Lion Finance Group PLC (BGEO) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to Bank of Georgia Group PLC's financial results for the first quarter of 2020. [Operator Instructions] I must advise you that this conference is being recorded today. I would now like to hand the conference over to your speaker today, Archil Gachechiladze, Group CEO. Please go ahead.

Thank you, operator. Welcome, everybody, to our first quarter earnings call. Today, in addition to discussing our Bank of Georgia perspective, I'm delighted to welcome Papuna Lezhava, Vice Governor of National Bank of Georgia, who has kindly agreed to join us to give his view on recent developments in Georgia. Before I pass towards -- to him, I would like to touch on a high level certain points. So COVID-19 global pandemic has been a significant -- has caused significant impact on all of our people and economy and the way we lead and work. We will have some of our previous announcements, as you know, and you have seen some of the things that -- the impact has been on us, but I would try to reiterate that our immediate and first priority has been the health and well-being of our employees and customers and protection of bank. In addition, we have maintained excellent ongoing business continuity and operational efficiency and ensured the long-term stability and strength and profitability of the bank. This -- I will touch on this aspect in more detail after our Papuna's address to you. But there has been a big change in the way we do business short term and it will have some long-term effect as well. Our first quarter results have been robust. What's significant is that we have taken a charge for -- or the full expected charge of this cycle upfront. This may be a little bit more conservative than most of the market participants have done, but we think it reflects the strength of the system and of our bank. At the same time, the government of Georgia's response to this crisis has been exemplary and they have done remarkably well in terms of containing the virus and the spread of it. We'll cover some of the figures later on, but Georgian government has acted early, has acted in a decisive manner and has already laid out a very detailed plan of ending the lockdown, which is 22nd of May and then gradual opening up, including of international travel from the 1st of July, although it will be country by country, and we will be subject to strict rules in terms of what needs to be followed. Economic challenges are there and the times ahead of us are uncertain. But Bank of Georgia has anchored this crisis in a very healthy state in terms of the asset quality, in terms of the NPLs being the lowest historic low; in terms of profitability, being very strong, highly liquid and in a strong state in any way you look. Also, last but not least is the strength of the team and the people. I have to say a great thank you to all of Bank of Georgia employees who have got together as one big team to go through a major change of operational change, which in a very short period of time, and they had been done very successfully, and I'm very proud of that, and I would like to extend my gratitude to all of our employees. At this point, I will hand over to Papuna, who will make some comments and cover the macroeconomic and regulatory perspective. Papuna? Thank you for joining.

