Ladies and gentlemen, welcome to Isbank's Third Quarter 2024 Financial Results Audio webcast. Today, our presenters will be Ms. İzlem Erdem, CFO; Ms. Nilgün Yosef Osman, Head of IR and Sustainability. As always, the presentation will be followed by a Q&A session. If you wish to ask a question, please raise your hand or type in the Q&A area. Now, I hand over to İzlem.
Thank you, Özge. Welcome to our earnings presentation for the third quarter. This is İzlem speaking. Thank you all for joining us. Please let me start with the short summary of macro outlook. In the third quarter of 2024, the lagged impacts of tight monetary policy were more effective on industrial production, while the services sector displayed a relatively resilient outlook in general. Besides the increasing volatility in the global markets in August, the inertia in the services prices continues to be the main issue as there is still backward indexation. Thus, the underlying trend of inflation remained higher than expectations in the third quarter. Additionally, higher-than-expected monthly inflation in the recent months also delayed the rate-cut expectations. We anticipated annual inflation to hover around 43% at the end of 2024 and GDP growth to be around 3% for the full year.
On the other hand, despite the temporary volatility, a declining trend in retail sales is expected to support the disinflation process, as the consumption expenditures tend to slow down. Improving risk perception, accompanied by a better external balance outlook and strong reserve accumulation, resulted in several rating upgrades. This trend suggests that real appreciation of the Turkish Lira will continue in the last quarter as well. As you know, we celebrated our 100-year anniversary at the end of August together with all our stakeholders. It was a memorable and proud moment for all of us. As we are moving into our second century, we will continue to create sustainable value for our stakeholders. Against the backdrop of these macro and operating conditions, we registered improvement in our swap-adjusted net interest income despite ongoing pressure on funding costs.
Strong, clean trading income generation continued to support the revenue base in this quarter as well. Our continuous remarkable performance in fee-generation business supported the profitability. Needless to say, asset quality indicators remained intact, and we sustained our best-in-class performance in asset quality metrics in the third quarter. Last but not least, we maintained our solid capitalization levels. These levels are definitely strong enough to absorb any potential adversities in the economy as well as to support future growth. This is valid for the liquidity levels as well. On the next slide, we have the major P&L items as well as the profitability and efficiency indicators. Despite ongoing pressure due to additional macroprudential measures in the third quarter, we managed to increase our swap-adjusted net interest income by 41% on a quarterly basis, benefiting from asset repricing while keeping the cost of funding under control.
At the same time, our sustainable performance on clean trading income improved further in this quarter by posting a 5% quarterly and a 63% annual increase. Thanks to our continuous efforts, outstanding net fee income generation continued, registering a quarterly increase of 13%, carrying the annual growth to 155%. On a quarterly basis, our total operating income increased by 15%. OPEX, on the other hand, increased around 30%, mainly on the back of salary adjustments and one-off payments to our employees as a celebration of our 100-year anniversary. However, please note that this was already taken into account when we were budgeting this year's OPEX. It is also noteworthy that we kept our non-HR expense growth well below the average annual inflation level, leading to a below-CPI total OPEX growth, indicating our controlled stance in managing costs.
Thus, fee coverage of operating expenses increased to a strong 82%, and cost-to-average asset ratio stayed at 3.8%. All in all, our return on equity as of the end of September stood at 20.5%. Now, I will leave the floor to Nilgün for the details of the bank's performance.
Thank you, İzlem Erdem. Welcome all, and thank you for joining the webcast. In this slide, you can see the main balance sheet items. In the third quarter, we managed our loan growth in line with our strategic priorities, taking into account monthly lending caps. We continued to be selective, and our focus was on productive areas such as SME business, exports, and investment, most of which are exempt from these limitations. Our quarterly TL lending growth was 9.6%. FX lending, where we still observe healthy demand from corporates, increased 4.2% in the third quarter.
We continued to be active in export finance. At the same time, tourism continues to be a key area for us. On the funding side, we maintained our concentration on widespread, granular core deposit base. There was around 10.8% quarterly growth in TL deposits, while FX deposits increased by 6.7%. During this period, we continued to stay in line with the regulatory threshold for the conversion rates from KKM to conventional TL deposits. Needless to say, we maintained the largest demand deposit base among private banks. As of the end of this quarter, 42% of our deposit base is comprised of demand deposits, providing substantial support to our funding cost base. Moreover, core deposits that are sticky in nature make up around 70% of total deposits. As for the external liabilities, our total external dues were $8.1 billion.
