Turkiye Garanti Bankasi AS

IST:GARAN.E

Earnings Call Transcript 2023-Q2

[Operator]

Hello and thank you for joining us in Garanti BBVA's Second Quarter 2023 Financial Results Webcast. Our CFO, Mr. Aydin Guler, and our Investor Relations Director, Ms. Handan Saygin will be presenting today. [Operator Instructions] The presentation will now start. So I'll leave the floor to our presenters.

[Handan Saygin, executive]

Hello, everyone. We're now half the year and elections behind us. It is great to be with you again at another superb result call. Let me start, as usual, with the macro backlog operating in. The main highlights are that the new government economic policies will be key for the upcoming scenarios.

It seems that gradual normalization that will be supported for growth is a more likely scenario at least to the local elections in 7 to 8 months. However, the scenario of gradual normalization and economic policies is expected to keep inflation under pressure.

In today's inflation report announced by the Central Bank Governor 2023 year-end estimate is 58%. The existing strong growth momentum we witnessed an above 4% first half growth, gradual normalization and economic policies and the resilient global growth outlook combined will be supportive of the economic growth in the short term. Accordingly, we expect GDP growth to be 4.5% this year.

This growth-supported environment, along with the recent tax hikes, high wage adjustments, sharp currency depreciation, demand for factors eventually worsen inflation expectations. We now forecast year-end consumer inflation to be 60% with risk tilted to the upside.

Regarding current accounts deficit, even though 5 months to date deficit amounted to $38 billion, we expect the year-end figure to be around $40 billion with the supportive factors like tourism revenues and growth composition to in favor of net exports. This alludes to a level just under 4% of GDP. The good outlook in here is that the expected change in the growth composition and easing energy prices are expected to shift the deficit to a surplus in 2024.

So first half financial results were attained on the back of ongoing adaptation to the highly challenging regulatory environment, which presented itself with significant pressure on funding costs. Our swift margin defense manifested itself with selective short-term Turkish lira lending growth versus the thin and even negative spreads seen in the quarter. Thankfully, we could offset this inevitable margin drop with our strength in fee-generating businesses and solid subsidiaries and muted NPL inflows.

Undoubtedly, our sustained top-notch core banking revenue generation capability remains to be our key differentiation. Even though there was an out-of-proportion increase in funding costs, in efforts to meet regulatory thresholds, we could still grow our core banking revenues by 12% in the quarter and 52% year-on-year.

Net income booked in the second quarter was TRY 18.4 billion. This figure includes TRY 2 billion of pre-provision reversal as management upon the post-election normalization and the macro environment decided to reverse a portion of the free provisions built to date. So by end of first half 2023, we are left with TRY 6 billion of free provisions on balance sheet.

Net income, even when adjusted for the provision reversal, suggests a positive growth performance. As main contributors to this, we can count the 16% quarterly increase in fee income, the threefold increase in net FX by install activity gains and well-defended margins, reflecting on core net interest income performance.

Six months cumulative result of TRY 33.8 billion of net income suggests outperformance not only to our operating plan expectations, but also to our peers especially the performance in the fundamental core banking areas.

Return on equity booked in the first half was 38.3% and return on assets was 4.2%. Main components leading to these solid results on Page 6, remains to be customer-driven asset growth. Our assets reached TRY 1.9 trillion at the end of first half. Dominating portion of assets despite getting diluted because of the significant currency devaluation that happened about nearly 40% year-to-date remains to be loan's share with 52%.

In the quarter, we booked an accelerated loan growth. Naturally, it had to be regulation compliant and selective and registered a 15% Turkish lira loan growth that helped to ease the pressure on net interest income.

Year-to-date, 6 months to date, the Turkish lira lending growth registered was 27%, and there was also 2% growth in dollar terms in foreign currency lending. Securities sharing assets were 14%. And unlike first quarter, in the second quarter, there were no new regulatory required security additions. There were some CPI and fixed rate security redemptions hitting the quarter, a portion of which were replaced with FRN securities.

Cash and cash equivalents as well as other assets, high portion in assets relate largely to currency. A significant 34% devaluation we've seen in the quarter alone caused a visible increase in the accruals of foreign currency protected deposits, currency difference, and that is booked under other assets, ballooning the portion to 9.5% of assets.

Now, where the Turkish lira loan growth was driven from can be seen on this page, Slide 7. Our performing loans reached almost TRY 600 billion by end of first half. Compliant with the regulatory framework, growth drivers were SME loans and credit cards in the quarter. Accordingly, we booked market share gains in Turkish lira loans, Turkish lira business loans and particularly in SME loans. Our leading position in consumer loans as well as credit card issuing and acquiring volumes among private banks remain.

On the funding side, deposits dominate the funding sources, funding alone 3/4 of the assets. All the funding sources are closely and actively managed in defense of our margins. Despite the motivation we had to attract and grow foreign currency protected Turkish lira time deposits, demand deposits share in funding, more than 30% of the assets remained intact.

