Ladies and Gentlemen, welcome all to Türkiye Is Bankasi 2025 conference call, , Financial Results Audio Webcast. Today's presentation will be led by Ms. Izlem Erdem, CEO, Mr. Mehmet Türk, CFO, and Ms. Nilgün Yosef Osman, Head of Investor Relations and Sustainability. After the presentation, as always, we will have a Q and A session. You may raise your hand to ask your questions or submit them via the Q& A box. Now I leave the floor to Izlem. Good evening.
Welcome to our earnings presentation for the second quarter. This is Izlem speaking. Thank you all for joining us today. I am welcoming you with my newly added responsibility in Investor Relations and Sustainability function that I have taken over from İzlem. I would like to take this opportunity to sincerely thank İzlem for her valuable contributions and dedication and wish her all the best in her retirement life. I look forward to sustaining and constructive communication going forward. After this quick introduction, I would like to briefly go over the macro backdrop of our operating environment and provide our view for the remainder of the year. We can then continue with our bank's second quarter performance. In the second quarter, the monetary policy stance was tightened due to the increased volatility in the financial markets during the period.
Not only the annual inflation continued decline in line with the forecast, but also the sector inflation improved alongside with the CB R T's decisive stance and the pursuit policies. Following the improvement in inflation expectations and a recovery in reserves, the CBR T resumed the rate cutting cycle in July, lowering the policy rate by 300 basis points to 43%. As the markets maintain stabilization, the CBRT is expected to continue rate cuts throughout the year. In this context, we anticipate a year end policy rate around 35%. Given the continuing tight monetary policy stance, we expect the disinflation process to continue and the 2025 year annual inflation rate to be slightly below 30%. The Turkish economy continued to lose momentum with an annual growth rate of 2% in the first quarter of 2025.
Leading indicators for the second quarter suggest that production remained under pressure while consumption moderated. Thus, we anticipate a moderate economic growth of around 3% for the whole year. Budget deficit in the first half of the year was 51% of the target set in the medium term program. While the expansion in interest expenditures in the first half of the year could pressure on the budget balance, the limited rise in other expenditures seems to have offset this pressure. Relatively low cost of oil prices due to weak global economic activity as well as the expected increase in services revenues would support the current account outlook in the coming months. We anticipate the current account deficit to be around $20 billion at the end of 2025. Let me share the highlights of our performance in the second quarter.
In this quarter, we have once again felt the advantage of having a diversified revenue stream. Strong fee generation, along with decent subsidiaries' contributions, supported the bottom line. We have effectively tackled the margin pressures and held our ground successfully in terms of containing the net interest margin decline to a very limited level. Going forward, we can say that we are well-equipped traders for meaningful improvement in future performance. As we re-entered the rate cut cycle with a well-positioned balance sheet, we continued our disciplined cost management and kept our OpEx growth below average CPI inflation levels, staying at the lowest level among peers. As always, we demonstrated resilience in managing asset quality, displaying the best-in-class asset quality indicators.
When we look at our major profit and loss items, we believe that we have been quite successful in containing the imminent impact of increase in funding costs by keeping the quarterly decline in swap-adjusted net interest income at a limited level, not changing the recovery outlook on a year-on-year basis. Hence, our net interest income has increased fourfold. Additionally, as mentioned, we have been able to benefit from our well-diversified revenue base in offsetting the pressure on net interest income. In that sense, we can say that thanks to our ongoing efforts, net fee income generation gained pace in this quarter, registering an impressive partial increase of 22%, carrying the annual growth to over 46%. Income from participations has also provided a decent support to our net income this quarter. On the cost efficiency side, our stellar performance in containing OpEx growth also supported our bottom line.
Annual increase in OpEx was limited to less than 30%, still below average inflation levels. Once again, fee growth outpaces cost increase. In the second quarter, our fee coverage of OpEx surpassed 90% level. In line with our guidance, there has also been steady improvement in other efficiency metrics such as cost to average assets and cost income ratios. All in all, our return on average equity in the first half stood at 18%. Other than the impact of the additional tightening in net interest income trajectory, our operating performance was very much in line with our expectations. Considering the effect of unexpected hike, impulse rate, and reworking on the metrics of new policy path. We need to revise our net interest margin guidance and thus now anticipate return on equity for the full year to materialize around 25%.
