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Edited Transcript of HALKB.IS earnings conference call or presentation 8-Aug-19 3:30pm GMT

Q2 2019 Turkiye Halk Bankasi AS Earnings Call

Istanbul Aug 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Turkiye Halk Bankasi AS earnings conference call or presentation Thursday, August 8, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Conference Call Participants

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* Alan Ramsey Webborn

Societe Generale Cross Asset Research - Equity Analyst

* Deniz Gasimli

Goldman Sachs Group Inc., Research Division - Associate

* Mehmet Sevim

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to Halkbank's First Half 2019 Financial Results Conference Call and Webcast. I now hand over to Semih Tufan, Head of Investor Relations. Sir, please go ahead.

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Unidentified Company Representative, [2]

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Good evening to everyone. This is Semih Tufan speaking, the Head of Investor Relations Department. Please let me introduce myself in brief. I have been working at Halkbank for the last 10 years. In advance of moving to Investor Relations. I was acting as the Division Manager in Structured Finance. Many thanks for the time you spent to hear about our bank's performance. And now please let me switch to our presentation.

On Page 1, our assets grew by 5.4% quarter-over-quarter and 23.2% year-over-year, reaching TRY 429 billion in nominal terms. Loans continue to have the highest share in total assets with 64.6% and followed by the securities accounting for 23.1%. Liquid assets are made up of 89% in the form of the foreign currency. We have FX liquid assets of USD 5.7 billion, excluding swaps compared to wholesale funding of USD1.8 billion, which will be due in the last month. Accordingly, FX liquidity coverage ratio is at 300%, which is well above regulatory limit of 80%.

Looking at Page 2, in an environment of high interest rate, we opportunistically increased our TL security portfolio by purchasing fixed and floating rate instruments. Accordingly, we improved our total security yield to 15.2% from 14.2% in the first quarter.

On the FX side, we received securities of almost USD 1 billion in return of the recap settled in April. Securities portfolio is heavily classified as amortized cost. CPI linkers increased to TRY 19.2 billion from TRY 16.7 billion in the previous quarter and generated TRY 867 million interest income, which was up compared to the previous quarter, where we booked TRY 740 million.

Page 3 shows us a very limited lending activity during the second quarter. The total loan growth is in line with the sector average, but slightly higher in Turkish lira, which mainly comes from the corporate customers. On the other hand, our CGF exposure slightly reduced to TRY 24.6 billion from 26.2 billion in previous quarter. We achieved to preserve market share at 10.6% as it was in the first quarter. Further details of loan book we have are on the next page.

TL loan book accounts for 67.1% in total loan portfolio. On the other hand, FX loans are mostly constituted by corporate customers against strong collaterals and treasury guarantees. On the right-hand graph, we see that SMEs have the biggest share with 40% in total loan book, while CGF and corporate loan shares are 7% and 15%, respectively.

When it comes to retail book, which makes up 16% of the total loan portfolio, it's again quite secured on account of housing loans, which constitutes more than half of it, and consumer loans of which almost 70% granted to either pensioners or payroll customers.

When we look at the sector breakdown of the loans, we can see that manufacturing, trade and retail are leading sectors in the total exposure. We have also exposures to joint ventures and holdings, which are classified and shown in the segment of rent income business activities. Our exposure to construction and energy sector is not excessive with only 7% and 6% shares, respectively.

Page 5 elaborates on asset quality metrics. NPL portfolio increased to TRY 11.5 billion, mainly due to one-off big ticket movement to stage 3 loans, which is in the energy sector. This is the reason why our NPL ratio increased to 4%, which is still below the sector average and in line with our guided level. Excluding one-off ticket, NPL generation can be considered as flat with previous quarters.

By the way, in parallel to the sector practices, we also switched our provisioning methodology to a hybrid model under IFRS 9, including both collective and individual assessments while we were using only collective adjustments until this quarter. That is why we saw that NPL coverage declined to 63.4% from 73.4% due to release of impaired provisions of a selected number of customers because of switching to hybrid methodology and it became consistent with the sector average.

