Türkiye Is Bankasi A.S. (ISCTR) Earnings Call Transcript & Summary

Welcome all to Isbank 2025 First Half Financial Results Audio Webcast. Today's presentation will be led by Ms. Ebru Ozsuca, Deputy CEO; Mr. Mehmet Turk, CFO; and Ms. Nilgun Osman, Head of Investor Relations and Sustainability. After the presentation, as always, we will have a Q&A session. [Operator Instructions] Now I leave the floor to Ebru.

Good evening. Welcome to our earnings presentation for the second quarter. This is Ebru speaking. Thank you all for joining us. Today, I am welcoming you with my new added responsibility in Investor Relations and Sustainability function that I have taken over from Izlem. I would like to take this opportunity to sincerely thank Izlem for her valuable contributions and dedication and wish her all the best in her retirement life. I look forward to sustaining strong 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 to decline in line with the forecast but also the sector inflation improved alongside with the CBRT's decisive stance and the pursuit policies. Following the improvement in inflation expectations and the recovery in reserves, the CBRT resumed a 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 this inflation 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 put pressure on the budget balance, the limited rise in other expenditures seems to have offset this pressure. Relatively low course 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 USD 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 contribution supported the bottom line. We have effectively tackled the margin pressures and held our ground successfully in terms of containing this interest margin decline to a very limited level. Going forward, we can say that we are well equipped to register meaningful improvement in future performance as we reentered 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 quarterly 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 in policy 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 Nilgun 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 TL 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 consist of export loans, a strong indication of 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 white spread granular core deposit base. There was around 7% quarterly growth in TL deposits. The increase in FX deposits mainly stemmed from euro-dollar parity movement and on adjusted terms, there was indeed no growth. We maintained the largest demand deposit base among private banks as of the end of 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 views 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 to mention that nearly half of our short-term deals 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 second quarter, 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 the 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 will 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 for spread contraction due to pickup in deposit costs. As rate cut trajectory restarted as of July, NIM improvement is underway in line with our expectations. We believe that additional tightening has slightly postponed the 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 our TL portfolio is 47%, positioning us advantageously for the upcoming periods. Despite the downward trend in inflation, we continue to benefit from CPI-linked 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 permissions. 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 the recent years, efficiency and cost management have gained more importance in 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% and while fee coverage of HR expenses reached nearly 230%. Furthermore, cost to average asset ratio declined to 3.6% and our cost income ratio improved by 10 percentage points. We will continue to focus on efficiency by leveraging our strengths in adapting new technologies, upskilling our talent force, pioneering digital banking services and centralizing process management. 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 remained strong at 26%. Our NPL formation rates reflect our experience in underwriting as well as robust collection capabilities. Our NPL ratios across all major segments such as SME and retail loans was lower than private bank's average. It is important to highlight our strong performance in NPL ratios in general, but mainly in 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 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 BRSAs 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. Whilst sensitivity, 200 basis points increase in TL interest rate is around 8 basis points. In our previous earnings call, we have not revised our 2025 expectations and targets as it will be premature to revise our yearly guidance back then. 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 time line of the simplification path, 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. And I would now like to open the floor for questions.

Our first question comes from David Taranto, Bank of America.

My first question is on NIM, and thank you for the granularity on the NIM chart on Page 9, 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? Or is your peak NIM expectation higher or lower versus the initial expectations? And second question is about the details of your NIM guidance. How do you foresee the Turkish lira deposit rates during the second half of the year? Do you assume rates to more 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 higher level of demand deposits and your client base. But do you see these deposit rates on the FX side as sustainable over the next several quarters?

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 lira loan yields and Turkish lira deposits and money market funding costs. However, with the Central Bank's proactive stance in response to the financial market movements, bringing in unexpected hike in funding costs and causing the rate cut cycle caused a delay in the improvement trajectory for 2025. 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 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 lira loan portfolio is around 60%, Turkish Securities portfolio is around 25%, whereas the share of Turkish lira deposits stayed 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 6 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 spread widening. In our current baseline scenario, we anticipate CBRT to go for consecutive rate cuts in the remaining 3 meetings, though levels may defer depending on the market developments. But 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 parcels converging with the other actors, there might be some easing in Turkish lira deposit costs, which will help us expand Turkish lira spread, as you see in our presentation. Maybe I could be more precise. I could share that our back book Turkish lira loan yield is around 4%, and the cost of blended Turkish 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 would 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 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 has been postponed by around 2 quarters, with the potential to reach peak level past midyear 2026, considering the rate cut cycle continue in line with the ongoing disinflation process. Maybe I can here say that your question, the exit NIM of 6%, most probably will be seen in the second quarter of year 2026. Though it would not be reasonable to point out a specific level at the moment. Please also note that if there would be any simplification on the macro prudential measures in the future, this might provide additional support to our NIM baseline. I hope this answers your question. And you had one more question on our FX deposit levels. We believe that with our widespread customer base, our FX deposit levels will continue to be at the lower levels. So we are -- we feel quite strong at that side. I could also say that around 70% of our FX deposits is on-demand -- stays as demand deposits.

While waiting for the next question, we can look at some of the written questions. We have some questions from Valentina Stoykova, Barclays. One of them is actually very much in line with the previous question that David had asked, but it has some additional aspects. So for example, what is the asset liability maturity mismatch? And what is your approach to lending securities portfolio and funding and also what sort of macro assumptions to make into your NIM forecast?

On the Turkish lira side, our asset liability maturity mismatch, as I said, is around 6 months. And I can say that we are not carrying a mismatch in our FX side. And in our macro assumptions, we expect the post rate to be around 35% by the year-end. I think -- and on the -- and the inflation to be just slightly below 30%.

Another question from Valentina is regarding our FX liquidity levels.

By the end of June, our total LCR stood at 127% and FX LCR at 284%, 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 around USD 6 billion, around USD 7 billion, I can say, in USD terms.

So 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? And 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 emerged as the primary areas of credit risk with relatively higher and elevated NPL ratios and also the rising NPLs in domestic 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 3 reversals. There is a big one file, which is a one-off transaction. So without that, there are not major reversals in Stage 3 in our portfolio.

Our last question is again from Valentina. So she asks our Eurobond issuance plans until the end of the year.

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.

So 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 the strong performance, there lies our strength 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.