Turkiye Garanti Bankasi AS

IST:GARAN.E

Earnings Call Transcript 2019-Q2

[Handan Saygin, executive]

Welcome, everyone. We're very happy to host all of you here in our head office, the ones joining through the conference call and the ones attending through the web stream. We are here with our CEO, Fuat Erbil, and our CFO, Aydin Güler; and myself, Handan Saygin, Investor Relations.

Now we'll be presenting you today our 2018 and 2019 plans, along with the strategic journey -- just a moment. So there are 3 parts in our agenda. So I'll give you a quick wrap-up on the 2018 status, what we based our operating plan, the 2018 numbers. And then we'll disclose our 2019 operating plan. And then I'll leave the floor to our CEO to talk to you about our transformation journey.

Now let's start with the market position. I mean just to remind you that we're very happy and that we lead among the peers in terms of profitability. We have the highest ROA, highest ROE among the peers. We ranked top not only in the profitability but also in the capital levels, highest core equity Tier 1 level we have. And we were the ones that could distribute the highest dividends in 2018.

And moving on to the revenue items. Not only we have the highest NIM level among the peers, but also, the performance has been consistently the best. And again, this is one area we lead along with the net fees and commissions, again, in that line. Again, we have, by far, the highest net fees and commissions. And in terms of net fees and commission generation capability, meaning the -- its portion to interest-earning assets and the noncash loans, we ranked top. So with all the strengths, of course, we were able to achieve last year, having the best cost income ratio, the most improved and the lowest cost income ratio among the peers.

Now on the 2018 status wrap-up. If you recall our initial -- I mean our guidance, 2018 guidance, we were expecting a Turkish lending growth of below 14%. Actually, the year started off quite well. In the first half, we already grew 9% in this line item but then, as you know, significant changes in the macro environment. The third quarter, it was pretty muted. And fourth quarter, we did see some shrinkage in Turkish lira loans. So most likely, the year-end 2018, we expect that to be in the low single digits.

So versus the guidance, yes, it's lower. It's going to be -- most likely end up to be lower. In foreign currency lending we said shrinkage, and yes, we do expect shrinkage. So that's an in-line guidance. In NPL ratio, we had to revise it in July that we're expecting 4% to 4.5% NPL ratio. Now we are -- we're revising that a little bit. There's a -- it's going to be higher, it seems, maybe near 5% levels, rather. And along with that, we are revising our net cost of risk, excluding the currency impact, to be rather near 250 or around 250. But the good thing is that despite these higher provision costs, the margin, including the swap cost and including the CPI, we'll be seeing a beat -- clear beat there given the high CPI rating, of course, and the core margin being strong. And fee growth, again, there's going to be a beat, it seems. We do expect around 30% versus our initial guidance of higher than 20% fee growth.

[Aydin Güler, executive]

Not initial, but...

[Handan Saygin, executive]

Well, during the year, [indiscernible]. You also may have expected in the first 9 months the performance here on [ it ] remained above 30%, and it seems like we're going to finish the year above 30%. Of course, this is something that, again, helped by the interest rate level, and that's impacted our payment systems, fee generation positively during the year.

So OpEx, growth-wise, if you recall, we had guided around average CPI OpEx growth. And right now, you may also recall from the 9 months realization that this is significantly below the average CPI, and it seems we're going to be finishing the year above -- I'm sorry, below average CPI. So there's a beat there as well.

[Aydin Güler, executive]

Which is there is CPI of...

[Handan Saygin, executive]

Average CPI of last year -- actually, it's like 2016, not last year. Last year, like 20%, if we take. So there's going to be -- it seems we'll be sustaining the first 9-month performance by the...

[Aydin Güler, executive]

Much less than 20%. I think it's fair to comment on this issue.

[Handan Saygin, executive]

So -- yes. Okay. I'm sorry. So these clear beat line items were good buffers to compensate the higher-than-anticipated provision costs, basically. So I'm very happy to say that -- glad to say that even though there are some changes in some line items in terms of beats are being lower, in terms of the ROE, when we take into account -- adjust for the free provisions we have set aside during the year, we'll end up getting to the ROE that we initially anticipated. So -- but we did continue -- just to give you in parenthesis, we did continue setting aside free provisions in the fourth quarter's after the third quarter's figures.

Now...

[Aydin Güler, executive]

So -- but very, very -- in summary, we took the advantage of the last quarter's extraordinary CPI income to set aside better provisions. As you can see here from the increase of cost of risk, that's the pure source of this increase as well as free provisions. So by having this opportunity in the -- especially in the last quarter, so we just make those adjustments for the year-end but maintaining the ROE level, including the free provisions around 17%, which has been the guidance for the whole year.

[Handan Saygin, executive]

Okay. Now let's move to the main agenda item, 2019 operating plan. What we based our plan -- the macro assumptions that we based our plan on is that we're expecting a GDP growth to be lower next year but still remain in the positive territory. And -- so our assumption is that it's going to be 1% next year. I mean not next year. We're already in 2019, sorry. And in terms of the funding costs, the interest rates, we do expect to get some -- we do expect that Central Bank remains tight until they see a permanent recovery in inflation outlook. And it seems like by midyear, it is possible that they may start lowering interest rates and maybe end the 2019 year-end with 20% rate. In terms of inflation, these tight policies were able to curb the worsening inflation. So we believe we saw the worst reading in inflation already in 2018, and we're expecting to end 2019 with 16% inflation.

So now based on this macro, how will our balance sheet look? We do project a loan-driven asset composition to remain. So loans in assets, it seems, year-on-year, they will be slightly lower, but that has to do mainly with the -- with our new subsidiary that's now moved from the loan line to others, our LYY, the new Otas-related subsidiary.

And in 2019, in terms of asset growth, we're expecting around 5% growth, TL lending growth to be around 5%. We do expect the shrinkage in foreign currency loans to continue and be around 10% next year. So this alludes to a lending growth, basically, that's parallel to the asset growth around 5% for total lending.

[Aydin Güler, executive]

With the assumption of Turkish lira against dollars, will be 6.10 end of the year.

[Handan Saygin, executive]

Yes. So the depreciation is assumed to be in line with the inflation.