Furthermore, Stage 2 loans grew in volume from TRY 18.6 billion to TRY 22.7 billion. And in the share of total loans from 6.6% to 7.9%, but its share in total is still one of the best in the sector.

Page 6 manifest debt. NPL ratios of both consumer loans and SME loans are remarkably lower than the sector average, for which we have always emphasized our conservative structure.

Next page refers to the provisions in the amount of TRY 794 million set aside for one-off big ticket move to NPL, the impact of which on the bottom line was offset by reversals due to the change in provisioning methodology. We see the quarterly increase in gross and total cost of risk. But thanks to our collection performance and provision reversals, the net cost of risk improved to 72 bps from 111 bps in the first quarter.

On Page 8, we see that TL loan-to-deposit ratio increased to 152% since we opportunistically switched our funding preference from deposits to interbank money markets, especially in the last days of the quarter to avoid high deposit costs due to tight competition. But it immediately came back right after quarter end to where it was intra quarterly.

Blended loan-to-deposit ratio is also slightly higher at 107.3% due to the same reason, but still below sector average. Considering TL funding costs, including deposits starting to decline in the first week of July. We will continue to act opportunistically to optimize overall funding cost in the following quarters.

Our sizable securities book enables us to further engage with short-term money market facility to lower our funding cost when needed. We also emphasize on our low reliance on FX wholesale funding and our FX liquidity is more than enough to cover FX wholesale debt maturity maturing in 12 months. FX wholesale funding makes up 7.9% of the total liabilities versus sector average of 22.6%, and it gives us an extra comfort in terms of liquidity coverage. Let's flip to the next page.

We are the second largest deposit franchise in the sector. Nonetheless, our deposits shrank by 2.3% quarter-over-quarter, which was driven by the contraction on TL-denominated commercial and state deposits. But please bear in mind that state deposits are fluctuating during the quarter due to its nature. We still have further room to increase our shares in the following quarters.

When it comes to FX deposits, it almost remained flat compared to the first quarter. We have the following page addressing the details of our deposit base in terms of the interest rate. The cost of TR deposits slightly increased from 16.3% to 16.5%. But starting from end of June, deposit rates have been on a declining trend, and we expect the rates to reduce further and to see more positive reflection on the back book in the following quarters.

Another positive takeaway for the second quarter was that share of demand deposits continue to increase so that we saw a jump from 16.5% to 17.6% in this figure. Flipping to the next page, where there are detailed explanation on the spread dynamics. Cost of deposits in blended terms continued to drop in the second quarter and reached to 9% from 9.8% in the first quarter, and it paved the way for an enhancement in the core spread improving to 4.4%. Security spreads also improved to 2.6% from 1.2% and supported net interest margin.

On Page 12, we saw a jump in the total operating revenues to TRY 3 billion around TRY 2.3 billion in the first quarter due to the well performance in the core business and cost management. But it was consumed by provisioning burden of a big ticket NPL which limited bottom line income.

On Page 13, you are given a detailed look at our top line revenue sources. Interest income from CPI linkers increased to TRY 867 million on a quarterly basis. Net interest income improved by 31.2% quarter-over-quarter, driven by cost effect improvement plus contribution from CPI Linkers. Accordingly, quarterly net interest margin was improved to 2.6%.

On the other hand, fees did very well by delivering a record-breaking TRY 720 million nominally, which translates into 16.9% quarter-over-quarter and 47.3% year-over-year increases. We are happy with the performance and the results of our diversification efforts, and we'll continue to do our best to manage improvement in the following quarters.

Switching to Page 14. OpEx significantly declined by 9.3% quarter-over-quarter and its share to average assets improved 1.4%, showing how disciplined our operating expenses space base has been managed. In the second quarter, OpEx yearly growth is at 14.5%, which is well below CPI print recorded as of relevant date.

Page 15 sheds a light on capital adequacy evolution. Capital adequacy ratio improved to 14.6%. As shown by the remarks down right, we have had EUR 900 million fresh, 81 capital during recap step taking place in April, which added around 185 bps into our capital adequacy ratios. Given the structure of the transaction, our additional Tier 1 ratio was also boosted by 188 bps state support in the most reasonable manner has been taken very positively looking at the recent comments from the market participants and the international rating agencies.