Our short-term dues were $4.1 billion, of which nearly half of it is consisted of syndicated loan facilities. Against that, our FX liquid assets are more than enough to cover short-term repayment amount. FX LCR was again at comfortable levels with 356%. FX wholesale funding continued to be an integral part of our efforts to maintain an optimal mix on the liabilities side. In order to manage the maturity profile efficiently and diversify our funding sources in the third quarter, we obtained over $500 million with a 10-year tenor under our DPR securitization program, carrying the total amount of DPR financing over $900 million for 2024. ESG remained a priority in FX wholesale funding. On top of being able to obtain a more diversified base of ESG-related funding instruments, their share in total funding stayed at high levels.
By the end of the third quarter, the share of sustainable funding stood at around 62%. Going forward, we will continue to evaluate potential transactions based on market conditions, as well as the needs of our balance sheet management, and continue our cooperation with our counterparties for FX wholesale funding transactions. On the next page, we have the NIM and spread evolution. Even though interest rates reached a plateau, high funding costs and growth caps, which somewhat limited the loan repricing, continued to put pressure on our margins. Additionally, the termination of right-way swap operations with CBRT resulted in a shift in the composition of short-term funding to repo transactions. As you already know, over the course of the third quarter, during the increasing volatility in the financial markets, CBRT has taken additional tightening measures, carrying the average cost of funding to higher levels close to the upper band.
Thus, the ongoing pressure on funding costs delayed the expected margin recovery. In such an environment, by keeping the cost of funding under control and benefiting from asset repricing, we managed to increase our swap-adjusted net interest margin by around 90 basis points. Currently, our NIM is signaling an upward trend, which suggests a sustainable improvement in the positive territory. After this transitory period, we believe that 2025 will promote a favorable operating environment in which our balance sheet will have the capacity to attain sustainable profitability metrics. As of the end of September, the share of securities in total assets was 19.2%. Looking at the composition of TL securities, we see that the share of fixed income securities was 41%. We continue to maintain the diversified structure of the book.
Our CPI Linker portfolio makes up 32% of TL securities, contributing to our income base by 14.6 billion TL in the third quarter. As you know, for the valuation of the CPI Linker portfolio, unlike our peers, we are using 12-month-ahead CPI expectations. Therefore, we continue to benefit from a stable and consistent revenue stream from this portfolio. Moving on with net fees and commissions. As we always emphasize in recent years, we have been focusing more strongly on the fee-generating businesses as a way of boosting the income base without consuming capital. We have concentrated our efforts to grow the business volume of products and services, which provide fees and commissions, as well as widening the active customer base. We also recalibrated the pricing tools and practices to improve this revenue stream. Accordingly, fee income generation was again remarkable in this quarter.
We achieved a quarterly increase of 13%, carrying the annual growth rate to an impressive level of 155%. Also, please note that this year we increased our number of digital customers by around 1.5 million, contributing to a sustainable fee base in the long run. Drivers of the strong growth were again across the board, with an eye-catching performance of payment systems growing by 253% annually. The next page shows the NPL and provisioning trends. We sustained our best-in-class performance in asset quality metrics in the third quarter. Our NPL ratio stood at 1.9%. This performance is owed to our selective and prudent policies, strong collection performance, as well as technology and AI-based decision-making mechanisms in lending. NPL inflows in this quarter suggest a slight increase, especially on the credit card side, which is a natural outcome of the high-interest rate environment and slowdown in economic activity.
However, it is noteworthy that we haven't seen a significant pickup in commercial flows, including SMEs, which is a strategic growth area for us. Additionally, it is important to mention that there isn't any sector-specific issue according to our portfolio analysis. Needless to say, our strong collections continue to support asset quality indicators. In this period, we successfully sold an NPL portfolio comprising mainly retail loans amounting to TRY 1.5 billion, with a solid recovery rate of 35.1%. Our total net cost of risk, including currency impact, stood at 104 basis points. Furthermore, as part of our cautious approach, our NPL coverage ratio stood at 73%, the highest among peers. The next page shows the capitalization levels. Our capital ratios remained at solid levels at the end of Q3. The Capital Adequacy Ratio, without the BRSA's Forbearance Measures, stood at 15.4%, while Common Equity Tier 1 was at 12.6%.