So moving on to the -- like what makes up the loan growth is that, yes, I mean, relatively, we're expecting a muted loan growth in 2019, but the growth will remain, and the leaders of the growth will be, again, the Turkish lira business banking and credit cards. So Turkish lira business banking loan, we're expecting 10% growth, and in credit cards, 15% growth, whereas on the consumer loans, we're expecting shrinkage. Why is that the case? It's mainly due to the fact that we will be having the highest level of maturity hitting 2019, and we don't anticipate the demand to be strong to cover this maturing portion.

So in mortgages, we're expecting 10% shrinkage; in autos, 10% shrinkage. In general purpose lending, though, where we believe we can maintain flat loan book there because, as you know, these are small ticket items and with average duration 1 year, so we think we aim to keep that book flat next year.

[Aydin Güler, executive]

And the reason why we're having better growth estimation for the credit cards because of the base effect, number one. Number two, we just launched -- actually, soft launched already a credit card program for travel and entertainment, Shop & Fly. So we believe that this will give us another buffer to grow more than the market for the next year.

[Handan Saygin, executive]

Okay. On the foreign currency front, foreign currency loans, we do expect the downward trend to continue, especially due to the lack of demand and significant reduction. So as I mentioned earlier, we're expecting 10% shrinkage -- further 10% shrinkage in foreign currency lending in 2019.

Now moving to the funding part. The funding will remain to be deposit-heavy, and customer deposits, we do expect some increase in the weight of the assets from 58% to 61%. So that will allow us to -- also given the loan growth projections, that will allow us to manage the loan-to-deposit ratio -- total loan-to-deposit ratio around 100% in 2019. So you're going to see further improvement.

[Aydin Güler, executive]

But we're ending 2018 to -- very close to 100%.

[Handan Saygin, executive]

Yes. Already there. So it seems we'll manage -- we'll be able to easily manage around 100% level.

And in terms of the foreign currency borrowing, that borrowings portion, you see that it's coming down from 19% to 17%. That has to do largely with the fact that, as I mentioned, the foreign currency loan book has been diminishing and has been -- we're coming from 20% market share levels back in 2010 to 10%, most likely, we expect by year-end 2018. So the need to fund the foreign currency loans, this has come down. The need to also raise foreign currency funding has diminished.

We have eurobond redemptions coming up in July and October for EUR 500 million in July and $750 million in October. And then we have syndication rollovers. But in our operating plan, we did assume lower than 100% syndication rollover mainly due to the high cost. And also currently, we do have comfortable liquidity. But overall, our approach in this foreign currency borrowing is that we will continue to be opportunistic there. So if market conditions are attractive, we'll try to get in there but with the focus mainly to extend the maturity.

[Aydin Güler, executive]

I think it's worth to mention, we've been always sharing with you and with the investors the levels of -- the level of the buffers, foreign currency liquidity buffer that we're carrying. Maybe you remember, it was -- almost all the time is around $10 billion. As of now, it is $11.2 billion, $11.3 billion. So with this figure, I mean, the recent history, I mean, including before these turmoil times, we've been getting the highest level of foreign currency buffer. So this will give us, as Handan stated, more room to be opportunistic in our wholesale funding strategies throughout the year.

So if you find it opportunistic, and of course, we're going to tap it, but we don't push ourselves to roll over every coming issuances, including syndications or eurobonds or whatsoever, with 100%. We will be more -- we will have more balanced approaching that includes liquidity concerns but as well as pricing.

So that's why our borrowings will shrink in the total liabilities from 19% to 17% going forward in favor of deposits. So we'll be increasing our customer deposits in that respect.

[Handan Saygin, executive]

Now let's look at the -- what's going to happen to margins. For that, let's start with the spread. Now in the last quarter of 2018, there was a period that we saw actually a negative TL loan to TL time deposit spread. Well, including demand deposits, we didn't see negative, but this is the spread versus TL time deposits. And by December, it did improve. And now projecting this spread-out, it seems the core spread expansion will be continuing into 2019 and '20. So yes, we're being squeezed at this time. But when we take into account also the focus of our -- for the low-cost deposits, our strong demand deposit base, which makes up about 1/4 of our total deposits, the projection doesn't look that bad. And it seems like excluding the CPI, we'll be able to maintain the core margins flat year-on-year. So 2019 margin, excluding the CPI, we expect that to be flat year-on-year. But in 2018, in the core margin, the last quarter, as I mentioned, because of the spread, we will see some hit. So the core spread, there will be some slight suppression. So over that, we do expect flat 2019. But looking into 2020, it's -- the projection in that, there's going to be a significant recovery in the core margin in 2020.

Now taking into account the CPI portion, I mean, I'd like to explain it differently because last year's CPI was record CPI. So we did enjoy those windfall gains, and it doesn't seem it's going to repeat next year. So the CPI will have a pressuring effect on the overall margin. And so including the CPI, it's inevitable right now that we're going to see some margin suppression in 2019. On the foreign currency front, you see on the...

[Aydin Güler, executive]

No major change.

[Handan Saygin, executive]

No major change. So -- and also, in terms of the swap utilization, again, we'll continue our opportunistic capping there.

[Aydin Güler, executive]

I think in terms of spread -- Turkish lira spreads, I can safely say that we have seen the worst spreads in Turkish lira last year in November -- October and November. And by that point on, the spreads start to get better and better, but the recoveries improvement is not impactful yet. As we have stated here, the 1% difference between 23 and 22 is a little bit improved. But this pace is highly correlated with the rates of the Central Bank. In our assumption, this will take maybe after May, maybe after June, so that we will be enjoying much better improvements in terms of spreads in the second half of the year. I mean that's another safe bet that we can share with you.

And one thing related with the CPIs for your calculations, very roughly, we'll be recognizing around TRY 6 billion 2018, income coming from the CPI linkers. Based on our inflation assumption of total assumption, that will be decreasing to TRY 4 billion, and the TRY 4 billion itself is still a good amount of money. But comparing to last year's extraordinary TRY 6 billion, so expect TRY 2 billion net income -- sorry, gross income shrinkage coming up from the CPI linkers. That's gross.

[Ali Erbil, executive]

That 25.24 [indiscernible].

