Financial Institutions

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Financial Institutions

Financial Services / Turkey

Kapital Faktoring A.S.

Full Rating Report

Key Rating Drivers

Standalone Strength Drives Ratings: Kapital Faktoring A.S.’s National Rating is driven by its position as a leading, independent company in Turkey’s fragmented factoring sector, and its successful record of sound financial metrics. The rating also reflects its highly specialised business model in a volatile economic environment.

Leading Independent Franchise: Kapital is the largest independent non-bank owned

factoring company in Turkey, controlling 5.6% of domestic factoring receivables at end-2015. Kapital leads the sector in terms of total equity and profits. However, Kapital is small relative to Turkey’s financial sector in absolute terms.

Higher-Than-Average Risks: Kapital’s customers present higher-than-average risks. Kapital provides short-term, working capital loans to SME and micro-commercial companies. The business model is solely based on factoring transactions, as with-recourse factoring receivables made up 98% of Kapital’s total assets at end-2015.

Robust Capitalisation: Supportive shareholders have allowed Kapital to operate with high

capital adequacy ratios (equity/assets: 40.3% at end-2015) and its significant capital buffers should enable it to absorb large unexpected losses. Leverage and gearing ratios are also comfortable and Kapital has consistently operated with a net debt/equity ratio of around 1.5x or below, which compares well with the sector average (4.6x).

Low Impaired Loans, High Concentration: Credit losses to date have been low and the

impaired receivables ratio (based on amounts overdue by 90+ days) reached a low 2.3% at end-2015, which compares well with peers and the sector average (5.7%). However, the rating also captures the short-term and concentrated nature of factoring receivables, which heightens risks at Kapital.

Strong Profitability, Good Cost Efficiency: Margins are well above the sector average and

Kapital’s performance indicators consistently outperform those of its peers. Strong earnings and profitability over volatile interest rate and economic cycles enable Kapital to regularly distribute dividends, but also retain a high portion of earnings, further growing the equity base. Solid pre-impairment profits provide a buffer to absorb unexpected losses. A low headcount and a limited branch network support good cost efficiency.

Reasonable Funding and Liquidity Profile: Kapital relies on typically short-term wholesale

funding from bank borrowings and local bonds. It operates with a short-term balance sheet and the average maturities of receivables are between 90 and 110 days. Bank-owned factoring companies can access parent funding but this is not the case for Kapital. Nevertheless, market access has been reasonable and Kapital typically uses less than half of its credit lines from Turkish banks, albeit these are not committed.

Rating Sensitivites

Asset Quality, Leverage Key: Downward rating pressure could arise if there is significant

deterioration in asset quality and a material increase in leverage or receivables concentrations. This is not Fitch Ratings’ base case, given the stable outlook.

Operating Environment: Kapital’s rating is sensitive to deterioration in the operating environment. A continued successful record of operations and a diversification of funding sources could create moderate upside for its rating.

Ratings National

Long-Term Rating A+(tur)

Sovereign Risk

Foreign-Currency Long-Term IDR BBB− Local-Currency Long-Term IDR BBB

Outlooks

National Long-Term Rating Stable Sovereign Foreign-Currency Long-Term IDR Stable Sovereign Local-Currency Long-Term IDR Stable Financial Data Kapital Faktoring A.S.

31 Dec 15

31 Dec 14

Total assets (USDm) 442.6 495.5 Total assets (TRYm) 1,289.3 1,150.1 Total equity (TRYm) 519.4 443.3 Operating profit (TRYm) 96.7 92.4 Published net income

(TRYm) 77.2 73.9

Net interest margin 9.6 10.1

Operating ROAE 20.1 22.0 Impaired receivables/gross receivables 2.3 1.8 LICs/avg. receivables 0.7 0.1 Interest coverage ratio 2.3 2.6 Equity/total assets 40.3 38.6

Debt/equity 1.5 1.6

Related Research

Fitch Rates Turkey's Kapital Faktoring 'A+(tur)'; Outlook Stable (March 2016) Turkey (March 2016)

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Financial Institutions

Operating Environment

Bank-Owned Companies Causing Consolidation

Turkey’s factoring sector is dominated by about 10 companies, which controlled about half of receivables at end-2015. The presence of bank-owned factoring subsidiaries, which enjoy better funding access, has increased significantly in recent years. This causes higher competition in target customer segments. Foreign shareholder presence is less widespread across factoring firms when compared with the banking sector, as local knowledge is crucial to assessing sector and borrower quality.