And finally, on the last page, we have had a branch network details as usual. That has been subject to a small increase in the second quarter while the number of the branches is almost flat. Looking at the breakdown on the brand banking transactions on the top right, we are happy to see mobile banking and Internet banking accounts for almost half of the transactions. And again, happy to see digitalization efforts are paying off.

This concludes our presentation. And now we can switch to Q&A session, I guess.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Deniz Gasimli from Goldman Sachs.

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Deniz Gasimli, Goldman Sachs Group Inc., Research Division - Associate [2]

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A few questions from my side. One on the revenue side, just if you could comment over this exact swap utilization and swap cost during the quarter? Because it appears that there's a sizable trading loss, which is probably driven by swap cost. Just want to get any granularity on that front. And going forward, with the rates going lower, how do you see the dynamic evolving in terms of swap utilization, swap costs and Turkish deposit costs? Do you see swap utilization coming down as you switch towards more TL deposit gathering? In which case, do you see supportive kind of cost of funding backdrop in the second half of the year? So if you could give a bit more color on where you see rates going quite the end of the year? And where do you see the cost of funding and the margins going are driven by that. That would be my first question.

On the second question, just on asset quality. As you mentioned, there's one big ticket item, energy exposure, which resulted in NPL ratio going up to 4%. Previously, earlier in the year, you guided for NPL ratio at 4% by year-end. So now was this one big ticket item going to the NPL. Do you -- are you going to change your NPL guidance for year-end? And another question would be on tax. There was a small reversal as well. So is this due to the same reason of repatriation from BaFin operations that we saw in the previous 2 quarters? And do you see it continuing in the second half of the year as well? And finally, on capital, I think looking at the consolidated capital ratios, the common equity 1 ratio declined by around 20 basis points to around 9.4%. I think for other banks, for the second quarter, we saw capital ratios increasing. So I want to get your take on what draw the slight deduction to capital ratio. And yes, that's about it.

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Unidentified Company Representative, [3]

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Thank you very much, Deniz, for asking these questions. I would like to start with the first one. Yes, you are right. The trading expenses is made up of roughly 61% by the swap cost during this quarter, we have increased our security portfolio to get the flexibility to switch our funding base from the deposits to internal money markets because we didn't want to enter into the hard competition on the TL deposit side. And we saw a very good yield opportunities on the securities, which was issued by the Turkish Treasury. And we increased our security portfolio. Then we switch our funding sources from the deposits in Turkish lira to internal money markets. That's why swap cost increased, as you said, and it made a big portion of the net trading -- total trading expenses.

When it comes to the second question, yes, we have already seen a considerable reduction on the rates on deposits, Turkish lira deposits and the swap costs on the right side of the balance sheet. We will continue to benefit from the swap transactions through the internal money markets. And we think that it will have a very positive effect in terms of the net interest margin and spreads. And we will -- we didn't change our guidance in terms of the NPL, and I think that we will stick with 4% by the year-end in terms of the NPL.

Regarding this tax provision. As you know, the repatriation act ended in April, but and then 3 months later, it's extended further with an exception of something regarding the offshore subsidiaries. As you know, BaFin branch is an offshore branch, and it's not possible to get this repatriation as we experienced during the first quarter.

So we didn't have any provision reversal for the tax within this quarter.

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Unidentified Company Representative, [4]

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And with respect to your last question on common equity Tier 1 ratio, Deniz. By the way this is (inaudible) speaking. Yes, as you correctly said. We have seen a decline of 20 basis points. I mean, as you know, there was a depreciation from March to June, which is playing and obviously, a role in the increase of risk-weighted assets, which is driving our capital ratios down. Plus, we have started to buy big oil shares to support the share prices when it was quite depressed. This has an impact of 7 8 basis points negative, obviously, on the capital ratios. This is another factor. And in the absence of a strong bottom line to support, which is the main source of quarter 1 ratio generation, obviously, it was very difficult to see an improvement. And nowadays in the 1 month that we left behind as of the first week of August, our common equity 1 ratio is in a slightly better shape for determining in the absence of these factors that I have counted. Maybe we can make some additional comments on your -- with regards to your first question, with respect to our funding strategy going forward. On top of the explanations of (inaudible) I mean, we have seen a significant, let me say, decline in the marginal deposit pricing versus the level that we saw as of June. And we are talking about 600, 700 basis points improvement on the marginal TL deposit side, which is very good and obviously will reflect on the separate and net interest margin, especially starting from mid-August because of the 40 days average duration that we have for Turkish lira deposits.

