3 25.9 13.9 20.8

Credits (Million) 285,616 367,445 392,621 525,905

Annual Increase (%) 30.4 28.6 6.9 33.9

Non-Performing Loans (Million) 8,550 10,345 21,853 19,932

NPLs /Total Credits 3.5 3.7 5.2 3.7

Net Income (Million) 14,916 13,422 20,076 21,931

Annual Increase (%) 31.3 -10.0 49.6 9.2

Shareholders Equity (Million) 75,850 86,402 110,887 134,290

Annual Increase (%) 27.0 13,9 28,3 21.1

Source: BRSA

Statistics show that in the 3rd quarter of 2008 Turkish banks stopped lending altogether and froze their level of loans. Until the 3rd quarter of 2009 bank loans show no increase. It was reported that many SMEs turned to the factoring sector in that period because banks had reduced or discontinued their lines, yet statistics point to the contrary. The factoring sector put a sudden break on loans in the 4th quarter of 2008 and decreased receivables by 28%. In 2009, factoring companies resumed lending earlier, in June, and posted a 49% increase in factoring receivables that year.

Figure 26 - 2007-2010 Banking Sector Credit Volume (Million TL)

286,427 320,367 343,521 361,720 368,014 366,756 368,579 392,944 417,093 454,846 475,403 475,403 525,905

200,000 250,000 300,000 350,000 400,000 450,000 500,000 550,000

Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010

Figure 27 – 2007-2010 Factoring Sector Credit Volume (Million TL)

6,223 6,460 7,451 7,759 5,604 5,440 6,509 7,046 8,396 9,078 10,423 11,364 12,400

0 2,000 4,000 6,000 8,000 10,000 12,000

Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010

There is also an interesting comparison between the banking and factoring sectors: In 2008 when the NPL ratio on factoring receivables rose to 8.2%, this ratio was still 3.7% in the banking sector. The banking sector experienced its peak level of NPL ratio by the third quarter of 2009 at a time when the ratio in factoring was improving.

Figure 28 – Banking Sector Credit Volume and NPL Ratios

4.3 3.7 4.4 5.3 4.9

4.9 5.4 4.5 3.1 3.7

3.1 3.5 3.1

3.8

5,000 10,000 15,000 20,000 25,000

2006 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009 Q1 2010 Q2 2010 Q3 2010 Q4 2010

0.0 1.0 2.0 3.0 4.0 5.0 6.0

NPLs NPL Ratio