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Edited Transcript of HSBK.AL earnings conference call or presentation 21-Aug-19 1:00pm GMT

Q2 & H1 2019 Halyk Bank AO Earnings Call

Republic of Kazakhstan Aug 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Halyk Bank AO earnings conference call or presentation Wednesday, August 21, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mira Kasenova

Joint Stock Company Halyk Savings Bank of Kazakhstan - Head of Financial Institutions & and International Relations

* Murat Uzakbaevich Koshenov

Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board

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Conference Call Participants

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* Andrew Keeley

Sberbank CIB Investment Research - Head of Financial Institutions Research & Senior Analyst

* Babatunde Ojo

Harding Loevner LP - Portfolio Manager of Frontier Emerging Markets, Analyst of Frontier Emerging Markets & Partner

* Conrad Scheurkogel

Artha Capital Management, Inc. - Research Analyst

* Elena Tsareva

BCS Financial Group, Research Division - Senior Banking Analyst

* Isaac E. S. Schwartz

Robotti & Company, Incorporated - Portfolio Manager

* Ivan Kachkovski

Renaissance Capital, Research Division - Research Analyst

* Svetlana Aslanova

VTB Capital, Research Division - Equities Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to Halyk Bank First Half and Second Quarter 2019 Results Conference Call. I'll now hand over to Ms. Mira Kasenova, Head of International Relations. Ma'am, please go ahead.

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Mira Kasenova, Joint Stock Company Halyk Savings Bank of Kazakhstan - Head of Financial Institutions & and International Relations [2]

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Thank you. Good evening, ladies and gentlemen. Welcome to Halyk Bank conference call on presentation of financial results for the first half and second quarter of 2019. Participants on today's call on Halyk Bank side are Ms. Umut Shayakhmetova, Chief Executive Officer of Halyk Bank; Ms. Aliya Karpykova, Deputy CEO, Chief Financial Officer; Mr. Murat Koshenov, Deputy CEO, Corporate Banking; Mr. Almas Makhanov, Chief Risk Officer; Mr. Viktor Skryl, Head of Strategic Office, International Activities; and myself, Mira Kasenova, Head of Financial Institutions and International Relations.

During the first half of 2019, the bank earned net income of KZT 164.2 billion. Net income for Q2 2019 increased to KZT 89.7 billion compared to KZT 24.1 billion for Q2 2018 due to loss from impairment of nonfinancial assets for KZT 28.5 billion in Q2 2018 as well as KKB's derecognition of tax laws carryforward of KZT 43.3 billion in Q2 2018 due to the merger into Halyk Bank. Total assets increased by 1.1% versus the end of 2018 and by 2.2% versus Q1 2019, mainly as a result of funds inflow from the REPO transactions in Q2 2019. Investment securities decreased by 17.2% versus Q1 2019 on the back of accumulation of funds for a payment of a 1-year cross-currency swap with NBK on the 3rd of July 2019. This also resulted in significant increase of cash and cash equivalent versus Q1 2019, mainly in short-term deposits with NBK.

Compared with Q1 2019, net interest income increased by 5.4% to KZT 97.7 billion. Net interest margin increased to 5.1% per annum for Q2 2019 compared to 5% in Q1 2019, mainly as a result of increase in the share of placement of interest-bearing liabilities into interest-earning assets.

Net interest spreads decreased from 5.2% per annum in Q1 2019 to 5% per annum in Q2 2019, mainly due to the amortization of discount on receivables on sale of assets installments in Q2 2019.

Fee and commission income for Q2 2019 increased by 13.9% versus Q1 2019 as a result of growing volumes of transactional banking, mainly in payment card operations as well as cash operations and bank transfers settlements.

Prior to the merger, the transfers within legal entities current account in Halyk and KKB were treated as external transfers and relevant fees were applied. After the integration, the transfers between those current accounts are being treated as internal, and therefore, are free of charge. As a result, fees derived from bank transfer settlement decreased in Q2 2019 versus Q2 2018 by 11.8%. Fee and commission expense increased by 14.9% compared to Q1 2019, mainly due to increased number of transactions of other banks cards in the acquiring network of the bank.

Operating expenses for the first half of 2019 decreased by 36.3% versus the first half of 2018, mainly due to loss from impairment of nonfinancial assets of KZT 30.3 billion in the first half of 2018 and cost optimization on the back of synergy effect from merger of KKB into the bank. Operating expenses increased by 9.9% for Q2 2018 versus Q1 2019, mainly due to the indexation of salaries and other employee benefits starting from the 1st of March 2019.

The bank's cost-to-income ratio decreased to 22.3% compared to 44.6% for Q2 2018 on the back of low operating expenses and high operating income in Q2 2019.

On the balance sheet compared with Q1 2019, loans to customers increased by 2% on a gross basis and 2.1% on a net basis. The increase in loan portfolio was attributable to increase in corporate loans, 1.1% on a gross basis increase in SME loans, 3.2% on a gross basis and increase in retail loans, 3.2% on a gross basis.

