Turkiye Garanti Bankasi AS

IST:GARAN.E

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to Garanti Bank's Third Quarter 2018 Financial Results Webcast and Conference Call. Our presenters at this session will be Fuat Erbil, our President and CEO; Aydin Güler, our CFO; and Handan Saygin, Head of Investor Relations. [Operator Instructions]

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

[Handan Saygin, executive]

Thank you. Hello, everyone. We're back again with our sustained strong earnings performance, delivering an return on average equity of 17.5%. What did I do, just a moment, I'm just trying to open the slide. Delivering a return on average assets of 2% and return on average equity of 17.5%.

Our net income ended up to be TRY 5.6 billion, representing 20% earnings growth in the 9 months of the year. And this is even after setting aside TRY 700 million of free provisions in the last quarter, which we felt would be a prudent move given the significant changes occurred in the quarters and the rising uncertainties in the operating environment.

As you must have all followed, Turkey's GDP growth expectations have been negatively impacted with the recent financial shocks. Turkey depreciated against the dollar by as much as 60% in the quarter on top of the 21% depreciation already happened in the first half. CBRT's significant 625 basis points rate hike, which was above the expectations, could ease the quarterly currency devaluation to 31%. Affected by the currency pass-through, inflation hit worrying levels in the quarters such that the September reading was the highest of the last 15 years.

The new economic program was also announced in the quarters that suggest an aggressive fiscal consolidation plan in the short term. The prudent stance of the fiscal policy should complement the already tight monetary policy conditions to rebalance the economy.

Let's now move on to the story of the last quarters. The main topics were: the significant deceleration in lending, given the rate environment; holding sufficient liquidity; proactive management of the loan book and prudent provisioning; sustained core banking revenues; and strong solvency via the sustained earnings, basically capital generation.

Now starting with Page 6. Now even though the year-to-date lending growth recorded was 21%, getting us to TRY 278 billion in total loans, it includes a depreciation of 58% year-to-date. Actually, when adjusted, our lending mix, looking at the lending mix, we need to look at it adjusted, is quite balanced. 1/3 is Turkish lira business banking, 1/3 is consumer and credit card, and 1/3 is foreign currency.

Both Turkish lira business banking and consumer lending cut pace and quarterly change in Turkish lira lending book turned out to be slight negative. Given the deceleration in the economic activity, we expect Turkish lira lending growth to remain muted until year-end.

Foreign currency loans continue to shrink as expected, as was the trend, and quarterly shrinkage was 4%. This trend is likely to continue as well, and the annual foreign currency lending shrinking can easily be actually double digit.

Now let's look at the liquidity on Page 8. Here, on the left-hand side, you see the assets and liability mix. It's quite clear that deposits together with the merchants payables -- customer and bank deposits together with the merchant payable can sum the entire loan portfolio. Borrowings share and funding assets seem to have gone up to 21% and purely -- this purely relates to currency devaluation as the borrowings are predominantly in foreign currency. I'll get in more details later on in here.

Now in the quarter, the deposit growth was in TL actually, as there was a trend of dedollarization by the end of the quarter, especially when currency levels reached around -- near TRY 7. On top, we were able to attract new deposits, even though our pricing did not differ much from the sectors, we ended up being customers' preference in this time of high volatility.

Now still, when we look at the deposit composition, more than 1/4 is prefunds, mainly demand deposits, 27% of the consolidated deposits. And compared to the sectors, we remain to be well above the sectors' average, the comparable figures are 25% at Garanti versus 21% in the sector. And 75% of the Turkish lira deposits are from SME and retail customers, whereas 60% of the foreign currency deposits are from SME and retail. Now these deposits are typically relatively low cost and sticky, giving us comfort.

The above sector growth in Turkish lira deposits, especially in the last quarters, helped us to significantly improve our Turkish lira loans-to-deposits ratio, registering an improvement of 14%. That is double the improvement that the sector experienced in the same quarters. This also improved our total loan-to-deposit that now stands at 101%.

Now on the next page, you see the foreign currency situation both for funding sources and lending.

Starting with the history of it, the growth period in foreign currency lending was in between year 2010 and 2013. And accordingly, foreign currency funding grew with demand. In 2013, with the start of currency devaluation followed by years of election period, the foreign currency loan demand was muted. We also took the opportunity in this period and managed our group exposures and risks, revisited company limits at times, reducing our concentration.

Accordingly, we have been shrinking the foreign currency loan book at an annual pace of 4% over the last 5 years. And in conjunction, as borrowing needs diminished, our foreign currency borrowings shrank as well. We do expect in the current operating environment this trend to continue, so basically, there will be lower dependency on foreign currency funding as foreign currency loans continue to diminish.

Moving on to the next page to see what we have as external debt, is a total of $13.1 billion, made up of eurobonds, securitizations, syndications, sub debts, MTNs, covered bonds and such. You'll see on the right-hand side the maturity profile.

Now $5.3 billion of our external debt is due within a year, $4.8 billion of this is the short-term portion of the long-term debt as majority of our external debt is long-term.

In an extreme scenario, where all of this gets paid within, we have doubled the liquidity buffer. Our readily available current liquidity is $10 billion in the foremost money market placement, right way swaps, unencumbered securities and the foreign currency reserves we optionally keep at the central bank within the reserve option mechanism. These -- all added together, we have sufficient liquidity.

