Turkiye Halk Bankasi AS

IST:HALKB.E

Earnings Call Transcript 2018-Q1

[Operator]

Good day, and welcome to the Halkbank First Quarter 2018 Financial Results. Today's conference is being recorded. At this time, I would like to turn the conference over to Hakan Eryilmaz. Please go ahead sir.

[Hakan Eryilmaz, executive]

Hello, everyone. This is Hakan Eryilmaz speaking, Deputy General Manager Incharge of Treasury Management and International Banking. I have Mr. Burak Muezzinoglu, whom some of you have already met with, the new Head of Department of Investor Relations and Financial Institution; and Mr. Umut Kovanci from our Investor Relations team alongside myself will be hosting the conference. I hope you will find our presentation useful. We will do our best to make it as detail as possible to provide you enough color on how the first quarter was and how it looks like for the rest of the year.

Our net income grew by 10.5% quarter on quarter, reaching TRY 790 million despite free provisions we set aside amounting to TRY 70 million. One can easily see that our quarterly ROE, which has bottomed up last quarter is now recovering, reached 13.5% level is adjusted for additional provisions. Our net loans increased by 5.9% quarter-on-quarter and 6.7%, when excluding the impact of IFRS 9 just to have a like-for-like comparison. The key driver of our loan growth has been SME lending as expected as accompanied by corporate loans, where we have seen the impact of Turkish Lira depreciation given high FX concentration in the segment.

Deposit growth, we can define as modest, was really higher during the quarter, but you are all familiar with how stretched our [indiscernible] deposits market can get in the last few days of the quarter because of the competition. So we decide to replace some cost of TL deposits with alternative Turkish Lira funding sources, namely CBRT funding and our loan to deposit ratio has slightly increased to 107.6%, which is still quite comfortable from the liquidity point of view. While we are still waiting for being allowed to [indiscernible] maturing portions under CGF [ chain ]. We have been distributed our limits under the second part of the program deferring to the remaining TRY 55 billion. We continue to benefit from the advantage to [ link ] our leading position in the SME segment. We are able to build up a good volume also under Phase II. We believe CGF loans will continue to make substantial contribution, especially in the target sectors and regions of our country. As a leader bank in CGF granted loans, I believe we again brought our dedicated unit position in SME business and we'll continue to focus more on going forward. It is also our effort, loan extended to SME customer now account for 39% of the total loan book.

Purchase quality metrics reveal how discrete our risk management has been and how smooth the transition to IRFS was handled. NPL ratio further improved to 2.8% and growth specific CoR was at only 54 basis of points, quite a low guided level despite increasing specific loan coverage We see Group II loans increase both normally and as a percentage of total net loans, which was mainly driven by the prudent approach that we follow under IFRS 9. Net increase was almost TRY 2.8 billion. One of the key focus we have for this year is one of the [ most ] management and efforts to further increase efficiency.

Well, first quarter OpEx was down Q-on-Q, however, yearly growth looks to be higher at 17%, due to the low base of the last year. As you know, we started to pay pension and bonus in April 2017 which is causing a base effect in the first quarter where we paid TRY 50 million. Once this portion is excluded to have a more accurate yearly comparison. The increase will be at 12.5%, which is lower than the guidance of 14%. This base effect is going to disappear starting from the second quarter.

Another topic that I have to touch on before handing over to my colleagues is the capital position of the bank. We think the bank has been doing a very good job to sustain comfortable level of the total capital adequacy and Tier 1 ratios. You know we are more relying our internal capital generation capacity of the Bank. We just financed the first subordinated bond issuance amounting TRY 1 billion last year in October. This was a real success from both supporting capital adequacy and funding cost management perspective. That's why we are keen on having another issuance in the second half of the year to further strengthen the capital base as [indiscernible] in the budget beginning this year. Our total capital adequacy ratio almost purely consists of Tier 1 capital and we are happy with the existence level of the core capital ratios than comparing with the required level. Well, thanks for your patience. This is all from me for the time being and I'm very happy to leave the floor to Mr. Burak Muezzinoglu to briefly go over the presentation before switching to questionnaires. Thank you.

[Burak Muezzinoglu, executive]

Hello, everyone welcome. This is Burak Muezzinoglu speaking. Let me briefly introduce myself. I have been working at Halk Bank for more than 12 years. I started my carrier as an IT Auditor, after 7 years in Board of Auditors. I had been a member of our treasury team for 5 years. I was at [indiscernible]. In the middle of last March, I was appointed as the Head of FI & IR in our bank.

