Turkiye Garanti Bankasi AS

IST:GARAN.E

Earnings Call Transcript 2023-Q1

[Operator]

Hello, and thank you for joining us in Grananti BBVA's First Quarter 2023 Financial Results Webcast. Our CEO, Mr. Recep Baştuğ; our CFO, Mr. Aydin Güler, and our Investor Relations Director, Ms. Handan Saygın, will be presenting today. As always, there will be a Q&A session following the presentation, and you will be able to ask your questions either via raise your hand button or by typing done into the Q&A area.

The presentation will now start, so I'll leave the floor to our presenters.

[Handan Saygın, Director, Investor Relations]

Good afternoon, everyone. Here we're again starting of another year with a strong beat to expected results. As sustained core banking earnings outperformance, once again underscores our key differentiation. Before getting in detail on the financials, let me, as usual, quickly remind you the macro environment we were in in the first quarter 2023. The main highlights are that the economic growth momentum, despite the negative impact from the devastating earthquake and approaching elections remains strong.

Throughout the year, what will support this is the expected fiscal expansion and better global outlook. We expect GDP growth to be 3% in 2023. Regarding budget deficit, we expect tax revenue growth to weaken in 2023 versus the prior year, due to our expectations of relatively weaker economic activity. Accordingly, we expect the budget performance to be worse than midterm program targets, due to further deterioration led by the reconstruction efforts in the earthquake affected areas.

Even though we project the budget deficit of 4.6% for the year, March figure was only 2.6%, so it seems budget deficit is faring far better than we may actually be proven wrong in this projection. Inflation wise, we expect annual CPI to come down further to 40%, 45% range just before the elections and year-end inflation to be 45%.

The supply disruptions in the earthquake region is expected to pose an upside risk on inflation outlook. On current account deficit, expected adjustment in activity after the elections and a promising tourism season might help the deficit to end the year at near $35 billion, which is around 3.5% of GDP. As a further reminder of the environments that we were in, the highly challenging regulatory environment prevailed also throughout the first quarter, and we continued our swift adaptation with sustained improvement in core banking revenues and as well proved our resiliency in earnings outperformance.

Even under such challenging regulatory backdrop and about [TL 10 billion] [ph] lower CPI linked revenues quarter on quarter, we could book [TL 15.5 billion] [ph] of net income in the first quarter of 20 23, representing a quarterly earnings of 22%, which is most likely the lowest among peers, and an annual improvement of 87%. Even better representation of the banking performance is the sustained growth in core banking revenues by 7% Q-on-Q, and 62% year-on-year.

Results suggest sustained outperformance to expectations, as well as peer comparisons, especially in the fundamental core banking areas. The growth in core net interest income, meaning with the inclusion of swap costs and exclusion CPR revenues was 1.6 fold. Net fee and commission income was 2.1 fold and subsidiary income was 2.4 fold that of last year's. And operating expense growth in the quarter was managed in-line with guidance.

What is behind our sustainable growth, profitability, and strength is our disciplined capital allocation. In the quarter, given our strategically managed loan growth and regulatory imposed lirization targets, Turkish lending growth was a mere 10% as guided actually, and Turkish deposit growth was a significant 32%. In terms of profitability, return on average equity of 38% and a return on average asset of 4.5% in the first quarter, suggests outperformance to our operating plan guidance, as well as improvement versus same period last year.

The drop in return on equity and return assets versus year-end results is purely attributable to the exceptionally high CPI linked revenues of last year. Looking briefly also to some key performance indicators showing our strength in liquidity, provisioning and capital is that in the first quarter, for the first time, it's not ever for – at minimum last 15, 20 years, our Turkish loan to Turkish lira deposit ratio dropped below 100% to 93%, and our foreign currency loan to deposit was at 60%.

Our cash provision coverage of 4.8% is double the level of our [NPR ratio] [ph]. Our total free provisions of [TL 8 billion] [ph] remains on balance sheet, and our consolidated capital adequacy ratio of 16% suggests a well-capitalized level.

