Turkiye Garanti Bankasi AS

IST:GARAN.E

Earnings Call Transcript 2019-Q3

[Operator]

Hello, and thank you for joining us in Garanti BBVA's Third Quarter 2019 Financial Results Webcast and Conference Call. Our CEO, Mr. Recep Bastug; our CFO, Mr. Aydin Güler; and our Head of Investor Relations, Mrs. Handan Saygin will be presenting today. Kindly note, there will be a Q&A session following the presentation. The presentation will now start. So I'll leave the floor to our presenters.

[Handan Saygin, executive]

Welcome, everyone. Here we are with the 3 quarters of 2019 already behind, happy to present once again another set of solid results.

Let me first start with -- there with a quick snapshot of the first 9 months, where we stand relative to our operating plan guidance. As you can see on Slide 2, we are either in line in the areas like growth, spread, asset quality and OpEx -- sorry, of steering better in fundamental lines such as spread margin performance and fee growth relative to the guidance.

As discussed only a couple of months left for year end, there it does not seem to be any downside risk in meeting our ROE targets for 2019.

On next page, you'll see that there is significant and sustainable pre-provision income generation capability in each and every quarter. This strong capability allowed us to satisfy strong buffers without risking our profitability targets and guidance for the year.

Our 9 months cumulative pre-provision income exceeded TRY 11 billion, TRY 11.3 billion to be exact, versus TRY 5 billion of net income. It probably translates into a return on equity of 13.5% and return on assets of 1.6%, and thus, further capital generation. On top of all the P&L provisioning, I would like to highlight in here that we maintained our pre-provisions buffer of TRY 2.35 billion as well. And this allowance suggests a hidden capital buffer of 72 bps. That is, as you would expect, not part of the already high capital equity ratio of 18.1% on a consolidated level.

On the right-hand side of the page, notice that 81% of the revenues at Garanti are from net interest income and fees. These are mainly customer-driven sources of revenue that we value and that of high-quality and that what constitutes the sustainable and healthy income generation capability at Garanti.

Now let's look in detail what happened in the last quarter or what is trending on Slide 4. On the left-hand side, seasonal balanced, loan mix among consumer, Turkish lira business and foreign currency loans. Turkish lira lending, after 5% shrinkage we had seen in the prior quarters started to pick up towards the end of the third quarter parallel to the drop in new loan rates.

The year-to-date Turkish lira loan growth turned positive 1%. Although the lending activity has been quite magnificent here so far, we do expect an acceleration in growth and believe in our 5% growth target in Turkish lira loans is achievable by year-end.

On the foreign currency lending side, we saw a sharp 6% shrinkage in the last quarter, as expected. A big portion of this shrinkage relates to strong redemptions during the period. There is also some U.S. dollar parity effect. By the end of the year, shrinkage most likely will also end up to be as guided, 10%.

Now looking further to how Turkish lira loans have been faring on Slide 5. We see a visible pickup, meaning a positive 2% growth in consumer loans, which finally kicked in after 4 quarters of shrinkage in consumer lending. Owing to the significant drop in interest rates, and thus, the new loan prices, this positive turn is mainly steered by the general purpose lending and credit card. New originations in general purpose lending in the third quarter reached more than double of what we had seen at the lowest level in the fourth quarter last year.

Accordingly, we could begin the quarter at 6% growth in general purpose loans. Mortgages, on the other hand, even though they are on an improving trend as of the third quarter, new originations were not sufficient to compensate the redemptions and shrink by 4% in the quarter.

Our leadership position in consumer loans among private banks is maintained as well as the leading position in Turkish lira lending. On next page, looking at the assets and liabilities breakdown. Loans continue to make up around 60% of the total assets, whereas deposits, along with deposits like Turkish lira bonds issued and merchant payables fund 67% or more than 2/3 of the assets. This picture suggests further improvement in loan-to-deposit ratios. Notice on the bottom right-hand corner, both for total and Turkish lira portion, the ratios.

In the third quarter, we had seen positive 3% growth in Turkish lira deposits and slight 1% shrinkage in foreign currency deposits. Year-to-date growth though in foreign currency deposits remained higher than Turkish lira deposit growth, reflecting the strong dollarization we have seen in the first half of the year.

The strength of Garanti continues to be the demand deposits share in total deposits. The ratio improved to highest ever level of 31%, meaning almost 1 out of 3 liras deposited at Garanti is not interest-bearing. The ratio is significantly higher than the sector average of 24%. This alone is a perfect indicator that Garanti is customers' preferred main bank.

Quickly moving on to the liquidity levels versus the external debt on the next page. Notice that, as of September end, we had total short-term views of $3.4 billion versus a readily available foreign currency liquidity buffer of $10.6 billion. Threefold the amount, basically, we need for short-term views.