Let me start with the Page 3. This quarter we have carried the weight of the previous quarter in terms of cost of funding. Therefore, we witnessed a slight decrease in net interest income on a quarterly basis. We have been doing our best in terms of OpEx management. Collection performance is another aspect, which comes through prominence. Consequently, the net income delivered at TRY 790 million, which grew by 10.5% quarter-on-quarter, despite TRY 70 million free provisions.

Let's move to the next slide, Slide #4. Asset growth was strong. Assets grew by almost 5% quarter-on-quarter, reaching a total volume of TRY 320 billion, which resulted in a year-on-year growth of more than 29%. Please also note, the base impact of the first quarter of last year, which was lacking in credit guarantee funds utilization.

If you may follow on Page 5, CPI-linked securities amounted TRY 12.2 billion, which makes up 31% of our total book. We have taken advantage of them again, with a TRY 465 million income. At the right-bottom of the page, you will realize a 20% share of securities measured at fair value through P&L. Please bear in mind that TRY 10 billion securities borrowed in the previous quarters have been included to this calculation. So adjusting for that the share of securities at fair value through all other comprehensive income will be 45% and at amortized cost would be around 55%. Whereas the share of securities measured with the fair value through P&L was [indiscernible].

Let's continue with loans on Page 6. Here we witnessed SME-oriented loan growth in harmony with our strategy that we proclaimed many times. Year-to-date growth at 6.6% looks to be somewhat above our yearly loan growth guidance of 17%. However, please bear in mind the depreciation [ income ]. Our FX loans increased 4.8% quarter-on-quarter, but in USD terms the growth was 0.7%. Regarding credit guarantee fund it was the key driver of the loan growth not only within our bank, but in banking sector as well as -- as well in the previous year.

The second phase of CGF, which started in mid-February has not proceeded that fast, since it was determined to be allocated for more specific areas. We have living amount of -- we have living loan amount of TRY 19.4 billion, out of the total limit of TRY 22.5 billion from last year and TRY 1.5 billion out of the total limit of TRY 3.7 billion by the end of March 2018.

Let's have a closer look at the loan portfolio on the next page. The portfolio is still into -- still Turkish Lira dominated. FX portion is 31%, which was driven by the Corporate segment. Considering the breakdown of customer segmentation the lion's share belongs to SME by reaching 39% share and it heads towards 40%, which we have already targeted.

On Page 8, it's obvious that we more or less preserved our market share of retail loans, despite moderate growth. Now let's continue with asset quality on the following 3 pages. Our NPL ratio continues to improve and beat the sector average, just at that without selling or writing of our net loans unlike most of the peers. Transition into NPL was moderate and collection performance was astonishing. Our NPL coverage in terms of expected losses on non-performing loans is at 79% -- 79.5%, which is quite spectacular to present us the smooth transition to IFRS 9, when examined in conjunction with cost of risk that you may follow on Page 11. It was 54 bps in the first quarter and total cost of risk was 76 bps. And so net cost of risk, it reflects the strong performance of our bank in terms of collections and provision reversals, amounting to TRY 188 million.

Reaching to the funding side on Page 12. Well, our loan to deposit ratio ended 2017 at 105% and it climbed to 107.6% mostly because of the depreciation impact. However, by looking currency wise to L/D ratios, TRY at 121% and FX at 86%, both are at comfortable levels. Another important thing worth the mention, FX wholesale funding makes up almost 11% of our total liabilities, which is obviously very well compared to systems average of 23%. This makes us more resilient to potential shocks into external funding, limiting the impact of cost increases mainly driven by global factors, where we have less control of unfortunately.

Page 13, we present our market share of 10.5% in total deposits. Thanks to our CapEx to excess to deposit sources through our strong and widespread network in our country.

On Page 14, we see that while time deposits share in total deposits slightly decreased to 85.7%, demand deposits shares increased to 14.3% in total. Since we rely on local currency more than FX in deposit business, Turkish Lira deposits constitute 61% of total deposits, where FX deposits make up only 39%.