This suggests not only our customers' trust and clear preference but also contribute positively to free funds in average interest-earning assets, a ratio that is well above the average in the industry and actually sets the main pillar in our financial differentiation feeding margin performance. What it means is that with customers' funds that are kept as demand deposits and our free equity, we found a significant 45% of our interest-earning assets.

Borrowing share in funding assets, on the other hand, stood at 6.6%. Total external debt is now $4.2 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.

On the total foreign currency debt of $4.2 billion, $1.4 billion is due within a year. We have a foreign currency liquidity buffer of $4.8 billion, that is far more than the short-term need.

In line with the continuing liraization efforts, the accelerated growth in Turkish lira deposits or largely foreign currency protected Turkish lira time deposits remains. And we ended up with a twofold growth in Turkish lira time deposits since the beginning of the year. Even though this much higher growth in Turkish lira time deposits diluted our Turkish lira demand deposit share in total to 18%, we have the highest Turkish lira demand deposits based among private peers with a balance of TRY 137 billion.

The regulatory price caps on lending as well as the lira deposit targets immensely pressuring funding costs caused an inevitable drop in margins. Nevertheless, our legacy of superior core margin generation capability remained intact even after adjusting with the option premium costs offered to foreign currency protected deposit holders.

Quarterly core margin drop was 205 basis points, taking into account the option premium costs offered to foreign currency protected deposit holders that is booked under the trading line. Cumulative core margin as of end of first half ended to be 2% when we include this added cost to liraize the deposits, suggesting a cumulative margin drop of 328 basis points so far.

The outlook in here looks promising, though. It seems we may have left the worst behind in terms of downward margin trend. We had already started seeing the trend reversal on the outstanding Turkish lira loan yields and as of June end. Also, this week's regulation adjustment will help carry the loan yields to more sensible levels and allow originations with reasonable spreads.

Now moving to the subject of asset quality on Slide 11. Of the gross loans total of TRY 1 trillion, 13% is Stage 2. Even though there seems to be a quarterly increase in Stage 2, when adjusted with currency, it has actually dropped as the recoveries from Stage 2 with very thin risk were higher than Stage 2 inflows.

Noticed a strong 20% Stage 2 coverage, especially not just the coverage of foreign currency loans under Stage 2, that is quite high and is on average 34% versus 9% for the Turkish lira loans covers that includes the very low risks under SICR portion. In short, we sustained our highly prudent provisioning.

As for the NPLs on next page. NPL inflows in the quarter remained limited with the supportive growth environment and strong collections. Combined with the growth booked, NPL ratio further improved to 2.1%, while our total provisions, including the write-down portion reached a record level of above TRY 62 billion, representing a total cash coverage of almost 6%. Recall that we had the highest provision level in the sector.

We can see on the next slide how this translates into risk costs or provisions, we can say, where net cost of risk as of first half ended to be 65 basis points, of which 42 basis points was due to the impact of the earthquakes. Isolating the earthquake-related portion, in the quarterly net provisions chart on the bottom left-hand side, you can actually see a further buildup of provisioning parallel to the growth we have booked. Despite this highly prudent provisioning, overall, our net cost of risk is faring better than our guidance that was expected to be around 100 basis points.

Moving on to the performance in net fees and commissions, we could sustain our first quarter performance in doubling last year's net fees and commissions. Our first half commission income exceeded TRY 14 billion. A strong 16% quarterly growth on top of last quarter's high base reflects a clear differentiated capability, strength in relationship banking and digital empowerment.

Main contributors to the growth were again money transfer fees, our #1 rank in here is a clear representation that Garanti BBVA is customers' choice as their main bank. Besides the money transfer fees, payment systems as well as cash and noncash fees contribution to net fees and commission growth remains very strong. In here, recall that we had expected and guided for a growth that is around the average inflation. So far, the performance suggests there can be an upside to our guidance.

As for the operating expenses performance on Slide 15, quarterly operating expense growth was flattish when the portion that was impacted by the currency is taken into account. Year-on-year operating expense growth was 122%, of which near 9% was due to the currency depreciation that is fully hedged.

Slightly higher than the guided growth in operating expenses can be explained with the so far low base effect as the multiple salary adjustments we had done last year occurred post first quarter. So expect convergence to guide at level of 100% operating expense growth by year-end. Cost/income ratio as of first half was 36% and fees coverage of operating expenses was 58%.

Regarding capital. On Slide 16, capital remain strong. Income generated in the second quarter could largely compensate the negative impact arising from the significant currency devaluation as well as amortized portion of the sub debt. Capital adequacy ratio at end of first half remained at a strong 15.8% and core equity Tier 1 at 13.7%. We have TRY 49 billion of excess capital on a consolidated basis and without any forbearance impact. And as a secondary buffer, we still have TRY 6 billion of free provisions on balance sheet.

