Hello, and thank you for joining us in Garanti BBVA's Second Quarter 2023 financial results webcast. Our CFO, Mr. Aydın Güler, and our Investor Relations Director, Ms. Handan Saygın, will be presenting today. As always, there will be a Q&A session following the presentation, and you will be able to ask your questions either via raise hand button or by typing them into the Q&A area. The presentation will now start. I leave the floor to our presenters.
Hello, everyone. With now half the year and elections behind us, it is great to be with you again at another super results call. Let me start, as usual, with the macro backdrop we're operating in. The main highlights are that the new government economic policies will be key for the upcoming scenarios. It seems a gradual normalization that will be supportive for growth is a more likely scenario, at least till the local elections in 7-8 months. The scenario of gradual normalization in economic policies is expected to keep inflation under pressure. In today's inflation report announced by the central bank governor, 2023 year-end estimate is 58%. The existing strong growth momentum we witnessed an above 4% first half growth.
Gradual normalization in economic policies and a resilient global growth outlook combined will be supportive of the economic growth in the short term. Accordingly, we expect GDP growth to be 4.5% this year. This growth-supported environment, along with the recent tax hikes, high wage adjustments, sharp currency depreciation, demand pull factors, eventually worsen inflation expectations. We now forecast year-end consumer inflation to be 60%, with risks tilted to the upside. Regarding current account deficit, even though five months to date, deficit amounted to $38 billion, we expect the year-end figure to be around $40 billion with the supportive factors like tourism revenues and growth composition shift in favor of net exports. This alludes to a level just under 4% of GDP.
The good outlook in here is that the expected change in the growth composition and easing energy prices are expected to shift the deficit to a surplus in 2024. First half financial results were attained on the back of ongoing adaptation to the highly challenging regulatory environment, which presented itself with significant pressure on funding costs. Our swift margin defense manifested itself with selective short-term Turkish lira lending growth versus the thin and even negative spreads seen in the quarter. Thankfully, we could offset this inevitable margin drop with our strength in fee-generating businesses and solid subsidiaries and muted NPL inflows. Undoubtedly, our sustained top-notch Core Banking revenue generation capability remains to be our key differentiation.
Even though there was an out of proportion increase in funding costs, in efforts to meet regulatory thresholds, we could still grow our Core Banking revenues by 12% in the quarter and 52% year-on-year. Net income booked in the second quarter was TRY 18.4 billion. This figure includes TRY 2 billion of free provision reversal, as management, upon the post-election normalization in the macro environment, decided to reverse a portion of the free provisions built to date. By end of first half 2023, we are left with TRY 6 billion of free provisions on balance sheet. Net income, even when adjusted for the provision reversal, suggests a positive growth performance.
As main contributors to this, we can count the 16% quarterly increase in fee income, the threefold increase in net FX buy and sell activity gains, and well-defended margins reflecting on core net interest income performance. Six months cumulative result of TRY 33.8 billion of net income suggests outperformance, not only to our operating plan expectations, but also to our peers, especially the performance in the fundamental Core Banking areas. Return on equity booked in the first half was 38.3%, and return on assets was 4.2%. Main components leading to these solid results, on page six, remains to be customer-driven asset growth. Our assets reached TRY 1.9 trillion at end of first half.
Dominating portion of assets, despite getting diluted because of the significant currency devaluation that happened about nearly 40% year to date, remains to be loans share with 52%. In the quarter, we booked an accelerated loan growth. Naturally, it had to be regulation compliant and selective, and registered at 15% Turkish lira loan growth that helped to ease the pressure on net interest income. Year to date, six months to date, the Turkish lira lending growth registered was 27%, and there was also 2% growth in dollar terms in foreign currency lending. Securities sharing assets were 14%. Unlike first quarters, in the second quarter, there were no new regulatory required security additions. There were some CPI and fixed rate security redemptions hitting the quarters, portion of which were replaced with FRN securities.