[Handan Saygin, executive]

Thank you. Now the most fixed guidance line item, asset quality, let's move on to that one, which is not always the easiest part to predict given our highly dynamic operating environment. So as always, we do choose to guide you as conservative as possible in this line. So taking into account this conservativeness, let's say, we are projecting an NPL level that's less than 7%. Now how we get to this level is that now in the new NPL inflows, we think we'll be lower, especially upon the fact that most of the big ticket items were already accounted in 2018, especially in the last quarter. And so year-on-year, when we just look at the new NPL inflow line, it's going to be lower. We do expect lower. However, we do expect higher inflows coming from the retail portfolio. I mean we haven't seen much in 2018 in [ slow-term ] retail. But in expectation of the lower GDP growth, higher unemployment rates, we're expecting some inflows from the retail portfolio.

Also in our assumption lies a collection performance that's lower than last year, about 1/3 lower than 2018. So combine that with the denominator, not as much growth in Turkish lira lending. We're expecting an NPL ratio below 7%. And the translation of this into the total net cost of risk, we're projecting a net total cost of risk of below 300 basis points. So this is where we stand in terms of the...

[Aydin Güler, executive]

As Handan stated, maybe I'm rephrasing again, it's not easy item going forward to forecast, to estimate the budget. These 2 ratios, because NPL ratio is -- you cannot control much because the denomination effect is always there, number one. But cost of risk, more importantly, we did approach, as always, very prudent, very conservative. So what we believe, as of now, most of the big tickets asset quality story is almost over. But next year will be in terms of growth, in terms of inflation and so on and so forth, macro-wise, not an easy year. So we're expecting the smaller tickets from the retail portfolios, and [indiscernible] portfolios, will continue to deteriorate. So we're bringing some pressure on the NPL ratio as well as net cost of risk. So we try to be as conservative as possible. And hopefully, we will come up with some upsides if we can here.

And the debt 300, as an example, based on some macro assumptions, which are the macro realities 2, 3 months ago, so we have seen a better outlook in terms of macro now and going forward. So that will hopefully positively impact in our IFRS models for the upcoming provisions. But again, take it around 300 for your conservative analysis studies. Hopefully, we'll update you -- guide you in time. So this year is going to be a very difficult year for us to promise, especially on this slide, anything specific for the next 12 months. Hopefully, it will -- coming up better guidance’s throughout each quarter.

[Handan Saygin, executive]

But, of course, our prudent provisioning always serves as a good cushion, especially in a decelerating economy. So a little more well guarded. Would like to speak well, right?

Now let's look to the net fees and commission. The double-digit growth momentum will be preserved in 2019 as well after a significant increase in 2018 of 30%, around 30% that we anticipate for 2018 year-end. The growth will be mainly coming from the payment systems. And payment systems, recall that they contribute more than 50% of our net fees and commission. So we do expect about mid-teens net fees and commissions growth coming from the payment systems and money transfer fees, whereas on the cash and noncash loan fees, we're expecting slight to slightly down. This is parallel to our lending growth projection.

[Aydin Güler, executive]

But again, this is -- remember, last year, when we were here, it came up with the same low teens guidance for fees and commissions and also suddenly come up around 30%. So hopefully, it will come up some good surprise. But again, to be on the conservative side, make your calculations with your low teens in this front as well.

[Handan Saygin, executive]

Okay. Now lastly, let's also look at the operating expense items. Now cost discipline, you must have noticed, has been one of our top priorities for the last 3 years, and 2019 will be no exception. We are projecting the low CPI growth to continue in 2019 as well. Now, of course, there are uncontrollable facts causing costs to increase eventually such as the Turkish lira depreciation and high inflation. We got hit in 2018, but we managed it quite well, as I mentioned earlier. We project the impact of these 2 factors, TL depreciation, and the high inflation, to be in the low teens parallel to the macro expectations.

As you're aware, we've been implementing a new business model. Last year, we shared it with you, the branch model. The last 1.5 years, we've been working on this. And not only that but also, we've been investing in a grand technology hub in Pendik, like a space center. That project has been underway for a long time. Now these 2 visionary projects are now up and running, and therefore, we will be seeing the amortization costs hitting the OpEx line starting from 2019, from this year. So this impact alone will have roughly 2% increase in OpEx on a year-on-year basis. And despite this, the overall, again, we'll manage just below CPI.

Now also, in terms of the number of FTEs, you may have noticed actually has not been growing for the last 3 years, which is also true for our number of branches. Now this trend likely will remain the same as our new service model enables us to operate with much higher efficiency. And on the other hand, our HR strategy remains the same, and our HR costs are to increase above inflation.

And for the portion that's controllable, we will continue to work on projects to create further efficiencies and keep the OpEx growth below the average CPI.

[Aydin Güler, executive]

Yes. I mean I was going to mention 2 things. I mean as Garanti culture, we don't like to be showing off things, and we try to be more quiet than being on the stage. The IT compass that we built, I mean, we would like to host you there, but it's in Pendik. So it will take for you to go and come at least 3 hours for you. So we don't want to hear some more words from you, but I hope one time, we'll create an opportunity to show you. I mean we've been creating a hub -- I mean really, really something to be seen. So that is already effective end of this year. So all our IT operations and related functions, already more than fully based in Pendik and functioning from there, that's finished. And that will create some -- as you might guess, an impact on our OpEx. As well as our branch transformation, I will be giving the details in a few minutes, that's finished as well, end of November, and 97% completion. We call it 100% because the 3%, there are some special cases for the branches. So that's finished as well.

So those are creating the pressures on the OpEx, but we are still saying, and in the last 3 years, we are the true leaders of the sustainable efficiency performance. That will be the thing going forward as well, including 2019. So you will be seeing us not only best bank but also best efficient bank in the country. So this will continue.

[Handan Saygin, executive]

Okay. Thank you. Now we actually move to your presentation.

[Aydin Güler, executive]

So I don't want to bore you much, but I would like to give you, on behalf of our whole team, the transformation journey, some flavor from our transformation journey. So we believe that the transformation is happening for the last -- I don't know how many years or decades. It's because of the technology, because of the customers, because of the competition. So the technology has been changing, as you know, we've been following very closely. Drastically, that is impacting the customer behaviors and the needs. So their expectations are changing. And competition, I mean, so far, I cannot say that we've been threatened by the nonfinancials or nonbanks yet, but what we have seen, very good examples globally. So we have to be ready to compete or fight with this type of -- in a competitive environment. So that's why we've been transforming ourselves for many years, and this will continue.