Thank you, Archil. Thank you, Archil. Hello, everyone. I would like to cover this talk in 3 major topics. I will talk about the macro environment and outlook. I will touch upon banking sector and the regulatory response to this crisis and then in a few words about what to expect going forward. So I cannot avoid talking about epidemiological response of the government, which, as Archil mentioned, was quite strong. We've seen few recognition statements and articles across international press. Since 3 months ago, when we had the first case, Georgia has only faced 12 deaths. And currently, all active cases of coronavirus at 264, which is the lowest point over the past month, and it is collapsing with a high speed. Of course, the fight is not over against the virus and especially because this is an international challenge. It's not only a challenge for Georgia. And given Georgia is a small open economy highly dependent on international trade partners and quite heavily service-oriented, we expect the economic hit to be significant. In terms of numbers, we expect exports to drop by about 20%, tourism will go down by 50% to 60% this year and remittances will be down by 30%, which, overall, based on our estimates, should result in real GDP decline of 4% compared to precrisis target of 5% growth, which is a significant shift. The government response as well as Central Bank response to this challenged has been quite proactive, and we hope that this -- that the measures that I will lay out going in a few minutes will counter the crisis to significant manner. So as a result of this foreign inflows reduction, we expect balance of payment shortage of about $1.4 billion compared to what was the previous estimates, and this will be compensated by already negotiated DFI package of GEL 1.6 billion. So Georgia was lucky or maybe forward-looking in having existing International Monetary Fund program, which was augmented due to the coronavirus crisis, and Georgia was the first country that received existing program augmentation from IMF. And this led the international community, international donors to participate in the full funding package quite quickly. So we expect a GEL 1.6 billion inflows, additional inflows compared to what it was planned from DFI community. And in addition to that, we expect another GEL 1.5 billion inflow from IFI towards financial and real sector. So this will, of course, help countries response against the crisis. It will strengthen our foreign reserve balance, which currently stands at GEL 3.2 billion, and which, by the way, is 100% of ARA metric. This is a new metric that International Monetary Fund uses to assess reserve adequacy. And the GEL 1.6 billion that we expect will be added to these reserves. And by the end of the year, we expect the ARA metric and the reserve level to remain around the same level because a significant portion of this foreign inflows will be channeled to the economy. Given we assess this shock to be temporary, and this temporary shortage of foreign currency should be substituted by the DFI funding. As a result, the impact on depreciation, on local currency depreciation will be limited. We've already seen significant depreciation against the USD, but also against trading partners. And we don't see that further depreciation will be warranted to absorb the shock. We think what the level of depreciation that local communities saw is together with international support that we expect should be enough to fill the gap. And the Central Bank, within our price stability mandate, has committed to intervene in foreign exchange markets more frequently throughout this crisis with 2 objectives: first, to curb excess volatility of the exchange rate; and second, to provide sufficient liquidity to FX market to help find its balance position. With regard to fiscal stimulus, we do expect some increase in budget deficit, but fiscal stimulus will be quite measured because Ministry of Finance is committed that if the revenue side, which was planned on quite conservative assumptions, if revenue side happens to be stronger than expected and this will not translate to excess spending. And as a result, budget deficits instead of 8.5% will be less. With regard to monetary stance, monetary policy stance, we entered this crisis with high inflation and hence tight monetary policy. We expect throughout the year monetary policy to remain moderately tight but with an easing trend throughout the year. And by beginning of 2021, we expect inflation to reach its target, which is 3%. Now about the banking sector, as Archil has already alluded to, banking sector has entered this crisis with quite strong buffers and well prepared. If there is the best time we could wish for the crisis, probably this was the one. Profitability over the past several years was quite strong for the system. It was averaging 20% of return on equity. NPLs are at its lowest point of 3%. And capital adequacy is -- precrisis, is about 20%. So what -- the impact that this crisis is having is, of course, not insignificant but measurable. So the strategy we took as a supervisor in this environment is to recognize expected losses proactively and use excess capital buffers to absorb these losses. So from the initial days in March, we had made public that we will be willing to take significant countercyclical measures to address this crisis, and we have released capital buffers of about GEL 1.6 billion to partially absorb expected losses and partially support credit growth. And in case downside scenario materializes, we have preserved about another GEL 1.5 billion of additional capital, including the bank's internal capital buffers, to be released if necessary. Though at the current stage, we think that initial assessments of the crisis was not shy and the reserves that the bank have booked, which cover the full cycle expectation of the crisis, are sufficient. Of course, there is a probability of downside scenario as well, but that probability has reduced over the past couple of months, given how the pandemic scenario played out and given that Georgian economy has slowly started to reopen. A few words about additional measures that we have introduced. So initially by second half of March, there was certain liquidity pressures from local currency driven by volatility in deposits, in retail deposit market. But it was not driven by fundamentals -- those fundamentals. It was a slight panic of depositors, but it was not quite significant. As always, increased the worries in local currency liquidity and banks to maintaining strong buffers and increasing the local currency interest rates. So we saw the need to come to the market, and we introduced instruments to support liquidity in case needed. So these instruments are more of precautionary nature to count the market rather than to support immediate mix because the volatility in deposit market that we saw at the end of March has significantly count already in the first half of April. But we have committed to provide to the sector as much the liquidity as it needs in local currency as well as in foreign currency subject to our foreign exchange reserve expectation, which currently stands at GEL 3.2 billion, and which is about 20% of GDP, and we expect additional GEL 1.6 billion inflows from DFIs and most of which will be channeled to the economy. And in addition to that, we have also temporarily suspended the regulatory reforms and initiatives in order to focus all our and the bank's attention on crisis management and recovery plans. So we postponed almost all regulatory reforms, except for banking resolution framework, which is expected to fully phase in by end of this year, except for digitalization efforts such as open banking, digital onboarding, database decision-making, which are all quite important in this new area of safe distance servicing. And IFRS adoption, which -- for which we have quite fast track time line, with a mandatory adoption of end of '21, but will also allow voluntary adoption by the beginning of 2021. So that is in the nutshell about the regulatory response. Now what we expect and what is the government strategy? So I will allow myself to speak on behalf of the government given we will be closing coordinating, finding the appropriate solutions in response for the challenge that we are facing. So I will split this in 3 stages. And the first stage, which was announced already in the beginning of this crisis, was more socially targeted measures to help those that are most vulnerable to the shock. In the second stage, the government will periodically be announcing economic stimulus measures for affected sectors, and these measures will be tailored for sector-specific environments and mostly targeted to the sectors that add the biggest, biggest value to the economic growth. And banking sector certainly is one of them. And actually the banking sector will be the backbone of this quick recovery. And it will play the most crucial role. So second stage is about finding a quick recovery solution. And the third stage, which is more of the medium term in both structural reforms, targeted at adapting to the new reality, which is digitalization of services and diversification of supply chains by our trading partner. And in this third stage, Georgia is positioned to leverage on its strengths, which is cheap labor force, low tax environment, strategic geolocation and preferential trade agreements with EU, most of CIS countries and China. So the main goal of this strategy is to aim at creating more competitive and more productive Georgia, with hopefully higher economic growth potential in the new world order. I will stop here, and I will be here during the remainder of the call to answer any questions if you have.