In late 2013, the banking regulator, BRSA, introduced certain prudential limitations for factoring companies. The most important of these is a gearing ratio limit (receivables/equity) of 30x, which Fitch views as very generous. In addition, the BRSA has introduced further capital measures where factoring companies must have a minimum paid-in capital amount of TRY20m. This led to some sector consolidation as smaller firms struggled to boost capital. Demand for factoring services in Turkey is volatile and depends on economic conditions. Factoring companies primarily extend short-term, working capital finance to SME and commercial customers. Credit is secured with invoices and post-dated cheques, a common practice in Turkey. The factoring sector has grown significantly in recent years, with factoring receivables more than doubling since 2008. However, the sector is small and represented less than 5% of total financial sector assets at end-2015. Few companies participate in cross-border factoring with the majority having primarily Turkish lira balance sheets.

Company Profile

Largest Independent Factoring Company

Kapital is the largest non-bank owned (independent) factoring company in Turkey. It provides with-recourse domestic factoring services to a SME dominant customer base, all in Turkey. At end-2015, Kapital had a 5.6% market share by total domestic receivables. Kapital’s relatively high market share has remained broadly stable in recent years (2014: 5%) despite the strong competition that has arisen from bank-owned factoring companies.

However, Kapital engages entirely with domestic factoring transaction and has a policy of not servicing the import- and export-factoring businesses, unlike large bank-owned factoring companies. Kapital was the largest company measured by shareholder’s equity at end-2015 with an 11% market share (end-2014: 10%). It also recorded the highest profit in the sector for two consecutive years and posted a high 20% of total factoring sector profits in 2015.

Kapital was established in 1992 as the first non-bank owned factoring company in Turkey. It targets small, medium and micro enterprises. Kapital had five branches at end-2015 with a total of 75 employees serving 1,300 clients across multiple cities in Turkey. Istanbul – the highest GDP generating city in Turkey – accounts for a high share of total business volume.

The company is 99% owned by Kapital Mali ve Gayrimenkul Holding, which is entirely owned by the Turkish Sadioglu family. There have been no changes in ownership since the company was set up and the family remain fully committed to the business. The family’s other business interests are in finance and real estate. Shareholders have consistently supported the operations of the factoring business, through capital injections when necessary. Kapital converted retained earnings into paid-in capital in 2014 to comply with higher regulatory requirements. Figure 1 Figure 2 0 5 10 15 20 25 Factoring receivables

Equity Net profit (%)

Source: Company data adapted by Fitch

Kapital's Market Shares

Ownership Structure End-2015 Kapital Mali ve Gayrimenkul Holding 99% Sadioglu family members 1% Related Criteria

Global Non-Bank Financial Institutions Rating Criteria (April 2015)

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Financial Institutions

Monoline Business Model

Kapital manages a diversified portfolio with the majority of its factoring volumes being in small-sized transactions, sourced from a broad range of companies across many industries. Kapital’s business model is solely based on factoring transactions and factoring receivables comprised 98% of total assets at end-2015. This highlights the monoline business model of Kapital, the lack of diversity and a specialisation in one sector, making it susceptible to the volatile operating environment.

Kapital stopped its export and import factoring operations in 2013 to avoid lower profit margins and competition with bank-owned factoring companies. The latter participates in cross-border factoring as their parents’ wide network of correspondent banks and factoring companies make it easier to assess credit quality. Kapital’s business volumes have remained relatively stable despite its single-line business model and the challenging Turkish operating environment.

Management and Strategy

Good Experience, Sound Execution

Kapital’s management has an acceptable degree of depth, stability and experience. Given the company’s small size, responsibilities have been concentrated among a small group of senior individuals. However, turnover is low and senior managers have adequate experience in Turkey’s banking and factoring sector. A history of successful performance is demonstrated by Kapital’s market position.

The general manager has been in place since the company’s was established and has strong experience in the factoring field. Other senior managers have either been at the firm since it was set up or have been brought in from larger bank-owned factoring companies. Local market knowledge appears sound and management is aware of changing regulations, competition risks and macro variables that may affect Kapital’s operations.