Now let's look at the asset quality components. And start with what we have in hand both for Turkish lira and foreign currency loans. Now starting with the Turkish lira loans on Page 12, we see a well-balanced mix between business and consumer, roughly 1/2 and 1/2, you see here. Since more than 90% of the Turkish lira loans are fixed rate, they have not been negatively impacted by the recent significant increase in interest rate.

Additionally, considering the fact that the household debt to GDP in Turkey is only 17%, this is as of December '17, now it's even lower, and this, when compared to the other countries, again, very much lower. It's actually far below the levels of the emerging economies, which is 40%. We're less worried about the consumer and credit card portion of the book. Plus 38% of our consumer loans are collateralized with houses, autos, and 43% of the general purpose loans are granted to our salary customers.

On the business banking side, besides the strong collateralization, 21% is under the credit guaranteed fund scheme.

Now moving on to the foreign currency loan breakdown on Page 13. $4.3 billion out of consolidated total of $20.5 billion loans are from subsidiaries in The Netherlands and Romania. The bank-only foreign currency loans amount to $16.2 billion. Now in here, I want to remind you that in Turkey, consumers are prohibited to borrow in foreign currency, so all of the foreign currency lending are business-related.

Of the bank's foreign currency loans, 11% are to exporters, 26% are to conglomerates, multinationals and big commercial customers for their working capital needs, and 63% are project finance loans. Of the project finance loans, 75% have low currency risk, and most of the projects actually generate foreign currency revenues.

On the right-hand side, you can see the breakdown of the project finance loan. Energy loans make up the largest portion, with 44%. Within the energy portfolio, share of electricity generation is 75% and share of renewables within the generation portfolio is 55%. These are deemed low risk as there's a feed-in tariff to these -- to this portfolio. Infrastructure projects make up 23% of the project finance loan book and around 90% of these have government guarantee. 10% is coming from our one largest telecom exposure, and the remaining, roughly 1/4 of the project finance loans, is made up of various M&A and investment type of deals. Now we regularly conduct FX sensitivity analysis of our portfolio as part of our proactive staging and provisioning practices.

Let's now look on Page 14 to give you more insight on staging. Now our Stage 2 share, in total, it stands at 16%. In the total amount, you don't see much change from quarter-on-quarter, 41.2% to 41.5%, but there's a significant increase in the coverage, move up from 9.6% to 11.3%. What happened here is that some portion moved to NPLs, some large tickets from Stage 2 moved to NPL Stage 3. And with the increase in the changes in the macro environment, some new entrants gone to Stage 2. But in total, Stage 2 share in performing loans ended up to be 16%. I would like to remind here that this figure is not comparable amongst banks, mainly due to 2 factors: the differentiation in quantitative assessment criteria, there's a differentiation in quantitative assessment criteria; and secondly, there's an approach difference for the qualitative assessments for the ones that are in watch list, the ones that are restructured. And this was the case also in the past, many of you are aware of that. And also, the time that we keep under Stage 2 also differs. We typically keep, at minimum, for 2 years the restructured loans under Stage 2 or for lifetime. So this approach difference also insulates our Stage 2 portfolio. When we look more closely, actually, within the Stage 2, 64% actually is not delinquent at all. And 1/3 of the 64% comes from the SICR portion. But when you look at the rest, only 10% is more than 30 days past due, about 16% relates to one big loan, the telecom loan, and 9% is -- are those past dues that are less than 30 days. So majority, 64%, is not delinquent at all. But we do provide -- we do individual assessment for the qualitatively assessed portion, and we do provide sufficient coverage and difference coverage but the blended Stage 2 coverage ended up to be 11.3% on a consolidated basis and even slightly higher, near 12% for bank-only basis.

Let's also look at the NPL evolution. Now in the third quarter, you may notice the significant increase in the new NPLs and -- but there has also been significant increase in the collections. So a portion of the new NPLs can be explained also with the currency. As within the net NPL inflows year-to-date, that -- the total has been TRY 5.7 billion, TRY 2 billion relates to currency. But nevertheless, yes, we do expect to be adversely impacted with the current operating environment, the expectations in NPL inflows or such that we do expect further inflows. The NPL ratio deteriorated in the third quarter to 4.2% on a consolidated basis and 3.9% bank-only basis. We haven't done any NPL sale year-to-date and we -- I mean, current plans we don't have, but we do expect further deterioration in the NPL ratio, and some portion will relate in this year-to-date figure, about 1/3 of the net NPL relates to currency.

The cost of risk -- corresponding cost of risk to this is that excluding the currency impact, net cost of risk on a consolidated basis in the first 9 months ended up to be 130 basis points, and the currency impact on top came in to be 125 basis points, which is 100% hedged, so there's no bottom-line impact coming from currency depreciation.

So this tells the asset quality situation. So we've been actively managing this impact, and we do expect to be adversely impacted with the changes in this market condition.

[Ali Erbil, executive]

It includes, Handan, the fees that we have set aside at TRY 700 million to this figure, that 130 bps will make 170 bps, right?

[Handan Saygin, executive]

Correct. Correct.

[Ali Erbil, executive]

So I mean, your calculations, that 130 bps, addition TRY 700 million free provision, you will end up 170 bps in terms of net cost of risk.

[Handan Saygin, executive]

Correct. But currently, the free provisions aren't assigned to any loan, any creditors.

[Ali Erbil, executive]

Correct. This is [indiscernible] free provision.