On Page 15, re-pricing in loans and transforming it into yield on loans successfully continue, as it has been the case for the last 3 quarters. However, because of the stickiness of cost of deposits, we witnessed 30 bps tightening in cost spread. When we look at the present picture today, you may see the recovery in upcoming quarters, as more of the pricing keeps its space and overall the cost impact.

On Page 16, you see the details on core revenues -- our net interest margin drops off somewhat due to the tightening in spreads. Besides we do not engage for transactions reasonably, therefore all burden of cost funding reflect on NIM.

On Page 17, our successful performance in OpEx management is quite visible. We witnessed 5.4% quarterly decrease. Moreover, it has tripled TRY 50 million TRY promotion payments to pensioners to make pay comparison with the first quarter of 2017, year-over-year increase in OpEx is just 12.5%, which is better than the full year guidance of 14%.

Looking at the next page, solvency ratios. Capital adequacy ratio and Tier 1 both decreased a fair amount. They are at 13.4% and 12% respectively. The decrease was mainly because of the Turkish Lira depreciation. However, the shareholders equity increased almost by 16% in 1 year, now at above TRY 26 billion.

Last, but definitely not least -- not least, we have the breakdown of banking transactions on Page 19. 30% of the transactions were carried out through mobile banking, which we continue to invest and improve. Regarding branch expansions strategy, 3 new branches were added within the first quarter and the total number reached 966.

That's all from me and we can pass through question and answer I think.

[Hakan Eryilmaz, executive]

Hello Celestina, we can now switch to Q&A session.

[Operator]

[Operator Instructions]. And we have Deniz Gasimli from Goldman Sachs.

[Deniz Gasimli, analyst]

I have 3 questions from my side. One, I think -- question would be on the deposit -- on the funding side, I think is being of the position, you mentioned that, deposit growth was 4% versus 7% for loans and this is as you switch to -- correct me if I'm wrong, is that CBRT funding that you are utilizing now, which is why you utilized less deposits this quarter, just want to get more color on this funding? If you have -- is it similar to the 4Q '17 funding that you received, which was also low cost? Just want some more kind of details on this and how do you plan to proceed with funding going forward, is it in similar fashion? That's my first question.

My second question would be on asset quality and this quarter was really positive, that is [ quality ] in terms of the NPL ratio dropped and coverage increase. But looking at the, obviously the Group II loans, the watchlist loans, the ratio went up from 2.5 to 3.7 and I was wondering what's driving this increase, is this because of IFRS 9 implementation, which is why it's a kind of resulting in a more conservative classification or are there any big ticket items, there has been a lot of news flow regarding some big ticket corporate restructuring happening in Turkey. So, would this increase include some of those loans or is it just kind of business as usual increase?

And my last question would be on margins, just want to like understand if why -- what drove the increase in cost of deposits this quarter, and given the rate hike we had 2 weeks ago, what's your expectation of the funding and if you expect assets re-pricing to offset that? And also there was some news flow about how banks mortgage rate cut that -- I mean that was on the press that you've reduced some of the rates on mortgages and just want to understand what is -- how much lower versus existing rate is this and if there will be any kind of yield impact, if any on this, or are you are planning to offset it through more volumes? Thank you very much.

[Umut Kovanci, executive]

Hello Deniz, this is Umut Kovanci speaking. Thank you for these very comprehensive and good questions. And let me start with the first one, with the strategy that we follow to manage our deposit base, as you know, we tend to have a higher volume intra-quarterly and we obviously -- the loan growth was catching up with the loan growth during the quarter until the last few days of March actually.

As we were heading into the end of quarter, well, because of this let me say stretched balance sheet frankly in the Turkish banking system, especially on Turkish Lira side, the competition is getting intensified and I think we got familiar with this and we know how to survive this competition and that was the strategy we follow, which means we let go some costly TRY 7 million, TRY 8 million commercial deposits that are let me say more sensitive to interest rates. As we always say, we wouldn't be hesitating on, let me say giving up on our deposit growth guidance of 20%, if we see further speaking this on the deposits pricing, well as you know, as expected, the incremental portion that we had seen in the last days of last year has quickly faded away within a few weeks beginning this year, this was fully in line with the expectations.