Thank you. Thank you, Papuna, for this overview. I would like to complement National Bank of Georgia and the Georgian government for handling this COVID-19 crisis and the impact so far extremely successfully. And this -- probably, at this point, it's a bit early to summarize it. But definitely, the early signs are very encouraging, and we appreciate that a lot. So I'll just underline the fact that what just Papuna mentioned that he will be staying with us for the whole call to answer the questions as well. So I will try with that to summarize our results for the quarter and then go to Q&A, so that you've got a chance to ask us questions and ask our regulator questions as well. So with this, basically, I would like to touch on a number of things. One is our people and customers and our business continuity. Our -- us managing the strong liquidity and what we are doing regarding this, maintaining our solid capital position and what the changes have been there, maintaining our robust asset quality and earnings going forward and ensuring the long-term stability and strength and profitability of the group. And then I would like to touch on digitalization as well. So with this, as we mentioned before in our announcement as well, our key and primary focus is the priorities on the -- on our people and customers and the business continuity. So when a big change happened in the middle of March when the lockdown was announced, we had started preparing for a switch into the new environment, where we put in place a 3-month grace period on all the retail loans to significantly reduce the requirement for physically, for the customers to visit the branches. We also -- the main branches have remained open, meanwhile, with significant additional security measures that we have put in place. As well as on the health side, we've done a number of security measures to protect the health of our employees and our customers. Whenever possible, banking services conducted -- are being conducted via call centers. So we have beefed up our call centers significantly as the number of incoming calls have increased as well, and we have maintained good quality there. And we've increased -- significantly increased our digitalization drive in an expedited way. So overall, I think the team has done an incredible job switching from an office, back office location into working remotely, including the call centers, in fact. A lot of operators of express branches that are working from home are working as call operators now. So it has been quite a significant switch in terms of operational switch, and it was done seamlessly basically without any problems and without our customers feeling any major discomfort. Now in terms of liquidity, we went into this new environment with a significant liquidity. Our liquidity coverage currently is 121% and net stable funding ratio is 123%. We have started working with IFIs and -- in terms of providing loans for and lines for -- through the whole cycle. So we are looking for longer-term financing. We already arranged $100 million, and there's a very strong pipeline of about $0.5 billion, which is basically additional to our usual financing above the $100 million, roughly, that we would be looking at. Our deposit base has remained strong. Early on, I think, end of March, roughly, we had a few days where we saw a little bit higher outflows than usual. But that has been limited in terms of overall of around 1% to 2% of the overall deposit base. And even that came back mostly in April. And overall, I think depositors have been well assured and stable. So deposit base is strong, and we have aligned very strong pipeline of financing if and when needed to deploy it on one side to refill the liquidity. And on the other side, to be ready to aggressively finance the economy if and when we feel that, that is the right time, which may be in few quarters, not at this point, for sure. In terms of our capital position, as our Vice President of National Bank, Papuna, has summarized, the National Bank has released a lot of buffers. The consolidation buffer requirement of 2.5% of risk-weighted assets has been reduced to 0. The currency induced credit risk buffer has been reduced by 2/3. The phasing in of other buffers has been postponed without the specific date at this point. And there has been also readiness expressed by the National Bank that there could be further releases if and when maybe if a downside scenario is to be played out. Having said that, the recent developments of the last few weeks has been very positive in Georgia in terms of epidemiological development and the economic development therefore. Although we have to be cautious about this optimism and see how it all plays out over the next few months. The National Bank has been -- and the whole sector has been conservative in terms of booking the full expected impact of the credit losses upfront in the first quarter. And we have seen the results, therefore. And that, in addition to the devaluation of about 15% that has happened in the last quarter, has resulted in capital ratios, which currently stand at 8.3% and 10.6% and 15.3% accordingly with core Tier 1, Tier 1 and total capital ratios, which are 140 basis points, 190 basis points and 200 basis points above accordingly in this list. Furthermore, we've drawn down our subdebt Tier 2 capital basically in April of additional $55 million. And in terms of managing it, we were thinking of repaying part of the Tier 2, which we did not. So we have built up a little bit more buffers there. And we believe that going forward, this GEL 400 million in terms of the regulatory number, which is -- I would like to highlight the fact that is NBG number. And in IFRS terms, we have booked a little bit more than half of that GEL 220 million related to this upfront, and we believe that, that reflects the current estimates of the full cycle impact of overall, and that is fully reflected in the numbers. In terms of the asset quality, so as you know, from previous quarters, the cost of risk has been gradually decreasing over the last 3 years. Overall, because of better management of credit, but also because the overall macro environment has been derisked given risk-adverse policies that has been put in place over the last couple of years by the National Bank. So I think those policies are serving us very well in this tough economic environment. And we are basically coming into the shock with the best asset quality that we have had historically with NPL ratios at 2.1%. And obviously, after this charge, our coverage has come from about 86% to 147%. On the NPLs, we will change accordingly obviously going forward, but at this point, these are incredibly high numbers and encouraging numbers. So overall, I think what we are seeing is that there will be increases on the NPL side, but going in, I think, is a super strong position, and we believe we are fully provisioned for the whole cycle. Now in terms of the digitalization, we have been covering this quarter-after-quarter, but I could definitely highlight the fact that we are in a market-leading position in terms of digital capabilities. We have seen an incredible growth in our number of Internet banking transactions. And overall, I can say that our number of transactions that are done outside of the branches has increased in the first quarter now to above 94%. And changes versus 93% and 94% may not seem large, but when you talk about the number of transactions within branches, obviously, that you can see how significant that can be. And overall, we see that a number of active users have grown significantly year-on-year. Almost 50% now as well as number of transactions are giving us very strong numbers. So in terms of some of the other numbers, you have seen a summary of our performance. We have seen January and February that was characterized by pre-COVID times, which was focused on growth and profitability. And March, which was definitely not focused on growth. So some of the numbers that we see in terms of the portfolio growth reflect this early 2 months of focus on growth on one side. And on the other side, the devaluation that has happened. So in nominal terms is higher growth, obviously. For the rest of the year, we don't expect much growth on the portfolio. We don't expect much change in the currency either. As National Bank has outlined, our expectation are similar that the current exchange rate as well as the additional financing mobilized by the government and National Bank are more than enough to cover the shortage that we will see in terms of hard currency for the country. So with that, we expect more or less a constant portfolio going forward, while we will be generating capital on the next few quarters to increase the buffers, and we feel our capital buffers that we are currently using. So our focus of 15% growth and above 20% return on equity remain in place medium term. But for short term, obviously, this is not relevant, and we should not expect that for this year. I would also like to touch on the expense side, which was up by roughly 15%, which was partly due to the fact that we are looking at increased IT spending and capitalization but also partly due to the fact that there has been part of an increased operating expenses that have come in end of February and March to make sure that the safety standard is upheld in our branches, while we have not yet been able to adjust the cost accordingly in the first quarter. That exercise is ongoing in terms of cost-cutting, and we'll be seeing the results of those going forward in the second and more so in the third quarter going forward. So that's roughly where we stand. And on this, I would like to open it up for Q&A. And operator, please open it up for question-and-answer session, please.