[Handan Saygin, executive]

Free provisions, correct. So let's move on to the fourth main topic, that's our core banking revenue that's sustained. Starting with the margin, we -- as we dynamically manage our balance sheet and defense margin, again, this last quarter, I would say, was a success. There has been significant increase in the interest rate, but the margin suppression in the quarter was limited to 40 basis points. In the quarter, also, we were helped by the CPI linker revenues. The CPI linker -- in our CPI linker calculation, the CPI assumption in our CPI revenue calculation was 23.2% in the quarters, bringing revenues -- CPI-related revenues, doubling of what we had seen in the prior quarters -- more than doubling of what we have seen in the prior quarters.

Now given the rate increase, of course, the liabilities got hit faster due to the duration this month. So we did see spread suppression, and we will continue to see that in the fourth quarter, the biggest -- it will be -- the spread suppression will be more visible in the fourth quarters. But going forward, again, we will be helped by the CPI linker revenues. And most likely, the CPI linker adjustments in the fourth quarter will be very, very significant. It could be as high as triple, almost triple of what we booked in the third quarter.

So moving on to the fees. The story hasn't changed. We continue delivering 32%, more than 30% growth in net fees and commissions. This story is the same as the biggest contribution in here comes from the payment systems, helped by the interest rate environment and also the activity pickup in issuance and acquiring volume.

On the cost side, our disciplined approach continue. The operating expense growth was way below inflation. Year-on-year, what we booked was only 11%, even though we did see some adverse impact of the currency devaluation as 12% to 13% of our OpEx is foreign currency-linked, but of course, we do take the actions to make sure that the bottom line impact to this is limited. We do hedge certain big foreign currency expense items. And accordingly, our cost income ratio improved furthers. The consolidated cost/income is 43.1%, the bank only is 40.1%. And the fees coverage of OpEx remained at high levels of 60% on the consolidated, 67% on a bank-only basis.

Now let's look quickly to the solvency portion. Our strong solvency remains. Now in the last quarter, given the sharp changes in the macro picture, especially in the currency, the regulators announced some temporary measures, some forbearances. With the forbearances, actually, it's clear that given the capital generation we booked, our capital adequacy ratio improved. But we were -- of course, without these forbearances, given this 31% currency devaluation, our capital adequacy ratio did get impacted, it came down to 14.7% on a consolidated basis and 16.3% on a bank-only basis. Now these are still way above the minimum required level. The required level for capital adequacy ratio is 11.5%. And our figures are, despite near 60% devaluation year-to-date, with the capital generation, we were able to still deliver well above the required levels of capital adequacy ratio. We have -- compared to the 14.7% capital adequacy ratio, we do have more than TRY 10 billion of excess capital, and this basically suggests very strong results.

And now, looking ahead just quickly, just reviewing over the guidance we had shared with you in our last presentation, in the first half results, the environment after that changed a lot as well. So the macro environment, the current macro environment does pose downside, especially on growth and provisioning. The Turkish lira loans in our last budget revision, we had guided less than 14%. It is true, but it probably will end up to be high single digits. At most, maybe 10%, what would you say? I mean, hopefully...

[Ali Erbil, executive]

It's not single digit but very, very low double digit, 10%, 11% will be the maximum that we can see. But for foreign currency, the shrinkage is continuing year-to-date. We have seen 8% shrinkage. It will continue further, then that will lead us double-digit shrinkage in foreign currency loans. NPL, we're already 4.2% at a consolidated basis. Our guidance, 4% to 4.5%. That will bring some downside risks with it as well as the net cost of risk, we're still within our guidance, which is 130 bps. Although our guidance was 150 bps for the whole year, we most likely seeing a downside outlook, coming quarters, I mean, in this quarter, Q4. This will lead maybe around 200 bps net cost of risk for 2018 with a slight downside potential.

[Handan Saygin, executive]

There are large tickets. I mean, it's really hard to fine tune the net cost of risk, but we're expecting about 200 basis points, maybe just slightly higher by year-end.

[Ali Erbil, executive]

NIM, we're doing pretty strong. Spreads are pushing a lot in terms of pressurizing a lot, our net interest margin. But very strong CPI linkers contribution for our NIMs. And as you much remember too, quarter by quarter, we have seen TRY 1.3 billion in Q3, that will be more than double in Q4, if not higher. So that will definitely, positively impact our NIM. We said flat, even we might bring some influence at net interest margin after CPI and swap included.

Fees, as you can see here, there is a closedown in the system lending, but our fee performance is still very strong, 30-plus still, and our guidance, 20%, will definitely most likely will be much higher year-end, so that we'll have some positive impact for our bottom line going forward.

OpEx, we said 10%. We're doing, what we believe -- I mean, we're doing great. Not to be -- let's not be that humble in that issue. So 11%, we try to maintain around 11%, so we set a neutral OpEx growth for the remaining of the year, for the last quarter. Of course, ROE will be under pressure just because of the provisions that we are setting aside in terms of specific -- especially, that will definitely impact our ROE, but still we'll do our best to bring good level of ROEs as well as ROAs. But 17% that we have come up with is the highest level for this year-to-date. So most likely, we will have downside risk on earnings or returns performance.

[Handan Saygin, executive]

The priority has shifted, so we would like to start next year much stronger.

[Ali Erbil, executive]

Yes, yes. I mean, there, basically, the very summary. Thank you, Handan, for your presentation. Economy has been slowing down extraordinarily starting from Q3, but bank is performing better than expected, I believe. Most likely, we will be overperforming the sector as well in many items. The biggest part going forward will be the asset quality. I'm sure you'll be asking many questions related with that, but I think our conscious stance for some time, prudent stance on the asset quality will definitely help to tackle with this challenging days. So thank you all for the time being. Let's start to take questions.

