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BYZANTINE EMPIRE

Mehmet Emin Karamehmet is called Secret Boss for his complex financial dealings. But the Turkish businessman owes his own banks $4 billion, and if the new government doesn't make him pay, it could badly hurt Ankara's credibility.

Mehmet Emin Karamehmet is called Secret Boss for his complex financial dealings. But the Turkish businessman owes his own banks $4 billion, and if the new government doesn't make him pay, it could badly hurt Ankara's credibility.

By Craig Mellow
January 2003
Institutional Investor Magazine

Turkey's Justice and Development Party (AKP) took power on November 3 promising to cure the national habit of borrowing billions and pouring it down black holes -- a habit whose legacy has been prices that double every year or two, 20 percent unemployment in the cities, a Turkish lira at 1.5 million to the dollar and dependence on a $16 billion International Monetary Fund program to maintain national solvency.

If the AKP government is in earnest about reforms, analysts say, it might start by dealing with Mehmet Emin Karamehmet. In 2002, Forbes magazine ranked him as the 87th-richest person in the world, with net assets of $4 billion. That is about the sum, give or take half a billion, that he now owes to his own banks. Karamehmet is both symbol and substance of any serious reform effort.

Turkey, spurred and partially bankrolled by the IMF, has spent as much as $40 billion, or the equivalent of 25 percent of its GDP, cleaning up its banking system following a February 2001 currency panic that cut the lira's value in half and shrank the economy by one tenth. Completing the banking-reform job is vital for the AKP and its charismatic leader, Recep Tayyip Erdogan, if they are ever to achieve real progress toward their consuming ambition: European Union membership for Turkey. And Karamehmet is a major obstacle to a banking overhaul.

Yet instead of squeezing the brash businessman for the fortune missing from his banks, the AKP has made noises about constraining the crusading Banking Regulation and Supervision Agency, or BRSA, which is pursuing the money. This has worried investors and IMF officials.

Otherwise, though, they see the new government as Turkey's best hope in decades. Encouraged by Erdogan's sound macroeconomic rhetoric and the two-year-old party's relative lack of special-interest baggage, investors bid up the Turkish stock market 20 percent between the election and mid-December.

The EU's refusal last month to set a starting date for talks on Turkey's admission was a disappointment for Ankara, but if anything, it adds to the urgency of reforming the country to meet EU membership criteria -- including revamping a banking system that's still shaky.

"On the whole, the AKP is convincingly presenting a new vision of Turkey," says Michael Marrese, head economist for emerging Europe at J.P. Morgan Chase & Co. "But their stance on the BRSA is very much a wait-and-see area [for investors]. Bank restructuring has come to a halt."

Ali Babacan, the 35-year-old MBA from Northwestern University's Kellogg School of Business who is the new Economy minister, says, "Our voters know we are not going to do anything special for anyone." Adds Saban Di¸sli, a banker-turned-founding-member of the AKP and now a member of Parliament: "We told people during the election not to expect Switzerland from us tomorrow. Our one promise was that we wouldn't lie to them."

Karamehmet, 58, is chairman of Çukurova Group, one of the half dozen family conglomerates that dominate Turkey's private sector. Named for the Mediterranean region where Karamehmet's father and grandfather started out growing cotton, Çukurova controls about 100 subsidiaries, from textiles maker Çukurova Sanayi Isletmeleri to Turkcell, the top Turkish wireless carrier, whose $1.9 billion New York IPO two years ago rocketed Karamehmet up to 29th on the 2000 Forbes global rich list.

Çukurova also owns two newspapers and a TV station that have unswervingly supported the AKP both before and since the election. Çukurova newspaper Sabah gives "full support to everything the government does, no matter how stupid it is," contends Mahmut Kaya, research chief at Garanti Securities in Istanbul.