[Operator Instructions] We're now taking the first question from the line of Tolu Alamutu from Tellimer.

I have a few questions, please. The first is regarding the probabilities that you assigned to the base-case and worst-case scenarios in your releases. I think it's 50% to the base case and 40% to the worst case. Given your comments regarding the progress that's been made in Georgia so far, would you still be as conservative as that now looking through to the rest of the year? Or would you make any adjustments to those assumptions? My second question is about asset quality. Obviously, you noted that your NPL ratio is just at a historic low at the moment. Where do you expect that ratio to be at the end of this year? And then how high could the NPL ratio go? And are there ways that you can mitigate that? Is there any market for selling NPLs or anything like that in Georgia? Thirdly, regarding the bonds that you have outstanding, can you just confirm that the plan is to repay the Lari-denominated Eurobond that is due next month? And also, would Bank of Georgia consider buying back any of its securities? Also, can I confirm maybe from the Central Bank that the restrictions that have been imposed do not extend to coupon payments on the perpetual securities?

I will go one by one. So first, as you said that the outlook or the recent developments have been very positive, although I would say that not enough time has passed for us to really update our economic outlook. So the IMF, the National Bank, the government expects contraction of the economy by 4%. EBRD has published 5.5% contraction. We tend to be more or less around 4%, our medium case or, let's say, the scenario-weighted case, more or less it's close to the National Bank expectation. Having said that, there's upside, there are upsides there. There are downsides. But right now, the way we look at it, the chances of upside are stronger than on the downside. So like the rating agencies are saying basically, there's -- the outlook is positive. But I think it's a bit too early to right now make big adjustments, and we have to see how the end of the lockdown plays out because there will probably be a pickup in the cases and how that is managed. And I think the structures put in place are well built to make sure that this pickup is managed to help. But we have to see that play out before we can say that we are changing our estimates towards positive. In terms of NPL, I think we would be wrong to say a specific number by end of the year. All we can say is that our estimates and expectations are fully covered by the provisioning that we have put in place for the first quarter throughout the cycle. So it's -- it reflects not just for this year, but for next year. The cycle impact should be provided for -- by this provision, large provision that we have seen. In terms of the market for -- secondary market for that, it's rather limited, to say. There's some market for smaller retail type of loans, the recovery agencies that can bid, but their capitalization is also limited. So there's not much in terms of the market to offload that. Although I will not include those kind of specific funds being formed or entering the country because there is a real opportunity there. In terms of -- third question was about bonds. And I can definitely confirm that whatever liabilities that we have, including the Lari bond, we have all expectations of meeting in short and medium term. Lari bond is obviously short term, and this -- we have all the expectations of repaying it and basically then continue our story. On the coupon side, I would like to ask Papuna to share his views in terms of A Tier 1 to see the confirmation and so forth. Papuna?

Yes. Thanks, Archil. Thank you, and -- thank you for the question. So the A Tier 1 instruments are new across the world. It's not only new for Georgia and primary purpose of this instrument is to use its optionalities during the stress time and, I would say, encourage stress. The instruments are undergoing a test, whether they're serving its purpose. Currently, we don't see any immediate urgency to suspend coupon payment. So that for now, they will be continued. And let me also say that we highly value our investors. We think that they put trust in Georgian banking sector through this instrument, and we will definitely not penalize them vis-à-vis other jurisdictions. So we will be closely following what others are doing regarding the A Tier 1 instrument and their coupon payments, and we'll be closely resembling the same. As for the instrument as a whole and whether we expect it collapse or not core that will be a very last resort measure, and we are committed to do everything in our hands and not to come to that scenario. And if we see further deterioration signs, we will use different methods to conserve the capital in order not to trigger collapse. And these measures can include possible suspension on coupon payments, if the situation deteriorates further.

Thank you, Papuna. Although when you focus on the negative, it does not sound great, but at the same time, all the expectations are a bit better than currently what is reflected in the numbers, and that's our view on this front.

The next question is coming from the line of Andrew Keeley from Sberbank.

I have a couple of questions. First of all, on your provisioning, could you help us kind of understand how you get to the 7.4% cost of risk? Could you maybe tell us what kind of share of this cost of risk, the 7.4%, was due to kind of macro adjustments under IFRS 9? And were those kind of macro inputs basically based on your GDP scenario and the relative kind of probabilities of those scenarios coming through? And would it be right to think that if you end up moving more towards your kind of negative GDP scenario that, that would suggest that there would potentially be further additional provisions based on the kind of worsening of macro inputs? Or that's not the case? And I suppose, to more broadly, what is the case that a sizable volume of loans were moved from stage 1 to stage 2? Is that the case? That's my first question, then I'll follow up later.