If we were to include free provisions as part of capital, that would take our capital adequacy ratio to 16.3%. On top of that, if we were to include also the BRSA forbearance impact, it would add another 210 basis points, technically carrying our consolidated capital adequacy ratio to 18.4%. The foreign currency sensitivity on our capital adequacy ratio is that for every 10% depreciation, it is 39 basis points negative.

Now this wraps up our financial presentation. Now moving on to our value creation on the nonfinancial side very briefly. We are happy to be the first bank from Turkey to announce interim decarbonization targets for 2030 to achieve 2050 Net Zero. We're one of the pioneers in open banking and now we basically serve as a hub for other banks accounts. Our 13.8 million mobile-only customers clearly support that we're customers' choice as their main bank.

Diving a bit more on our nonfinancial value creation and starting with employee satisfaction, our most recent poll results, 4.3 points out of 5, indicating strong employee loyalty, we're one team striving to be always better. This is also evident in our inclusion in the Bloomberg Gender Equality Index for 7 consecutive years.

Our main goal is creating sustainable value beyond serving our high base of 14.1 million digital active customers, of which 13.8 million as I said, are mobile bank as well -- mobile banking customers as well. Digital channels share in total sales reached 89% and almost 1 out of 5 mobile transactions in the sector is through Garanti BBVA. In line with responsible banking model, for us, sustainability has moved beyond just financing. We have so far mobilized TRY 86 billion in sustainable businesses since 2018.

We also focus on managing the direct impact we have through our community investment programs. And as of 2022, our such contribution has reached TRY 72 million. Along with these, we also care about what we shouldn't finance. We have been carbon neutral since 2020.

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

[Operator]

[Operator Instructions] So the first question is coming from Waleed Mohsin.

[Waleed Mohsin, analyst]

Congratulations on a strong set of numbers. A couple of questions, please, from my side. First, I wanted to ask, given some of the unwind in regulations, which is quite encouraging and the normalization in the policy rate environment, things seem to be moving in a positive direction. I wanted to get your thoughts on what you think are the biggest risks at this moment from a profitability perspective. I mean what are you monitoring as your key risks, whether it's asset quality or a risk of further dollarization at some point. So any thoughts on that in terms of what you think are the key risks would be quite helpful.

Second question would be on margins. It seems from your commentary and from the other banks as well that somewhere in the third quarter, it should mark the trough and even within the third quarter, you would start seeing Turkish lira loan-to-deposit spread expansion.

On that front, I wanted to get a sense of how do you see margins shaping up into the fourth quarter? And the change in the deposit rates, do you see any risks around that, especially given that we first had a pretty big spike in deposit costs into the second quarter. And then now we're starting to see deposit costs come off a lot. So any risks associated with that? Any color would be very helpful.

[Aydin Güler, executive]

Waleed, for your first questions regarding biggest risk. I mean, in asset quality, we don't see any further situation. I mean it is already over provision. And for the time being, we are very comfortable with the level. But of course, margin started to pick up at the latest regulation change. Commercial rates started to be like 32.06%. So cost of funding is going to be below 30%. So we have some sort of positive margin getting started. But depending on Central Bank further tightening will lead the game, I mean, but for the time being, we are all positive for the coming quarters and even for third quarters -- I mean, fourth quarters.

So I mean, I don't want to complain about the regulation. We are doing our best to manage the balance sheet as you see. But I mean, we are used to it. I mean, so we will do our best to manage, let's say.

For margin, yes, starting from July, actually, we have some -- again, after this latest regulation change, some easening. We started to see some positive NIM even with the effect of FX protected premium on it, so Handan just mentioned. So we will continue to have positive upside as we go along through the quarter. And I think it will be better than second quarter from my calculation. So we are on top of it. So we will do our best to manage. I mean, this is how it is for the time being. I hope it satisfies your questions.

[Waleed Mohsin, analyst]

So just to get it clear, you think third quarter margins will be better than second quarter despite the dip at the start of the third quarter?

[Aydin Güler, executive]

Yes. That's what we are seeing, I mean, today, yes.

[Waleed Mohsin, analyst]

Got it. And maybe just one final kind of follow-up on this. How much of an expansion are you -- have you seen on the loan-to-deposit spread in tier terms so far? Is it around 400, 500 basis points now where the spread is?

[Aydin Güler, executive]

First half, as Handan just showed in the presentation, together with FX protected premium payments drop first half end about 328 basis points, we might have further 30 bps situation for the rest of the year. So another maybe 36 negative territory, let's say, this is core NIM.

[Operator]

The next question comes from Konstantin.

[Konstantin Rozantsev, analyst]

I have 2 questions...

[Operator]

Konstantin, sorry for cutting, but the line is not very clear. We can hardly hear you.