Karamehmet got into hot water with the BRSA because, in the course of its cleanup, the agency audited his two banks, Pamukbank and Yapi ve Kredi Bankasi. Together they hold about one sixth of Turkey's deposits. The BRSA auditors discovered that at least half of the two banks' lending went to Çukurova Group companies but was never repaid. The banks recorded the interest payments they were not receiving as revenue, enabling them to show a profit and Karamehmet to look even richer.

Until a couple of months ago, the BRSA, which has already closed two dozen insolvent Turkish financial institutions, seemed on the brink of kicking Karamehmet out of the banking business. The agency seized Pamukbank from Çukurova in July, citing a $2 billion capital deficit, and was closing in on its big brother Yapi Kredi -- one of Turkey's top four private banks, along with Akbank, Türkiye Garanti Bankasi and Türkiye I¸s Bankasi. About 40 percent of Yapi Kredi shares had been pledged as collateral for dud loans extended by Pamukbank, meaning that the state now owned them. And the law forbids owners of one collapsed bank -- like Karamehmet -- from controlling a second one. The BRSA was pressing the Çukurova chieftain to repay the banks.

Then on November 22 a court decision gave Karamehmet new breath. It granted an injunction against the state's takeover of Pamukbank, even though the BRSA had already transferred close to $3 billion in state-held Treasury bills to the bank to keep it ticking. The court said that the regulator hadn't adequately studied a Çukurova proposal for merging Pamukbank into the marginally more healthy Yapi Kredi. The whole mess was then thrust into limbo as Karamehmet sued the BRSA to get Pamukbank back; that suit slowly wends its way through Turkey's lower courts.

More ominous, the new AKP brooms launched a series of curious attacks on the BRSA -- Turkey's best hope for financial probity, as far as the IMF and other outsiders are concerned -- and dropped hints that they might review Karamehmet's case. Two days after the AKP's election triumph, Industry and Trade minister Ali Coskun told the press that the BRSA was "inept in terms of its structure and appointment of its management." The bank cleanup agency has drawn "many complaints from the market," elaborates the AKP's Di¸sli. He asserts that business rivals may have influenced the previous government against Karamehmet. "Maybe we have to go back and look at the Çukurova situation," suggests Di¸sli. "Maybe one party is pushing it." Economy Minister Babacan adds: "A lot of people claim that the BRSA is doing a good job. But there are also a few people saying that some of the decisions they took were actually influenced by the previous government."

The IMF, from which the AKP is trying to pry the next $1.6 billion loan tranche, doesn't see the BRSA's activities in such politicized terms: The Fund supports the banking agency's seizure of Pamukbank as a key reform and lists a restructuring plan for Yapi Kredi as a condition for providing further funds to Turkey.

Even with the steeliest political will, Turkey's administrative and judicial apparatus would be challenged to wrest payment out of Karamehmet's byzantine asset base. Yet if it can't, a government already over its head in debt may well wind up bailing out Karamehmet's depositors, while he remains a cell phone billionaire. The AKP should strenuously resist a straightforward bailout. "The Çukurova business will be kind of a litmus test for the new government," says Murat Berk, Turkey analyst for CAIB investment bank in Istanbul. "Three or five years ago, Karamehmet would have gotten away with running his banks the way he did. Now he'll have to make some restitution, hopefully."

Karamehmet declined to be interviewed for this article and did not respond to repeated faxed requests for comment. But Sali Basaga, Yapi Kredi's secretary general, says the bank's $1.8 billion in loans to Çukurova companies were secured with collateral originally worth three to four times that much. However, he says, the value of the collateral, mostly shares in Çukurova companies plus some real estate, has plunged over the past two years, leaving an "unsustainable" hole in Yapi Kredi's balance sheet.

KARAMEHMET HAS LONG BEEN THE LONER IN Turkey's gregarious business and political circles. Sakip Sabanci and Rahmi Koç, the country's preeminent business patriarchs, are celebrity-page figures in Turkey, generously bankrolling symphonies or endowing libraries. But the intensely private, workaholic Karamehmet keeps a low profile. He gets to the office at 6:00 or 7:00 a.m., stays until late at night and drives himself home to a villa on Istanbul's outskirts, according to journalist Aydin Haskebapçi, author of Secret Boss, a biography of Karamehmet.