So the very good example, as I already stated, the branch transformation project that we have started 1.5 years ago. The implementation took in 1 year, a little more than a year. So we have converted almost 97% of our branches to a new format. We call it internally the silent revolution. I believe it's a silent evolution because it was a really big thing, big project aiming a lot of things. But what we did in this project, we really -- the role of the new lobby service model, I think, designed, physically designed, not only physically designed but designed everything, including the process fees, including the customer journeys and try to make them as much as digital as possible.

And most of the efficiencies will come from the final item. We redefined the roles and responsibilities in the lobby levels. We used to have 5 different responsibilities and 5 different people working for that interesting specific responsibility, give merge under [ 2 ]. So this was the biggest challenge to converting our people overnight from one -- someone to multiple persons. So it was a very great project. It ended. So we converted all our branch network very successfully.

What we got -- actually, we aimed or we object our objectives in 4 pillars. Number one, it was the sales and efficiency improvements. These are the real figures that's reflecting the realities of the first half, to be frank because things are quite -- much quieter in the second half of the year. But what we have tested, what we have seen in the normal days, we improved our sales at least by 10%. So that happened. That has proven reality of this project.

Number two, we digitized all the processes, and we make them as much as digital and lean possible. So we'll be giving an example here. A loan, a typical branch loan is taking now 7 minutes. It used to be taking half an hour in the branch in terms of total process. It's 7 minutes because of the digital loan approval process. Now as of now, that 85%, I'm sure, about 90%.

Our main objective, one of our main objective was the employee is creating the better, more competent employees for the future of this bank in the branches. I think we're glad to say that -- I can say that we created that capacity and that competence in our branches. And customers has always been our first priority. What we have seen -- the waiting times in the queues are shrinking. And now I can very probably share with you that based on our NPS, Net Promoter Score researches, we are still, again, the #1 bank in the country in terms of Net Promoter Score or, in other words, customer satisfaction.

I think this project also has a lot to maintain this leadership in the customer happiness. But is this finished? Yes, the project is finished, but things are still under progress. As BBVA, our purpose is to bring the age of opportunity to everyone. This will be our motto. This will be our purpose going forward. So this means our transformation journey will continue.

What you will see us in terms of our transformation journey was all the building blocks. There are many that we can share with you that we've been concentrating on do-it-yourself. It has been very first priority for some time, and now it reached 93%, as far as I remember, 93%. Whatever you can do in the branch, you can do with digital in the consumer. 93%, I think, one of the highest levels globally. For the commercial clients, corporate clients, we're above 50%, yes. So we will be continuing to build more efficiencies and more flexibilities, functionalities and do-it-yourself.

The second pillar is the open market. Open market in -- I don't want to bore you in the details, but to serve any customer, that includes noncustomers of Garanti through not only Garanti channels but from everywhere. So that's the spirit. That's the objective that we want to position ourselves going forward. So that's why we call us not a digital bank but a digital company. There are a lot of things to do going forward, you might agree with me, but that is the clear vision for us going forward.

The third one is the touch points. We believe that, yes, technology is important. Efficiencies, processes are very important, but our people are the key assets of Garanti, has always been like that. So it will be like that forever. So what we try to do, we migrate the power with the technology power. The branch project was an example, good example as well as with the step platform. We've been sharing with you this step platform. That's the one app, one single app on our tablets. So that is the banking platform for our employees. So that makes our people mobilized. So that makes our people with the customers through technology. That will be our main vision, one of the main vision pillars going forward.

The other thing is the data and advice. I mean I can say that there are a lot of things to be done here. I don't think anybody is doing a great job globally, including big tech companies. So there's a long way to go, but our very core value proposition to customers is trust. So we believe that trust is coming with data and the power of data, sharing with the data -- of customers' data with us. So we're building our older processes and strategy and the policies regarding this data use, data efficiency and come up with the right advice, right solutions to our customers based on data, including to improve the customers' financial out. That will be another important pillar going forward.

And finally, we've been investing our business model for some time heavily. So the items here, I already mentioned to you the data-driven organization. That is one of the keys. Lean processes with engineering automation are the second part. AI is -- and the robotics, I mean, we started to use robotics, not the physical robots but robot algorithms in our operation centers by now. So this also will improve.

And finally, we've been transforming our organization, our [indiscernible] organization to agile organization. That has already started with the head office, and it will continue with many functions throughout this year.

So overall, this will be the main items in our efficient business model. Hopefully, we come up with more details.

So finally, to wrap up our expectation before taking your questions. Again, tough year, not an easy year, challenging year, but the good news is expected. So our approach not to face with the surprises, especially negative surprises, so we come up with this -- from this outlook, more robust, more conservative and prudent, as always, with some guidance’s to you. So Turkish lira loans, let me repeat, 5%, mainly driven from business lending, not from the retail, except credit cards. Foreign currency loans, no demand, not big investments in the country and a lot of redemptions. So that has been happening in the last 3 years. It happened in 2018, and it will continue as saw in 2019 as well with 10%.

NPL, we just comment on that. Net cost of risk like that. And hopefully, we'll come up with some upward revisions in a positive way in these figures. NIM, again, we come up with the conservative approach. Hopefully, second half of the year will be a better year than expected. So we come up with some improvements in the NIM margins. Figure of low teens, I don't want to make any further comments on the fee and the OpEx. And as a result, we're still under this conservative assumptions guidance as we still can come up with low teens ROEs.

So we believe that in a challenging environment like this, it's not going to be easy to come up with some good profitability. So under these circumstances, coming up low-teens ROEs is a good performance. But hopefully, this rebalancing period will end soon, end of this year. And hopefully, starting from 2020, it will come up much better ROE figures. As I stated here, we're not changing our midterm ROE targets at high teens, hopefully, for some years, above 20%.

So this is the summary and we are all now ready to take your questions. Right, Handan?

[Handan Saygin, executive]

Yes, please. Yes.

[Ali Erbil, executive]

One gentle reminder. Because of everybody listening to us on the video, could you please speak on the microphone and introduce yourselves. Thank you.