Now, Let me explain the components leading to these solid results. As of the first quarter end, our assets reached [TL 1.5 trillion]. In the quarter, even though the regulatory requirements lead to an out of an ordinary increase in TL securities, the highest weight in assets remained to be customer driven with loans’ share in assets of 55%, pointing to our core banking priority.

Securities share reached almost 17%, due to [TL 40 billion] [ph] fixed rate security additions booked to meet the regulatory requirements. Accordingly, the share of fixed rate in TL securities went up to 39% from 28%, with rest being CPI linked and FRNs. Note that all of the new additions are booked under our help to collect portfolio so to eliminate the value fluctuations affecting capital.

Total loan growth in the quarter was 9%: 10% growth was in TL loans. And 3% growth in foreign currency loans owed to the current attractive spreads on export loans. Continuing with TL loans on this page, Slide 8. Our performing loans reached TL 520 billion by end of the quarter. Both the magnitude and the area of lending was shaped in-light of the new regulatory framework and closely monitored.

Accordingly, TL loan growth cut pace to 10% in the quarter from the mid-teens in prior quarters. Relatively higher growth remained in credit cards and consumer loans with 28% and 16%, respectively, while business loan growth turned negative on a consolidated basis. Accordingly in the pie chart, you will notice the growing weight of consumer and credit cards and 45% share in total for business loans.

We have a leading position TL loans, consumer loans, credit cards among private banks with market shares of 19.5%, 20%, and 23.3%, respectively. In-line with the regulations, limiting lending, and negatively affecting business loan growth, in business lending, we lost last year’s market share gains in one quarter. And now have 17.5% market share. SME loan market share loss, though, was relatively limited and our market share remained above 20%.

Moving to the Funding. Deposits dominate the funding sources. Both time and demand deposits, as well as deposit like TL bonds issued and merchant payables fund nearly three quarters of the assets. Demand deposits alone continue funding more than 30% of the assets despite the more attractive FC protected time deposit scheme rates.

Even though there has been a regulatory driven increase in the avg interest earning assets due to the securities portfolio additions in the quarter, free funds, meaning demand deposits and free equity total, still remain very high, but mathematically speaking, now fund 38% of the interest earning assets versus 50% last year. This inorganically lower rate of 38% is still superior and differentiates us.

Borrowing’s share in funding assets has been further reduced down to 6.9%. Total external debt is now $4.4 billion, and you can see the foreign debt components in the pie chart on the bottom right hand side. That is predominantly securitizations and syndications. Against this total debt of $4.4 billion, of which $1.4 billion is due within a year. Our total foreign currency liquidity buffer is $5.3 billion. So, still sustaining almost four-fold the short-term need as buffer

The drop in foreign currency liquidity buffer in the quarter versus year-end directly relates to the regulations supporting liraization, which you will clearly see on next slide where there has been accelerated growth in Turkish Lira deposits in the quarter, supported by the liraization efforts. The drop you see in foreign currency deposits fueled the Turkish Lira time deposit growth or in other words foreign currency-protected TL time deposit scheme.

So, there was an extraordinarily high growth of 40% in Turkish Lira time deposits in just one quarter versus 11% growth Turkish Lira demand deposits. Even though, this regulations imposed much higher growth in Turkish Lira time, diluted our Turkish Lira demand deposits share in total to 22%. With demand deposits exceeding [TL 125 billion] [ph], we still hold the highest Turkish Lira demand deposit base among private peers.

And this differentiating strength manifests itself in our superior margin performance that is on next page. Even though our superior core margin generation capability, which our legacy, remains; a quarterly drop in margins was well anticipated, especially from its peak level at end of last quarter. Quarterly margin drop was a significant 614 basis point, largely due to CPI adjustments. We used 35% inflation estimate in our CPI value calculations in the quarter.

The quarterly drop in the core margin was well anticipated and guided given the regulatory price caps on lending and the removal of the deposit price cap on the foreign currency protected deposits. Core margin drop on the other hand, was relatively limited to 125 basis point quarter-on-quarter from 5.7% in the fourth quarter last year to 4.4% and it was flat year-on-year.

