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* Moody's downgraded Turkey to "junk" in September
* Fitch review of investment grade expected early in 2017
* Turkish banks use Fitch rating as baseline for assets
* Downgrade raises risks for borrowing costs, lending outlook
By Asli Kandemir
ISTANBUL, Oct 4 (Reuters) - Turkey's love affair with international credit agencies - if it ever existed - is already over and its banks may rein in lending yet more if the last of the big firms, Fitch, downgrades the country's rating to "junk".
President Tayyip Erdogan has long criticised the agencies, most recently when Moody's followed Standard and Poor's last month in removing Turkey's investment grade rating. He will have another opportunity to vent his feelings if Fitch does the same when it reviews its BBB- sovereign rating in early 2017.
"I love rating agencies and they love me," Erdogan said with sarcasm last week, accusing Moody's of being political with its downgrade on Sept. 24, which followed a lowering of Turkey's outlook after a failed military in coup in July.
"Put a few cents in their pockets and get the rating you want, this is how they work," he said.
Fitch's influence remains high as the only one of the three main agencies that still ranks the country investment grade. Turkish banks have used Fitch's rating as the benchmark to calculate their risk-weighted assets, used to determine whether they have set aside enough capital to withstand shocks.
The agency already has Turkey on a negative outlook and analysts think a downgrade from BBB-, the lowest investment grade, is possible. This would push up borrowing costs while prompting commercial banks to trim lending as they move to shore up their balance sheets, sending ripples through the banking and financial sectors.
Turkey's economy weathered the Moody's downgrade without too many difficulties, but Prime Minister Binali Yildirim acknowledged on Tuesday that the failed coup had taken a toll, prompting the government to revise its year-end growth forecast to 3.2 percent from 4.5 percent.
S&P has already cut its rating to two notches below investment grade, and analysts say a Fitch move could have more impact. It would not only make banks' borrowing more costly but double risk weightings on foreign currency reserves they keep at the central bank and non-lira securities to 100 percent.
"If Fitch downgrades Turkey, the banking sector's capital adequacy ratio will fall 125-150 basis points," said Sadrettin Bagci, a banking analyst at Istanbul-based Deniz Investment. "This may further hit banks' appetite to extend loans."
The banking sector's average capital adequacy ratio is strong, standing at 15.8 percent at the end of July, well above the banking watchdog's lower limit of 12 percent and the legal requirement of 8 percent.
But lending is less positive, with year-on-year growth of around 8 percent, well below the central bank's guidance of 15 percent. A downgrade could dent that further, while also cutting into capital adequacy ratios.
The banks are under pressure from Erdogan to provide cheaper credit to consumers and companies to boost slowing economic growth. However, they rely heavily on foreign borrowing to fund their lending at home, and that will become more expensive.
"Should Fitch downgrade, its impact will be more crucial than Moody's in terms of banks' capital," said a senior banker who declined to be named. "Some banks may fall below the 12 percent threshold, further tightening loans."
Many banks already have loan-to-deposit ratios of over 100 percent and are reluctant to extend credit further.
With economic growth slowing, demand for credit is also easing. "We are focusing on the supply side, but there is very low appetite from credible firms to use loans. There is no backlog of feasible and bankable projects," the banker said.
Turkish banks' dollar borrowing costs already took a hit in anticipation of the Moody's downgrade, rising an extra 10 to 20 basis points over the Libor benchmark interest rate, although their euro costs remain steady at around Euribor +75 bps.
In a measure of the decreased appetite institutions have for Turkish risk, and the difficulty Turkish banks are having in finding takers for debt, the roll over ratio for maturing syndicated loans fell to 95 percent this year, from 120 percent in 2015. Anything below 100 percent shows declining interest.
Turkish banks borrowed $19 billion via syndicated loans last year. Before the end of this year, Vakifbank, Garanti Bank, Yap Kredi and Finansbank all have syndicated loans that will mature.
The possibility of a Fitch downgrade - coupled with an expected interest rate rise by the U.S. Federal Reserve before the end of this year - is likely to push up the cost of rolling over that debt.
"Borrowing costs will increase by 50 basis points. If the Fed raises rates, this may also add another 35 basis points," said Atilla Yesilada, an analyst at Global Source Partners, who advises foreign investors.
However, once political developments are added to the mix, the rise could end up greater than this. "If we consider the political risk premium, foreign borrowing costs may go up 100 basis points, Fitch's downgrade will add another 25-30 bps on top of that," Yesilada said.
Despite the expected impact on the private sector - which has total external debt of $299 billion, a little over half of which belongs to the financial sector - bank bosses are so far putting on a brave face.
"There may be some increases in banks' foreign borrowing costs," said Hakan Binbasgil, chief executive of Akbank, one of Turkey's biggest lenders. "But the increase will be limited to 25-50 basis points, which is not very significant."
Erdogan is dismissive. "They suddenly cut our rating. So what?" he said of Moody's, adding that nobody took ratings agencies seriously any more. "Cut Turkey's rating as much as you want, this isn't the reality in Turkey." (Editing by Luke Baker and David Stamp)