Our $750 million eurobond redemption hit the fourth quarter and our total $1 billion syndication redemption, including the $180 million 2-year tranche that was signed in 2017 will also hit. Syndication loan that we do with our correspondent banks all over the world is planned to be renewed, and the announcement of this will follow the redemption, most likely by the end of November.

Here, I would like to highlight the historic quarterly trend of total external debt. How it's trending down versus strongly maintained foreign currency liquidity buffer on the bottom right-hand corner. Our quick foreign currency liquidity buffer, meaning the foreign currency reserves we keep under the reserve option mechanism, flat money market placements and unencumbered securities has now turned to be even higher than our total external debt. It is $10.6 billion versus $9.8 billion of debt -- external debt.

Moving now on to the fundamental P&L items. Let's start with the margin performance. On the upper left-hand chart, notice the strong improvements in the quarterly margin. 48 bps expansion brought the quarterly core NIM margin to 4.3%. Strong improvement in Turkish lira spreads due to significant rate cuts support this margin.

Multi Turkish lira loan yield of the book dropped by 120 bps from June to September, versus the monthly Turkish lira deposit cost dropped from 430 bps in the same period. Since the rate cuts of September and October are to further support funding costs in the fourth quarter, spread expansion will continue.

To give you a better idea, let me share with you the new Turkish lira deposit pricing that it is now steering around 12% these days versus September end of 14.3% versus June end of 21.5%.

On top, the foreign currency redemptions incurred in the quarter totaling $1.8 billion, also positively contributed to margin in the third quarter. Now looking at the cumulative NIM. Cumulative NIM year-to-date, we were able to improve our core margin by 50 basis points, which is already beating our flat guidance for the full year.

We successfully continue to deliver sector's highest cumulative margin, including swaps. 5% cumulative margin as of the 9 months includes significantly lower CPI contribution versus 2018, though. For the first 9 months of this year, the average CPI use in devaluation was 10.7% versus last year's October reading of 25.2%.

Now to demonstrate better and show you the successful track record in margin management, let's look at the chart on next page, showing the margin trend since 2015. Since 2015, weighted average cost of funding of the Central Bank tripled from 8% to 24%, while currency depreciated more than 100%.

On the upper half of the page, you'll see the evolution of our core margin in black line and it fares in the range of 3.5% to 4%. If you were to add the gains from the CPI linkers on top of the core margin, which is the green line, performance of this hedging instrument definitely gets verified.

At the bottom half of the slide, Turkish lira and foreign currency spreads show our successful due currency balance sheet management. Now moving to the asset quality on Slide 10. As we have been anticipating and guiding you, we had an increase in the commercial NPL inflows in the third quarter. With this move, certain files that were in Stage 1 -- Stage 2 got moved to Stage 3, with further increase in coverage. Consequently, the share of Stage 2 in gross loans dropped to 15% from 16% and NPL coverage increased to 62% from 58.5% in second quarter. And thus, the total loan provision coverage went up from 5.5% to 6.2%. This coverage level should be the highest level in the sector.

On next page, we can clearly see the quarterly flows. In the third quarter, total of TRY 2.6 billion of net NPL inflows broke the NPL ratio up to 6.7% from 5.7% in the first half. As a result of the NPL inflows the -- and increased coverage, the cumulative net cost of risk ended to be 227 basis points as of the 9 months end, excluding the 14 basis points of currency impact, which is 100% hedged and has no impact to the bottom line.

If you may recall, in our last earnings call, we had given you heads up regarding the anticipated evolution of net cost of risk for the rest of the year on a quarterly basis. In corporate and commercial files were quite muted in the first half and we were largely expecting the hit from commercials in the second half. With the realized moves in the third quarter, we are faring totally in line with our budget and guidance.

Now on next page, let's move on to the fee, where we continue to grow our fee, far better than our initial guidance of low teens and recorded a growth of 24% on top of the highest based fee-base in the sector. This is largely due to the upside we exhibited in the credit cards business, noncash loan fees and money transfer fees.

Annual growth in the payment systems fees of 35%, though, won't seem to repeat next year, mainly due to the recently imposed cap on merchant fees. We calculated the impact of this cap and I can share that the overall impact to continued fee growth will be manageable.

As you know, we run a well penetrated and the most profitable credit cards business in the country. Plus our diversified sources of fee and commission income will continue to give us the means to mostly mitigate this regulation impact.

Before we turn onto the OpEx on next page, please notice the increasing share of digital in our fees. Its share in noncredit linked fees now reached 47%, and 1 out of 2 products sold is end-to-end stages so now as Garanti.

Operating expense increase remains under control and was recorded as high teens, 19%. This growth, even though it includes some out-of-budget items, such as the increase in saving deposit insurance fund premiums and the elimination of 5% pension fund incentive still reflects around CPI type of growth -- average CPI type of growth.