We believe that our capital ratios are strong enough to absorb any potential adversities in the economy, as well as to sustain the growth whenever it is deemed favorable. As we always share, the sensitivity of our Capital Adequacy Ratio to 10% depreciation in TL is around 35 basis points, while the sensitivity to 100 basis points increase in TL interest rates is around 8 basis points. Before moving on to the Q&A session, let's take a look at our guidance. We performed mostly in line with our guidance items for 2024, with the exception of the Net Interest Margin, which has downsized risks compared to our expectations due to the late rate cut cycle. Accordingly, this might have an impact on our ROE guidance levels.
On the other hand, we have already started to observe a positive NIM trajectory starting from Q4, which will be supported by the monetary easing throughout 2025. This concludes our presentation. Thank you all for your attention, and I would now like to open the floor for questions.
At the moment, we have a question from Mehmet Sevim, J.P. Morgan. Mehmet, you can unmute yourself. Thank you.
Hi, thanks very much for the presentation. I have just a couple of questions, please. One on the NIM evolution so far. Clearly, it's evolving behind the initial expectations. You've explained the reasons very well. But if you look at the current guidance, that would have implied an exit level of 4% at year-end. And clearly, we're quite far from this level. So could you please guide us how to think about the NIM evolution into the year-end and also into 2025 with now the delayed rate cut expectations? And just another question on asset quality, if I may. Obviously, things are still well under control, but I'd love to understand how you're seeing the trends in the individual segments, and especially in the corporate and SME book as we go into 2025, also taking into account the delayed rate cut.
Some of your peers are now talking about 200-250 basis points of cost of risk in 2025. Can I ask what your views are on this? Thanks very much.
Thank you, Mehmet Bey. First, I will touch on the net interest margin evolution. As you know, in our second quarter call, we announced that our guidance for the year-end net interest margin for an exit NIM of around 4%. But unfortunately, the third quarter developments revealed that it will not be possible. Especially if we think about the developments in the third quarter, I can say that the most important challenge regarding the net interest margin trajectory was the still elevated course of funding costs. In addition to the lack of any relaxation with respect to deposit costs due to macroprudential measures, termination of right-way swap operations with CBRT, this resulted in a shift in the composition of short-term funding to repos.
As you already know, over the course of the third quarter, during the increasing volatility in the financial markets, especially in the global markets, CBRT has taken additional tightening measures, carrying the average cost of funding to higher levels close to the upper band of the interest rate corridor. Thus, the ongoing pressure on the funding costs delayed the expected margin recovery, and on top of these, pressure from reserve requirement obligations also continued. Despite all these challenges, we managed to increase our swap-adjusted net interest margin by around 90 basis points by optimizing, let me say, our funding mix. As the monetary tightening continued throughout the first nine months of the year and expected rate cuts have been postponed, this also put pressure on our year-end net interest margin guidance.
As you might recall, as you might remember, we mentioned that we were expecting two rate cuts from the central bank in November and December, in total 500 basis points rate cuts. The recent inflation figures, especially the trend in the seasonally adjusted inflation figures and the announcements coming from the central bank, revealed that the possible rate cuts cycle, not only the rate cut, but let me say the monetary easing, postponed to the next year. We might see a rate cut in December, but the probability has decreased significantly. That's why we can say that the NIM guidance, there's a downward risk on the NIM guidance, but I can say that as of the fourth quarter, we are in the positive NIM territory. All in all, we can say that there is significant downside risk to our 2024 full-year NIM guidance.
But for the next year, it is still early to make concrete comments as we have just started our budgeting process. As you all know, there are still some important milestones that we will be focusing, especially these, let me say, milestones will have an impact on our assumptions, such as the upcoming inflation report, as well as the remaining two months' monthly inflation trend, not only the headline inflation, but the seasonally adjusted figures as well. However, I can give you a weak color with regards to our preliminary expectations, which indicates a range of 2%-3% net interest margin level for the beginning of the next year. For sure, the coming days and 2025 is expected to provide a more clear picture in terms of the policy framework, as well as the NIM trajectory in line with the disinflation process.