Cash and cash equivalents, as well as other assets, high portion and assets relate largely to currency. A significant 34% devaluation we've seen in the quarter alone caused visible increase in the accruals of foreign currency protected deposits, currency difference, and that is booked under other assets, ballooning the portion to 9.5% of assets. Now, where the Turkish lira loan growth was driven from can be seen on this page, slide seven. Our performing loans reached almost TRY 600 billion by end of first half. Compliant with the regulatory framework, growth drivers were SME loans and credit cards in the quarter. Accordingly, we booked market share gains in Turkish lira loans, Turkish lira business loans, and particularly in SME loans. Our leading position in consumer loans, as well as credit card issuing and acquiring volumes among private banks remain.
On the funding side, deposits dominate the funding sources, funding alone 3/4 of the assets. All the funding sources are closely and actively managed in defense of our margins. Despite the motivation we had to attract and grow foreign currency protected Turkish lira time deposits, demand deposits share in funding more than 30% of the assets remained intact. This suggests not only our customers' trust and clear preference, but also contributes positively to free funds in average interest earning assets, a ratio that is well above the average in the industry, and actually sets the main pillar in our financial differentiation, feeding margin performance. What it means is that with customers' funds that are kept as demand deposits and our free equity, we fund a significant 45% of our interest earning assets. Borrowing share in funding assets, on the other hand, stood at 6.6%.
Total external debt is now $4.2 billion. You can see the foreign debt components in the pie chart on the bottom right-hand side. That is predominantly securitizations and syndications. Of the total foreign currency debt of $4.2 billion, $1.4 billion is due within a year. We have a foreign currency liquidity buffer of $4.8 billion, that is far more than the short-term need. In line with the continued liraization efforts, the accelerated growth in Turkish lira deposits or largely foreign currency protected Turkish lira time deposits remained. We ended up with a twofold growth in Turkish lira time deposits since the beginning of the year.
Even though this much higher growth in Turkish lira time deposits diluted our Turkish lira demand deposits share in total to 18%, we have the highest Turkish lira demand deposits base among private peers, with a balance of TRY 137 billion. The regulatory price caps on lending, as well as the lira deposit targets, immensely pressuring funding costs, caused an inevitable drop in margins. Nevertheless, our legacy of superior core margin generation capability remained intact, even after adjusting with the option premium costs offered to foreign currency protected deposit holders. Quarterly core margin drop was 205 basis points, taking into account the option premium costs offered to foreign currency protected deposit holders that is booked under the trading line.
Cumulative core margin as of end of first half ended to be 2% when we include this added cost to lirize the deposits, suggesting a cumulative margin drop of 328 basis points so far. The outlook in here looks promising, though. It seems we may have left the worst behind in terms of downward margin trend. We had already started seeing the trend reversal on the outstanding Turkish lira loan yields, and as of June end. Also, this week's regulation adjustment will help carry the loan yields to more sensible levels and allow originations with reasonable spreads. Moving to the subject of asset quality on slide 11. On the gross loans total of TRY 1 trillion, 13% is Stage 2.
Even though there seems to be a quarterly increase in Stage 2, when adjusted with currency, it has actually dropped, as the recoveries from Stage 2 with very thin risk were higher than Stage 2 inflows. Notice a strong 20% Stage 2 coverage, especially notice the coverage of foreign currency loans under Stage 2 that's quite high and is on average 34%, versus 9% for the Turkish lira loans coverage. That includes the very low risks under SICR portion. In short, we sustain our highly prudent provisioning. As for the NPLs on next page, NPL inflows in the quarter remained limited, with the supportive growth environment and strong collections.
Combined with the growth booked, NPL ratio further improved to 2.1%, while our total provisions, including the write-down portion, reached a record level of above TRY 62 billion, representing a total cash coverage of almost 6%. Recall that we have the highest provision level in the sectors. We can see on the next slide how this translates into risk costs, or provisions, we can say. Where net cost of risk as of first half ended to be 65 basis points, of which 42 basis points was due to the impact of the earthquakes. Isolating the earthquake-related portion in the quarterly net provisions chart on the bottom left-hand side, you can actually see a further buildup of provisioning parallel to the growth we have booked.