[Operator]

[Operator Instructions] We are taking the first question from Simon Nellis, Citi.

[Simon Nellis, analyst]

As you expected, the first question is on asset quality. Can you just run through the key variables that you use for your IFRS 9 model for Stage 2 and Stage 1 provisioning, the GDP growth forecast and the unemployment rate? And how sensitive would further changes to those assumptions be on provisioning? That will be my first question.

[Ali Erbil, executive]

Hi, Simon. Let's answer one by one. I mean, that is not -- I wish that model will be that simple model. I mean, we can, of course, share with you our GDP and unemployment expectations for this year and next year. We're expecting, as we said, around 3% GDP growth this year. We're not expecting very slight deterioration in the unemployment for the remaining of the year. For the next years, unemployment will be reaching close to 12% at the end of the year. And most likely, GDP growth will be around 1%, 1.5% for 2019. But to -- our model, of course, we just started, especially as ICR portion of our Stage 2 launch has already been parameters -- macro parameters has already been inputted to our IFRS 9 model. So this is bringing higher provisions starting from Q3. This will continue going forward. Although we haven't seen anything, especially the small ticket retail and SME loans portfolio deterioration yet, but this will be pre-measures that we are taking in terms of provisions. So the way -- in summary, those portfolios are not significantly deteriorated yet, but to tackle with this in advance for the lower GDP growth, higher unemployment, we are already starting to set aside some specific provisions for Stage 2 loans. That has already included 130 bps specific net provisions, and it will continue with the same speed this quarter and in the coming quarter next year.

[Simon Nellis, analyst]

Super. And I guess, following on from that, I mean, under these macro assumptions, where do you think that NPLs will probably peak in the cycle? I guess it's still a bit early to say, but I mean, what's your thinking in terms of how bad it's going to get and when that might occur? I mean, do you think this is a 2, 3-year cycle? Or is it a 2-year cycle? How long is the cycle? And where do you think NPLs will max out for guarantee?

[Ali Erbil, executive]

I mean, we don't know. I mean, this is only my personal hunch based on my personal analysis. I think the peak we'll see at the end of 2019 in terms of NPL ratio, the peak level or -- not in 2020.

[Simon Nellis, analyst]

Right. Okay. And then just one last question, I mean, fee growth has been also very robust. I mean, how sustainable is that given the slowdown that's coming? I know it's a bit early to give guidance for next year, but how confident are you that you can continue growing fees at a nice pace?

[Ali Erbil, executive]

I mean, we're already at the end of the first month of the last quarter. Believe me, we're still running at the same pace, around 30% on the fee growth. So there is very limited downside of -- I mean, it might go down below 30%, but I'm not expecting some extraordinary moments in the fees and commissions. But next year is going to be not that easy in terms of the fees and commissions because of the slower growth, especially from the lending part. But as you know, our diversification in the fee base is quite well diversified. And being the leader bank in the digital, in the payment systems, in many product areas will give us the flexibility to deliver the highest levels of fees. I mean, we haven't come up with the guidance yet, but I would say, for the next year, it should be CPI plus, again, in terms of fee growth. And if you consider this year's base, which is almost 30% higher than the previous year, so I think CPI plus fee generation will be quite satisfactory.

[Operator]

We are taking the next question from [ Bob Kommers ], UBS.

[Unknown Analyst]

I have a question about your spreads. You had mentioned during presentation that in the fourth quarter, you expect more pressure on the spreads. I was just wondering where you expect those lira spreads to go to, at what level and when you expect those spreads to bottom out?

[Ali Erbil, executive]

Bob, as you have repeated, yes, I mean, Q3, end of Q3, we had still, in terms of Turkish lira loan-to-time deposits, not the blended deposit but time deposits, spreads wise, we delivered a positive spread. But Q4, we are having slight negative spreads right now starting from October. So this will most likely continue a few months more. This quarter, definitely a quarter only for Turkish lira, it's going to be negative. And it will -- we will start most likely either 0 or slight negative spreads through to 2019. But we're expecting in the second half or after May, we will -- definitely we'll enjoy a cost of funding-wise, we will be having some release in terms of cost of funding, and most likely in the second half, we'll be enjoying much higher positive spreads than the usual in 2019. But overall, in terms of net interest margin-wise, this includes, as you know, all kind of closed-end revenue items in our interest side, CPI is doing great, 1.3, I said more than double, I am very conservative there. So that will give us lot of flexibility in Q4 not only for the NIM management but also for our provision headwinds. So definitely, net interest margin will be flattish, if not higher, for all year, Q4 definitely a plus. CPI's contribution next year will be less. I don't want to give the guidance yet because we don't know the net numbers for the guidance next year but don't expect the same high levels of net interest margin 2019.

[Bob Kommers, analyst]

Great. My second question relates to loans. I respect that there is not much visibility maybe but yes, particularly the lira loans, you indicated you expect them to remain flat broadly in fourth quarter. When do you expect that to recover a bit? And what should be driving that?

[Ali Erbil, executive]

I think, overall, growth-wise next year will be a challenging year. So the same near-term trends will continue definitely, not only in Turkish lira as well as foreign currency, especially for ourself will continue most likely. The inflationary and the result rate environment will be the key if we see some sustainable improvements in the rate environment that definitely triggers the demand. But I'm not expecting anything, not before the end of first half next year. So the muted growth trends will definitely continue in the coming -- at least 6 to 8 months.