Cost income ratio of 9 months is realized at 39.6%, proving our strong efficiency commitment. This ratio compares very favorably to Bloomberg, Emerging Europe, regional banks average of 48%. Now let's also touch base on our solvency on Slide 14. Our solvency improved further in the third quarter with a consolidated capital ratio of 18.1% and a core Tier 1 ratio of 15.7%. Both of these ratios are well above the regulatory requirements of 12.6% and 10.6%, respectively.

Taking into account the minimum requirements as of the first 9 months, on a consolidated basis, we have around TRY 22 billion -- well, actually, on a consolidated basis -- bank-only basis TRY 22 billion, consolidated basis, TRY 18 billion of excess capital.

This excess capital amount does not even include the TRY 2.35 billion pre-provisions we have set aside over time. If we had not set aside any such provisions, our capital adequacy ratio would have been near 19%. The contributors to capital movements can be seen in the cap chart below. The biggest contributor to capital improvement in the last quarter is market and creditors related and mainly stems from the drop in foreign currency lending as well as the shift in asset allocation to lower risk-weighted assets.

Now this concludes our presentation. Thank you for listening. We can now take your questions.

[Operator]

[Operator Instructions] And we are taking the first question from Sam Goodacre, JPMorgan.

[Samuel Goodacre, analyst]

Just a couple of questions from my side. The first one is just to pick up on the point you mentioned, Handan, on the merchant fees cap. Could you give us a little bit more color on that -- sorry, I may have missed that. But more broadly, I did believe that payment fees are linked to the prevailing policy rate. So I suppose a bit more color on the general pressure you would expect in payment fees and the growth in that segment of your fee income alone would be good.

The second question is about the deposit costs and particularly in light of your front book pricing at 12%. Given where the policy rate is? Do you think that there is therefore more limited room to reprice further lower the front book. And therefore, that the sort of NIM momentum going forward on core spreads is rather the back book catching up?

And then the third question is just on the high stock of pre-provisions you've got and what your thoughts are on those? What your strategy would be to release any pre-provisions over the course of next year and things like that. So that would be great.

[Recep Bastug, executive]

This is Recep Bastug. Starting with your first question. The impact of new fee regulation on merchant fees, yes, we have a calculation there will be a very important effect. But as Handan mentioned, it is a manageable effect. As you see, roughly 50% or 49% of our fee income comes from payment business. So here, we have the biggest payment business in the country. So we have a very strong [ band] effect, but the new regulation directly, directly has a negative impact our fees income. So next year, our growth will be limited. You have seen this year over 30%, 35% growth in fees and commissions of payment business. Next year, you will not see it like that. It will be, maybe 1-digit number, I have to admit it. But the other part, thanks to our conventional business, the commercial corporate and SME business, including the retail part out of credit card payment business, their contribution will be much more than this year. So we will be growing over the sector next year in net fees and commissions, but 100% we have -- we are going to lose some reasonable amount in our payment systems fees.

We have some calculations, but unfortunately, still we have been waiting from Central Bank to clarify some calculation methodologies related with some detailed issues. That is the reason we cannot calculate the 100% impact. This is the first one.

The second one, yes, as of today, below 13%, our cost of funding for carry time deposit. There are some rooms. It is not huge as we have had in this quarter. There are some rooms for improvement because we have been expecting another rate cuts I think, in December. And also, there will be more rate cuts according to inflation rate in 2020. So with those expectations, we have been waiting some more improvement with this item.

The last one, pre-provision release. No, our strategy with that pre-provision will continue. We don't think to touch it this year. Thank you.

[Operator]

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

[Deniz Gasimli, analyst]

Just 2 questions from my side. One, on cost of risk, I mean, this quarter there was obviously an increase because of the NPL -- additional NPL classifications, which I believe is in line with the BRSA instructions. I just wanted to clarify what the -- if you -- provisions for most of it? And what would be expected kind of impact of this NPL increase and cost of risk impact in the fourth quarter.

And from what I see your Stage 2 loan amount has actually reduced sequentially because I suppose of some of the movements on Stage 2 to Stage 3. I just want to confirm that as well.

And my second question is on rates, as you said, your margin rates are now at 12%, meaningfully down since second quarter. And from your expectations by when would your back book get to 12% rate overall?

[Recep Bastug, executive]

The first question -- the first answer to your first question, the cost of risk, the BRSA list full effect is affected to cost of risk. We have provisioned full coverage with bank's existing level. As you see that, at the end of the second quarter, the Stage 3 coverage ratio was 58.5%. Now it is 62.3%. So full list spec is reflected to cost of risk. The next quarter, our cost of risk will be around this number, maybe 10 bps less, 10 bps more. But still, we are below the number that we declared in the beginning of the year. This is related with cost of risk. So the 12% deposit rates, I think within 2 to 3 weeks from now on, it will be below 12%. If it goes like that. By year-end, we will be, by far, below that amount because it is going well. If we do not have any uneconomic problem, I think we will get very strong number before year-end.