Despite this highly prudent provisioning, overall, our net cost of risk is faring better than our guidance that was expected to be around 100 basis points. Moving on to the performance in net fees and commissions, we could sustain our first quarter performance in doubling last year's net fees and commissions. Our first half commission income exceeded TRY 14 billion. A strong 16% quarterly growth on top of last quarter's high base reflects a clear differentiated capability, strength in relationship banking, and digital empowerment. Main contributors to the growth were, again, money transfer fees. Our number one rank in here is a clear representation that Garanti BBVA is customers' choice as their main bank. Besides the money transfer fees, payment systems, as well as cash and non-cash fees, contribution to net fees and commission growth remains very strong.
In here, recall that we had expected and guided for a growth that is around the average inflation. So far, the performance suggests there can be an upside to our guidance. As for the operating expenses performance on slide 15, quarterly operating expense growth was flattish when the portion that was impacted by the currency is taken into account. Year-on-year operating expense growth was 122%, of which, 9% was due to the currency depreciation that is fully hedged. Slightly higher than the guided growth in operating expenses can be explained with the so far low base effect, as the multiple salary adjustments we had done last year occurred post first quarter. Expect convergence to guide level 100% operating expense growth by year end.
Cost-to-income ratio as of first half was 36%, and fees coverage of operating expenses was 58%. Regarding capital, on slide 16, capital remains strong. Income generated in the second quarter could largely compensate the negative impact arising from the significant currency devaluation, as well as amortized portion of the sub-debt. Capital and ratio at end of first half remained at a strong 15.8% and core equity Tier One at 13.7%. We have TRY 49 billion of excess capital on a consolidated basis and without any forbearance impact. As a secondary buffer, we still have TRY 6 billion of free provisions on balance sheet. If we were to include free provisions as part of capital, that would take our capital ratio to 16.3%.
On top of that, if we were to include also the BRSA forbearance impact, it would add another 210 basis points, technically carrying our consolidated capital ratio to 18.4%. The foreign currency sensitivity on our CapEx ratio is that for every 10% depreciation, it is 39 basis points negative. This wraps up our financials presentation. Moving on to our value creation on the non-financial side very briefly. We are happy to be the first bank from Turkey to announce interim decarbonization targets for 2030 to achieve 2050 net zero. We're one of the pioneers in open banking, now we basically serve as a hub for other banks' accounts. Our 13.8 million mobile-only customers clearly support that we're customers' choice as their main bank.
Diving a bit more on our non-financial value creation, and starting with employee satisfaction, our most recent poll results, 4.3 points out of five, indicating strong employee loyalty. We're one team striving to be always the best. This is also evident in our inclusion in the Bloomberg Gender-Equality Index for seven consecutive years. Our main goal is creating sustainable value beyond serving our high base of 14.1 million digital active customers, of which 13.8 million, as I said, are mobile banking customers as well. Digital channels share in total sales reached 89%, and almost one out of five mobile transactions in the sector is through Garanti BBVA. In line with responsible banking model, for us, sustainability has moved beyond just financing. We have so far mobilized TRY 86 billion in sustainable businesses since 2018.
We also focus on managing the direct impact we have through our Community Investment programs. As of 2022, our such contribution has reached TRY 72 million. Along with these, we also care about what we shouldn't finance. We have been carbon neutral since 2020. This concludes our presentation. We have the floor to you for questions. Thank you for listening.
Hello again for the Q&A session. You can ask your questions by typing into Q&A area or by using Raise Your Hand button. Once your name is announced, you are welcome to ask your question. one minute for the first question. The first question is coming from Waleed Mohsin . Hi, Waleed, please go ahead.