It is highly possible that throughout the year, the expected gradual monetary easing cycle will provide a strong improvement in generating net interest income, so if I shift to your second question related to the asset quality, in fact, during the last few years, during the last two years, our NPL ratio has followed a downward trend and stood at comfortable levels, and this is the case even for this year. At the end of 2023, our NPL ratio was 2.1%, and as of the end of September, this figure declined to 1.9%. This was mainly driven by our prudent policies, healthy portfolio structure, and strong collection capabilities, as well as the economic activity hovering around the potential growth figures, but for this year, as the economy is cooling down, we still continue to implement prudent policies and with good, let me say, strong collection performance.
So the outcome of the prevailing economic conjuncture or the operating environment, especially the tight monetary policy, although there are some risks, the prevailing stance does not create a significant deterioration in our NPL ratio, mainly thanks to our prudent policies. As per credit cards, I have to mention it, in line with what we have already anticipated, as a result of macroprudential measures alongside higher rates, it is inevitable to see deterioration to some extent. This has, in fact, been reflected on our monthly inflows. On the other hand, despite some limited increase in the NPL ratio of credit cards, I can say that the NPL ratio for the credit cards still stands at around 2.5%, which is quite manageable. And due to the moderate share of this item in total loans, it doesn't have a significant impact on our overall NPL ratio.
We are not observing any worsening in the asset quality indicators of the SME segment, neither in the form of heightened flows nor any deterioration in early warning signals. And especially, you know, our main strategy, the lending strategy, was to have a growth, especially on the exempted areas of the SMEs. And the good performance of the SME lending and the relatively low NPL ratio, which is hovering around 1%-1.1% level, proves that we are right in our strategy and we are implementing the right policies in handling this special segment, which we feel ourselves comfortable. So I can say that as a result, needless to say, our strong collections continue to support asset quality indicators. And as we have stated in our presentation, our cost of risk stood at around 104 basis points. But as the economy cools down, we are expecting an upward trend.
But for the next year, I can say that we can see our cost of risk to be around 150 basis points, which can be regarded as a slight normalization. So we feel ourselves in terms of cost of risk for the coming conjuncture.
That's very helpful. Thank you, İzlem. If I may just ask on the first question, and thanks again for all your views there, but you mentioned early trends suggest 2-3% NIM levels for the beginning of 2025. So that will be basically the first few months after the rate cut. Is that fair to assume?
We are expecting it in the first quarter. You know, we are not just expecting the rate cut, but any kind of monetary, let me say, easing will be important for us. That's why it will be a total package for us. That's why we will be one of the banks which will have the most positive impact coming from the monetary easing. That's why, as I mentioned, we might even see a rate cut from the central bank in December. But taking into consideration the wage adjustments of January, we can say that starting from January, I think the rate cut cycle and the accompanying, let me say, macroprudential easing will start. And that's why at the start of the year, maybe in January, we will be highly possible that we will see a 2-3% net interest margin.
Okay, that's very clear. Thank you, Izlem Erdem.
Thank you.
At this point, we can take some written questions. Valentina Stoykova from Barclays has a few questions. First of all, she asks the amount of our FX liquidity by the end of the third quarter. And also, she has a question regarding whether we will exercise the call option that will be upcoming next year. Thank you.
So I will first touch on the FX liquidity. As of the end of September, we have a solid FX liquidity buffer of around $8-$9 billion. And more than one-third of this FX liquidity is composed of funds used for swaps, and the rest of the FX liquidity is composed of money market placements, unencumbered cash, and bank notes and securities. And our FX Turkish lira swap utilization is around $2 billion. And in the presentation, we mentioned that our short-term FX liabilities are around $4.1 billion. This means that we are quite comfortable in terms of our FX liabilities debt service. So we feel ourselves comfortable with the prevailing liquidity. And I can say that our FX LCR, again, at comfortable levels at around 356% level.
The second question is related to call option.
Yes.
Considering our upcoming 2025 call option, we will assess and make our decision according to the conditions in the financial markets.
As far as I can see, we have no more questions that have not been answered. So I hand over to our presenters for closing remarks.
Thank you very much for your participation. We think today we have disclosed another good set of results indicating our expertise and judgment in navigating both favorable and challenging operating environments. We feel confident that our diversified balance sheet structure will provide strong support not only to the banking sector, but also to the Turkish economy in our next centennial. Regarding the details, let's be in touch. Looking forward to seeing you all in person soon. Thank you very much.