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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to Garanti Bank's Fourth Quarter 2018 Financial Results Webcast and Conference Call. Our presenters are 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.
Welcome everyone. So here we are again with another year behind of sustained earnings by all the odds of 2018. Now undisputedly 2018 was quite a challenging year, a year of sharp moves. Interest rates went up by 1125 basis points and nearly doubled. Currency at some point in the third quarter depreciated by more than 80% and ended the year with 40%. The currency pass-through and the high growth realized in the first half of the year ended up carrying inflation through the last 15 years' record high level of 25% in October.
All this had significant hit to the economic activity and all the growth rates were negatively impacted. We saw severe deceleration from a 6% pace in the first half to no growth. Even in such a year like last year we could prove once again our strong returns and capital generation capability. We increased our pre-provision income by 51% in 2018. Our core banking revenue performance, namely net interest income and net fees and commissions, as well as the operating expense trends remained healthy. And actually, we ended up beating our expectations in these fundamental categories. Whereas the windfall gains we could book in the last quarter from the CPI portfolio provided the opportunity and the comfort to set aside further pre-provisions and increase coverage. Accordingly, with an addition of TRY 1.09 billion of pre-provisions booked in 2018, TRY 700 million was booked in the third quarter, you may recall, and we added TRY 390 million in the fourth quarter. Our total pre-provisions reached TRY 2.25 billion. Now post-provisions our net income in 2018 was TRY 6.7 billion, representing a 5% earnings growth, 15% return on average equity and 1.7% return on average assets. With these results, our capital adequacy remained solid at 16.5%.
Now let's look into more detail as what lies behind this performance. Let's start with the growth in lending on Page 5. Now even though the start to the year was a good 9% growth in the first half, the year ended with a 2% Turkish lira lending growth. You can see that on the right-hand side. Given the environment, the new originations in Turkish lira consumer and business banking loans were not sufficient to compensate the maturing book in the second half of the year, whereas the growth in the credit cards continued and ended the year with a total of 16% growth. On the foreign currency side, after 5% shrinkage in the first half, in the second half this shrinkage gained pace actually and the year ended with 18% lower foreign currency loan book. It was largely due to the absence of large-scale projects and high redemptions. In the end of the year, we see a well-balanced loan mix among foreign currency loans, Turkish lira business loans and consumer loans each having about 1/3 share when adjusted with currency. In total, loans make up 61% of our assets.
And one addition to foreign currency shrinkage in the last quarter we have a written off portion of the large-tickets type of loan.
Yes. Thank you. And now let's look at how we fund our assets. Let's start with Page 7 where you can clearly see in the liabilities and shareholders' equity breakdown that deposits fund more than 60% of the assets basically easily covering the loan book. In 2018, the Turkish lira deposit growth continued uninterrupted throughout the second half as well and accordingly we booked 18% growth in Turkish lira deposits. Whereas on the foreign currency deposit side, the shrinkage continued as some retail customers took the opportunity to de-dollarize. Overall, our performance here remains better than sector. Our loan-to-deposit ratio, you can see on the bottom left-hand side, improved by 14 percentage points from the beginning of the year till the end versus 7% improvement that is seen in this sector. And our demand deposits share in total deposits remained well above the sector's average, bank-only 25% as guaranteed versus 21% in the sector's. Now before moving on to the next page, notice the second biggest funding source in the liabilities and shareholders' mix. Borrowings fundings, 19% of the asset, so now let's look at what makes up that. You can see on the next page the portion of the borrowings that's external debt which actually is the majority of the borrowings totaling $12.4 billion. $5.4 billion of this is due within 1 year, so we provide here the maturity profile of our external debt in detail on the right-hand side. We have syndication rollovers in the second and fourth quarters of next year, the portion in green, and 2 eurobond redemptions in the second half, the portion in gray, you may notice. Renewal of these will be dependent on the market conditions around their redemption time. In the meantime, we have doubled the liquidity as buffer to these short-term dues. The quick liquidity we have in hand amounts to $11 billion.