[Samuel Goodacre, analyst]

Yes. It's Sam Goodacre from JPMorgan. I've got a couple of questions. The first is on asset quality and, specifically, it relates to the expected deterioration in your retail portfolio. We've obviously had an early corporate cycle. What sort of cycle are you expecting from retail in terms of the duration and the magnitude? And can you share some of your expectations on the macro indicators that would impact retail? Was unemployment part of the kind of demographic that you think the weakest and that you are most watching as it were. So that's the first question on retail to quality. The second one is on fees. Because, of course, your guidance for 2019 is exactly what it was this time of year of 2018. And as you said, there's a massive surprise. How much of that surprise was under your control? And related to the transformation journey that you've just been speaking about, what elements of that transformation could you perhaps point to as future drivers of [ more volume ]?

[Ali Erbil, executive]

Thanks, Sam. Regarding the first question, the current picture, if I'm not mistaken, I'm going to give you rough figures. Maybe my colleagues correct me if I'm wrong. The retail portfolios, total NPL figures, including all products as of now is less than 4%. Including mortgages, including credit cards, including GPL, those 2 products are uncollateralized products, as you might guess, including the auto loans. So we're assuming the unemployment as of now is 11.3%, very roughly. This might go up about 13%, but not 14%, about 13% end of the year. That's our best case scenario. That's one thing in our models in that calculations for the NPLs and the cost of risk.

And number two, please do remind that the household debt to GDP is still 15%, 16% to GDP ratio or something like that, I mean, much less than before. So yes, there will be deterioration in the retail portfolio, as expected, within our figures. And what we try to do, come up with some worse macro parameters. We are modeling those assumptions for this retail portfolio. That includes higher unemployment, higher inflation and worse than the expected foreign currency after -- going forward, although none of them exposed to foreign currency. That is the main indicator for the whole economy.

So very -- in summary, very briefly, we tried to be as conservative as possible for the portfolio in our assumptions. That is already included in our guidance’s. But our real debt much concerned coming up from those segments going forward, not much relatively than in the past.

The second part of the question, fees and commissions. I'll give you one example. You have seen the average inflation expectation for 2019 is 19% and 55% of our fees coming up from payment systems. Payment system fees, 2 portions: merchant fees and the credit card fees.

We already increased the annual card fees, [ with interest ]. That same thing will be happening with the merchant fees. So I'll give you a tip for the upside. 55% of the portfolio, fees and commissions portfolio, is already linked with the CPI. So there might be some loss coming up from the cash loans, yes, true. Our cash loan portion is how much? 17%? 14%, 15% of the total. Expect 5% growth, 10% growth, much less than the inflation. So royalties are really, really low guidance. Hopefully, I mean, I don't want to promise again. What I guide you, in theory, low levels, but in terms of my hunches, it should be much better. Hopefully, our Board is not listening to me.

[Handan Saygin, executive]

Maybe one small reminder, if I may add. In the retail portfolio, the average ticket sizes are small. So I mean if we're seeing higher unemployment, like almost all of this unemployment is gone -- and their already existing interest rates are at attractive levels because they're fixed, rates. So don't expect as much flows as we received from those big-ticket items.

[Ali Erbil, executive]

And transformation, I think it's already happening. I mean, we call -- we don't call our transformation journey digitalization or digitizing ourselves, but it's the main -- the main part is happening. I mean, we've been the leaders for the last 22 years in this digital world. And I think we are the, by far, best performance generating fees and commissions from that segment. That's part of our transformation journey. And we're not losing any market share, we're not losing edge from that front. So transformation will further help to improve the fees and commissions going forward, hopefully. Sorry.

[Gabor Kemeny, analyst]

This is Gabor Kemeny from Autonomous Research. I would also ask about asset quality, as I think a key assumption of the 2019 [indiscernible].

[Ali Erbil, executive]

Your guidance cover for this year. Change your subject. You've been asking all the time asset quality questions. Okay.

[Gabor Kemeny, analyst]

So yes, the NPL formation, you are expecting to slow down and migrate to retail, I understand. And I'm sure you have done many sensitivities. And as you said, around your macro assumption, would you be able to give us a sense of how the asset quality metrics could look like if, let's say, we don't get a modest growth in the economy, but a more negative scenario with, let's say, a recession?

And the other question, I understand that you are expecting roughly 2-percentage point NPL formation in 2019. And the provisioning assumption, which is below 3%, suggests that you might actually over provide for the NPL. So that sounds very conservative. Are you expecting the additional provisions on the -- so what is driving the additional provisions on the Stage 1 and Stage 2 exposure, given that you see an easing in the macro parameters of your model?

[Ali Erbil, executive]

I mean that's the best case scenario. But in our -- the more conservative more -- worse scenario and worst scenarios, the NPL ratio, still within the single-digit levels. That is in our budgetary NPL scenarios. So I can state that NPL will stay single digits not only in our best scenario but in our worst case scenario. So that is one thing I can share with you.

The second part was the...

[Handan Saygin, executive]

The provision.

[Ali Erbil, executive]

I mean the bigger tickets, by nature, comes up with some collateral for the NPL. I mean as an example, a big company or a big project that always comes up with some collateral value. So when you go down for the SME portfolio that's also valid, it comes with the collaterals all the time. So the provision level is relatively less. But when you go a little further down for those credit cards, for those GPLs, for those retail portfolio, those are uncollateralized. So whenever you provision, you have to provision 100%. So that's not the case for the much bigger ticket items. That's why -- that is the main difference between cost of risk and the 2 percentage points of NPL increase.

[Gabor Kemeny, analyst]

And you mentioned a worst case estimate in terms of your NPL and provisioning sensitivity. Would you be able to give us a sense of what assumptions did you make in this worst case in terms of macro parameters.

[Ali Erbil, executive]

I don't have it with me, but -- and again, dollar goes up, again, about 7 -- negative growth to 2%, 3% negative growth in the country, 4% -- minus 4%, those are typical worst-case assumptions for our scenario. And I'm sure next question will be, in that scenario, what will be the level of the cost of risk? That will be less than or around 400 bps.

[Handan Saygin, executive]

We have Waleed in the front row.

[Waleed Mohsin, analyst]

Waleed from Goldman Sachs. A couple of topics I want to explore and I also wanted to talk about the asset quality. So given the news around restructuring of [ soccer club ] debt as well as news around consumer debt restructuring, which is -- probably will be undertaken by Ziraat bank. I just want to understand if this would have any implication for Garanti. And what kind of implications would that be? And secondly, have you seen any other incremental impact from Otas as some of your competitors have highlighted? So any impact from that?