Now I will leave the floor to Nilgün for the details of the bank's performance.
Thank you everyone. Welcome all and thank you for joining our webcast. In this slide you can see the main balance sheet items. In the second quarter we strategically managed our selective loan growth, taking into account monthly limitations. It is important to mention that our main focus is to preserve our healthy loan portfolio with a sustainable risk return approach. Our quarterly TL lending growth was 10%, bringing the year-to-date growth to 18%. While maintaining our prudent and selective lending approach, we feel comfortable with our year-end, year-long loan growth guidance, which is around 35%. FX lending increased by 8.4% in dollar terms in the second quarter. When adjusted for the euro/dollar parity, the increase comes down to below 4%. 35% of our FX lending consists of export loans, a strong indication of the low risk structure of our FX loan portfolio.
In total export lending, we have a leadership position among private banks with an outstanding market share of around 28%. On the funding side, we maintained our concentration on a widespread, granular core deposit base. There was around 7% quarterly growth in TL deposits. The increase in FX deposits mainly stems from Eurodollar parity movements, and on adjusted terms there was indeed no growth. We maintained the largest demand deposit base among private banks. As of the end of the second 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 71% of total deposits. Regarding the external liabilities, our total external dues are $8.7 billion, of which $5.1 billion is due in the next 12-month period.
Against that, our FX liquid assets are more than enough to cover our short-term external liabilities. It is worth mentioning that nearly half of our short-term dues is coming from syndications. FX LCR was again at comfortable levels with 284%. ESG remained as a priority in FX wholesale funding, helping us to obtain a more diversified base of ESG-related funding instruments. By the end of the second quarter, the share of sustainable funding stood at 57%. Today we will be releasing our bank's first report aligned with the IFRS sustainability standards. This marks a key step in our commitment to enhance transparency and sustainability. The report offers a clear view of how climate-related risks and opportunities are embedded in our strategic and financial decision-making, providing valuable insights into the resilience and adaptability of our business model in a transitioning economy.
Going forward, we will continue to evaluate potential transactions for FX wholesale funding based on market conditions as well as the needs of our balance sheet management. On the next page, we have spread evolution. In the second quarter, market conditions remained tight due to increased volatility in the market. As a result, deposit costs were in an upward trend throughout the quarter. Since mid-June, we have started to see an improvement in TL spreads. As inflationary pressures begin to ease, the tailwinds towards interest income generation are becoming more apparent. Our lower-than-market deposit costs on the FX side continue to provide support to our net interest income base. On the next page, we have the NIM evolution. In our latest earnings presentation in May, we stated that our NIM improvement would be dependent on the duration of tightening.
As the tightening resumed during the second quarter, our net interest margin remained slightly under pressure compared to the previous quarter. A minor decline has been observed, mainly stemming from TL spread contraction due to pickup in deposit costs as rate cut trajectory restarted. As of July, new improvement is underway in line with our expectations. We believe that additional tightening has slightly postponed a gradual improvement in NIM rather than distorting the overall recovery. We expect recovery in NIM to continue in the third quarter, gain significant momentum in the fourth quarter, and keep its expansion throughout 2026. Within this framework, we revised our full-year NIM guidance to 350 basis points expansion. We could expect a further improvement to be attained in 2026. As of the end of June, share of securities in total assets was 18%.
Share of fixed income securities in TL portfolio is 47%, positioning us advantageously for the upcoming periods. Despite the downward trend in inflation, we continue to benefit from CPI linker revenues with TRY 13.4 billion interest income in the second quarter. Our valuation methodology, which takes into account 12 months ahead CPI expectations, provides us a stable and consistent revenue stream from this portfolio. Moving on with net fees and commissions in the second quarter, fee income increased around 22% on a quarterly basis, bringing annual growth in the first half to 46.2%. Drivers of the growth were again across the board. We are expecting to be in line with our guidance by the year end. In recent years, efficiency and cost management have gained more importance in a relatively high inflation environment.
As you know, we have been taking solid steps in terms of transforming our business models in line with our digitalization strategy, which enables efficiency gains as well. OpEx growth in the first half of the year was around 30%, better than our guidance for the full year. We are cautiously optimistic with regards to keeping our OpEx increase below our guided level of average. CPI fee coverage of OpEx rose to 91.5% while fee coverage of HR expenses reached nearly 230%. Furthermore, cost to average asset ratio declined to 3.6% and our cost to income ratio improved by 10 percentage points. We will continue to focus on efficiency by leveraging our strengths in adopting new technologies, upskilling our talent force, pioneering digital banking services, and centralizing process management. The next page shows the NPL and provisioning trends. In the second quarter, NPL ratio stood at 2.5%.