And there was some kind of stabilization until the last days of March actually, but at the end of March and in the early days of April actually, because of the balance sheet make up and let me say other developments we have seen in the market, the deposit pricing started to go up and we decided to let it go and let our loan to deposit ratio increase a little bit from 105% up to 108% and this actually is referring to the strategically we intent to follow going forward. If we see the signals in the deposit market continue to be there, I can comfortably say that we will do our best to optimize our funding base in terms of, let me say cost management. I think this is answering your first question, and I think this is directly linked to the third question that you asked on the net interest margin performance of the bank and cost of risk.

Actually, even though we have seen some kind of relaxation on the marginal deposit rates, the higher rates that we saw in the last days of last year continue -- has continued to take its toll on the stock deposit cost actually and this has let me say continued until mid-February. We have seen a sharp increase in January and partly in February, but in March actually, after we have seen this stabilization on the margin -- we're taking about margin rates, plus we -- the re-pricing impact was already gone -- already let me say finished. And we actually have seen the impact of relatively lower pricing on the cost of -- on the stock cost of deposits.

And actually margin was better in terms, of course a bit, but as you know there was not enough time to see a full compensation of the increase we had to see in the first 2 month of the quarter. And accordingly our cost of risk and our net interest margins shrank down a little bit. And as you know, the other major components of the net interest margin is the contribution from CPI-linked securities and one can easily see that there was an increase of roughly TRY 17 million compared to the previous quarters in nominal terms about [ fluctuations ] to the NIM is largest in this given another strong growth in our interest earning assets base. So accordingly there was no significant contribution from interest income from CPI-linked securities.

And in the absence of let me say activity on the top market, so we have everything -- all the cost increases especially on Turkish Lira on our interest expenses -- it is not helping us from that perspective and accordingly we have ended up with relatively lower net interest margin as expected. Well, by the way this was not a big surprise for us. This was completely in line with the guidances. And looking at, as you know, we left behind almost 45 days -- almost 40 days in the second quarter, I'm looking at the dynamics so far in April and partly in May, it is pretty much fitting into what we've seen in March, rather than in January and February, which means there will be a good chance to increase our cost of risk in the second quarter.

And I think we have done our best to re-price our existing loan book and accordingly another 30 basis points increase we have seen on our loan yields, which was pretty much in line with what we have had in the previous quarters, actually. So there was a continuation of the strong momentum that we have achieved on the loan yields and with the expansion of new loans in an environment where interest rates are relatively highest, as you know we have an ambitious growth guidance on SME segment and the pricing level is quite satisfying for us to continue to stick with our existing strategy and actually the results are kind of like a proof for that for the first quarter.

So I think the -- let me say, good performance of the bank on managing the cost of risk will be there -- will be much more visible in the second quarter as the existing dynamics makes -- is making -- obviously making me think in that manner. And with respect to the asset quality question, as you know, the increase -- the net increase on our Group II loans, it should be at around TRY 2.8 billion, which, let me say is translating into -- obviously, we've reached the volume of TRY 7.9 billion, which is translating into 3.7% of total loan, which is not that high and a great majority of this increase is let me say, mainly attributable to the prudent policy that we are also adopting under IFRS 9. As you know long-term loan is restructured in the past according to the BRSA regulation -- according to the BRSA regulations, we will not necessarily follow it actually under Group II loans. There was not that kind of an implication from BRSA regulation. But under IFRS 9, long-term loan is restructured, we should shift the customer and follow it under Group II.

As you know we have done our best with IFRS 9 model. We build up, we progressed and we fine-tuned it and we have put each and every loans that we have in the portfolio into the IFRS 9 model and according the they have been assigned their ratings through the model. And if a loan has a relatively low risk according, which is referring to 10 on the performing portfolio, let me put it that way. Then IFRS 9 obviously suggest us to follow it, to shift it into Group II, even if there's no overdue, there's no delinquencies. Well this portion should be amounting to more than TRY 2 billion out of [ TRY 2.8 billion ] -- they are not in any kind of overdue or any kind of delinquencies, but we decided to shift them into Group II just to be -- just to act prudent under IFRS 9 application, let me put it that way.

So on the other question, with respect to the mortgage loans, actually we have already mortgage loan packages with interest rates starting from 95 basis points per month for similar tickets and lower maturities. But the customers are obligatorily needed to buy additional products such as credit card, overdraft loans or domestic payment orders and other products designed to support profitability and we believe it is good for cross-selling opportunities.