And finally, linked to this point last quarter, you've guided for 300 -- below 300 basis points of net cost of risk for 2019. In terms of quarterly net cost of risk, most banks have talked about first quarter as being the most difficult. Where do you see first quarter net cost of this? Or where would you see peak net cost of risk on a quarterly basis?

[Ali Erbil, executive]

[ Soccer clubs ], we will have no exposure to [ soccer clubs ]. So are not getting involved in the restructuring of the [ soccer clubs ] process. We don't know anything related with that. For the debt, especially the credit debt, restructuring announced yesterday. And very frankly, we really don't know the conditions of the restructuring program, whom are eligible, in what terms. And in terms, meaning, we know the loan structure, but we don't know who are eligible, what makes you go and get the loan, we really don't know. So I cannot give you the neat picture regarding that. But I can share with you for our credit card portfolio, NPS ratio is 4.3%, and the total book of our NPL is like TRY 1.1 billion.

So if that portfolio moves in, I think that's not a very bad news for Garanti for the micro level. So -- but again, I cannot make any comment regarding how much will be the impact and so on and so forth without knowing the structure yet. Unfortunately, we cannot share. I cannot share with you. If I knew, I would do so.

[Waleed Mohsin, analyst]

[indiscernible] the one they have difficulties, not the [indiscernible]. So they have the eligible...

[Ali Erbil, executive]

The definition is not clear. Are those NPL customers eligible or delinquent customers are eligible and so on and so forth. So -- but again, we'll let you know as soon as we have the information. The Otas, I'm sure you heard from our dear friends yesterday or today regarding Otas and the structure, the same structure applies to us. So this means 33% write-off. The remaining will be now, as a single loan, it will be, as Handan stated, in the first quarter, most likely, will be the equity and loan swap 20% to 80%. This means we'll be some kind of positioning that company as our subsidiary with 20% of the remaining growth.

So in total, the total amount written off plus equity will be 50%, maybe a little bit more than 50%, very roughly. So that's the thing I can share with you. Anything else, I don't have any other information. So what was the last question?

[Handan Saygin, executive]

The cost of risk.

[Ali Erbil, executive]

I mean it's very difficult. Unfortunately, it's very difficult for you. I mean I can share with you this quarter will be this much, this quarter will be that much. But more likely, the intensity will be in the first half, that's because we'll look into that in the next 3 quarters. But how much will be the distribution to the year, but expect that throughout the year. And I expect that the retail performance comes with a lag. I mean better -- to the better news with a lag, to negative news with a lag. So it started, and it will continue to start. Even if the economy started to perform in the second half, the impact will be not directly in a positive way to the retail portfolio in the second half. So unfortunately, I don't have any information. And yes, we have numbers in our budget, but those are more equally distributed numbers throughout the year.

[Alan Webborn, analyst]

This is Alan Webborn from SocGen. What, in your view, is the message that the regulator is giving to you in terms of core capital? I think you've all had the early Christmas letters from the regulator telling you, you have to have 12% in Tier 1 if you want to pay the dividend. Is that how you interpret it? And how do you feel the regulator is -- wants you to behave in this environment? And once I get the 2 of you to talk about dividends, perhaps you could give us a view on what you think is the responsible approach given what the outlook is for next year. And that was the first question.

The second question was on loan restructuring. Are you -- how do you feel the process is going. I mean from the outside of Turkey, we hear numbers of there being up to 1,000 corporates in the process of taking advantage of laying restructuring opportunity and so on, and whether that's good for like the SME tale of companies. How do you feel the process of the corporates adjusting to the new environment is going? Do you wish it was being done in a different way? Do you have a particular approach? What's your intention and what you feel the impact on you risk costs is as a result of this process? That was the second question. And the third one was, obviously, we do a lot for the Garanti employees if we're getting an above an inflation improvement in our salaries this year. It always seems a little generous in this environment and always seems that a fixed cost that, again, it's a very uncertain environment. How do you manage -- I know you want to keep your employees happy, but the above-inflation HR costs is a market where we have very little idea what the economic growth outlook is going to be. Now cost of risk could be 500 basis points at the end of this year if there are a few shops that we're not expecting. How do you manage that, giving that message to your employees differently in a very uncertain year. It would be interesting to get your view about it.

[Ali Erbil, executive]

Difficult question, the last one. The first one, the BRSA direction, in general, capital -- those measures, core balance measures, we've been saying those were temporary. And they just said, it's over, they were temporary. So we are back to normal, back to BRSA, Basel III standards. So the approach of BRSA is just as in the universal approach anymore, so end of the year. So we're not expecting anything new on that front. Regarding the dividends, we are still internally in the discussions if we should or should not pay dividends this year. So that decision has not been taken or sealed by the Board yet, so I cannot share with you. We will be applying to BRSA to pay some or not.

But to us, in our reading of what BRSA says, if you're comfortable with your capital, you might come up and ask for it. So that's our interpretation. So as soon as we decide internally and approved by the Board, then we will come up, leave to you the guidance if you're going to pay the dividends this year or not. So I think this was the first question.

The second question. I mean in general, what you see, Alan, from Paris or from London, a little bit worse picture. I mean regarding -- here's an example, this restructuring concordatos. Concordato is an English word. No? I'm not sure anybody asks this. But I think that English speaking people understand concordato. I think, yes. So it's a little bit exaggerated this year. I mean the number of companies, end of the year, reached like 1,500 -- 1,500, 1,600. And then you look at the last 2, 3 months, inflows is much less, but not the system. But we've been working almost 1 million from very small companies to very large corporates. And commercial companies, excluding the SMEs, we've been working like almost 40,000 companies, only us, not the system. So the numbers are a little bit more attractive and exaggerated in that front. I'm not saying to you we're not restructuring anything. I mean what we're doing internally, if a customer, an individual or a company, have a difficulty to pay their upcoming debt in terms of installments, in terms of capital. But if they have the ability to maintain their performance, going forward, you're helping them. That's our approach. And that's our responsibility as well as a banker, as a bank. In that front, that's happening. But more the news -- I mean this started to the year last year, remember 2 names, 3 names. The same corporate names, we talk and talk and talk, and we just stop talking by now, those 3 names. But can you name another 3, 5 names on top of that list? Not much.

So we talk about [ soccer clubs ]. So it's a few [ soccer clubs ]. I don't know how many banks. I think 2 or 3 banks.

