CLOSURE OF YAPI KREDI DEAL HIGHLIGHTS FOREIGN

UNCLAS SECTION 01 OF 02 ISTANBUL 000758 SIPDIS SENSITIVE STATE FOR EUR/SE AND EB/IFD TREASURY FOR INTERNATIONAL AFFAIRS - CPLANTIER AND MMILLS DEPT PASS EXIM AND OPIC NSC FOR BRYZA AND MCKIBBEN E.O. 12958: N/A TAGS: EFIN ECON EINV BEXP TU SUBJECT: CLOSURE OF YAPI KREDI DEAL HIGHLIGHTS FOREIGN INTEREST IN TURKISH BANKS REF: A. ISTANBUL 218 ¶B. ISTANBUL 97 ¶C. 2004 ANKARA 1437 ¶D. 2004 ISTANBUL 1558 Sensitive but unclassified. Not for internet distribution. This message was coordinated with Embassy Ankara. ¶1. (SBU) Summary: The announcement on Monday, May 9 that Koc Financial Services and the Cukurova Group had reached final agreement by which Koc and its Italian partner Unicredito will purchase Yapi Kredi Bank vaults Koc into the banking big leagues and removes the largest remaining cloud hanging over the banking sector after the 2001 crisis. Together with the planned sale of much of his Turkcell stake to Nordic Telia Sonera, it will also permit Cukurova owner Mehmet Karamehmet to climb out from under his USD 4 billion debt to Yapi Kredi and the Savings Deposit Insurance Fund (TMSF). When coupled with other recent international transactions, the deal also highlights the fact that foreign investors are looking first to the financial sector as they consider making direct investments in the Turkish economy. End Summary. ¶2. (SBU) At last a deal: Koc and Cukurova reached preliminary agreement on sale of the bank at the end of January (ref A),but concern had grown in recent weeks over the amount of time negotiations and due diligence were taking. Some speculated that Karamehmet was unhappy with the sale price, given recent more lucrative deals for other banks. (Mid-sized Disbank was sold in April to Belgium's Fortis Bank at 1.9 times book value, whereas the Koc deal effectively was at book value itself.) Speculation grew more heated last week that rival Sabanci Group's Akbank might make a late bid, as competition in other sectors between the two giants intensified. The delay prompted a warning on May 7 from Banking Regulatory and Supervisory Agency (BDDK) Chief Tevfik Bilgin that the process was taking too long. With that encouragement, agreement was initialed a short three days later. ¶3. (SBU) A new start: For both Koc and Yapi, the deal represents the opportunity to make a new start. By bringing together Yapi with its own smaller Kocbank, Koc will be among the sector leaders, with an 11.4 percent market share and 567 branches, roughly equal to the rival Sabanci group's Akbank, but with a larger presence in retail banking and credit cards. Yapi staff have been anxious for some time for the deal to be finalized. Under the board appointed by the BDDK last year, they have complained that Yapi has essentially been taken over by the state and has lost its earlier dynamism and market leadership. That problem is evident in recent sectoral statistics, which shows banks ranging from market leader Akbank to small players like TEB and Denizbank gaining market share in loans at Yapi's expense. The current board, an observer told us, is more preoccupied with investigating the past than developing new business, as is reflected in the number of court cases opened against former directors and management for deals that went sour. The practice has poisoned attitudes at the bank and led to inactivity. Koc has promised to end the practice. ¶4. (SBU) Foreign Interest: With the deal, foreign ownership in the sector, which had already risen from 3 percent at end-2004 to 8 percent, will rise further to 15 percent. Other foreign players making moves in the Turkish market include BNP-Paribas, which purchased the small TEB Bank, Belgium's Fortis, which purchased 89.3 percent of the shares in mid-size Disbank for 1.28 billion USD, and now Yapi. Still on the block are Garanti Bank (with rumors that HSBC or Deutsche Bank may be interested),Finansbank, and Denizbank. Despite problems with the Turkish investment climate, the banking sector is one in which foreign investors seem to be able to operate without major problems (e.g. Citigroup and HSBC). Now that Turkey has a date to begin EU accession negotiations, and Turkey's macro situation seems to be stabilizing, foreign (especially European) banks seem to be betting on the huge growth potential here. Turkey's very low ratio of credit to GNP and its young population are in marked contrast to the mature, slow-growing home markets of the investing banks. BDDK Chief Bilgin earlier predicted that foreign participation in the sector could reach 