The action that was taken today actually has been mainly as a simplification to our existing mortgage loan packages. The rates are set between 98 bps and 120 basis points per month if I'm not mistaken, which is quite similar to the previous one and additional products again has been preserved as it was in the portfolio. Looking at our -- looking at the existing level of stock yields on the mortgage loans, obviously the mentioned numbers are higher than what we have in the stock on a yearly basis. So there will be no -- let's say delusion from the - let me say adjustments that we have made today in terms of stock yields on the mortgage loans.

[Operator]

We'll take our next question from Ovunc Gursoy.

[Ovunc Gursoy, analyst]

The first question is, how do you see the trajectory of interest rates going forward, do you guys expect any interest rates hike in the next CBRT meeting? And how would it reflect to your margins going forward? Second question is about the external audit in your bank, how is the process going? Will there be a report coming soon in June maybe? Thank you.

[Umut Kovanci, executive]

As you know, CBRT has its set of tools designed over time and depending on what was required by the economic conditions, [ they enriched ] the set of instruments that is used in fight against inflation and other volatilities. And last example was they decided to increase basically the [ window ] rates, which was followed by adjustments made in the reserve option coefficients on top of other tools that have been effectively used by them. Now, we also observed that there is a good growing demand for simplification to the monetary policy in the market. Some consider it useful to increase the efficiency to better manage expectations and sent messages in a more direct manner to the market, that might be on the agenda we believe [ plus the way it's paid ] for a change. This is all I can say for the time being with respect to the positive response from CBRT. And what was the other question?

[Ovunc Gursoy, analyst]

It was about the external audits. Yes, how is the process going?

[Umut Kovanci, executive]

This is still an ongoing process, as you know the lawyers are physical present within our bank and having access to the -- having a direct access to our database and taking necessary information what they need without asking for permission from us. There is a direct link that they benefit. You know there are lawyers and they are conducting this audit and they promised us to present the results of the comprehensive due diligence in June and for the time being there was no change to the expected schedule. This is the feedback we have from them. Maybe end of June -- maybe there might make shift towards end of June. We were saying in the beginning or in mid-June, but maybe end of June or early July, depending on, let me say how much they progress and how much they need in terms of time management. So it is still an ongoing process.

[Operator]

[Operator Instructions]. And we have Emir Moran from ULNU.

[Emir Moran, analyst]

Two questions on my side. I missed the first part of the quick Q&A, so I'm sorry if I'm repeating the same question. But can you please tell us how you see the assets quality evolution going forward, it seems like the cost of risk is quite low in the first quarter, do you think this is sustainable, how do you see it? And the second question is did you use any swaps during the quarter. If yes, what's the swap cost during the quarter? Thank you.

[Umut Kovanci, executive]

Let me start with the swap cost, thank you for the questions Emir. Swap cost should be at around [indiscernible]. This is taken in account the cost of shorter term and longer term swaps and the swap volume was at around TRY 2 billion, which is really low actually. And the other question on the asset quality, well we are still sticking with the existing guidances, flattish non-performing loans, plus the 80 bps growth on specific cost of risk. Well, that we have shifted into IFRS 9 as you know, we were expecting to see high provisions in the first pay of transition and high level of coverage, but we ended up with -- it's a large increase on our growth on specific coverage from 78% up to 79%. But please bear in mind that we are still guiding for a 81% below specific coverage, which is actually also saying and indicating that the total coverage should be higher than 110%. So I think the 80 basis points should be the normal run rate for growth and specific cost of risk once we have in mind the aging impact on the loan portfolio. As you know, IFRS 9 is bringing so much -- let me say changes -- material changes when it comes to provisioning, especially provisioning on the non-performing sides the collateral issues, they will not be respected anymore once the loan term is impaired and other things, that's why we would like to basically stick with the existing level of guidance.

[Emir Moran, analyst]

Do you think you would set aside further pre-provisions in the coming quarters?

[Umut Kovanci, executive]

We have done it in the first quarter, mainly because of the difficulties that we are [indiscernible] in calculating the exact impact of changes in the permit is IFRS 9 model, this is the main reason. We are making fine tunings each and every day with changing conditions -- macroeconomic conditions or let me say loan specific conditions. The reason why actually to just be well prepared against the volatilities, which may be driven by the changes in the parameters of the model and I don't think that there will be additional free provisions going forward.

[Emir Moran, analyst]

One final question if I may. Do you think the ROE target for the full year, which was between 15% and 16%, if I'm not mistaken, do you think that is achievable?