Closed NPL declined slightly compared to the previous quarter and collection rate in the first half remains strong at 26%. Our NPL formation rates reflect our experience in underwriting as well as robust collection capabilities. Our FEL ratios across all major segments such as SME and retail loans were lower than private banks' average. It is important to highlight our strong performance in NPL ratios in general but mainly in the SME segment. As you know, traditionally, NPL ratios in SME tend to increase in an economic slowdown. However, thanks to our balanced underwriting practices and collection capabilities as well as extensive customer data, SME business is one of our core strengths. On the other hand, we maintained our conservative approach and kept our stage 3 coverage ratio at around 66%, highest among peers.
Our net cost of risk was 176 basis points for the first half including currency impact, our prudent stance, continuous efforts, and conservative risk management principles coupled with utilization of latest technologies like AI. We do not anticipate a significant downside risk in our asset quality indicators, which will continue to differentiate us both positively. Next page shows the capitalization levels. Our capital ratios remained at solid levels at the end of second quarter. Capital adequacy ratio without the BRSA's forbearance measures stood at 15% while Common Equity Tier 1 was at 13%. 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.
Sensitivity of our capital adequacy ratio to 10% depreciation in TL is around 50 basis points, while sensitivity to 100 basis points increase in TL interest rates is around 8 basis points. In our previous earnings call, we have not revised our 2020 expectations and targets as it will be premature to revise our yearly guidance spectrum as of today. Observing the market and reconsidering our projections, we have deemed it necessary to revise the guidance levels of NIM and ROE. Here we have provided a summary of guidance items for your convenience going forward. Depending on the pace of rate cuts and timeline of the simplification, we will continue to proactively manage our swap adjusted NIM, which will continue its upward trajectory well into 2026. Apart from this, fee income contribution, cost management discipline, asset quality metrics, solid capital base will continue to be our main focus areas.
This concludes our presentation. Thank you for your attention. I would now like to open the floor for questions.
O ur first question comes from David Taranto, Bank of America. David, I have unmuted you. Please go ahead.
Hello, can you hear me? Hello.
We can hear you. Hello.
Good afternoon. Thanks for taking my questions. My first question is on NIM, and thank you for the graduality on the NIM chart on page nine. Very helpful. Your initial guidance regarding the exit NIM for this year was around 6%. Do you still see this level achievable in the first half of next year? Is your peak NIM expectation higher or lower versus the initial expectations? My second question is about the details of your NIM guidance. How do you foresee the Turkish deposit rates during the second half of the year? Do you assume the rates to move in line with the policy rates, and your FX deposit costs are materially below the sector level? It has been the case for some time now, which I assume is a function of high level of demand deposits and your client base.
Do you see these deposit rates on the FX side as sustainable for the next several quarters? Thank you.
Thank you, David, for the question. I will try to answer as a whole. Our NIM guidance of 450 basis points expansion in the beginning of the year was mainly based on the widening spread between Turkish loan yields and Turkish lira deposits and the money market funding costs. However, with the Central Bank' s practice stance in response to the financial market movements bringing an unexpected hike in funding costs and pausing the rate cut cycle, it caused a delay in the improvement trajectory. Therefore, in May we shared our initial view on the net interest margin outlook as being dependent on the duration of the tightening, which in fact continued a bit longer than our first impression. Now, as we are more clear on the trend ahead of us, we revisited our guidance level for clarity.
I could just shortly remind the composition of our Turkish lira denominated interest earning assets and interest bearing liabilities. The share of Turkish loan portfolio is around 60%, Turkish securities portfolio is around 25%, whereas the share of Turkish lira deposits stay at around slightly above 80% and the money market transactions including short-term swaps around 17%. In its nature, these items carry a structural duration mismatch, as you know, of around six months. In this sense, the fact that we have been able to preserve our loan yields in the second quarter was not only important for managing the cost pressure during the period but also will make sense to further contribute to the rate widening.