So what I'm trying to say, I'm not defending the lousy picture that we have in terms of asset quality, but we are managing. If we can manage, we're setting us for the provisions very generously. But at the same time, it was fine on the Stage 2, it's required on the Stage 3. That's happening. But overall, the image internationally in that front, a little bit more exaggerated to me. These are my personal comments.

Regarding the HR costs and the inflationary, and so on and so forth. Number one, the employees are, as I stated in my presentation, the main assets of banks. We believe that we have the best talent in the country and we would love to work with them forever, with the best talent. So I think that's one thing. That's an investment for us. It's not an expense, number one. But regarding the difficulties in the coming environment, we've been increasing the efficiency, and we keep up paying them. All the time, inflation and average salaries of Garanti employees should be higher than the average bank employees in the system most likely. So -- but we're happy to make the raises, and inflation raise is just the customer taken into account. Everybody, every employee expecting an inflation. If you don't do any inflation, you'll be in a trouble. So that's another side of the story.

But that's not [indiscernible] for Garanti employees' work for sure. But on top, and I did not mention the FTEs, we've been transforming as well in terms of headcount. Year 2017, total FTE decreases from [indiscernible] almost 5%. Total FTE reduction in 1 year in 2017. '18, around 3%, on top. So we're not, at the same time, we're growing. We're optimizing not the branches, number of branches much dramatically, but optimizing the number of FTEs in a positive way, and this will be sustainable performance of Garanti going forward. As long as we can do that, we will be happy to pay them more if we can. So that's all the -- our approach. It might be different from other companies' approach. And hopefully, we'll be doing that.

[Hadrien de Belle, analyst]

Hadrien De Belle, KBW. Just a follow-up question on asset quality. And IFRS 9, how much profit [indiscernible] decreasing you can have in your profitability, meaning macro and in GDP, in your 300 basis points cost of risk? That would be my question.

[Ali Erbil, executive]

In terms of nominal values, maybe we can share with you. But the budget of this year, TRY 2 billion, roughly.

[Hadrien de Belle, analyst]

TRY 2 billion?

[Ali Erbil, executive]

For the whole year, the provisions regarding the macro. Or am I exaggerating it?

[Handan Saygin, executive]

TRY 1 billion. TRY 1 billion.

[Ali Erbil, executive]

TRY 1 billion.

[Handan Saygin, executive]

TRY 1 billion is the max.

[Hadrien de Belle, analyst]

For '18 or '19?,

[Ali Erbil, executive]

For '19.

[Handan Saygin, executive]

For '19.

[Hadrien de Belle, analyst]

TRY 1 billion.

[Ali Erbil, executive]

TRY 1 billion. But for '18, we had set aside much more.

[Aydin Güler, executive]

It's an ongoing process [indiscernible] '18, so how we approach to the...

[Ali Erbil, executive]

So macro permit, we saw the main inputs. And the provisions are the outputs. And around the system, I think, it is more conservative, that is the number. And this sets aside, I don't know how much, TRY 1.2 billion. I think more.

[Aydin Güler, executive]

TRY 1.2 billion.

[Ali Erbil, executive]

TRY 1.2 billion in 2018. So just to make sure to compare the numbers. So only for a macro impact, to make it clear, 2018, TRY 1.2 billion; budgeted for 2019, TRY 1 billion. So in 2 years, TRY 2.2 billion from only macro impact.

[Handan Saygin, executive]

That's still conservative. We're not expecting as much macro volatility as we made in 2018, actually. That makes it conservative.

[Simon Nellis, analyst]

Simon Nellis from Citibank. Just a quick question on the free provisions that you have. You have quite a bit of free provisions. It sounds like you're going to create more in the fourth quarter. In your plan for 2019, is there any release expected in those numbers [indiscernible] for a rainy day.

[Ali Erbil, executive]

Not planned. I mean, of course, we'll be watching very closely the developments. But it is no more likely that we will be setting aside any further provisions. That's also not flat. No release, no increase.

[Simon Nellis, analyst]

You haven't really -- have you factored in some -- because you've had currency hedge impacts on the risk cost continues in 2019.

[Ali Erbil, executive]

That's still the same approach.

[Simon Nellis, analyst]

So the 300 excluding any...

[Ali Erbil, executive]

Fully hedged approach will continue in 2019 as well.

[Simon Nellis, analyst]

I mean the 300 basis points were below risk cost guidance is excluding the currency impact. So actually it could be higher given the currency depreciation factored into our plan.

[Ali Erbil, executive]

I think including.

[Handan Saygin, executive]

Including.

[Ali Erbil, executive]

Including.

[Handan Saygin, executive]

To make it comparable to the peers.

[Emir Moran, analyst]

Emir Moran, [indiscernible]. Can you share your capital ratio targets for next year -- for this year, actually, and where they would stand compared to 2018 year-end?

[Ali Erbil, executive]

I think, so around '17, most likely at the same level that we had this year. So we are not expecting major changes much.

[Handan Saygin, executive]

And profitability will continue, and the risk-weighted asset growth...

[Ali Erbil, executive]

And the FX portfolio will be shrinking in the risk-weighted assets. And FX expectation, as we have stated, more normal than the recent developments. So we believe we can maintain our car ratio around '17 as we have -- as we will be reporting this shortly at the end of 2018, solar ratios, solar car ratios.

[Emir Moran, analyst]

[indiscernible]

[Handan Saygin, executive]

85% of Tier 1.

[Ali Erbil, executive]

Yes, yes. 85% of the total car ratio is Tier 1. No plan in the Tier 1 or Tier 2.

[Unknown Analyst]

[indiscernible]. My question is regarding the monetary policy, the expectations, as well as for representation. You are plugging in roughly 400 basis points easing towards the end of the year. So when do you expect the easing to start in terms of timing? And does all the spreads -- does evolution affect that evolution?

[Ali Erbil, executive]

I mean it's not easy to guess, but what we're saying that type 1 is their policy as had been shared with the public why the economy management will continue. With that assumption, Central Bank will wait for some trend change, real trend change in the inflation. And this will trigger the downward trend in the interest rates, our expectations close to second half. So this means, May, June will be the trend change point. So that anything can happen, I don't know, I say. But in terms of trend, the real thing will be happening after June. That's in our calculation. So based on assumptions, 16% will be this year's inflation. So 400 bps rate cut will be happening mainly in the second half of the year.