Now let's look into the asset quality in detail. And start with taking a look at our Turkish lira loan book on Page 10. And we mentioned about the well-balanced mix, 50% of the Turkish lira loans are business loans and of the business loans, 18% are actually Credit Guarantee Funds guaranteed. The other half are consumer loans and credit cards. Of the total consumer loans, 35% are collateralized. And actually like -- that includes -- that doesn't include those granted to the salary customers. So about 43% of our general purpose loans granted to salary customers are kind -- somehow collateralized, you can call. And actually, when we look at the overall picture in Turkey, the household debt to GDP right now stands with only 14% and this compares very favorably to the emerging economy averages of 40%. So that's one thing to keep in mind. Now let's look at the foreign currency loan book. Foreign currency loan book, even though it looks 40% of total loans when currency adjusted is 1/3. And majority of the foreign currency loan book is made up of project finance loans and 63% of the bank-only or the unconsolidated foreign currency loans. 75% of the project finance loan have low currency risk and as most of the projects generate foreign currency revenues.
Many of you are familiar with the breakdown of the sector and what makes up of these so I won't get into detail in this. 27% of the foreign currency loans are working capital and other loans which are granted to largely to big corporate and commercial clients and multinationals. And we conduct on a regular basis FX sensitivity analysis and proactively stage and provision these loans. And 10% they have the natural hedge; they are export loans.
So now let's move on to the next stage, the provisioning. Now here you see the staging breakdown of the growth loans. And here of Stage 2 in a local -- in total loans stands at 15% now you can see on the right hand side totaling TRY 38.7 billion, TRY 2.6 billion relates to the subsidiary, so you can notice here that this is slightly lower versus the prior quarters. Now, of course, there are lot of moving parts to it. As you can imagine, there has been continuing moves from Stage 1 to Stage 2 and from Stage 2 to Stage 3. Now overall, Stage 2 share is slightly lower versus the prior results as I've said. 2 main factors to it. One is the currency improved during the quarter by about 12%; and secondly...
And the majority of the Stage 2 loans affects the denominated loans. So...
Correct, correct, we'll actually get into detail in the next phase in this. And secondly, the sale of Telcom file is no longer subject to staging per IFRS 9 and now followed as loans measured at fair value through P&L. You can see in the footnotes as well. Now looking at the provision coverage levels of Stage 2, when adjusted for this Telcom file, it increased 250 basis points to 10.4%. Now more detail on Stage 2 can be -- actually we can look at the next page for that. Now 40% of our Stage 2 loans are quantitatively assessed, meaning the portion our IFRS 9 model generates based on the probability of default changes. Actually 81% of the quantitatively assessed portion is not delinquent at all, and the rest are less than 30 days past due. So accordingly, we provide only 4% coverage for this portion. Whereas the qualitatively assessed portion gets a much higher coverage of 15%. And here I would like to once again stress our approach difference in staging flow. We feel we have a rather prudent approach in terms of following loans on the Stage 2. For instance, the loans restructured and the refinanced they are followed under Stage 2 for at minimum 2 years or for lifetime. And we proactively move files to the watchlist as a result of advanced risk assessments, which actually used to be our common practice in the past. So this makes our staging not totally comparable to these peers, so once again I'd like to...
Highlight.
Highlight this, yes. Thank you. Now let's look at what happened in 2018 in terms NPL inflows. Now NPL -- new NPLs actually tripled. It looks slightly more than tripled, there's some subsidiary effect here. And it went up; the new NPLs at prior year was TRY 2.8 billion. In 2018, it reached TRY 9.8 billion. Now of the new NPLs 65% relates to corporate and commercial files and 35% to retail and SME. Now of course during the year we had good collections as well. Our collections performance was quite good in 2018. That still was not sufficient, of course, to offset these high NPL inflows. We had a very small NPL sale and write off. And here we didn't include Telcom file new NPL coming in and out, it's in the footnote, it is net of those, not net of that move. But by the end of the year, the NPL ratio basically doubled from 2.6% to 5.2% and this is where we stand now...