[Umut Kovanci, executive]

Yes we believe it is achievable. And again this is another item of the guidances that we are still sticking with. There will be, let me say further contribution from top line especially from top line, with respect to the net interest margin and net fees and commissions. For example, fees and commissions in the first quarter was pretty much weak as expected, but we have made some kind of adjustments in the fees and commissions to give an [ excellent ], actually this is yielding and promising a good hope for the time the [ grouping ] gets the developments that we have seen in the first 40 days of the second quarter and there will be another comprehensive changes to be made into the fees and commissions that we are raising from digital -- raising through the digital channels in the second half of the year. So that's the reason why we will continue with the 15% to 16% ROE expectation and of course, no need to mention that the strong collection performance will be there going forward.

And obviously we have succeeded more than the average run rate of the bank in the first quarter and this is not reflecting any kind of one-off impact -- any kind of one-off impact from IFRS 9, this is showing the few strong performance -- strong collection performance and a strong focus of the bank once the new management -- management came into force July last year. There is, let me say a strong motivation coming from the upper management. So I believe these 2 factors will be more than helpful to reach the targeted level, to be within the guided levels.

[Operator]

And we'll take our next question from Simon Nellis from Citibank.

[Simon Nellis, analyst]

Just on the free provision. So I missed -- I must've missed the number, but what did you book in free provisions in the quarter? How much?

[Burak Muezzinoglu, executive]

TRY 70 million.

[Simon Nellis, analyst]

And that's -- you don't have -- you didn't have any free provisions before right, so the TRY 70 million is the balance sheet amount, total?

[Burak Muezzinoglu, executive]

Right.

[Simon Nellis, analyst]

And just wondering what is the impact of IFRS 9 on equity? I didn't see in your notes any disclosure on what the impact is?

[Burak Muezzinoglu, executive]

It is at around TRY 290 million, which was directly reflected to shareholders equity through the net income of last year.

[Simon Nellis, analyst]

So the TRY 290 million positive impact?

[Burak Muezzinoglu, executive]

Right.

[Simon Nellis, analyst]

Did that also positively impact capital position?

[Burak Muezzinoglu, executive]

Not, actually, because as you know most of the excess provisions were coming from generic provisions, which were taken into consideration in the calculation of capital [ risk ] ratio on the Tier 2 capital. And actually there was a shift from Tier 2 to Tier 1, but the net impact was almost zero.

[Operator]

And we'll take our next question from Alan Webborn from Societe Generale.

[Alan Webborn, analyst]

I think you mentioned TRY 76 million of swap costs in Q1. So presumably that was taken on the net trading line, so therefore, you've got sort of TRY 100 million sort of positive of trading income. Is that about right, because that looks to be a good number?

[Burak Muezzinoglu, executive]

Alan, let me make a correction on the calculation. Actually, I said TRY 26 million.

[Alan Webborn, analyst]

TRY 26 million. Okay, sorry, I didn't hear that properly. That answers my question. And the second I had was that, obviously you pointed to this very strong level of collections in Q1 and clearly you've made an effort to do better. Are they simply Stage 3 reversal? So is that to know IFRS 9 impact that simply builds Group III and so on being reversed. And what have you actually done, have you increased your collection workforce? Have you been -- have you changed your system TRY 188 million in one quarter is double your run rate and I mean do you think possibly you can keep that up or is there a seasonality in terms of those collections? Just give us an idea of what's changed because clearly that's a big difference?

[Burak Muezzinoglu, executive]

There have been 2 [ lead ] reversed from Stage 3 provisions actually. That's I believe one part of your question. And the second one is, I believe we are doing our best. There is a strong motivation within the bank. We have continuously strengthened our colleagues in the field, who are showing a great dedication to the targets that they are given. So actually, there is no seasonality in the performance of the Bank. I think this should be the run rate going forward for the rest of year.

[Operator]

And we'll take our next question from Klim Fedoff from Lord Abbett.

[Klim Fedoff, analyst]

I have a question on capital. It's relatively low, I think comparatively to other banks and the hit from currency depreciation, was looks like 64 basis points in this quarter and obviously currency hasn't done well since then. Would you -- can you comment on it and what are your plans to boost it, especially since the core spreads and profitability, it's kind of shrinking?