[Operator]

We are taking the next question from Gabor Kemeny, Autonomous.

[Gabor Kemeny, analyst]

It's Gabor from Autonomous. A couple of questions on asset quality, please. I understand that as a base case, you expect a slowdown in the economy next year but still a positive -- slightly positive growth. So what do you think would happen if instead we got a significant recession so let's say a 4%, 5% recession. How do you think your asset quality would develop under such a scenario based on your models? And secondly, if we look at the net NPL formation you show in the presentation, if you exclude the FX impact, it comes to something like a 2.5% if we were to translate it to provisioning. Do you think that could be a fair run rate for provisioning going forward?

[Ali Erbil, executive]

Can you elaborate a little bit more, Gabor, what you said about the 2%?

[Gabor Kemeny, analyst]

Yes, so on the -- you show in the presentation the net new NPL formation.

[Ali Erbil, executive]

Yes, 8 50, yes.

[Gabor Kemeny, analyst]

Yes, and if we exclude it, just in the Q3, looking at Q3, and if we exclude the -- I mean, if we take into account the collections and exclude the FX impact, I think it comes to something like a 2.5% of your gross loans. Would that be a fair run rate? Annualized, would it be a fair run rate for provisioning? Or would that be -- or how would you think about it?

[Ali Erbil, executive]

We don't have the Q-only currency impact, actually. So I don't think -- it's not going to be fair to make that conclusion.

[Gabor Kemeny, analyst]

Sure. I mean, if we exclude the currency impact, that's what I mean. If we exclude the currency impact, it comes to something like 2.5% annualized, I think.

[Handan Saygin, executive]

Gabor, this is Handan. The 2.5% sounds understated. Actually, the TRY 2 billion I mentioned that comes from currency impact is for the year-to-date. And the third quarter-only figure is about 800 million to 900 million of the 2 billion. So when you adjust it, should be a higher figure than that.

[Ali Erbil, executive]

So the total net NPL, which is assumptions very roughly, don't take as exact figures, TRY 5.6 billion minus TRY 2 billion, TRY 3.6 billion?

[Handan Saygin, executive]

Yes.

[Ali Erbil, executive]

And you analyze this figure, you will end up TRY 4.5 billion net. So this will lead us -- what is the average total loans? 4.5 makes -- how much it is?

[Handan Saygin, executive]

2 -- 2 40.

[Ali Erbil, executive]

4.5 over 2 40, that makes less than 2%, additionals.

[Gabor Kemeny, analyst]

Anyway, I refer to Q3, Q3, not by month but anyways. So do you think like 2.5% going forward is...

[Handan Saygin, executive]

The Q3 collections are -- have been extraordinarily high. As you can see, it's double on what we have booked in the first and second quarters. So I mean, I don't think it will be right to say 2.5% as the norm, so...

[Ali Erbil, executive]

But I have found the number for you. This is bank-only -- the difference. Total, the FX impact Q3 only is around TRY 1.3 billion.

[Handan Saygin, executive]

Bank only.

[Ali Erbil, executive]

Just portfolio customers.

[Gabor Kemeny, analyst]

Can you comment on the downside scenario for the economy and the potential impact on the -- on asset quality, please?

[Ali Erbil, executive]

I mean, the downside scenario, the unemployment will be the key, the impact on the retail portfolios going forwards. As I already said, Q3 was muted in terms of the regular performance of the asset quality of the retail portfolio. We're expecting a slight deterioration in the retail portfolios in Q4. It definitely depends on the unemployment ratio. That is -- that we'll see. But what we're trying to, as I already said, definitely we will have a worsening NPL ratio coming from the retail, but it will be offsetted, most of it will be offsetted by the pre-provisions we are setting aside regarding our stage 2 loans, regarding on the macro impact. So we are more concerned for the business standing for commercial and corporate clients that is going to be the key element in the asset quality going forward. But as always, we didn't bring the sensitivity analysis for some years of this portfolio, how we are monitoring every quarter, almost 70% of this portfolio is analyzed based on the companies' leverages as well as their exposure to FX. So that method is still in case. That method, we are making sensitivities, and as a result of this methodology and analysis, we come up with the increases in the provisions. That's why that 130 is expected -- will deteriorate in the coming quarters. So the same performance in a base scenario, in a conservative scenario, let me put it this way, will continue in 2019 as well. So that is our base analysis. So whatever you will end up this year in total provisions, most likely will be the figure for the next year. Just to give you a heads up in terms of preliminary asset quality outlook for 2019.

[Gabor Kemeny, analyst]

Okay. So it could be similar to the 2018 levels under your base assumption?

[Ali Erbil, executive]

Yes.

[Operator]

We are taking the next question from Alan Webborn, Societe Generale.

[Alan Webborn, analyst]

Could you give us your view of the sort of measures that the government and agencies are putting into place? I know that -- I guess not all the details are available. But do you think in terms of loan restructuring, the FX issues, are you actually able to sort of restructure loans? Are you able to engage with corporates knowing what the environment is? Or are we still in a situation where it's very much wait and see in terms of what the support might be, who will be affected by it, can you use it? What's your feeling in terms of their -- after the headlines that we've had in terms of -- clearly, there's a lot of good intent to actually support the economy, support corporates that need it. Where do you think that the regulation is now? Do you think it's going to be useful? And how are Garanti engaging in that? That would be helpful. Secondly, could you just give us a view of just sort of the quarterly trends in your FX deposits and your TL deposits in terms of stock and flow? That would also be useful, and that's it.