Andrew, thanks for the question. And so you're absolutely right. So the provisioning is direct with the IFRS 9 approach where we have -- we planned the macroeconomic impact, but it's not just the headline number in terms of what we expect, but it's several scenarios that we have, like we shared in our statements. So it's 10% upside, 50% our expectation in terms of the baseline, and then we have a worst case that had a rather high expected value of 40%, which probably is being decreased as we see a better development. In terms of this number, it reflects not just those GDP numbers and the resulting prediction of our performance, but also sector specific. So for example, tourism is being affected, let's say, directly, given the loss of international tourists short term. So we see that, let's say, the GEL 830 million portfolio that we have in hotels and restaurants, that has a much larger hit versus, let's say, some of the other things. Then we also stress the retail portfolio giving certain assumptions, macroeconomic assumptions. And coming out of it, we derived the expected loss on the portfolio, and we take the NPV of any recovery we see. And that's how we arrived at the number. So as you rightly say, if things -- and we do the weighting of the different scenario on the numbers that we could add from. So this GEL 400 million reflects the weighting, as I described. So if it so plays out that we go into a worst-case scenario, obviously, this number will increase. If it plays out to be better than the weighted average of these numbers, then it will decrease. And we'll have the recoveries. So that's -- I hope that answers your question. Otherwise, I'm happy to provide more details.

We that's pretty helpful. So I mean, basically, if things kind of stay the same, say, through the second quarter in terms of your scenarios and your probabilities, then would it be right to think that kind of you would more or less return to a kind of normal run rate of provisioning from the second quarter? But not -- yes, but if things obviously improve, then that could potentially be releases or better-than-normal run rates?

Correct. So that -- I think that is something which is -- I wouldn't say quite specific to Georgia, but it's definitely different from most of what we are seeing in other jurisdictions where the regulator as well as banks have taken a view where they are charging [indiscernible] economy. We've looked at this crisis. And with the regulator, together, basically have decided to charge for the whole expected cycle.

Okay. That's very clear. My second question is just on your loan restructuring payment holidays. Could you share with us the kind of percentages or the volumes of loans by kind of different segment that have been restructured? And do you expect to see further impairment charges on the payment holidays in the second quarter? Or is that all done that GEL 39 million in the first quarter?

Yes. So first is we don't expect any nonrecurring charges going forward because the type of restructuring that has been done, I think, will not be -- is not a usual type of restructuring, which is basically not capitalizing the interest, but rather spreading it over for the remainder of the loan. So we don't expect those kind of restructurings. Having said that, the stream of restructuring that has been provided to all of our retail clients is not what we expect going forward. That was done specifically to reduce the traffic of people coming to the branches for restructuring in the times when it was -- the pandemic was playing out. So when you think about it, what -- how we could have reduced the impact the big banking sector has on that, I think that was what we considered was absolutely required and that's what we did. Having said that, customers have an ability to opt out by sending an SMS. So everything else was done automatically. 15% of our customer base have opted out. Although that 85%, I will not consider that restructuring in the usual stance of the banking approach given the nature of the restructuring. So on the legal entities, the SMEs and corporates, that grows one by one, and it's very much an ongoing process in terms of review and restructuring. So I think it's too early to discuss the numbers there.

Okay. And final question on your margin. There was quite a strong decline, I guess, in the first quarter, 40 bps or so, which came through on the asset side rather than funding costs, particularly the loan yields. How much of this 40 bps would you say was due to the lari weakening and the higher share of lower yielding FX in the portfolio? And how much was due to the kind of changing loan mix that we've been talking about for a while now? And generally, it seemed like you -- the impression had been that you'd kind of reached the bottom in terms of that yield compression due to the change in mix. But would you say that that's not the case?

So there was, as you rightly said, there's mix and there's devaluation, and devaluation causes a change of mix. What I specifically mean is the fact that when there's devaluation, the ratio of the dollar -- high currency loans increases automatically, right? Because the lari amount of that increases and lari loans don't. So it automatically increases the ratio of high currency loans, and those tend to be lower yield. Because you are talking about the corporate and SME, which have little bit lower yield than overall to retail, especially on the consumer side. So there has been an impact that came from that. Also, what we had was that on 11th of December, so end of December, basically, we had an increase of refinancing rate on lari. And that impact us more negatively, while the asset side takes a little bit longer to be repriced. And also, what we earn as the amount of money that we earn on the liquidity dollar, liquidity on minimum reserves have decreased as well in December. So those -- it was a combination. So this 40 basis points was a combination of little bit, I would say, change of the mix. But that, I would say that the lari devaluation cost change of mix, I would still qualify it as lari devaluation impact rather than the change of mix. So it was mostly lari devaluation and some of the other things happening in the macro environment and little bit the ongoing, let's say, change of mix, which was probably [ lockdown ].

Okay. So is it reasonable to say that if we now have a kind of stable situation with the lari that you would expect to be going back to the kind of stable NIM that you have been thinking about before?

To say anything about any number in this environment to be stable is very tough. So I would say that...

If the lari was stable.

Yes. I mean I would tend to be saying that, but there are other things that are affecting the business, NIM and other things, including, let's say, how quickly your portfolio turns. So if you have a lot of financing of new financing, et cetera, let's say, fee that is associated with loan issuance that is amortized and is included and the NIM gets digested the moment that gets refinanced. So that has a positive impact. So if you do not have, let's say, a quick turnover, that has a negative impact. So there are other things that are affecting NIM. So overall, in terms of the, let's say, margin like this, then it's -- I would say yes, but then there are other components in NIM that are being changed given the dramatically changed business environment. And that is very different in April. There are some recoveries that also play a role in NIM formation and so forth. So I think second quarter, there will be an impact on -- from these types of things. But then what really matters is how it stabilizes out in a more, let's say, new normal, which will probably be third and fourth quarter.