In our current baseline scenario, we anticipate the CBRT to go for constitutive rate cuts in the remaining three meetings, though levels may differ depending on the market development. All in all, we expect policy rate to shape around 35% or maybe 36% by the year end. Under this scenario, together with inflation expectation of households converging with the other actors, there might be some easing in Turkish deposit costs which will help us expand Turkish real estate as you see in our presentation. Maybe I could be more precise. I could share that our back book Turkish loan yield is around 49% and the cost of lira deposits for open accounts is around 37% by now.
I could also say that the cost of marginal term deposit is currently hovering around the policy rate and, in fact, in the second quarter it was for the margin deposit a few points above the policy rate. I say going forward, as long as inflation indicators remain on track, we believe that the market's inflation expectations and pricing behavior would improve in the coming months, and therefore we assume our swap-adjusted NIM to continue its gradual expansion throughout 2025 and 2026. To sum up, in the light of these expectations, we anticipate to increase our quarterly net interest margin by around 100 basis points in Q3 and at least 150 basis points in the last quarter, carrying full-year NIM expansion to 350 basis points.
Accordingly, our previous guidance had been postponed by around 2/4, with a potential to reach peak level past mid-year 2026, considering the rate cut cycle continues in line with the ongoing disinflation process. Debbie, I can here say that your question, the exit of 6%, most probably will be seen in the second quarter of year 2026, though it would not be reasonable to foreign out a specific level at the moment. Please also note that if there would be any simplification on the macroprudential measures in the future, this might provide additional support to our NIM baseline. I hope this answers your question. Sorry, Ants, you had one more question on the RFX deposit levels. We believe that with our widespread customer base, our FX deposit levels will continue to be at the lower levels. We feel quite strong at that site.
Thank you very much for the detailed answer.
Thank you. I could also say that around 70% of our FX deposits is on demand deposits. Thank you.
Thank you. Thank you very much.
While waiting for the next question. We. c an look at some of the written questions. We have some questions from Valentina Torkola, Barclays. One of them is actually very much in line with the previous question that David had asked, but it has some additional aspects. For example, what is the asset liability maturity mismatch and what is your approach to lending, securities, portfolio, and funding? Also, what sort of macro assumptions to make into your new forecasts.
On the Turkish lira side, our asset liability metric mismatch, as I said, is around six months, and I can say that we are not carrying mismatch in our FX side and in our macro assumptions. We expect the policy rate to be around 35% by the year end. I t hink, and the inflation to be just, you know, slightly below 30%.
Another question from Valentina is regarding our FX liquidity level.
By the end of June, our total LCR stood at 127% and FX LCR at 284.4%, well above the regulatory limit. We are very comfortable in terms of the FX liquid assets to cover our short-term external liabilities, and we have an imminent FX liquidity of more than $6 billion, around $7 billion I can say in USD terms.
The last question from Valentina is regarding our asset quality. In which segments do you see asset quality pressures given higher rates until the year end? Can you give us a bit more color on the increase in stage 3 reversals in Q2?
Let me try to answer that question. On the asset quality, I think the construction sector and also the textile industry clearly emerges as the primary areas of credit risk with relatively higher elevated NPL ratios, and also the rising NPLs in domestic-driven demand-driven sectors such as furniture trade and food and beverage industries suggest that there is a consumer side weakness and demand volatility which are surfacing in credit portfolios, but they are still muted, and we expect that while there are increases in NPLs in these portfolios going forward, with the rates coming down in 2026, I think there will be quite a relief in some of those sectors. Also, on the asset quality, on the stage three reversals, there is a big one-off transaction. Without that, there are not measured reversals in phase three in our portfolio.
Our last question is again from Valencina. She asks our Eurobond issuance plans until the end of the year.
Thank you. As you know, in the beginning of this year we have already issued an AT1. For the rest of the year, we will continue to monitor the debt capital markets closely, keeping our documentation up to date and evaluating issuance opportunities.
I don't see any remaining questions. Thank you all for joining. Now I close. Now I hand over to our presenters for closing remarks.
Thank you very much for your participation. We believe that we have presented a solid performance this quarter. Behind a strong performance, there lies our strengths in human capital, technological infrastructure, digital capabilities, as well as our sustainable business model, which is based on value creation for all our stakeholders. Regarding the details, you may always reach out. Looking forward to see you all in person soon.