[Ali Erbil, executive]

Alan, regarding the measures, you mentioned 2 main measures, but overall, the approach, what we see coming from the economy administration as well as the regulator, we find it very helpful and right measures. I mean, if we start with the FX, although there might be some slightly negative impact on our performance, but we found it very useful going forward just because of Turkish economy is very dollarized economy. The main intention here is to make it dedollarized. Of course, is -- it will not solve this issue overnight, it will take some years to adopt. But it will, I think going forward, very important structural change as in terms of reform agenda, we find it useful. So why would I paying my rent in dollars or if somebody's selling his car or house in euros or dollars? So these are very important steps as well as some impact for some businesses. But what we have seen, the impacts will be -- on negative terms will be temporary, but going forward for the midterm and long term, those are the right measures. Regarding for restructuring, there is -- there will be, very shortly, a framework agreement. I mean, what we have found in this framework agreement useful, it will give us a guideline to the banks in terms of to the restructuring. What we have in terms of big restructurings, luckily, we didn't have many items yet on our agenda, although the perception is much worse. But we have seen in limited experience as banks, we're not speaking the same language. So this framework agreement puts the required conditions, very basic conditions but important conditions to make decisions because it is taking time. So time is ticking away, so this is not good for the banks as well as for the corporates. So this will solve things with this agreement -- framework agreement very shortly. So overall, again, this is an agreement, nobody forcing us, but we agreed as banks on this framework agreement. Hopefully, it will be in live very soon. So I think these are the -- these were the important steps, not only this, and they will -- I mean, the regulator and administration will take the required steps if needed going forward. And one thing I should be underline is there is a great communication and collaboration among the parties, not only among the banks as well as economy administration and the regulation. I think this is also helpful for the whole parties and the stakeholders. Regarding the quarterly trends in terms of -- I think you're wondering about the rates, not the stock volumes, right?

[Alan Webborn, analyst]

Yes, yes, yes, just to understand what you're paying for...

[Ali Erbil, executive]

Nowadays, the stock is in Turkish lira, is around 22%, very roughly, as of today. And the highest marginal is around 25% maximum, maximum for the big tickets. But daily average is now situated around, again, 21% to 22%. So this will stay around these levels with a downside potential going forward in Turkish lira, okay? So hopefully, we have seen the highest in terms of total cost of Turkish realtime deposits of the stock. This will -- don't expect us to make it below 21% or 20% at the end of the year. I don't think it is possible, but we will most likely end up between 21% to 22% at the end of the year in Turkish lira. And most likely, again, depending on the inflation and rate environment in the coming months of 2019, we will see some improvements in the cost of funding in Turkish lira. In foreign currency, the dollar is around 4.4% as of now, the total cost of time deposits of the stock as of now. Maximum, we are -- as of today, we are giving, for the big tickets, 5.25%, that is the maximum to dollars that we pay. Again, this maximum level of cost of funding currently in place. We're not expecting any further deterioration as in the Turkish lira in our dollar deposits. Dollar deposits is the major contribution for our foreign currency deposits. Of course euros, we are paying much less, I don't know, average cost, but it should be around 1.8%, 1.7%, much less, obviously, than dollar deposits. I hope it helps.

[Operator]

We are taking the next question from Mehmet Sevim, JPMorgan.

[Mehmet Sevim, analyst]

You prudently set aside TRY 700 million of free provision this quarter, and stage 2 provisions have increased as well, yet at the same time, specific coverage has been on a declining trend since the first quarter. I think we're at 59% levels now, down from 68% levels. Can you tell us why specific coverage is coming down? And do you expect this trend to continue going forward? And what's your comfortable level of specific coverage?

[Ali Erbil, executive]

The reason being that change is highly covered, 2 files have moved from stage 2 to stage 3. It's -- That's the pure reason that you can see this trend. But overall, total provision, as you can see, is up by -- significantly, I mean, right? In first half, it was 110 total net cost of risk, now we're reporting 130, and we were saying that it will have upside potential. So provisioning story will continue, hopefully it will end it soon, but it will continue.

[Mehmet Sevim, analyst]

And one follow-up also. I know it's early to talk about it, but do you have any early indication of dividend payout from 2018 earnings, given the circumstances and your prudent approach? Would you keep last year's payout levels?

[Ali Erbil, executive]

I mean, there are -- currently, we haven't changed our policy yet, but we have been through little extraordinary days, as you know, recently. There are 2. Of course, this is the decision of the main shareholders, number one, first step and second step is the regulators, BRSA's approval. So we didn't have any clear decision yet to change temporarily the payout policy for this year or not, and hopefully, whenever we revisit and make a decision on this, I will come up with the very neat answer. But unfortunately, I -- we don't have any change yet. But again, it depends on totally subject to main shareholders, BBVA's decision as well as BRSA approval.

[Operator]

We are taking the next question from Deniz Gasimli, Goldman Sachs.