I mean we have started the quarter. We did slightly, let me say, high level in terms of back book cost but it has started to come down immediately after the, let me say, rate declines on TL deposit side, and it will be much more visible towards the quarter end and especially in the last quarter of this year.

We think there is more room to push it further down, looking at the offshore swap cost, looking at the (inaudible) that we have already seen in the short-term money market, plus CBRT's policy action also helped to accelerate this supportive trend.

And looking at the major hesitation that the marketplace have in their mind, which is obviously further dollarization in the sector. It looks to have pretty much stabilized despite we were cutting the marginal pricing on TL deposit side, especially we have seen after the quarter and we have seen a huge inflow from short-term customer deposits into TL from customer reports into TL deposits with longer maturities, which is showing that now, we are less money to swing from one source to another and keep everything intact for the time being. And with this dynamic with the expectation that these dynamics will continue going forward and everything will go through in line with the initial plan, we expect further translation into our core spread and margin in the remainder of the year. Our assumption was to have a flattish net interest margin beginning the year. We have seen a sharp decrease, unfortunately, during the first quarter. Second quarter was a quarter of recovery, and we are quite optimistic about the third, especially fourth quarter, which will inherit very good dynamics from the end of third quarter. Third quarter will obviously shape out, will be driven by many factors, and we will see some lag, which will limit the potential to be seen on the separate and net interest margin, but we will start with a very good base as early as the October, I believe.

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Deniz Gasimli, Goldman Sachs Group Inc., Research Division - Associate [5]

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Just on the tax question, just to make sure I'm clear. So you do not expect any further reversals in future quarters?

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Unidentified Company Representative, [6]

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Right. I mean, as Semih (inaudible) said, yes, we have seen an extension with some amendments by the year-end, which will keep out from booking further tax reverses. The income generated through offshore branches was excluded in the new extended package. And accordingly, there will be no further tax reversal related to debt and one shouldn't be surprised to see our effective tax rate normalizing going forward.

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Operator [7]

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(Operator Instructions) Our next question comes from Mehmet Sevim, JPMorgan.

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Mehmet Sevim, JP Morgan Chase & Co, Research Division - Analyst [8]

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Can you please elaborate more on the switch to the hybrid provisioning model, please? And maybe if you could give us some color of what kind of loans, so provision leases on the back of the individual assessment and hence, a drop in the coverage ratio. I think that will be great. And my second question is on your cost performance, given the second quarterly decline in the cost base in a row, what is driving this performance? And maybe what's your view on cost growth in the remainder of the year? And finally, if you could remind us what evaluation rates you're using for your CPI linkers, that will be very helpful.

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Unidentified Company Representative, [9]

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Thank you very much for the questions. Starting with the individual assets and collective assessment. With the enforcement of the IFRS 9 at the beginning of 2008, the banks are allowed to use 2 different assessment methodology for provisioning. The first one is collective assessment and the second one is individual assessment.

In the collective assessment, the banks are required to measure its -- their collection performance by having to look at their NPL ratio, sorry, NPL portfolio collections in the past 5 years. And then they need to assign a collection rate to use for the NPLs in the next.

For example, if a bank has a capacity to make the collection of, let's say, 45% from the total impact portfolio, it means that this bank is to make the provision for the rest, 55% for each and every NPL loan to be generated in the next. And this bank will keep provisioning for the further quarters until it reached 200% at the end of the fifth year. When it comes to individual assessment, it can be applied to a very limited number of the customer on a selective basis because it's not possible to apply to full the NPL portfolio because of the operational reasons.