But I think let's clear something, this is consolidated NPL ratio.
This is consolidated.
Solo, I think more importantly to follow the trend, solo is 4.80% -- 4.89%.
4.89%.
So solo NPL ratio ended the year with 4.89%.
Yes. Now the corresponding cost of risk to the NPLs or to the whole -- the provisioning, the net cost of risk, excluding the currency impact for 2018 ended up to be 215 basis points. There is 57 basis points of currency impact taking the total to 272 basis points. However, please note that this 57 bps actually do not impact the bottom line and we 100% hedged this portion and -- the -- offsetting portion you see under the trading gains line. So the net cumulative cost of risk for 2018 ended up to be 215 basis points.
Now let's review very quickly the sustained core banking revenues in the year. So let's start with the margin. We were able to sustain our core banking revenues and thanks to our dynamic balance sheet management, the defense to the NIM was quite good. In a year where interest rate doubled almost, we were able to defend the NIM well and excluding the CPI impact the core NIM suppression was limited to only 20 basis points. So it was well managed, I can say. CPI served their hedging purpose and CPI -- including the CPI, actually, we were able to increase the total NIM by 61 basis points to 5.3%. And the CPI impact has been, of course, very positive here since the CPI reading year-on-year more than doubled and the income as well doubling.
Now looking at the monthly spreads. We feel we saw the worst in October, I mean, you can see on the chart on the right-hand side that we actually -- when looking at the spread of TL loan yields versus the TL time deposit costs, we actually did see a negative spread in October. Then since then, we did see some ease, a normalization -- started normalization in the deposit pricing and our spread, that you can see here, the trend of the spread that is even widening as loan yields continue their upward trend and Turkish lira time deposit cost they are right now on the downward trend. As of today, the level of the TL time deposit cost is under 21%. And so that trend is continuing. This is also true for the foreign currency spreads.
So let's look at the core banking revenue and others components of the core banking revenue, the fees and commissions. Thanks to our well-diversified fee book, we were able to sustain a significant growth above 30%, we booked 32% growth in net fees and commissions in 2018. We were definitely helped with the -- from the contribution of the payment system, 50% of the payment net fees and commissions -- payment system form, these are mainly the -- our market leadership there and also the strength -- the leading position in issuing and acquiring businesses, definitely helped. Also the strong merchant network helped. We have the -- we have #1 position in terms of the POS network and the actively managed relations.
The fees here, they are a function of the prevailing interest-rate environment. So we benefited. We could benefit significantly in 2018 in this line and this reflected as a net fees and commissions increased. We don't believe this is a sustainable growth level but net fees and commissions, the diversified profile here definitely helped our fundamental performance, which typically fairs around net fees. We were able to deliver an outstanding 32% growth in this category.
Now let's look at the -- now let's look at the operating expenses. Our disciplined cost management remained and we delivered an operating expense growth that is below the average inflation of 2018. Our OpEx growth ended up to be 15% and versus the average inflation of 16%. And this number is TRY 8.8 billion of operating expenses includes the mix, Pendik -- our new technology sensors, a new branch service model amortization, which has an additional 1% impact for -- in the 2018 operating expense figure. All in, our cost/income ratio improved in 2018. We did see year -- since 2015 a significant 12% improvement in our cost/income ratio. Now cost/income ratio, excluding the provision, stands at 35.6%.
Now let's also move to the capital generation, the strong solvency we have. As the result of all this good fundamental results, we were able to keep our capital adequacy ratio solid at 16.5%. Now recall that this is a year of very high volatility, the currency impact alone on the capital adequacy ratio was about 2% which was more than offset by the net income we generated. And so -- and plus on top of this we -- last year, we distributed record-high dividends which had 63 basis points negative impact on the capital adequacy ratio and all in the levels remained well above the required level.