In here; we admit we will be seeing a lagged effect of deposit costs in the second quarter. First quarter core margin reading of 4.4% includes a limited quarterly average time deposit cost increase of 50 basis points. Also, it will be fair to show the effect of increased funding costs that were in the form of option premium costs offered to FX protected deposit holders, booked under the trading line.

Adjusted with those costs, quarterly core margin drop was actually – could have been actually 217 basis points, bringing the core margin to 3.1%, which is still a level that is superior in the sector.

Now, moving to the subject of asset quality, the main message here is that we continued to prudently increase provisions. The share of stage two hit 14% level and increased from TL 107 billion at year-end, to TL 120 billion, mainly with files that are impacted by the devastating earthquakes. Earthquake related files now make up10% of stage two and has 8% coverage.

Even though, this has caused a slight drop in the stage two coverage ratio to 18.4%, the coverages remain very strong. Where avg foreign currency loan coverage is 28% and SICR portion is actually a very low risk. Of the first quarter 2022 SICR portfolio, only 1% ended up in NPL by end of first quarter 2023. As for the NPLs, NPLs are on an improving trend helped also by the low interest rates customers have been enjoying.

The increase seen in the net new NPL in the quarter relates to the temporary booking of one big file that was under the Credit Guarantee Fund program, so it is soon to be recovered. Despite an improving NPL ratio, we continue building provisions. With total provisions exceeding [TL 41 billion] [ph], we have the highest provision level in the sector.

How this translates into risk costs or provisions, you can see on the next slide where net cost of risk ended 80 basis points in the quarter, of which 65 basis points was due to the impact of the earthquake. Just to remind you and explain you the reason for the quarterly seeming drop in provisions that has to do with the big bulk set aside in the last quarter post our annual IFRS9 model recalibration.

Moving to the topic of net fees & commissions, we could more than double our net fees & commissions on an annual basis and grow by 8% on top of last quarter’s high base. [TL 6.6 billion] [ph] of net fees & commission generation capability in just one quarter is owed to the strength in relationship banking and digital empowerment.

Main contributors remain; money transfer fees where our Number 1 rank in here is a clear representation that customers choose Garanti BBVA as their main bank. Besides the money transfer fees, payments systems, as well as cash and non-cash fees’ contribution to net fees & commissions growth remained high.

Moving on to the operating expenses. Year-on-year OpEx growth was 127%, of which 9% was due to the currency depreciation that is fully hedged. Still high annual growth can be explained with low base affects as the multiple salary adjustments we had last year occurred post first quarter So, expect the growth in operating expenses to converge to guided level of 100% by year-end.

Quarter-on-quarter growth of 31% includes earthquake related donations and costs related to relief efforts, as well as SDIF premium increase that typically hits first quarter. Given the operating circumstances in the quarter, cost income ratio at quarter-end was 38% and fees coverage of OpEx was 55%. Regarding capital, capital remained strong. Income generated in the first quarter alone could compensate the operational and market and credit risk increase starting a New Year.

The drop in the capital allocation ratio to 15.9% at quarter-end relates largely to the dividend payment and regulatory changes that lead to increase in risk weights on commercial loans and general purpose loans. We sustain our strong capital buffers. We have [TL 44 billion] [ph] of excess capital on a consolidated basis and without any forbearance impact. And as a secondary buffer, we still hold on to our [TL 8 billion] [ph] of free provisions.

If we were to include free provisions as part of capital, that would take our capital adequacy ratio to 16.5%. On top of this, if we were to include also the BRSA forbearance impact, it would add another 31 basis points, technically carrying our consolidated capital adequacy ratio to 16.8%. The foreign currency sensitivity on our capital adequacy ratio is that for every 10% depreciation, it is 35 basis points negative. Now, this wraps up our financials’ presentation.