No picture of Karamehmet's wife or 20-year-old daughter has ever been published. He rules Çukurova alone, too. Two of his four younger siblings work there without exercising much influence. The one colleague with weight is Rona Yircali, a school friend who is Yapi Kredi's CEO.

Karamehmet was born in 1944 in Tarsus, where his father, Mehmet Kemal, was already a landed grandee. The Çukurova Group's symbol is a prancing stallion, reflecting the father's favorite hobby, breeding racehorses. Young Mehmet Emin left home for Istanbul's Robert College, an elite prep school that teaches in English, then studied economics at Dover College in the U.K. He returned to Turkey in the mid-1960s, about the time that his father and some partners were starting Pamukbank, which collected savings deposits and funneled them into Çukurova's burgeoning investments in textiles, construction and steel.

Turkey's authorities have ensured a soft life for its financial-industrial barons for most of the past generation. In the 1960s and '70s, the government capped interest rates on deposits, insuring that the oligarchs' banks had cheap money to pass along to their industrial enterprises, which were protected from foreign competition by a maze of investment and licensing restrictions. "Turkey was a centrally planned economy until the end of the 1970s, but planned around the interests of the leading families," says Yavuz Uzay, a banking analyst at Global Securities in Istanbul.

In the '90s Turkey discovered global financial markets. The state ran up most of its $125 billion in foreign debt after 1993, spending much of it on boondoggles, such as a second Istanbul airport that nobody flies to and farm price support payments that vanished into middleman firms. A further $85 billion in domestic borrowing by the state kept bond rates high. Managed lira devaluation enabled banks to borrow hard currency and buy domestic T-bills at a dependable profit. Offshore fortunes piled up. Of the $28 billion the IMF has loaned Turkey since 2000, $26 billion has left the country, estimates the AKP's Di¸sli.

Çukurova was a marginal passenger on the Turkish gravy train until 1989, when Karamehmet's father died and he took over. Within a year he had split with his uncles, handing them some agricultural enterprises in exchange for control of Yapi Kredi. Old friend Yircali built the bank into Turkey's best-regarded retail franchise, with 5 million customers and a third of the market for credit cards.

Karamehmet was way ahead of his Istanbul rivals in seeing the communications future. Çukurova controls Turkey's top internet portal, Superonline, and leading digital TV service, DigiTurk. The Sabanci and Koç clans both refused the government's offer of wireless licenses in 1996­'97, assuming mobile phones would remain too expensive for the masses. Karamehmet, who had formed Turkcell in 1994 with Finland's Sonera, jumped at the chance.

But Karamehmet also courted trouble. He let industrial assets like Çukurova Celik Endustrisi steel and BMC trucks stagnate through the 1990s, just as Sabanci and Koç were modernizing their holdings through joint ventures with partners from Ford Motor Co. to French food retailer Carrefour. While financial rivals like Sabanci-controlled Akbank kept half their assets in government bonds, Pamukbank and Yapi Kredi piled funds into their decrepit corporate sisters.The most recent financial figures available on Çukurova's Web site show a pretax profit of $1.8 billion on revenues of $8.7 billion in 2000 for all of the group's enterprises. But with only Turkcell and Yapi Kredi publicly traded, both the BRSA and analysts are skeptical about how much the rest of the empire is worth.

Karamehmet could have plugged the hole in the banks' books after the Turkcell share offering two years ago, analysts say. His share of the $1.9 billion IPO came to about $1 billion, and the Çukurova companies' debts were more manageable then. (Of course, they've been compounding at Turkey's mountainous interest rates.)