[Umut Kovanci, executive]

Well Klim, we expect to see further improvements in the course of [ return ] profitability. This is referring to the part, which is mainly based on the internal capacity to generate capital internally, this will that will provide some comfort on the capital adequacy ratio. And the other thing that we may consider to do, especially in the second half of the year as [ nestled ] in the operational budgets, a subordinated issuance actually under Tier 2 capital, totally depending on the market conditions.

We have nestled in as I said that whether it will be in foreign currency to benefit from the hedge opportunity once Turkish Lira is depreciating or whether we will have it in Turkish Lira, which is something to be determined by the market conditions when the time has come in the second half actually and as you know, as you can easily remember, we have completed the first subordinated bond issuances last year in October, and it was in Turkish Lira and at the time of issuance the cost was at around 14.5%, which was fairly good compared to the assumption that we may have within foreign currencies, especially in U.S. Dollars with a yield of 7% to 8% plus the swap cost of those days to us and 13% would be making up roughly 70% in total. So that was the reason why we decided to have it in Turkish Lira, not in FX.

If we see the dynamics of our debt, we would be more than happy to step the [ DCM ] market again with an FX issuance, but if it is not possible from the pricing point of view, we never hesitate to be on the market with an issuance in Turkish Lira, not in FX. This is one of the solution that we may create in the second -- we may have in the second half of the year. The others could be the fine-tuning in our loan portfolio. As you know there are some other segments consuming more capital compared to other such as SMEs and let me say, some of the retail loans, if we decide to have a fine-tuning on the portfolio, I believe we can easily increase our capital adequacy ratios by substantial portion. And the other thing might be a potential reclassification on the securities portfolio if we decide to do this.

As you know available for sales formally known as available for sale portfolio, the mark-to-market revaluations are directly reflected into the capital, into the shareholders equity and causing some kind of volatility negatively on the capital risk ratio, if the rates are going up and we can easily switch from AFS into maturity portfolio, if we feel the pressure there. So what I'm trying to say we have our measures that are available on the table and if we see further risks -- further pressure on the capital adequacy ratio, I think we never hesitate to take the necessary measures to be within the guidance level of 14% as a total capital adequacy ratio and the verbal guidance for Tier 1, which is above 12.5%.

[Klim Fedoff, analyst]

So you still plan to finish the year around those levels, what are you trying to say?

[Umut Kovanci, executive]

Yes, right. We are still with the guidance.

[Klim Fedoff, analyst]

Question on I guess asset quality again, is your exposures to OTAS and Yildiz can you quantify them and if you are provisioning for them?

[Umut Kovanci, executive]

Yes, as for OTAS we made it public in the auditor's report, USD 160 million exposure we have, which is relatively low. And as you know, we are not among leading banks in the syndication and we are -- as you know the loan was already shifted into Group II in the fourth quarter of last year and we increased the provisioning level once we shifted into IFRS 9 and the provisioning levels should be higher than that was required by IFRS 9 by the way. So we are trying to be more prudent than it was required by the model on OTAS, but with respect to Yildiz holding, we have never made it public and there are still ongoing negotiations. Well obviously some of the banks have agreed on the proposed conditions of the negotiations, but there are other banks who have their objections and still working on the restructuring agreements and that was the reason why we continue to fall off the loan under Group I, we did not shift it into Group II.

[Klim Fedoff, analyst]

And I guess one last question from my side, do you expect, this is more second quarter now, do you expect a larger contribution from inflation-linked portfolio?

[Umut Kovanci, executive]

Yes, this is right. Well, as you know, we are following the methodology with a lag of 2 months and based on realized monthly CPI figures and we have a very educated estimation on how much they will contribute into the bottom -- into the top line of the second quarter. So there will be a strong increase in the interest income that we have from CPI-linked securities, which is another let me say hedge instrument actually that we like in an environment where interest rates are higher and the inflation is fairing above expectation.

[Operator]

[Operator Instructions]. And there no further questions.

[Umut Kovanci, executive]

Thank you for your patience during the call and thank you for the interest you have shown on the conference call today and take care until our next earnings call.

[Hakan Eryilmaz, executive]

And also of course anytime you can easily contact to us and communicate. If you have any question in your mind, we are happy and pleased to answer your question. Thank you very much and have a nice evening.

[Operator]

That concludes today's conference. Thank you for your participation, you may now disconnect.