On a selective basis, individual assessment banks are using -- are taking into the consideration for some factual data, such as the collaterals, mergers and acquisitions potentials, some future cash flows, et cetera. And then the -- present value of the amount calculated through this way is to be deducted from the total NPL risk and the provisioning is to be made for the rest amount of the total risk.

There are 2 different assessment methodology for the provisioning. The most of banks in the sector has been using a hybrid model, including collective and individual assessment model. But we, as Halkbank didn't use a hybrid approach until this quarter. But for the first time in this quarter, we started to use the hybrid model. And then we applied this model to a very limited number of the customers. And then we have a provision reversal in amount of roughly TRY 800 million, thanks to this methodology change.

For the CPI linkers, we have been using 16.2% for evaluating our CPI linkers. This is the answer for your second question.

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Unidentified Company Representative, [10]

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The other one's related to the cost performance, cost management. I mean we will -- I mean we've been doing our best to keep it under control, manage it in the most disciplined manner, and it has been yielding into successful results.

Now 6 months cumulative is below CPI, whereas we had an initial guidance of CPI plus a few percentage point that we still keep. But obviously, we will have a good potential to beat the guidance or within the guided level going forward. And for what kind of loans, I mean, we have used this individual assessment. I mean many thanks for bringing this forward. I mean it is worth to make this kind of service if the loans are well collateralized, if there is an opportunity to see huge inflow potentially for the rest, for the, let me say, remaining life of a loan. I mean there should be a good opportunity to, let me say, see inflows. I mean, otherwise, it doesn't work to, let me say, make this kind of switch because of the operational burden. I mean we applied this only for a very, let me say, limited portion.

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Unidentified Analyst, [11]

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That's very helpful. Maybe just a quick follow-up then. So given the operational limitations in applying the individual assessment, can we expect that you will increase the number of loans to which individual assessment is applied? And would that basically lead to further decreases in the coverage ratio? Or do you think the coverage ratio will then stabilize at current levels going forward?

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Unidentified Company Representative, [12]

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Thank you, Mehmet. In short, we are happy with the existing level of coverage, which is 63% for Stage 3, which is pretty much in line with the sectors. I mean, yes, we might have more loans, which might be made subject to these assessments, which are well collateralized and have been in the NPL portfolio for a very long time. And accordingly, we set aside the highest level of the provisioning according to the, let me say, rules that are in place.

But what can I say is we are at the existing level of coverage for determining, and there is no intention to make increase or decrease for the time being.

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Operator [13]

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(Operator Instructions) Our next question comes from Alan Webborn, Societe Generale.

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Alan Ramsey Webborn, Societe Generale Cross Asset Research - Equity Analyst [14]

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What's your view of how quickly the reduction in rates and therefore, presumably at some point, the cost of loans is going to start coming through into volumes. Are you -- is it sort of going to coincide with the sort of October period, where you think sort of funding costs come down, the holidays are over there will be more demand. I mean are you already seeing any shift? Or do you think rates need to come down a bit further before you start to get, for example, better retail demand or corporates more interested in doing things. What's your feeling about how much the sentiment has changed since the rate cut?

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Unidentified Company Representative, [15]

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Well, thank you, Alan. I mean looking at the demand composition that we faced so far from the, let me say, from the ground. I mean, yes, the demand is picking up through corporate segments for the time being. As you know, they are more flexible with their strategy. It is much easier for them to move their demands either earlier or forward on the basis of good relations with the bank's available limits. And let me say, having some expertise on the funding plans and investments and let me say, working capital needs. And accordingly, we have already started to see demand picking up from the corporate segment.

With respect to the others, so far, the demand dynamics actually looks to be pretty much in line with that of second quarter rather than the first one. I mean, as you know, we are an SME bank and as a bank, having a strong focus and emphasis on the SME business. So far during the, let me say, third quarter, during the third quarter, we have not seen demand increasing probably in the absence of more flexibility for the SMEs, they should act more rationally and more timely to, let me say, realize the borrowing, let me say, appetite from banks. Probably they're in a wait and see mode and waiting for further cuts on the lending rates and looking at the CPI path, looking at the supportive tailwind that we have as the content for outline, but overall, for the banking system. Probably this will be translated for the SMEs and for the others to come to the banks and ask more borrowing from banks starting from fourth quarter because of the said reasons. I mean, as you said, we are on the brink of, let me say, holiday period, which is, let me say, delaying the funding needs and activities. But as early as October with CPI bottoming out, especially, there is good expectation. Let me say, concentrated on the October, probably this will offer a very good chance for any potential borrower to, let me say, come to the market and looking for loans.