"Karamehmet just never thought somebody would come and count the money in his banks," Haskebapçi says. Neither, apparently, did the foreign investors who snatched up most of the 42 percent of Yapi Kredi shares offered on the market, making it the most widely held Turkish stock internationally by 2000.

But somebody did come and count the money. Turkey's financial structure was rickety enough by February 2001 that a spat between Prime Minister Bülent Ecevit and President Ahmet Sezer over police powers provoked a flight from the lira, collapsing the currency despite central bank intervention of at least $6 billion. Interest rates soared, credit dried up, and the economy shrank more than 9 percent in 2001.

Turkey's banks, which had a mere $10 billion in capital before the crisis, lost perhaps half of that as borrowers went broke and the cost of hard-currency loans swelled in deflated lira. But the state managed to bolster Çukurova's major competitors with a debt swap that exchanged their short-term lira bonds for longer-term obligations indexed to the dollar and euro. Akbank, Garanti Bank and I¸sbank all returned to profit last year after a ghoulish 2001. Pamukbank's and Yapi Kredi's problems proved to be of another magnitude.

The February 2001 lira collapse goaded Turkey to attempt long-overdue reforms, starting with the banking sector. The country's national debt soared from 67 percent of GDP to 92 percent as Ankara borrowed to cover a bank bailout. Meanwhile, BRSA head Engin Akcakoca, backed by then­Economy minister Kemal Dervi¸s and the IMF, put every bank in the country through a three-stage audit aimed at force-marching them to international accounting standards. By last summer Turkey's banks had been thinned from 80 to about 50.

The BRSA intervened at 19 banks, pouring in $20 billion to cover a 100 percent deposit guarantee extended two financial crises ago, in 1994. Pamukbank was the elephant of the group, sucking up $3 billion. A further $20 billion went into state banks, which for years had extended soft loans to politically favored projects. "These banks were taking deposits at 70 percent interest and lending to a lot of parties at 20 or 30 percent," Garanti Securities' Kaya says. "You can lose a lot of money that way."

Turkey's economy has come around. Growth in the year just ended was as much as 7 percent. Inflation is near the IMF target of 35 percent, and bond rates are about 50 percent -- tight money by local standards. Thus the AKP's timing in ascending to power now looks relatively favorable. "The dirty jobs were done by the previous government," says Hakan Avci, an equity strategist at Global Securities in Istanbul. "These guys just have to hang on for a year or so, and things should get better."

One mess the Dervi¸s reformers didn't finish cleaning up, though, was the Karamehmet banking imbroglio. The injunction against the BRSA's takeover of Pamukbank complicates an already tortuous negotiation between the bank agency and Karamehmet. It is "technically" impossible for the boss of Çukurova to maintain control over either of his banks, insists a BRSA official. The group owes about $2.3 billion to Pamukbank and $1.8 billion to Yapi Kredi.

The banking regulator, created in 2000 at the IMF's behest to be free of control by any ministry, wants to take over both banks and force Karamehmet to pay off his debts to them gradually. If he doesn't cooperate, the state can get rough. "If there's a settlement, you don't have to exercise a criminal court case," the BRSA official says. "You can if you need to."

But in the realpolitik Turkey, the threat of jail looks flimsy. Just before the elections, magistrates released 20 or so chiefs of other failed banks who had been in prison awaiting trial for fraud. A BRSA move to grab Çukurova's Turkcell shares -- he still owns two fifths of the company post-IPO -- would likely bog down in a legal morass. If the government can't wring funds out of Karamehmet, it will likely have to throw more money after the $3 billion it has already put in Pamukbank -- not a welcome prospect for a country struggling to pay existing debt. "The state doesn't have the money to recapitalize these Çukurova banks," concludes Garanti Securities' Kaya.

Yapi Kredi's retail franchise might eventually earn something back in a sale to a foreign investor. HSBC Holdings and UniCredito Italiano have bought into Turkey in the past two years, and Société Générale, among others, is thought to be hungry for exposure. Yet Western giants generally prefer to start small and grow their own organizations in emerging markets.