Now allow me also to inform you on our value creation on the non-financial side as well. Now, one of the highlights that marked this quarter is our announcement of interim decarbonization targets for 2030 to achieve 2050 net zero. We are the first bank from Turkey to do so. Open banking was one of the most important agenda items and like always we were one of the pioneers. And now we are happy to say we are a hub for other banks’ accounts.

We are our customers’ first choice and the numbers clearly support that. With 13.4 million mobile customers we have the highest digital and mobile customer base. Diving deeper on our value creation; and starting with employee satisfaction which is crucial in our value creation.

Our hybrid working model allows for a healthy work life balance. We are proud to be included in Bloomberg Gender Equality Index for 7 consecutive years. And these contribute to employee satisfaction, resulting in a poll result that was 4.3 out of 5 and that is far above the sector average reflecting on our employee loyalty.

Creating sustainable value beyond serving the largest customer base is our goal. Recently launched “Ecological Steps” helping our customers track their carbon footprint with easy and fun tasks. Gamification is an important tool in taking care of our earth, and taking care of our future. In-line with responsible banking model, for us sustainability has moved beyond financing.

We have so far mobilized [TL 57 billion] [ph] in sustainable business. We also focus on managing the direct impact we have through our community investment programs. As of 2022, our contribution reached [TL 72 million] [ph]. Along with these, we care about what we shouldn’t finance.

We have been carbon neutral since 2020 and as you will notice on the next slide, we have been the first Turkish Bank to set and announce interim decarbonization targets for 2030 in four carbon-intensive sectors: power, automotive, iron & steel, and cement in-line with the PACTA methodology.

With the targets we set as part of the PACTA methodology, we track our customers' progress in their decarbonization processes and offer them financial support for their investments in new technologies and production methods along the way. We are proud to say that our efforts on these issues are recognized by various credible international agencies. We are included in 11 sustainability indices.

To name a few for instance in Dow Jones Sustainability Index, we raised our score from 75 to 83, which the fifth highest in global banking sector. We are qualified for the Global A List in 2022 in the Climate Change Program of CDP as the only Turkish bank, CDP as you may know is a well-recognized environmental reporting initiative. And with all these great results in our financial and non-financial strategic performance indicators, it is no surprise that we rank first in brand power among private peers and ranked number one in Net Promoter Score for SME, Commercial and Mobile banking.

Now, this concludes our presentation and we leave the floor to you for questions. Thank you for listening.

[Operator]

[Operator Instructions] So, our first question comes from [Waleed] [ph]. Hello [Waleed] [ph].

[Unidentified Analyst]

Thank you for the presentation and thank you for the detailed remarks in terms of highlighting Garanti's stronger balance sheet profile. So, I mean, continue with that, I wanted to ask two questions, which are interlinked. Number 1, given that there is expectation around policy normalization during the second half of the year, if you could share to the extent you can, some results from stress tests in terms of how you've, kind of stress tested the balance sheet to different scenarios, whether it's FX devaluation or a sharp increase in rates that will be quite helpful if you can share that?

Secondly, I mean knowing the profile of Garanti and how you've actually navigated previous episodes of economic uncertainty. Just wanted to, kind of get a sense of the agile management techniques that you would have or deploy as we move into a more normalized or more, kind of orthodox policy environment in terms of how you intend to deal with your bond portfolio and risk management? And perhaps linked to that, if you can talk about any potential for risk weight optimization that you can undertake as well. Those will be my questions. Thank you very much.

[Aydin Güler, Chief Financial Officer]

Okay. Waleed and thank you for joining and asking the question. Firstly, related with the stress test, and I think this covers the remaining part of your question first, interest rate. Our balance sheet is very well prepared for any outcome because our duration gap in TL balance sheet is less than three months. But the most important thing is that the correlation between inflation policy rate, loan rate and deposit rate has been broken. These rates must have a certain relation among each other until that correlation is established again, bank will operate with negative spreads and normalization will take some time.

Secondly, exchange rate in Turkey banks does not carry material currency risk and balance sheet. While banks assets are growing, their foreign currency assets are shrinking. Only high-quality foreign currency assets are left. Therefore, we don't see any NPL risk for the sector due to exchange rates. Thirdly, asset quality, we expect NPL inflow to remain under control as the strong economic activity helped real sector's profitability.