Hi, good evening. Thank you very much for the presentation. Congratulations on a strong set of numbers. Couple of questions, please, from my side. First, I wanted to ask, you know, given some of the unwind in regulations, which is quite encouraging, and a normalization in the policy rate environment, things seem to be moving in a, in a positive direction. I wanted to get your thoughts on what you think are the biggest risks at this moment, from a profitability perspective. I mean, what are you, monitoring as your key risks, whether it's, you know, asset quality or, you know, a risk of, further dollarization at some point? Any, any thoughts on that in terms of what you think are the key risks would be quite helpful.
Second question would be on, margins. It seems from your commentary, and from the other banks as well, that, you know, somewhere in the third quarter, it should mark the trough, and, even within the third quarter, you would start seeing, you know, Turkish lira loan to deposit spread expansion. On that front, I wanted to get a sense of, you know, how do you see margins shaping up into the fourth quarter? And the change in the, you know, deposit rates, do you see any risks around that? Especially given that, you know, we first had a pretty big spike in deposit costs into the second quarter, and then now we're starting to see deposit costs come off a lot. You know, any, any risk associated with that, any color would be very helpful.
Thank you.
Hi, Waleed. For your first questions regarding biggest risk, I mean, in asset quality, we don't see any further deterioration. I mean, it is already over provisioned, for the time being, we are very comfortable with the level. Of course, margin started to pick up at the latest regulation change, you know, commercial rates started to be like 32.06%, cost of funding is going to be below 30%. We have some sort of positive margin getting started. Depending on central bank further tightening, we'll lead the game. I mean, for the time being, we are all positive for the coming quarters and even for third quarters, I mean, fourth quarters. I mean, I don't want to complain about the regulation.
We are doing our best to manage the balance sheet, as you see. I mean, we are used to it. I mean, we will do our best to manage, let's say. For margin, yes, starting from July, actually, we have some... Again, after this latest regulation change, some easing, we started to see some positive NIM, even with the effects of FX protected premium on it, Handan just mentioned. We will continue to have positive upside, as we go along through the quarter. I think it will be better than second quarter from my calculation. We are on top of it, we will do our best to manage. I mean, this is how it is for the time being.
I hope it satisfies your questions.
Just to get it clear, you think third quarter margins will be better than second quarter, despite the dip at the start of the third quarter?
Yes. That's what we are seeing, I mean, today. Yes.
Got it. Maybe just one, you know, final kind of follow-up on this. How much of an expansion have you seen on the loan to deposit spread in tier terms, you know, so far? Is it around 400, 500 basis points is now where the spread is?
I mean, first half, as Handan, just show in the presentation, together with FX protected premium payments, drop first half and about 328 basis points. We might have further 30 basis points iteration for the rest of the year. Another maybe 36 negative territory, let's say. This is Core NIM.
Got it. Okay. Thank you so much for your answers. Thank you.
Thank you. Thank you, Waleed.
The next question comes from Konstantin. Hi, Konstantin, please go ahead.
Hello. Thank you very much for this presentation. So this is my questions. [audio distortion] I have two questions, which I want to ask.
Konstantin, sorry for, cutting, but the line is not very clear. We can, hardly hear you.
It is still not good. You cannot hear me?
Barely.
Let me call in.
Okay.
The box, [audio distortion] Thank you.
Thank you. We have a written question from Thomas: Can you please discuss most rigorous regulation now in place that is, obstructing optimization of balance sheet and ability to capture growth within segments featuring highest profitability potential?
Hello, Thomas. My answer will be the same, I guess. We are seeing some easing and normalization in the regulation. Commercial loan caps increase, as you know, credit card rates increase, and tier deposit costs are being declined. Credit card is like 2.89%, right? Monthly, so it correspond like the 35%, 36% levels. I mean, as I said before, I mean, instead of complaining, we are adjusting our balance sheet in accordance with the regulation. I mean, our track record speaks for itself. I mean, under any circumstances, we are able to deliver the best-in-class results, I must say. I mean, we are just doing engineering, balance sheet engineering, as regulation comes along, so we are trying to maximize our, you know, balance sheet spreads and margin.