[Konstantin Rozantsev, analyst]

Is still not good. You can hear me?

[Operator]

Barely. Thank you. So we have a written question from Thomas. Can you please discuss most rigorous regulation now in place that is obstructing optimization of balance sheet and ability to capture growth within segments featuring highest profitability potential?

[Aydin Güler, executive]

My answer will be the same, I guess. We are seeing some easening and normalization in the regulation. Commercial loan caps increase, as you know, credit card rates increase and deposit costs are being declined. So credit card is like 2.89%, right, monthly. So it corresponds like 35, 36 levels. So I mean instead of -- as I said before, instead of complaining, we are adjusting our balance sheet in accordance with the regulation. I mean, our track record speaks for itself. I mean, under any circumstances, we are able to deliver the best-in-class results, I must say. So I mean we are just doing engineering -- balance sheet engineering as regulation comes along. So we are trying to maximize our balance sheet spreads and margin. I mean, we are used to it, let's say.

[Operator]

We have a written question. So this is again from Thomas. He's asking on my 2 peers in Turkey, Garanti has not updated its ROE target. Is there any upside?

[Aydin Güler, executive]

In our guidance, our figure was 28. Yes.

[Handan Saygin, executive]

Already saying enough.

[Aydin Güler, executive]

Yes. I mean you can see we have upside. We can beat that level, yes?

[Handan Saygin, executive]

Yes.

[Operator]

We have a written question. [indiscernible] TRY deposit rate sustainable when inflation is expected at 58% at a year.

[Aydin Güler, executive]

Well, it's a very good question, but I mean, we are trying to see the evolution of inflation. So probably it will be very difficult to stay at this level, but we are waiting further, I mean, tightening SC, so that we will keep up the margin in a positive territory. So I mean, it's not easy to keep it up at this level but we'll do our best, let's say.

[Operator]

We have a written question from Konstantin. Could you please confirm what are TRY term deposit rates outside of the FX protected scheme; and second, a deposit rates within this FX protected scheme. Should the recently introduced RR for the FX protected deposits lead to a further widening of the spread between these 2 rates?

[Aydin Güler, executive]

I mean, for the normal deposit, let's say, 1 month tenure is around 25%, 26% level. For those who are willing to switch to FX protected scheme, what we are paying at the moment, a base interest rate plus a 5 percentage point premium, right? It basically comes to 28% levels. This is how it is nowadays, so below 30%. But as I said, depending on tightening the monetary policy, we will have different set of ratio or rate. So this is the level that we are dealing with nowadays. You remember, it was like around 40% or even more than 40% in 1 month ago. So it came down after this tightening decisions.

[Operator]

We have a written question from Valentina. Do you see any risk through our 2023 guidance?

[Aydin Güler, executive]

We believe it's too early to make any revision to the guidance as uncertainties prevail at the moment, magnitude and speed of the normalization process will be the key. We don't see any downside risk to our ROE guidance, but there might be some upside, downside to each P&L item leading to this ROE.

[Operator]

We have a written question from Mehmet. What are your views about trading income going forward? Separately, the increase in our quarterly trading income is less significant compared to other peers that have reported so far. Are there any differences in the way you account for FX depreciation impact from loans that makes a direct comparison to other banks less straightforward?

[Aydin Güler, executive]

So when you say trading, it's a very deep world. I mean when you say trading, I mean, you get from TR security gain, FX security gain, some derivative gains and FX buy and sell spread gains. So it consists of all 3 or 4 items. So in our case, our FX-protected premium costs booked under trading, so derivative in this case loss, some banks put this into NIM. But in our calculation, it is sitting in the trading book, but as I said, and for accounting purposes from the bank to bank, it might vary.

Why? Because if you book your swap -- I mean, spot lag or is sitting in the FX gain and loss, but forward lag is sitting on the trading line item. So there might be different curve usage in this ASC or offshore swap curve might give different results in accounting purposes. So -- but what we see in our trading basically, I mean, our FX buy and sell figure in the second quarter was very strong, and really offset some of our NIM erosion in the solo Q2.

So we are happy with the outcome. But when you say extraordinary booms trading gain income, so we need to investigate how it's coming from. So we are very decent accounting approach. And this is how we deliver in the second quarter.

[Operator]

It seems like we don't have any more questions. So this concludes the Q&A session. I leave the floor to our presenters for closing remarks.

[Aydin Güler, executive]

Well, thank you all for your participation, first of all. Looking back at the second quarter, regulations continue to shape our balance sheet composition. As Garanti BBVA, we once again proved the -- under any circumstances, we will differentiate with our best-in-class, I mean, core banking, let's say, revenue generation. So we are happy to see some easening and normalization in the economic policies, hope that this will continue in the coming months. Look forward to meet you all again with another set of stellar results. Thank you.