Next question is coming from the line of Ronak Gadhia from EFG Hermes.

Mine is just maybe a couple of follow-ups from Andrew. Firstly, I think you'd asked about the migration from stage 1 to stage 2 and maybe stage 2 to stage 3. I'm not sure if you answered that. Apologies if you did, and I missed it. My second question is on your borrowers who have foreign currency risk. So if I look at your presentation, roughly about 38% or so of your borrowers have FC loans, but I guess they're earning in lari. Could you talk about their ability to absorb the FX shock and how they're dealing with that? And my final point, I guess, is on your FX-related earnings, the big increase during the quarter on a year-on-year basis. Could you just highlight, is that driven by trading income? Or is that just a revaluation gain? It's just a one-off because of the movement in currency? I'm just trying to figure out how sustainable that is through the rest of the year?

Thanks. So you are absolutely right. I forgot to mention on staging. We do not provide stage 1, 2 and 3 breakdowns through the quarters, but we will be updating on a semiannual basis, a detailed breakdown, and that's when we will be providing the numbers. In terms of the FX, we made more money in this larger volatility because people tends to be taking positions in and out. So it's a trading volume. In terms of sustainability, it is somehow related to the volatility. So more volatility would mean that people will be trading more, and we will be earning more, less volatility would mean less. But overall, I think our FX income has been performing well. And what was your first question again?

The first one is on the proportion of your borrowers who are borrowing in foreign currency, but maybe their income is in lari. I mean if I look at your ratio, it's roughly about 35% to 37%. I just would -- sorry, go ahead.

Yes. So on that front, basically, 15% devaluation, obviously, is something that is affecting them negatively, but it's nothing new. So when we are financing in hard currency, on one side, we are requiring higher buffers in terms of debt service coverage ratios, lower leverage that we provide in those cases versus other cases when there is no mismatch in currency. Also, the National Bank is requiring 175% capital versus 100% in most of the corporate and SME loans when there's a mismatching currency. So that's more or less built in the system. So this kind of devaluation by itself is a bit negative, but not super significant. But obviously, all of the borrowers are being impacted on more other, let's say, by other economic things that are happening. Just to say basically about the devaluation, we had much larger devaluation happening 5 years ago when there was an oil crisis, 2015, and we have seen how the performance was in terms of the clients, and we saw a little bit higher cost of risk, but it was manageable absolutely. And this time, the devaluation is 3x less. So it's not very significant at this point. But the other economic impact is significant, and that is reflected in the overall numbers, I think.

Okay. And sorry just one final one. And I guess this is also a follow-up on what Andrew was asking. In terms of proportion of loans that are restructured, like you mentioned, it's still early days. You're taking it on a case-by-case basis. But could you provide any guidance in terms of what proportion of your customers are approaching you to restructure their facilities? Or what kind of pressure are you seeing on your corporate and SME book?

Right now, it's too early to provide. So I apologize that I'm not in a position to provide any specific numbers. It's a very much ongoing process. And we are working with client by client. At this point, I think it's too early to discuss the percentages, and we'll have much more detailed numbers by the end of the second quarter when we report those.

The next question is coming from the line of Mikhail Shlemov from VE Capital (sic) [ VTB Capital ].

I wanted a direction to follow up on the net interest margin discussion, specifically what is going on in the retail part of the group. I have noticed that in your presentation, there are loan yields in the lari have actually very steeply dropped by approximately 3 percentage points so together with the deposit rate increases driven by NBG regulations, capital is a fairly big margin squeeze. I was wondering how you think about the long-term sustainable retail margins going forward, especially as loan mix is actually changing and whatever the restructuring efforts or the changing the loan mix how it will impact the net interest margins on the retail side going forward.

Mikhail, thanks for the question. So in terms of how we look at specific margins, it depends on the specific product and the risk weighting and our expected cost of risk. So the way we price it is basically we price it given the cost of equity and our expected -- what our target are in terms of the profitability. So as you price that in, we are able to either sell some product level more or less than the market and now you don't want to change. So that's how we price it. So what we expect depends on specific products. So we'll have a little bit less margin on mortgages, obviously, which are in lari. But there's -- yes. So because this risk weighting there is 35% for the qualified mortgages, which are usually considered to be more liquid in terms of the real estate that they are financing. Smaller apartments, basically in parts of the cities that are more liquid. And there are other types of mortgages that are 100% risk weighted and those that are priced differently. Consumer will remain at a higher margin, and there has been relatively less of a growth there on more basis, so it will be less. But it will be -- I mean you see the margins or, let's say, the pricing of different types of products. But other than that, everything else will be a product mix. Something that plays into the margins as well is our view of cost of risk. So if we see that, let's say, through the cycle cost of risk has either decreased or increased, it will be reflected in our pricing. Mortgages particularly has been extremely low cost of risk type of investments, and we don't see a major change there so far. Or we don't expect it either because we don't see any bubble there.

That's helpful. So I want to just like to confirm that this 1 percentage point quarterly drop in lari yields on the retail price, that was fully loan mix, nothing else.