[Deniz Gasimli, analyst]

I have 3 quick questions from my side. One on your free provision stocks. Right now, you've accumulated around TRY 1.9 billion free provision. And I suppose next quarter, there will be pretty sizable windfall from CPI linker, so you may potentially book another round of free provisions. But do you intend to use this free provision stock next year? Given, I mean, that overall asset quality is not positive, do you expect to utilize your free provision for next year to offset some of the cost of risk pressure? My second question would be on -- I mean, kind of continuing from the previous question on NPL coverage, on [ specific ] coverage. So it came down to 60% on bank-only numbers and because of collateral and some of the exposures as you mentioned. My question being is as per IFRS 9 modeling or IFRS 9 rules or banking regulatory rules, is there like a lower limit to which stage 3 coverage can go? Or is it just a function of the loss coming in the fold and collateral on the exposures? And finally, my question -- my last question was on -- given that we're seeing loan pullback for Garanti and for the sector as a whole, and there's been some loan growth happening currently and the impact some decline on sector level in loan growth, does that maybe put pressure on the borrowers on the corporate or retail space in Turkey which may further exacerbate any asset quality pressure potentially for them? Or that's not a worry, and that's not kind of a topic that can come out of a cutback in lending?

[Ali Erbil, executive]

Deniz, the free provision story most likely will continue in Q4. We don't know. We cannot guide you much or if we have, but we try to set aside in Q4 as well. We'll take advantage of the extra CPI linkers income. For next year reversal of this free -- I mean, the reason being of having this free provisions, as you know, for very extraordinary events, incidents that may happen. So I cannot say that, as of today, we'll be reversing this much next year, or there won't be any reversal. So it is definitely depending on the onetime events going forward. This is more the reason being for -- to take any kind of prudent actions in advance for those difficult days. For the NPL coverage, as you said, the approach is there is no magic formula there or there's no rule, benchmark or minimum threshold type of thing. It is just because as a result of the valuation, one by one, individual asset file. So what we are doing, especially in the NPL portfolio, is just, as you said, calculating the default rate of the specific loan and as well as how much collateral we have and the conservative value of that collateral and remaining part is provision. So as a result, things are, in terms of big tickets and some individual names, this ratio differs from bank to bank and quarter-by-quarter. That is the reason why we are having. I mean, if we will have very smaller ticket SME loans, credit card, as an example, like portfolio, definitely we should have the provisions like 90%, 70%, 80%, but unfortunately, these are the very individually different -- or asset files. So I'm afraid we cannot come up with a minimum threshold for you. That's why this differs from bank to bank and quarter-by-quarter. I mean, in terms of the last question, this is chicken and egg. We were expecting a slower growth, slower growth means lower lending. It is happening. Slower growth triggers lower lending, that triggers higher NPL. So that is the scenario, that's why we are setting aside specific provisions. That's why we're setting aside free provisions. That's why we're guiding you worsening in the asset quality just because of this. So since this outlook will continue for some time, especially 2019, this will be the base outlook going forward. So I cannot say that, specifically, this is happening from related sector and so on and so forth. That's the unfortunately usual trends in a slower growth periods. Hope it explains your questions.

[Operator]

We are taking the next question from Yulia Di Mambro, Federated Investors.

[Yulia Di Mambro, analyst]

I have a few questions on your asset quality, please and then just a follow-up on liquidity after that. So firstly, just following up on your decision to raise fee provisions in the quarter. I thought IFRS 9 provisioning was supposed to be forward-looking, so are you preparing for something that your models are not necessarily picking up? And does that mean that you may need to tweak your models at some point in the future so they would pick up that risk? Secondly, on your restructured loans, would you be able to share with us what percentage of your stage one loans are restructured, and where do you expect that ratio to go? And also, in light of the -- kind of the slightly more lenient treatment that the BRSA is now allowing banks for restructured loans, do you expect to reclassify any of your restructured loans from Stage 2 into Stage 1 anytime soon? That's on asset quality. And I guess, question linked to that is, has the BRSA started conducting any stress testing yet? And what sort of parameters do you think that they could be using? And then lastly, on liquidity, can you share with us how much of the $10 billion of FX liquidity that you have is right way repos?

[Ali Erbil, executive]

Yulia, I mean in terms of free, there is no link between IFRS 9 methodology and the free provisions. I mean, the reason why we started to set aside free, aside from last year, as you know, we have very limited number, but we have one or a few very big ticket items in our portfolio, which is -- one of them, very important of them, is the telecom, as an example. So the free -- the accumulation free provisions is just because of the one-off events, not necessarily with the asset quality. But since we did not expose any other big risk other than our credit risk or loan risk, so we are setting aside to maintain the smooth performance, bottom line performance among the quarter. So that is the preliminary caution but not related at all with our IFRS 9 methodology. So this is the answer to the first question. The Stage 1 -- in the Stage 1 loans, restructured portion is 0. Whenever or whatever we restructure, that includes from very small ticket retail loan to very high ticket corporate loan, we stage under Stage 2. So 0% of any restructured loan under Stage 1. This is very clear methodology and the policy of the bank. The forbearance or the flexibility that has been given by the regulator to us 3 month, since we do have the restructuring policy, on top -- even if things get better with the related file, on average, we are keeping those files for 2 years in our Stage 2. So our...

[Handan Saygin, executive]

Not for lifetime, you mean.

[Ali Erbil, executive]

Of course, minimum 2 years. So the 3 month is, in our case, is 24 months minimum. In terms of stress test, we haven't seen any results yet, but the approach is typical. I mean, the tests are being done especially on the liquidity, solvency and asset quality. These are the 3 top main categories they have been focused on. But I don't know which states they are in terms of their audit findings, hopefully, we'll definitely hear from them soon. But we don't have any information yet on this issue. For the right way swaps, is around $4 billion, maybe roughly out of that $10 billion. That is the amount for the time being. Did I miss anything?

[Yulia Di Mambro, analyst]

No. That's it.

[Operator]

We are taking the next question from Vishal Iyer, JPMorgan.