The corporate governance standards are adequate for Kapital’s rating level and scale. The board of directors comprises three Sadioglu family members, the general manager and one independent member (ex-banker). The board has approval rights for credits over TRY2.5m, which means it is regularly approving larger exposures. To date, credit losses have been minimal suggesting that board members have sufficient understanding of procedures and customers.

There are frequent profit distributions to shareholders through dividend payments. However, the profit retention rate is high as dividend payments are usually a small portion of annual profits (only exception in 2013 when the pay-out ratio was 78%). Fitch has no evidence to suggest factoring receivables are being directed towards related parties and management appears to be independent in underwriting. However, Fitch believes this is a potential risk for Kapital, as it is for other independent factoring firms. Financial information disclosure appears good and in line with other Turkish factoring firms.

Management’s strategies include the sustained continuation of the traditional domestic factoring business and it has set prudent targets for receivables growth (16% in 2016), profits

(TRY100m net income) and asset quality (keep new impairments below TRY5m). Kapital’s

consistency in meeting financial objectives has been sound. The company has reported low impairments and above-sector-average profitability (return on equity has been above 16% since 2011). Management has also stuck to its objective of operating with a low gearing ratio, despite having a large equity base readily available. Kapital’s performance is also supported by impressive cost efficiency as the company has lower-than-usual staffing levels and places an emphasis on automation and IT. Kapital has a strong record of borrowing from banks and tapping local bond markets.

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Financial Institutions

continues to work with its target SME customer base and has not shifted to less familiar customer segments. However, operations are expected to vary over economic cycles as it is a company that works in the more vulnerable parts of Turkey’s economy.

Risk Appetite

Tight Credit Monitoring Systems

Kapital targets an SME client base of more than 1,300 customers in Turkey. The receivables portfolio is diversified across sectors and average ticket size is a low TRY18,000. Kapital has developed systems and expertise to turn around factoring transactions rapidly for existing customers. Management places an emphasis on speed, as it is what differentiates Kapital’s services from its rivals.

Kapital’s head office in Istanbul is effectively the central hub for all factoring transactions, with the branches across Turkey being marketing and sales units. Credit allocation procedures for new clients are initiated through the on-site inspection of a sales team of up to 10 people. Inspection reports are reviewed daily by management, where up to 15 new customers will be assessed to open up a credit facility. Kapital receives up to 150 applications a day for factoring services primarily from existing customers.

Kapital’s underwriting systems are sufficient for the sector in which it operates. Kapital has an externally developed, advanced underwriting software in place, primarily for credit monitoring. This software stores customer information with very granular details. It is automatically connected with Turkey’s credit bureau, which holds data on all rejected and impaired cheques as well as overdue interest payments, and the Turkish central bank’s risk data centre. Kapital’s operational risks are above peers, given the large reliance on this software. However, there have not been any businesses disruptions caused by system failures.

Kapital’s receivables are nearly all denominated in Turkish liras, as per management policy, which mitigates currency risk in the loan book. At end-2015, only TRY16m (less than 1% of total receivables) was disbursed against foreign-currency (FC) cheques and these were used to set up forward contracts to convert back to the lira with local banks. In addition, 99% of all receivables are disbursed on a “with-recourse” basis, which gives Kapital the right to seek repayments from both the customer and the endorsees of the cheque receivable. Typical cheques will have additional guarantors that endorse it and take liability, which mitigates credit risk.

Key senior individuals meet daily to discuss developments in customer industries and decide on the relevant exposures. There are no official limits, but management say it would not go above 30% credit exposure for a single sector.

Growth at factoring firms can be volatile given their small sizes, the volatile nature of the Turkish economy (in particular the SME segment) and the short-term nature of factoring receivables. Kapital’s receivables portfolio has grown by an average 17% a year since 2011, which is faster than the sector average (9%). In 2015, Kapital expanded its portfolio despite the economic disruptions caused by political tensions. Fitch believes Kapital has the ability to grow, given its underleveraged position. Management aims to expand its receivables book to TRY1.5bn, suggesting growth of 16% in 2016. This is in line with Fitch’s forecast for the banking and factoring sector.