[Deniz Gasimli, analyst]

Just to confirm on the -- from the BRSA side, the loans that were required for provision, you've done all of them in third quarter. But you still -- but the fourth quarter cost of risk should be around current levels, nevertheless, is that right?

[Recep Bastug, executive]

Yes. But our guidance was to be below 3%. Now this is [ 2.40 ]. As I told you, 10 bps more, 10 bps less, we will be around this number.

[Handan Saygin, executive]

Our guidance remains, Deniz.

[Recep Bastug, executive]

Yes. Because here in the -- there are natural inflow, natural outflow of that. That is the reason, according to the files that we have been controlling. This number is very satisfactory to us. The number of year-end will be around this one.

[Operator]

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

[Gabor Kemeny, analyst]

A question on the -- on margins. So you talked about the downward repricing of deposits, which will still be visible in the fourth quarter. So it looks like you are off to a decent exit rate in terms of your net interest margin for 2019. Now going into 2020, how sustainable do you think are these levels of margin? And when would you expect the loan pricing to kind of catch up with the deposit pricing, meaning any potential rate reductions?

And the other question is on the capital, but you flagged a more than 1 percentage point quarterly increase from market and credit risk and you mentioned that you move towards lower risk-weighted assets in the mix. Can you elaborate on that point a little bit? And tell us if this has any implications for the capital building in 2020.

[Recep Bastug, executive]

Thank you. The first one, yes, there are roughly more than 42 -- 40 basis point improvement in net interest margin in 2020, we are expecting more than 40%. There are some room still. This is the first one to your question. The second one, yes, that is 1 point, well, 100 basis points, 109 basis point improvement in market and credit risk side. If I need to give you the number, roughly, 50% of it is due to drop in foreign currency lending. Year-to-date, 8% in total, we have decreased our foreign currency loan portfolio, half of it. That's one.

The other part, there was amount that we have kept in Central Bank with 100% weighted average -- risk-weighted average. We moved it to a lower level of risk-weighted assets. The remaining 50% comes from that.

[Gabor Kemeny, analyst]

Okay. And just a follow-up on the margins. So what -- did you have any indication on the 2020 outlook in terms of whether this -- the Q4 levels -- to what extent are the Q4 levels sustainable?

[Recep Bastug, executive]

I have the numbers in my hand, but it will not be because they are stopping me to share numbers with you. That is a strong improvement more than as I see here. Let me tell you net increase in the interest -- net interest margin is 51 basis points. Now I told you 40, but it is not 40. It is 51 basis points net according to our calculations.

[Gabor Kemeny, analyst]

Okay. So just -- are we talking about Q4 or 2020?

[Recep Bastug, executive]

2020.

[Handan Saygin, executive]

Well, 2020. Well, Gabor, keep in mind that the starting point is high. And on top of this high margin will expand further -- with further interest rate cuts. And then that may be at sometimes, it's going to stabilize and come down. But on a cumulative basis, expect margin expansions in 2020 versus 2019 in the core margin.

[Recep Bastug, executive]

The number I gave you is the year-end number.

[David Taranto, analyst]

Relative to the 2019 average. Okay, understood. Understood.

[Handan Saygin, executive]

Okay.

[Operator]

[Operator Instructions] Seems that we don't have any more questions right now. So this concludes the Q&A session. I'll leave the floor to our presenters for closing remarks.

[Recep Bastug, executive]

Thank you for your attendance. So the third quarter of the year was a period that we observed significant improvement in inflation that could lead to reduction in the interest rates. Now we see the beginning of recovery in loan demand. Going forward, the increase in loan demand will be even more visible.

Committed to managing our balance sheet with sustainable growth strategy we could further strengthen our capital base. With this confidence, we will continue to support real economy by meeting the increasing demand. With our knowledge, experience and strong presence in the sector, we will maintain our leadership among private banks. We are, by far, the best bank in net interest margin, thanks to our dynamic assets and liabilities management, and this will continue.

In terms of asset quality, we feel confident with our strong buffers. Our continuous investment in digitalization ensures the sustainability of our core revenue generation capacity. I would like to emphasize that the principles of honesty, accountability and transparency are an integral part of Garanti BBVA's culture, and this assure sustainable long-term value creation. I thank you for joining us. I hope to be with you with better results in the coming quarters. Thank you very much.

[Handan Saygin, executive]

Thank you.

[Operator]

Thank you all for participating in Garanti BBVA's Third Quarter 2019 Financial Results Webcast and Conference Call. Have a longer evening.