Not quite. There's also what happens is that when there's a change in the refinancing of the National Bank refinancing rates, so the mortgages when we issue, they are usually 2-year fixed and then there's a margin to the refinancing rate. So last year, we had a significant increase -- in the year before in fact but last year as well in lari terms, in lari mortgages, which were tied and provided a 2-year fixed rate to our borrowers that was based on a lower refinancing rate of 6% at the time or 5.5%. And as the lari financing rate increased, we got squeezed on that portion of the portfolio. So I think that had a negative impact. So when you are growing in a rapidly growing environment, which we had last year on mortgages, you're negatively affected when your cost of financing increases for some period of time. And your [indiscernible] your refinancing rate decreases. And the portion of that, those impacted as well.

Okay. That's helpful. But it would also mean that just like once the National Bank would start even easing, well, actually, the yields on the retail book in lari should recover, right?

Absolutely. So those mortgages are, let's say, 8% fixed for 2 years. When we have the refinancing rate going up to 9%, we are, in fact, incurring losses there. As this rate comes down, we are already at 8.5% and maybe coming down further. Obviously, we'll be -- overall margin will be affected positively.

Okay. And out of this 1% change, how big it was this mortgage effect should we estimate?

Excuse me. Can you repeat the question, Mike?

Yes, out of this squeeze on the retail side, what proportion of this was actually driven by the mortgage effect, which I just discussed?

Unfortunately, I don't have that number ready, but I'm happy to provide you later on.

The next question is coming from the line of Henrietta Seligman from Somerset Capital.

I've got a couple of questions. The first question is, could you give some more detail please about what the terms of the IMF funding? And then also what the terms are expected to be of this further IFI funding that you're also planning to get? And then the second question is just on how the second quarter is progressing so far. And what are the factors that give you some optimism that this may be a better-than-expected scenario for the rest of the year?

Thank you, Henrietta. On the first question, since Papuna is online, and he has been personally involved in these negotiations, it would be great if he could provide little bit of color on IMF funding in that cycle.

Yes. Sure. So maybe without disclosing any specific contract, I can say that mostly this funding is in the form of debt. Out of $1.6 billion, $1.5 billion is debt and about $100 million is in the form of grant. They are all in foreign currency, so it will flow through Central Bank reserves. And interest rates are mostly concessional. Maturity of these loans is quite longer term, 15, 20-ish, some are more. Does that answer your question?

Yes. That's great. And just on to maturity, will there be any principal payments within that 15- to 20-year period? Or is it all at the ad of the term?

These are mostly product loans.

Regarding the second question, it's a bit early right now to discuss in terms of what we are seeing in the numbers. All I can say is that April was significantly negative given the full lockdown in the country. So nothing was functioning, and April numbers are definitely very low. Having said that, we have seen some pickup in terms of economic activity in the May numbers, and it was a partial, let's say, release of the lockdown. So some of this is, let's say, positive, but we very much need to see what part of it is a full recovery and what part of it was like stuff that was accrued in April and was being done in May. So in terms of the banking activity, I think it's too early to really make a judgment of how the overall picture will play out. All I can say is that definitely, second quarter will be rough, but that looks like it's going to be the case in most of the world. What really -- what we are looking at is how this third and fourth quarter will play out, and how that will be seen in terms of net fee and commission income and client activity and so forth and so forth. And what gives us optimism is what we are seeing in the overall how -- the early signs are, let's say, how the virus has been handled. So seeing, let's say, the death rates being or deaths overall being very low and number of active patients being under 300 and the way government has reacted and managed this crisis overall, I have to say that it gives a lot of optimism. But that remains to be seen how it all plays out as the lockdown ends to make sure that we control it much better. So we -- I think Georgia is in a position where it has taken basically almost a full control of this virus. And it has put things in place for the release so that whenever the lockdown ends, I think there are a number of procedures put in place to make sure that this process is managed. Unlike some of the other countries where I would say that the virus is spreading much more rapidly, but people are still pushing for the ending of lockdown. We are not in a position, definitely not. We are -- and that's what I mean by optimism. So what we are seeing in terms of how it's being handled is really exemplary. In that way, that will have its own effect on how the economy resumes functioning. And we are seeing some early signs, some early positive signs. I wouldn't be too positive at this point. I still want to wait until it all plays out. So I think end of second quarter, we'll have a much better picture.

And actually, if I might just ask one other question on the IMF funding and also the IFI funding that you're expecting to come through. How is that funding needs to be directed? Will it be directed to corporates and/or to individuals? And somewhat related to this is what are National Bank's expectations versus unemployment levels at the end of the year based on your GDP projections and where you expect to be hit the most?

Papuna, would you like to say something about this?

Yes. So the $1.6 billion that I have been talking about, it is fully public funding. So that's the funding that Central Bank and Ministry of Finance will receive. In addition to that, real sector and financial sector is receiving about additional $1.5 billion, of which we already know of. So that's -- the total pipeline is about $3.1 billion, $3.2 billion, which is 20% of GDP. Sorry, could you repeat your second question?

The second question sort of relates to this. And what are your expectations of unemployment based on your GDP projections and which factors do you expect to be muted this year?

Okay. Yes. So we expect unemployment high in a base case scenario of about 4%, 3.75% to be more precise. And starting next year, we expect gradual reduction because we expect the impact of the crisis to be relatively short term. And at least in the base case scenario, we don't expect it to drag into 2021.

The next question is coming from the line of Can Demir from Wood & Co.

Yes. I just want to follow-up on one of the questions that was asked in the call. You mentioned that from a -- Archil, you mentioned that from second quarter and almost, you would expect cost of risk to go back to 1% or so, meaning the run rate. Does that mean that you should see a cost of risk in the range of 2% to 3% this year if you look at it on a rated basis? Just wanted to understand your train of thought on that.