Limited Market Risk

The short-term nature of receivables allows Kapital to reprice contracts quite rapidly to reflect the changes in interest rates. The positive maturity gaps between time buckets result in positive profit effects when rates are rising and negative effects when falling. At end-2015, a 100bp rise or fall in Turkish lira interest rates would affect pre-tax profit by TRY2m (2.6% of 2015 total income). This is a fairly small impact as borrowings are relatively low in proportion to

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Financial Institutions

receivables book. Kapital does not own any marketable securities, which mitigates interest rate risk. Foreign currency risk is near zero, given that Kapital does not disburse FC loans and does not take FC funding.

Financial Profile

Low Impaired Receivables, Good Collection Rates

Asset-quality metrics are sound. Credit losses have been minimal and collections have been good. Kapital has a policy of not writing off non-performing receivables, unlike its peers, and the impaired loans on the balance sheet (TRY31m at end-2015) are all historic bad loans net of collections as a result. The impaired receivables ratio (past due by +90 days) has historically been low and was 2.3% at end-2015 (1.8% at end-2014), which compares well with the sector- and Fitch-rated peer average (5.7% and 7.6%, respectively). Specific provisions fell slightly to cover 91% of impaired loans.

The stock of impaired receivables grew by 48% in 2015, indicating a challenging year and a few large impairments. Kapital’s non-performing receivables origination is low, but increased to 0.8% in 2015 from 0.1% in 2014. This is still significantly better than peers and is comfortably covered by pre-impairment profits. Kapital’s receivables are moderately concentrated by sector with the textile industry amounting to 26% of total loans at end-2015. Other concentrations were in mining (15%), domestic trade (9%) and healthcare (8%). Kapital chooses not to work with petrol distributors, chemical companies or insurers.

Figure 4

Asset Quality

(%) 2015 2014 2013 2012

Growth of gross receivables 11.6 36.5 14.6 3.9

Impaired receivables/gross receivables 2.3 1.8 2.3 2.2

Specific provisions/impaired receivables 90.7 100.0 100.0 100.0

Net impaired receivables/equity 0.5 0.0 0.0 0.0

Loan-impairment charges/average gross receivables 0.7 0.1 0.9 0.3

Source: Fitch

High Concentration Highlights Small Absolute Size

The top 25 receivables by group borrowers amounted to a high 39% of total receivables at end-2015 (98% of equity). This reflects the small absolute size of independent factoring firms. Customers in the textile sector dominate with seven names, but there are no state-owned or related parties on the list. Of the top 25 borrowers, there were only four new customers in 2015; continued work with familiar customers provides some comfort in Fitch’s opinion. The textiles industry also dominated the problem loans list and top 15 problem loans accounted for 16% of problem exposures. The largest non-performing receivable accounted for TRY2.4m (0.5% of equity) and as it became non-performing in 2015 was the main driver in the non-performing loans (NPL) ratio increasing slightly to 2.3%. The 15 largest NPLs were fully provisioned at end-2015.

In addition, asset-quality problems could manifest rapidly at Kapital, and other factoring firms, due to the short-term nature of receivables (average 95 days maturity). While the top 25 list includes a few clients where receivables would have maturities extending up to a year, these are rare in Fitch’s view. At end-2015, Kapital had taken collateral worth TRY4.5bn against factoring receivables (3.5x the total portfolio) to seek recourse from, if necessary. In addition, the number of providers of cheques is very granular and diverse by sector and borrower, which mitigates risk. Figure 3 0 1 2 3 4 5 6 2015 2014 2013 2012 Kapital

Factoring sector average

Impaired Receivables Ratio

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Financial Institutions

Earnings and Profitability

Stable, Strong Profitability Supports Capitalisation

Kapital operates a monoline business and revenues are tied to volatile factoring demand. Its ability to diversify revenues is very limited and interest income (cheque discounting) amounted to 97% of total income at end-2015. Some factoring companies (mainly bank-owned) have started to introduce new products such as non-recourse, import and export factoring, and portfolio management, but this is still at its initial stage. Nevertheless, Kapital’s performance has been strong, and earnings and profitability indicators are more stable than at peers.