I mean, we are used to it, let's say.
Thank you. One minute for the next question. We have a written question. This is again from Thomas. He's asking, "Unlike two peers in Turkey, Garanti has not updated its ROE target. Is there any upside?
In our guidance, our figure was 28%.
Above 28%.
Yeah, 28%. Yeah.
Already saying an upside.
Yes, we can say we have upside, and we can beat that level, eh?
Yes.
Okay.
Thank you. We have a written question. "Is a 25%-30% TRY deposit rate sustainable when inflation is expected at 58% at value?" Thank you.
Well, it's a very good question, but, I mean, we are trying to see the evolution of inflation, so probably it will be very difficult to stay at this level. We are waiting further, I mean, tightening, let's see, so that we will keep up the margin in a positive territory. I mean, it's not easy to keep it up at this level, but we'll do our best, let's say.
Thank you. We have a written question from Constantine: "Could you please confirm what are TRY term deposit rates outside of the FX protected scheme, and second, the deposit rates within this FX protected scheme? Should the recently introduced RR for the FX protected deposits lead to a further widening of the spread between these two rates?
I mean, for the normal deposit, let's say one month tenor, is around 25%-26% level. For those who are willing to switch to a fixed protected scheme, what we are paying at the moment, a base interest rate plus five percentage points premium, right? Basically, comes to 28% levels. This is how it is nowadays, so below 30%. As I said, depending on tightening the monetary policy, and we will have different set of, you know, ratio or rates. This is the level that we are dealing with nowadays. You remember, it was like around 40% or even more than 40% in one month ago, so it came down after this tightening decisions.
Thank you. We have a written question from Valentina: Do you see any risk to your 2023 guidance?
We believe it's too early to make any revision to the guidance, as uncertainties prevail at the moment. Magnitude and speed of the normalization process will be the key. We don't see any downside risks to our ROE guidance, but there might be some upside, downside to each P&L item leading to this ROE.
Thank you. We have a written question from Mehmet: What are your views about trading income going forward? Separately, the increase in your quarterly trading income is less significant compared to other peers that have reported so far. Are there any differences in the way you account for FX depreciation impact from loans that makes a direct comparison to other banks less straightforward?
When you say trading, it's a, you know, very deep world. When you say trading, I mean, you get from lira security gain, FX security gain, some derivative gains, and FX buy and sell spread gains. This consists of all three or four items. In our case, our FX protected premium cost booked under trading, so derivative, in this case, loss. Some bank are put this into NIM, but in our calculation, it is sitting in the trading book. As I said, for the accounting purposes, from the bank to bank, it might vary. Why? If you book your swap, I mean, spot leg or is sitting in the FX gain and loss, but forward leg is sitting on the trading line item.
There might be different, you know, curve usage in this or OIS curve or offshore swap curves might give different results in accounting purposes. But what we see in our trading, basically, I mean, our FX buy and sell figure in the second quarter was very strong. Really, it offset some of our NIM erosion in the solo Q2. We are happy with the outcome. When you say extraordinary, you know, boom, trading gain income, we need to investigate how it's coming from. We are very decent, you know, accounting approach, and this is how we deliver in the second quarter.
Thank you. Seems like we don't have any more questions, so this concludes the Q&A session. I leave the floor to our presenters for closing remarks.
Well, thank you all for your participation, first of all. Looking back at the second quarter, regulations continue to shape our balance sheet composition. As Garanti BBVA, we once again prove under any circumstances, we will differentiate with our best-in-class, I mean, core banking, let's say, revenue generation. We are happy to see some easing and normalization in the economic policies. Hope that this will continue in the coming months. Look forward to meet you all again with another set of similar results. Thank you.