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Alan Ramsey Webborn, Societe Generale Cross Asset Research - Equity Analyst [16]

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Okay. And just sort of on the sort of the increase in the stage 2 loans. Is that just broadly spread? Is there any particular reason of 1 or 2 other that you've put one big ticket into Stage 3. Is there anything sort of significant going through into stage 2? Or is it just the general deterioration that you are expecting? If you could give us a little bit of color on that. And I guess my -- the last question was, clearly, you've made this big shift into -- you've had this one big ticket. Was that the reason why you decided to move to this hybrid method because this particular exposure was very well collateralized or you could see a reason to -- were the two link to or not?

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Unidentified Company Representative, [17]

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Well, Alan, thank you. With respect to Stage 2, I mean, it is across the board. I mean there's no concentration in terms of sector or a specific customer. I mean we have been active with restructuring during the quarter. We had some few remaining loan facilities, which I mean, what's planned to be subject to restructuring, and we completed them going forward. It should be cutting pace both in terms of restructuring and further migration from stage 1 to stage 2. Probably we will be able to keep it under control for the remainder of the year. So there is no change in the plan.

Actually, for the big ticket we sent into NPL. I mean we used our free provision stock of TRY 385 million to cover some part, almost half of the provisioning needs. I mean it was budgeted in the beginning of the year and we were in the expectation of this loan might shift into NPL by the, let me say, midyear. And accordingly, we were keeping our free provisions as intact as possible so far to use to absorb any potential increase related to the, let me say, asset quality deterioration. And we use them, it was in full. And this has helped us a lot to, let me say, to keep bottom line intact. And it is nothing more than just a coincidence. This I mean was -- this has happened in the same quarters where we have also serviced into hybrid methodology. I mean this was also planned to take place some time during the year. But I mean it is nothing more than a coincidence.

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Alan Ramsey Webborn, Societe Generale Cross Asset Research - Equity Analyst [18]

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So the 385 of free provision reversals are not in the -- sorry, the free provision reversals, are they not been -- they're not in the 952, are they? Well, I'm looking at Slide 7. They're elsewhere in other income. Is that correct?

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Unidentified Company Representative, [19]

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It is classified on this other provisioning, 975 does not include three provisions. We had TRY 804 million provisioning reversal related to the switch in the methodology. The remaining is obviously reflecting the pure reversal collection and accordingly, reversal performance of the bank from NPL, nothing else.

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Operator [20]

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(Operator Instructions) Our next question is from (inaudible)

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Unidentified Analyst, [21]

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I just missed it. You mentioned, but what's your CPI expectation regarding your CPI linkers portfolio. I think you said 15, but maybe I am wrong.

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Unidentified Company Representative, [22]

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It is now 16.2%.

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Unidentified Analyst, [23]

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For October to October, you mean?

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Unidentified Company Representative, [24]

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Right. Well, that's a -- well, this is not the expectation, but this is the numbers that we used during the first half to evaluate our CPI linkers portfolio. I mean this might be subject to revision and adjustments in the fourth quarter.

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Operator [25]

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(Operator Instructions) We have no further questions. Speakers, back to you for the conclusion.

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Unidentified Company Representative, [26]

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And we don't have any quick question coming through our webcast. I think that's all. I would like to take this opportunity to thank you all for sparing time to join our event to be with us, and many thanks for your passions that you show. I mean thanks for the constructive questions that we were asked.

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Unidentified Company Representative, [27]

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Thank you very much for joining our presentation. And if you have any questions, please don't hesitate to pay a call or to send an e-mail. Thank you very much again.

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Unidentified Company Representative, [28]

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Thank you. Bye-bye.

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Operator [29]

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Ladies and gentlemen, this concludes today's webcast. Thank you all for your participation. You may now disconnect.