Retail and wholesale have benefited from the low interest rate environment in the last two years, therefore, cost of risk faring at low levels. In case of interest rate hike, there will be an adjustment not in 2023, but in 2024 and 2024, we may consider normalized net cost of risk level as 125 million to 150 million levels. To sum up, what can I say as proven by our track record, our balance sheet is very well positioned for any outcome.

Second question is related with capital adequacy ratio and interest rate impact on that. So interest – increase in interest rates affect negatively the valuation of held to collect and sale portfolio and capital ratio. But loan rates will also increase if there is an increase in interest rates. And as I said, our duration gap is very suitable for adaptation to the new environment.

So, we will start seeing expanding in margins, but of course, lending demand will also cut face in an increasing interest rate environment. Since there are many moving parts in the balance sheet, it wouldn't be fair to give you a figure as there is no linear correlation. So, my comment is that our balance sheet is very well-positioned for any outcomes. So, we are able to manage our capital adequacy ratio easily in this volatile environment.

[Operator]

[Operator Instructions] Seems like we have a written question from [indiscernible]. So he asks, what is the current share of CBI pledged fixed rate long-term bonds in your total assets? Can you provide capital sensitivities to higher interest rates arriving from the secured portfolio?

[Aydin Güler, Chief Financial Officer]

So, the regulatory was our security portfolio increased about around TL 50 billion amount. And we are able to manage this environment with these levels. So, what you have seen in the balance sheet will be the final amount of fixed security. I think this answer is enough. Okay.

[Operator]

Thank you. Our second written question, sorry, can you please elaborate on sustainability of much muted deposit cost increase in first quarter?

[Aydin Güler, Chief Financial Officer]

The deposit cost increase was limited due to two reasons. We met 60% results towards the March and therefore, cost of deposits will come with a lag. Secondly, what you don't see directly under NII is the premium cost paid to customer around the FX protected deposit scheme to support conversion. We transparently presented it in our net interest margin chart.

However, I should also underline that this cost did not get fully reflected to the bottom line as we had hedging instrument that could largely offset this premium cost. And thirdly, always, I'm proud of saying that we are able to generate low cost of deposits, compared to the market conditions. Okay.

[Operator]

Thank you. We have a third question, a written question again. What is the biggest risk in the sector?

[Aydin Güler, Chief Financial Officer]

The risk in the sector, we may talk about three main topics. The first is margin management. The correlation between inflation policy rate, loan rate and deposit rate, as I said, has broken. This rate must have a certain relation among each other until the correlation is established again, we are going to be under negative margin pressure. So, although the sector's capitalization is strong, its current situation inevitably pressures banks’ profits.

Again, the profitability to last year's earnings were supported with extraordinary high CPI increase revenues. This year, due to lower CPI reading and expected core margin suppressions, earnings will be lower. However, in the long run, it will adjust when the correlation among interest rates are reestablished. We are currently in a transition period.

Thirdly, the biggest risk item in the sector for the next three years is cost of acquiring customers. Half of bankable population is already guaranteed customers. The important thing is how to deepen the relations with this customer. Current competition is based on acquiring customers at all costs. The [rate of] [ph] promotions paid to the salary customers in OpEx will increase significantly. And unfortunately, these expenses will not translate into profit for the banks.

[Operator]

Thank you. Seems like we don't have any more questions. So, this concludes the Q&A session. I now leave the floor to our presenters for closing remarks.

[Aydin Güler, Chief Financial Officer]

Thank you all for your participation. I would like to once again remember our citizens we have lost in the devastating earthquake. There is still damage that need to be repaired and we will heal our wounds together. Start to 2023 was strong, and we achieved a strong set of results demonstrating our residency under any circumstances. As guaranteed, we are ready with our strong and healthy balance sheet [composition] [ph]. We will continue to generate high quality and best-in-class earnings in 2023 under any circumstances. Thank you for your support and trust in us. I wish you all the best.