Figure 5

Earnings and Profitability

(%) 2015 2014 2013 2012

Operating profit/average equity 20.1 22.0 19.4 27.0

Operating profit/average assets 7.9 9.2 9.3 12.7

Loans and securities impairment charges/ pre-impairment operating profit

9.6 1.9 10.5 1.6

Interest coverage ratio 2.3 2.6 2.9 3.1

Net income/average equity 16.0 17.6 15.4 21.6

Net income/average assets 6.3 7.3 7.4 10.2

Source: Fitch

Kapital has some pricing power as a larger independent factoring firm. At end-2015 the average discount rate on cheques receivables was 22%. Average funding costs typically range from 11%-13%, giving a net interest margin of 10% at end-2015. This is above the 5.5% sector average. Operating returns continue to outperform peers and the sector average at 20% at end-2015, significantly higher than peers’ average of 5%. Net return on equity has been above 16% for the past five years.

Cost efficiency also supports profitability. Non-interest costs amounted to a low 1.5% of average assets at end-2015 reflecting a limited branch network and smaller headcount than usual. Kapital’s interest coverage ratio was a comfortable 2.3x at the same date (average at peers; 1.1x). Furthermore, loan-impairment charges have consumed a lower portion of pre-impairment profits (only 10% at end-2015 versus an average of 85% at Fitch-rated peers). High pre-impairment profits also provide a significant buffer to absorb unexpected losses (8.2% of receivables at end-2015).

Capitalisation and Leverage

Kapital’s capitalisation and leverage position is strong. Shareholders have allowed the company to sustain this high base to operate with a low gearing ratio and to keep bank borrowings at low levels. Kapital’s equity to assets ratio reached 40.3% at end-2015, significantly above the averages for the sector (17.2%) and peers (17.8%). Kapital’s paid-in capital amount is TRY20m and was increased from TRY10m in 2014 to comply with a new regulation. The remaining portion of total shareholders’ equity comprises accumulated retained earnings of TRY495m. Kapital is well above the 3% statutory gearing ratio, which Fitch believes is very generous, and operates with an equity/receivables ratio of a high 41%.

Robust Capitalisation, Low Gearing Ratio

The high equity base provides Kapital with more flexibility in funding. Kapital is using less than half of its credit facilities at banks as it can rely on equity to cover maturity gaps. Consequently, Kapital had a low debt/equity ratio of 1.5x at end-2015, well below peers’ (average; 5x). Management says it does not intend to increase leverage and will continue working with a similar balance-sheet structure. The dividend pay-out ratio is generally low which allows Kapital to expand its equity base. There are no plans for shareholders to take a large portion of the existing equity base for another investment, but management says dividend payments will continue at a similar rate.

Figure 6 0.0 0.4 0.8 1.2 1.6 2.0 0 10 20 30 40 50 60 2015 2014 2013 2012 (%) Equity/assets (LHS)_{Debt/equity (RHS)}

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Financial Institutions

Kapital’s absolute size of equity (TRY520m at end-2015) is nearly twice the size of the second-largest firm and controls 11% of total sector equity. We believe this capital provides a significant buffer to absorb losses. Provisioning levels are generally high and net NPLs to equity amounted to a low 0.5% at end-2015. Management does not envisage any ownership structure change or mergers or acquisitions in the medium term.

Figure 7

Capitalisation and Leverage

(%) 2015 2014 2013 2012

Equity/assets 40.3 38.6 46.0 49.7

Debt/equity 1.5 1.6 1.1 1.0

Receivables/equity 2.4 2.6 2.1 1.9

Internal capital generation 16.4 14.7 3.5 18.6

Funding and Liquidity

Wholesale Funding Reliant, Good Market Access

As a non-deposit taking institution, Kapital mainly funds itself through bank borrowings and local bonds in addition to its own equity. It is reliant on wholesale funding and especially the ability to draw borrowings from Turkish banks against the pledging of cheques it receives from customers. Kapital also has a record of tapping the local bond market and is able to source Turkish lira funding. Kapital does not have any FC borrowings, which corresponds with its asset base, denominated in lira.

Kapital has credit lines available, although not committed, from 12 Turkish banks, most of which are investment grade. At end-2015, Kapital was only using credit lines from seven of these banks and had used a low 44% of total available bank funding. The average interest rate on these loans was 13% at end-2015. Although all funding is considered short-term, the tenor of funding from banks can vary and ranged from overnight to one year.