So Karamehmet still has some leverage in his talks with BRSA, even if he doesn't ultimately prevail over it in court. Yapi Kredi is bleeding to death, now that it can't count interest it doesn't collect as income. (The bank lost about $270 million in the third quarter of 2002.) The BRSA's current formula for resolving the stalemate: It takes control of the two Çukurova banks, whittling Pamukbank down to a few branches and likely shopping Yapi Kredi to foreigners. It totals the Çukurova Group's combined debts to the banks (some $4.1 billion), then subtracts the group's share of the estimated resale value of Yapi Kredi. (Çukurova owns about 45 percent of the bank's stock.) The remainder to be repaid would likely be somewhat more than $3 billion. Once the state had formally assumed control of Pamukbank and Yapi Kredi, Çukurova Group would pay back 12 percent in cash up front ($300 million to $400 million, say) and the remainder of its debt over five years, or perhaps a little longer. Karamehmet would keep Turkcell, paying off the banks out of dividends or further equity sales.

Karamehmet prefers another alternative, acknowledges a BRSA official. He wants to reduce the cash he owes by giving the government equity in Çukurova Group -- consisting of those same enterprises that didn't pay back the loans in the first place. At least that was his position before the courts gave him encouragement on Pamukbank.

The official makes it clear that BRSA won't fold even if the court ultimately disallows its seizure of Pamukbank. "Our legislation passed by the Parliament is very, very clear," he says. "Any bank that is insolvent has to come up with a plan or will need intervention. There's no other way out."

That kind of pugnacity is essential if Turkey is to clean its financial stables to pass an EU sniff test, Western observers say. Yet the BRSA's attitude seems to grate on the AKP, despite the party's overarching goal of EU membership for Turkey. "It's essential that the BRSA continue to be strengthened," says Jeffrey Anderson, chief economist for emerging Europe at the Institute for International Finance in Washington.

The BRSA's six board members serve six-year terms (much longer than most Turkish governments last), two being replaced every other year by the cabinet of the day. Industry Minister Coskun has suggested expanding the board to include members from the Finance ministry, Treasury and even the industry lobby, the Union of Banks. That's a recipe for paralysis and political meddling, say BRSA staffers. "It's a bad idea," warns the BRSA official. "Under the central bank and the Treasury, nothing was done to these banks."

The AKP says it can steer Turkey from its Byzantine past to a European future because it owes no favors to the entrenched elite whose corrupt schemes have squandered the proceeds of the country's 1990s borrowing spree and kept investors away. "The No. 1 reason why people voted for AK Party is that they think they can trust us," Economy Minister Babacan says. "We are a totally new party with a totally new understanding." He recounts with a kind of bitter glee the country's decline in Transparency International's ratings of national probity: 3.8 out of 10 in 2000, 3.6 in 2001 and 3.2 this year, putting it 65th out of 102 countries ranked. "Not only is Turkey a corrupt country," says Babacan, "but the situation is getting worse."

The AKP ostentatiously publishes its own ascetic accounts on the Internet. The party spent all of $6 million on its election campaign, according to Babacan, relying on government funds and application fees for parliamentary candidates. It plastered images of Erdogan across billboards because it couldn't afford TV.

That positions the party to attack Turkey's systemic political decay and establish the kind of modern legal infrastructure that attracts global investors, Babacan argues. As it is, a single foreign direct investment in Turkey can require the signatures of up to 136 bureaucrats and, say critics, buckets of baksheesh. The need for reform is pressing -- and would be even if EU membership weren't at stake. Turkey remains among the world's biggest underachievers in attracting foreign investment. "We got just $1 billion in investment last year,"notes Abdurrahman Ariman, who heads the Foreign Investors Association in Istanbul. "We should get about $35 billion." Making an example of Çukurova might be a good start toward establishing credibility.