So we have charged for this cycle in the first quarter. Going forward, we expect the normal levels we used to guide were about 1.2%, around that. So between 1% and 1.4% is what we were discussing more or less. So if we are around these levels, if nothing else changes over the next few quarters would be normal. Does that answer the question? Or if you do the math and you average it out, it could be what you described more or less, but...

Okay. That's extremely helpful. And the other thing I wanted to confirm, you mentioned 85% of the retail portfolio is on payment for base, just I think all secured and mortgages. I just wanted to confirm that.

Say again? So we provided the 3 months automatic extension or whatever you call it for the whole portfolio, including all retail, including mortgages.

Okay. So 5% of retail portfolio is not [indiscernible]. Okay. And can you also give us the ECL numbers for the downside scenario as well? Would that be possible?

So in case, increase the downside scenario plays out, our current estimate, which is the downside scenario that we have is additional roughly GEL 200 million, additional reserves, if there is -- down scenario plays out. I think GEL 180 million is the number, but it's an estimate, so it doesn't [ fall in ] exact times.

Okay. If I may, I also have a question for Papuna as well. I want to understand how much room would be regulated to give the banks in terms of not meeting the normal CET1 requirement? And when would you expect the normal CET1 requirement to kick in?

Yes. So we basically regard all Pillar 2 buffers as usable during the crisis. And this is period of crisis. All Pillar 2 buffers can be used, meaning minimum capital requirement for CET, further system can go to 4.5%. And for systemic banks, we had suspended risk buffer, which currently for Bank of Georgia stands at 1.5%.

Okay. And would you -- I mean we're dealing with semantic period. Would you say that if Georgia grows next year, that means declines over. So the CET1 requirement would go back to normal level, like 11%, 12%?

No. So we recognize that the impact from the crisis is not small. It will be significant. So we will give the banks and full time to rebuild the capital back to pre-crisis level. So I cannot give any specifics to what period will be given and under what time schedule. It will depends how deep the crisis is, and we prefer to make that announcement after we consider that we have hit the bottom and recovery starts. But what I can say qualitatively is that we plan to give the bank ample period to build back the buffers in order for credit growth not to jeopardize the recovery and to -- on the contrary to support that recovery.

The next question is coming from the line of Andrey Mikhailov from Sova Capital.

I have a question on corporate loan restructuring, in particular, about its impact on the P&L. As I understand, this process is very active and ongoing. And the question is, could we see a charge, restructuring charge related to corporate loans in any one quarter, which is similar to the charge on the retail loans in Q1?

Andrew, the quick answer is no. So if the charge on the retail one was caused by the fact that we did not accrue the interest, but we spread it. So whatever interest was to repay was not capitalized, but accrued and spread over the remainder of the loan period. So that meant that the NPV of such amount was less than what would have collected if those payments were done. In corporates, no such restructuring is foreseen. So the answer is no.

[Operator Instructions] The next question is from the line of James Hamilton from Numis.

Can I ask what the Central Bank's thinking is on the dollarization given the current macro scenario with lari weakness and with an idea for corporates being entirely tax purposes and your lari-denominated loans may receive a preferential treatment.

Yes. So the dollarization is probably the largest structural risk for the banking system. It has been reducing gradually, though. In the past 3 years, we have introduced quite aggressive measures to curb the dollarization. So that's probably the most vulnerable sector that is impacted from dollarization is retail. And over the past 2 years, a number of legal changes and Central Bank regulations came in force that targeted the retail sector specifically. And these regulations were staged in throughout the process and eventually loans under GEL 200,000 can only be granted in local currency. And also in foreign currency, we have much tighter ratios for foreign currency loans in terms of payment-to-income and then loan-to-value ratios. Basically, payment to income -- payment-to-income ratio is tighter in foreign currency that assumes about 60% devaluation or depreciation of local currency. So if local currency is depreciated by 60%, only then the foreign currency loans will be -- borrowers will be paying as much proportion of their income as local currency borrowers. So obviously, that scenario is quite remote at this stage, and the depreciation that we already had, which was about 15% can be safely borne. With regard to corporate sector, so we regard that sector is a bit less sensitive towards dollarization because they have, first, better capacity to hedge. And second, they have -- some of them have natural hedge through exporting goods and services and most of Georgian GDP, large part of Georgian GDP was dependent on foreign inflows. And third, they have better capacity to change their pricing strategies to adjust to the new cost basis. So we see, in general, a low risk on the corporates, then retail and retail [indiscernible] over the past couple of years. You also asked about capital requirements. So in general, we have 75% add-on in terms of risk weight for foreign currency loans, and that's -- and that is the same for corporates and retail sector. Currently, we have reduced 2/3 of it, given we had depreciation of the local currency, and we consider that countercyclical move in this regard would be appropriate.

There are no more questions at this time. Please continue.

With this, I think this has been one of the longer conference calls, and that is absolutely understandable given the amount of changes that are happening around us. And thank you for joining our conference call, and I wish you health and well-being. And I would like to highlight and extend my gratitude to Papuna, the Vice President of National Bank, who has done a fantastic job early on in the crisis in terms of the banking, but also working with the government to come up with certain measures to counter the economic impact. Thank you, Papuna, for joining in these times where you are extremely busy. Thank you for finding time for talking to our investors.

Thank you.

With this, we conclude the first quarter call. Thank you for joining. Bye.

That does conclude our conference for today. Thank you for participating. You may all disconnect.