Turkish lira local bonds (TRY184m at end-2015) amounted to 24% of total funding. These are relatively long-term issues with two-year tenors (compared with common market practice of six to 12 months). We believe it is positive that Kapital is able to source long-term and unencumbered resources to fund its longer-term receivables. Two of Kapital’s three local bonds outstanding at end-2015 mature in 2016. These bonds have all have a floating rate attached to it and a quarterly interest rate of 3%-3.5%.

Kapital plans to issue larger local bonds, upon maturity of existing bonds, and would maintain the funding diversity. Management does not expect the funding composition of the company to change significantly in the short to medium term. The buyers of the bonds include qualified investors, pension funds and individuals.

Bank borrowings and local bonds amounted to 98% of total liabilities at end-2015. Liquidity buffers included TRY7.1m in bank placements, which amounted to a low 1% of total funding. Kapital runs tight liquidity (in line with the factoring sector) and mitigates the risk with a short-term balance-sheet, positive maturity gaps and relatively liquid, unencumbered assets. Kapital’s liquidity management relies on the satisfactory performance of factoring receivables. Figure 8 Local bonds 24% Funding Profile % of total debt

Source: Company data adapted by Fitch Bank borrowings

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Financial Institutions

Figure 9

Fitch-Rated Turkish Independent Factoring Companies

Company

Turkish Factoring Sector

Kapital Faktoring

A.S. Lider Faktoring A.S Eko Faktoring A.S.

Optima Faktoring Hizmetleri A.S. National long-term Rating/Outlook A+(tur)/Stable A(tur)/Stable BBB+(tur)/Stable BBB(tur)/Stable (TRYm) (%) 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014

Total assets (TRYm) 26,693 26,515 1,289 1,150 665 839 376 409 213 147

Factoring receivables (TRYm) 24,992 24,715 1,271 1,140 616 793 363 365 210 142

Equity (TRYm) 4,594 4,442 519 443 92 107 98 96 29 30

Profitability

Factoring yield 13.6 13.4 15.5 15.7 16.0 15.4 19.4 18.4 19.1 23.5

Cost of funding 9.7 7.9 10.0 8.5 14.6 10.2 13.0 12.2 11.0 14.4

NIM on earning assets 6.9 7.0 9.6 10.1 4.8 5.0 10.2 10.5 8.2 12.3

Cost/assets (avg.) 3.0 3.2 1.5 1.2 3.8 4.3 13.6 7.3 6.8 8.8

LICsª/pre-impairment op. profit 51.2 32.0 7.8 1.5 59.3 47.3 145.7 53.1 48.0 20.7

LICsª/factoring receivables (avg.) 2.2 1.6 0.7 0.1 1.6 1.2 6.2 2.9 2.6 1.7

Operating ROAE 11.4 18.2 20.1 22.0 7.6 9.0 -7.5 10.6 17.2 32.6

Operating ROAA 1.9 3.2 7.9 9.2 1.1 1.3 -1.7 2.4 2.8 6.3

Interest coverage ratio (x) 1.3 1.5 2.3 2.6 1.1 1.1 0.8 1.3 1.2 1.6

Asset quality

Impaired receivables/gross factoring receivables

5.7 4.9 2.3 1.8 4.2 2.1 19.9 10.9 4.1 4.5

Specific provisions/impaired receivables

81.4 74.3 90.7 100.0 100.0 100.0 86.6 95.5 72.6 73.5

Net impaired receivables/equity 5.9 7.3 0.5 0.0 2.2 0.0 9.4 2.2 7.7 3.5

Capitalisation and leverage

Equity/assets 17.2 16.8 40.3 38.6 13.8 12.8 26.0 23.4 13.5 20.1

Factoring receivables/equity (x) 5.4 5.6 2.4 2.6 6.7 7.4 3.7 3.8 7.3 4.8

Debt/equity (x) 4.6 4.8 1.5 1.6 5.9 6.8 2.9 3.2 6.4 3.9

ª LICs= Impairment charges on non-performing receivables Source: BRSA, Company data adapted by Fitch

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Financial Institutions

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