[Vishal Iyer, analyst]

Just one question on liquidity for me, please. Just following up on that, could you give a more granular breakdown on liquidity and what portion is the ROM FX securities and money market placements as well? And just in terms of the mechanics of unwinding the FX swaps and releasing ROM, I presume you need to have lira liquidity on hand for that. So do you have sufficient lira liquid assets to achieve that?

[Ali Erbil, executive]

In terms of ROM, I can give you a rough figure, it really depends on the day -- daily, but it fluctuates around $2 billion, very roughly. So we don't want to give very exact details of that 10 billion. But first coming from the right way swaps, and around 2 billion, a little less than 2 billion is coming from optional mechanism under ROM. We believe we do have enough Turkish lira liquidity as well as we have in foreign currency, but liquidity is a issue of -- with the very dramatic space. The liquidity in that front will be more important in hard currency than Turkish lira. So we believe that if there are -- I hope not, but there are challenging days in terms of liquidity, Turkish Central Bank will definitely come up with the tools to create Turkish lira liquidity. So what I mean, if you're asking specifically, that 4 billion we're doing with the London counterparties will be done very easily with central bank. And we did see some examples in the past, very temporary period of time, but we did see this type of measures in the past. But in terms of Turkish lira, total liquidity, it is around TRY 30 billion, very roughly speaking, as of now, again, but that is not a major issue in the -- in our liquidity items. More importantly, we are paying attention to foreign currency. But to let you know, we are carrying, as of now, around TRY 30 billion, 3-0 billion Turkish lira liquidity. On top, $10 billion-plus hard currency liquidity.

[Operator]

We are taking the next question from Tolu Alamutu, Exotix Capital.

[Tolu Alamutu, analyst]

I just have a few quick questions, please. The first is on NPL sales. You mentioned that you aren't considering that for the rest of the year. I just wanted to know what you're seeing in the NPL market and why you're not taking advantage of that in the same way as some of your peers? The second question is a follow-up on the restructuring framework. There were some headlines saying that some foreign banks operating in Turkey are not agreeing to this. I just wanted to know whether you could comment on that and whether there could be a delay in that framework going through? Third question is on capital. You mentioned that you have, I think, TRY 10 billion in excess capital. I just wanted to know what level that would need to fall to for you to consider, say, a capital increase in Turkish lira as we've seen some other Turkish banks do recently? And finally, would you consider buying back your foreign currency-denominated Eurobonds, given that you haven't -- you're expecting foreign currency lira demand to remain subdued?

[Ali Erbil, executive]

Thank you. I mean, the reason why we haven't seen any NPL sales is because of very limited buyer and the price that we will end up with will be less than what we are -- or we will be generating with our internal efforts, just basically, this is the reason why we didn't have NPL sales so far. As there was a market last year, and we did couple of -- I think, 3 times or 4 times, NPR sales, but there's no market this year, that's the pure reason. The -- As far as I am informed with the -- related to the foreign banks, the restructuring framework agreement negotiation is still in the phase and continuing but in a positive way as far as I know. But we haven't made any agreement yet, most likely next week or the other week, we'll be ending -- we're coming up with an agreement. In terms of capital, you said TRY 10 billion, actually, the correct figure is $10 billion extra liquidity. As of today, our consolidated ratio, with the level of the currency as of now, even 15%, that's -- 14 point something is now about 15%, this takes us -- we do have enough levels of enough capital. One correction, I'm sorry, you are right, I was wrong, TRY 10 billion. And buying back our foreign currency, Europe is not within our plan for right now. [ If we do have ]

[Technical Difficulty]

[Ali Erbil, executive]

So let me repeat my answer from the beginning. Sorry for this technical inconvenience. It was -- the question was why not you're having any NPL sales this year. I was just saying that there is no buyer, and even if we have buyer, the levels that they are paying is not at an [ attracting level. Can you hear us? ]

[Handan Saygin, executive]

[ I don't know. ]

[Technical Difficulty]

[Ali Erbil, executive]

So I think you're receiving my voice, although I didn't have any feedback. So very quickly, let me repeat the final question's answer. NPR sales, we're not planning because -- we didn't do it because of there is no attractive business on the table, so we not expecting anything for this quarter. In terms of the international banks' inclusion to the framework agreement, this is still ongoing. The process, hopefully we'll be ending up with an agreement very shortly. In terms of excess capital, we are having around TRY 10 billion, as we said, levels of extra capital, and our capital adequacy ratio with the BASEL III definition consolidated, as of now, more than 15%. We believe we have still higher levels of excess capital, and we're not planning any capital increase. And finally, you said any plans for the FX, Eurobonds buyback? That's not in our plan for the time being. If that's the plan, we'll let you know. Thank you. We can take the next question. No further questions. Sorry for the -- in last 10 minutes, we have some technical difficulties. We are terribly sorry for that. Overall, I would like to thank you all for your time and -- for our presentation and for your answers. As you can see, the performance is going at a very solid pace as always, and we believe this will continue going forward this quarter and hopefully next quarters in the coming year. So the business model, I think, justifies very basically, clearly, this performance. I think customer-driven business, commitment to the innovation and talent, products and transforming the bank in a right way will be a result in this performance. The machine is running at a very good pace, and hopefully, we come up with the same strong results in the coming quarters as well. So thank you all. We wish you a pleasant evening. So I would like to thank you all our colleagues as well.

[Operator]

Thank you all for participating in Garanti Bank's Third Quarter 2018 Financial Results Webcast and Conference Call.