30 percent. The potential private deals, as well as recent rumors (viewed skeptically by Istanbul analysts) that foreign banks may also be interested in Turkish state banks, could make that a reality. Already, however, concerns are being expressed about how high the foreign share should go, with Deputy Prime Minister Sener contradicting Bilgin and suggesting that the government may soon introduce a measure to limit foreign ownership in the sector. ¶5. (SBU) Details: Much remains unknown about the deal, but what is known is that Koc will purchase 57.4 percent of Yapi's shares for EUR 1.16 billion, giving the bank an overall value of EUR 2.02 billion or USD 2.6 billion. Koc will also issue a market call for minority shareholders, though this is unlikely to win much favor, as the bank's market capitalization is 13 percent higher-- valuing each share at 5.2 YTL, versus the deal price of 4.8 YTL. Much of the purchase price will be returned to the bank to cover the Cukurova Group's USD 2 billion in receivables to Yapi, though some portion will be directed to the TMSF to cover group debts to it as a result of Pamukbank's failure. Significantly, Koc will renew Cukurova's option to purchase the 13.1 percent of Turkcell shares that are held as collateral against the debt-- Cukurova plans to exercise that option and then package the shares in its Turkcell sale to Telia Sonera. All told, from the two deals Cukurova will generate some USD 3.5 billion, that should enable it to cover the lion's share of its obligations. TMSF officials thus have privately been ecstatic about the development, viewing it and another USD 433 million deal to sell Medya Holding (owned by Dinc Bilgin, owner of the failed Etibank) to another media company as its largest triumphs to date in securing significant repayment of debts stemming from the banking crisis. ¶6. (SBU) Pension Prerequisite: There is one prerequisite for the deal, however, which worries some market analysts, but which bank insiders predict will be finalized without difficulty. That is the required transfer of the bank's pension fund to the state. Like that of many other banks and other companies, that fund is significantly underfunded. (Note: Turkish "Ekonomist" Magazine estimated last month that economy-wide, there is a potential USD 5 billion gap that the government may have to cover. End Note.) Koc has apparently agreed to make up part of the shortfall, but some remainder must be assumed by the government. Bank officials believe that this and other problems in the bank's balance sheet were the reason that the deal remained at the low January valuation, despite the higher multiples in other deals in the sector and the bank's market valuation of USD 3.4 billion. In addition to the pension problem, Yapi Kredi had other overvalued assets, including its Fiskobirlik receivable (which apparently will be handled in the same manner it was by the government for other banks-- Yapi had earlier sought a more generous settlement),real estate holdings, and others. One bank official estimated that after due diligence, Koc had written the bank's book down by half, from USD 3.4 to 1.8 billion USD. With the coming cash inflow that will follow the deal to pay the Cukurova Group's debt, he believes the bank will have no problems either regarding liquidity or capital adequacy. Some USD 2.5 billion should come in, he predicted, much of it for items (the non-performing Cukurova loans, for instance) that were 100 percent risk on the bank's books. ¶7. (SBU) Comment: The Koc deal, together with the parallel Turkcell sale, promises resolution of the problems of the Cukurova Group-- one of the largest remaining from the 2001 crisis. Thanks largely to improvements in Turkcell's valuation, Cukurova should be able to fully pay off its debts and retain assets valued at up to USD 2 billion. Istanbul observers thus expect him to remain a major player in Turkish markets, and do not discount his taking an active role in the upcoming privatization of either Tupras, the National Lottery or Turk Telecom. The banking sector too emerges from a cloud, and should face a period of increased competition, as the country's two largest conglomerates, Koc and Sabanci, for the first time take each other on in the financial sector on a roughly equal footing. All in all, the multiple Cukurova-related deals constitute a win-win-win for Turkey: removing a cloud (by the name of Cukurova) from one of Turkey's top banks, confirming a substantial inflow of FDI, and facilitating large repayments to the TMSF. End Comment. ARNETT