And we set aside TRY 1.1 billion net free provisions that is not included in the capital base. So overall, TRY 1.1 billion, additional dividend payment and huge currency impact we ended the year almost with the same level of capital adequacy ratio as we ended year of 2017.
Great. Actually, if we hadn't set aside those pre-provisions the capital adequacy ratio would have been 40 bps higher 16.9%. And per our calculation based on the 2019 required level, the excess capital we have in hand currently stands at TRY 13 billion. Now let's have a status wrap-up. The return on average equity target was met when adjusted for the free provisions set aside during the year. In 2018 guidance beginning -- in the guidance we had, we met the ROE guidance, we were saying that we would deliver 17% and not take in into account any free provision. So adjusted with the free provisions, we ended up to be in line in our ROE guidance. There were few beats, the fee growth, we had a strong beat, and NIM we had a beat, definitely have [ by the ] CPI. We had operating expense growth beat. Yes, we were impacted which were sufficient enough to offset the higher-than-expected net cost of risk. We were guiding or expecting that to be around 150 basis points in our revision in July. The year ended 215 basis points. But the upside we could book from margin, fees and operating expenses could offset this downside. So thank you for listening to us. Now we can take the questions you may have.
[Operator Instructions] We are taking the first question from Deniz Gasimli, Goldman Sachs.
I have 3 quick questions from my side. One is on your OpEx trends during the quarters. So I mean, they increased sequentially, even the fourth quarter was driven by the non-HR expense which are up around 25%. So I just want to confirm that this is because of the amortization of the Pendik investment? And my second question is on the free provisions, as you alluded to, you have around TRY 2.25 billion of free provisions which are not included in the capital on your booking and you have the booking free provisions throughout the year. So I want to ask is there intention to use them somehow in '19 to maybe easier cost of risk this year, or is it purely for any extraordinary event and you haven't really -- you do not expect any kind of scenario where you'll be using it by just keep setting it aside for some, sort of, kind of unexpected circumstance? And lastly on dividends, I mean, I think, during the analyst presentation where you provide the guidance, you've -- from my understanding, you mentioned that there might be no dividend payout or lower dividend payout this year compared to 28% payout in -- for '17. So I just wanted to ask if you have any updates on guidance on what the dividend payout would be?
Thank you for your questions. In terms of OpEx, I mean, that's a normal trend. Normally there -- the last quarter has always been the highest quarter in terms of OpEx realization in our performance. Since this year is mainly because of -- as you can imagine, additional that the natural trend the amortization increase because we ended the whole Garanti Plus Project in Q4, as you know. So the amortization went up. And as well as the IT center now fully function -- functioning in Pendik so that also impacted as well. So overall, that's the reason that we believe we keep it under inflation, holding for the whole year. The OpEx guidance as we guide it, so hopefully, we continue with this performance in 2019. So you can -- we guided you in terms of 2019, OpEx environment -- CPI or less will definitely come up something below inflation in terms of OpEx performance as we did in the recent years.
Free provisions strategy -- it's truly for no specific reasons we set aside. As you know it was a year of a lot of challenges and it was a year of a lot of unexpected income as well coming up to CPI linkers. So we took advantage to balance going forward unexpected risk; we set aside some free provisions from meaning TRY 1.1 billion 2018. We no longer planning to continue with this strategy for 2019, that's a clear strategy for the funding. If anything changes we'll let you know, but we're not planning to set aside any -- not anymore. But in terms of utilization and reversals, we don't have, as I said, no plans so far. Again, these are for some extraordinary buffers or cushions for some extraordinary events. But again, if that would be the case and we'll let you know in advance. In terms of dividend, unfortunately, we are at the same page as we have answered your question during our guidance meeting earlier this month. Hopefully, very soon we will come up with big decision and based on the approval of the BRSA, so we will come up with a concrete yes or no. If yes and how much to you very soon. I hope this explains your questions clearly.
[Operator Instructions] We are taking the next question from Simon Nellis, Citi.