[Handan Saygin, executive]

Any other questions on the floor?

[Ali Erbil, executive]

We do have some...

[Handan Saygin, executive]

If we don't have further questions here. We can -- yes, I mean, do we have any questions for the ones connected to the conference call?

[Operator]

We don't have any questions on the line right now. [Operator Instructions]

[Handan Saygin, executive]

Okay. If there are no further questions connected to online, we have some questions addressed through the web. The first one is from [indiscernible] from Everest Asset Management. Could you please comment on Credit Guarantee Fund loans? How much of such exposure has been restructured? And how much have you actually collected from Credit Guarantee Fund?

[Ali Erbil, executive]

The main accumulation ended early this year in terms of Credit Guarantee Fund, and redemptions are still continuing. As of today, total balance of Credit Guarantee Funds is TRY 15 million.

[Aydin Güler, executive]

TRY 14.6 million.

[Ali Erbil, executive]

TRY 14.6 million as of now, the highest that we have seen, if you might remember, TRY 24 million, TRY 25 million. The NPL ratio, [indiscernible]?

[Aydin Güler, executive]

2.4%.

[Ali Erbil, executive]

As of now, still 3.7%, much less the market.

[Handan Saygin, executive]

Gross. That's gross, though.

[Ali Erbil, executive]

Gross. Yes, yes.

[Handan Saygin, executive]

3.7% is gross.

[Ali Erbil, executive]

That portfolio is generating 3.7% NPL ratio. As you might remember, 7% cap. So we are still developing that 7%.

[Handan Saygin, executive]

And the net is...

[Aydin Güler, executive]

[indiscernible]

[Ali Erbil, executive]

And the second question, what will be the minimum acceptable NPL coverage ratio for Garanti? How much coverage ratio could decline?...

[Handan Saygin, executive]

'19...

[Ali Erbil, executive]

I mean I don't know the year-end figure, but it should be around 60%. I think we'll be maintaining this figure. If not, it will go up going forward, just as mentioned to, I think, Gabor's question for the collateralized ones, big tickets versus the smaller tickets. So most like the NPL coverages will be around 60%, if not more. Second.

[Handan Saygin, executive]

From Valentina from Barclays. Where do you expect the majority of NPL inflows to come from, from Stage 2 loans or straight from your performing portfolio? What is the assumptions for coverage?

[Ali Erbil, executive]

The third question. I mean the inflows will come up from the mid-sized and smaller sized loans, that includes commercial SMEs and retail. That will be the main inflows coming up from the portfolio. Most likely, based on our previous experience, Stage 2 loans will be the main source of the NPLs going forward because of the IFRS 9, because of the restructuring and because of the other watchlist strategy of Garanti.

The second question, can you share your expectations towards 2019? Any increasing versus 2018 figures and so on and so forth?

I think we ended the year, again, around the same levels. I think as always, the -- we were the first movers. We've been criticized heavily and everybody is coming up with our levels. So the situation will be there, if not a little bit, we'll go up. But we're not expecting any further extraordinary increases in the special loans going forward. So as of now, it is 16%

[Handan Saygin, executive]

16%.

[Ali Erbil, executive]

Around 16%. So expect around those figures. Our -- John is asking, John [indiscernible] is asking a question.

[Handan Saygin, executive]

From [indiscernible] company. Garanti is going to be a house bank for many large corporates in Turkey, which are predominantly foreign currency borrowings. What is the downside of investing less into this franchise by shrinking the FX book?

[Ali Erbil, executive]

I mean as you expect, it's a balance game. I mean you're making a lot of gains, incomes, interest incomes, fee income, but at the same time, you're losing some because of the provisions. So the nature is shifting the Turkish lira. We find it very healthy. We are supporting to continue. Of course, those exporters, of course, those FX revenue companies will be borrowing from us in FX. But the FX story of the banking system for the next couple of years, I should say, is over. Expect those exports, of course. You'll find this healthy. It should be the case. I think we win as Turkish banks overexposed to big ticket FX loans, and we've been penalized recently for this as Turkish banks. So the downside, yes, less revenues. But upside will be hopefully, with the growth with the investment because Turkey is lacking in terms of investments in macro terms for some years, hopefully, one time, it will start again. So we as banks, and as a leading bank in the industry, will support these investments going forward, hopefully. So we'll be benefiting from that trend, hopefully, as well.

[Handan Saygin, executive]

So the main reason for the shrinkage in foreign currency lending is the redemption because we were large lenders in 2010 to 2013, so redemption technique.

[Ali Erbil, executive]

Yulia is asking from Federated Investors, are you assuming any new forbearance measures from -- on capital in 2019? No.

The second question, would the 7% NPL ratio will be the peak? Yes, in our business plan for 2019, '20 and '21 is the peak. Yes.

And the last question, giving your [indiscernible] for retail asset quality, what are you choosing to grow credit cards -- why are you?

As I already stated, credit cards, in general, has not been growing much in the last 3, 4 years because of the base, lower base effect. That was the main driver. And as I always stated, we have a new card program to tap the -- not the affluent, but mid-affluent segments with our travel and entertainment cards. So that will boost another market share in our credit cards, Yulia.

[Handan Saygin, executive]

Maybe one more thing to add here is that, keep in mind that in Turkey, the minimum dues are high. So -- and also the rollover ratios, average rollover ratio is still faring around 30% only.

[Ali Erbil, executive]

So we don't have any further questions. So thanks so much, first of all. So we wish you as a whole entity a great year.

So to just wrap up, just a few words. We as Garanti team, some our colleagues from on top management from our head office are with us, we are very confident, number one. We know what to do. We know what we are doing. I think this is very important. We have the best talent, best team, I mean, not only in Turkey. I mean I think when you compare with many jurisdictions, we have the great team. We have very clear minds, we trust this country. We will be here forever, so we'll be doing our best, and hopefully, we'll continue to be the best bank in Turkey for the short term, midterm and long term. Thank you for your patience, and we'll be in touch as we did last year with you with the [indiscernible]. So again, have a great year. Thank you.

[Handan Saygin, executive]

Thank you. And as an IR team, we're always here to help you further with your questions. So feel free to contact us anytime.

[Ali Erbil, executive]

Thank you.