For the presentation, most of my questions have been answered. Actually, I was just hoping you could -- the last one I had was on the Stage 2 reduction. Could you just go through the second driver of that? I didn't quite catch what the change was? Something about the loans measured at fair value not being included.
Maybe this is the portion, Simon, thank you. We can walk through what happened with that large exposure. As you might remember, we -- in the last quarter, the total loan amount was $1,150-something million, so this was the total loan amount to -- specific to those larger exposure. 33%, 3-3, has been written off during last quarter. So this take the total loan amount, which is in line with the external part evaluation, the total loan amount has reached $775 million. So this is the loan amount which is in the loan portfolio but as you know this portion has been in on the Stage 2 till the end of the third quarter. With this operation, our auditors recommended us to collect for this no longer as a loan but a financial -- specific financial asset subject to market pricing or regular valuation. So this will start at the end of this year, I mean, in this figures, still $775 million represented in our total loan portfolio but not in the Stage 2 loans. And starting from first quarter 2019, we will extract this $775 million from the loans and you will see this as a specific asset item in our assets which has caused financial -- or this -- the specific accounting name of this class...
Financial asset fair value through P&L.
Financial asset fair value through P&L class. So this is the main impact -- one of the main impact under Stage 2 specific to this one. And number two, as you have followed through our presentation, many items in our Stage 2 corporate loans, which is FX denominated, and since the Q3 and Q4 and Turkish lira appreciated, so that's also impacted positively, our Turkish lira total equivalent of Stage 2 loans. Those are the 2 main reasons of the main drop. On top, of course, there were some movements from Stage 2 to Stage 3, again, at the end of the year, Q4. So that's also dropped down to Stage 2 to this level. So these are 3 main reasons of this drop under the Stage 2 in terms of Turkish lira equivalent.
And maybe, I can follow on, since you are talking about asset quality. I mean, you're 1 month into the year. You're guiding for up to 7% NPL ratio. What are you seeing so far in the first quarter? How is asset quality progressing? You can say anything.
I mean, we remember, we said this year is going to be more -- we believe that 2018 was a year of the big tickets and the corporate loans, big ticket commercial loans year in terms of main contributors to the asset quality. We think we said, again, we're not expecting that much in close going forward 2019. I mean, again 1 month already, which is too early to comment but this is the case. I mean, overall, slight deterioration continuing as expected in the smaller ticket portfolios like SME portfolios, like in our retail portfolios. But overall, we don't have any big unexpected asset quality alarm signals to you we can share in the first month, which is totally in line with our budgets, if not better so far in terms of asset quality formations. But again, I know this is a good signal because January should be the worst month of the year in that regard. And hopefully, this will good indication for the rest of the year. And again to be on the safe side, to be only cautious, to be conservative. I don't want to give wrong guidance, but this is truly what's happening as of now for the funding regarding the asset quality.
There are no more questions in the line. Now I'll leave the floor to our presenters to address the questions we have received via web. Actually, we don't have any questions from the web as well. So I'm leaving the floor to our presenters for our closing remarks.
I think I wanted to make one thing clear, some of you, I mean, I'm sure all of you, but I need to make it clear. We are say -- reversed the forbearances measures which we had taken during August. So end of the year, before end of the year in terms of capital calculation, CAR calculation perspective for balance measures no longer in place. So we are back to standards of other fee calculations. So overall, the figures that we shared in terms of CAR has been based on this as of today standard approach.
So in terms of closing remarks, we already -- I mean, very -- 2 weeks ago we've been together to share with you our guidances. And hopefully, this year will be a better year than expected, and we'll share to you all of the developments as we go along throughout the year. Thank you for your, as always, contribution, support and the confidence. And we all as always Garanti team. We are confident with the economy. We are confident with the sector, and we're very confident and very positive with our performance throughout the year. Thank you.
Thank you all for participating in Garanti Bank's fourth quarter 2018 financial results webcast and conference call. You may disconnect now.