Halyk Bank's 90-day NPL ratio decreased to 8.7% from 9.1% as at the end of Q1 2019. The provision rate slightly decreased to 10.7% from 10.8% as at the end of Q1 2019. The 90-day NPL coverage ratio increased to 128.4%. Cost of risk on loans to customers for Q2 2019 was at 0.3% due to one-off repayments of large ticket problem loans.

Stage 3 ratio decreased to 18.6% from 20.4% as at the end of Q1 2019 as a result of prepayments and the write-off of previously impaired indebtedness of corporate and retail borrowers.

On liabilities side, deposits of legal entities and individuals decreased by 4.9% and 4.6%, respectively, compared to year-end 2018, mainly due to partial reserve funds by the bank's customers to finance their ongoing needs.

As of 30th of June 2018, FX share of corporate deposits decreased to 44.2% whereas share of FX in retail deposits remained mainly the same.

Compared with Q1 2018, total equity decreased by 1.9% due to dividend payments for financial year 2018, partially offset by net income by Halyk during Q2 2019. The bank continues to maintain very high capital adequacy ratios.

Based on our 6 months financial results, we have updated our forecast for financial year 2019. Net loan portfolio growth outlook remains unchanged in the area of 7%. Consolidated net income is to be approximately KZT 300 billion. Cost of risks is expected to be around 0.7%. Cost-to-income ratio is to be below 27%. Net interest margin outlook remains unchanged around 5%. Return on average equity is to be above 26%.

This completes our presentation. Now we would like open the floor for questions, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Isaac Schwartz, Robotti & Co.

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Isaac E. S. Schwartz, Robotti & Company, Incorporated - Portfolio Manager [2]

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Congratulations on the strong earnings and also on the improvement in cost of risk and provisioning. I was just wondering, looking back at the decade since the financial crisis, you generally earn more in the second half of the year than in the first half of the year. I think the only year where you earned more in the first half of the year than the second was 2014 when the oil price and the ruble and the regional currencies spiraled at the end of the year. So I was wondering, first of all, why has the business tended to be seasonal in that way. And can we draw any assumptions about 2019 given that track record? Hello?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [3]

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Yes. Isaac, just a moment, please. Yes. So -- yes, okay. You're probably right if we're looking back into the history. The logic which we put in providing these assessments, first of all, we at Halyk with clients, to look from the budget perspective, from the conservative side, this is number one. One of the biggest probably reasons. Secondly, typically, our operating costs are high in the second half of the year compared to this first half of the year. And we have noticed, we also mentioned that starting from March this year, we increased salaries of our employees that might drive -- somewhat drive our operating cost higher. Secondly, looking at the volatility on the FX side, we also put in certain conservative estimates on the cost of the swap which we extended for another 1 year. And also, the first half was particularly good in terms of cost of risk. So as you see, our cost of risk for the first half is trending at 50 basis points. And while we're reducing the overall guidance for the whole year from 90 basis points to 70 basis points, it still assumes a higher cost of risk for the second half of this year. But again I want to stress that we -- when providing guidance, we basically look at the figures which are budgeted and our typical approach in the budget process is look from a more conservative point of view.

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Isaac E. S. Schwartz, Robotti & Company, Incorporated - Portfolio Manager [4]

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Could you also just talk a little bit more about cost of risk? Looks like you guys have done a really great job on that side, but what factors were at play that made the rate come down so sharply in the last year?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [5]

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We think -- in terms of cost of risk, we think that we already for last -- probably couple of years except probably some one-off running on the normalized level. Probably, the first quarter was more normalized compared to the second quarter when we have some one-off repayments of problem loans. That's why for the second quarter, our cost of risk is standing at 30 basis points, which probably is a bit lower than we would consider normalized level. That's why we -- increasing the budget for the second half of the year. I think that's -- I have to say that we continue to work hard on the problem loans. And while we do not see specific reasons why we should -- we will expect any one-off, but certainly that might happen depending on whether we would be more successful in workout than normally we would expect on certain bigger loans.

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Operator [6]

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Our next question comes from Andrew Keeley, Sberbank.

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Andrew Keeley, Sberbank CIB Investment Research - Head of Financial Institutions Research & Senior Analyst [7]

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I guess I have a -- just a follow-up on Isaac's question in terms of your cost of risk, Murat. These kind of one-off workouts that you referred to, are they mainly -- are they coming from kind of KKB and legacy related loans and recoveries? Or are they from kind of Halyk's book? And I guess, just generally, do you kind of feel that you're pretty much through all of the kind of workout process and recoveries from the kind of legacy KKB book that you kind of inherited? Do you think that's more or less done now?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [8]

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There were some corporate loans from Halyk portfolio, but the majority of this coming from legacy KKB portfolio. And the more we workout, and obviously if you look for -- for example, results for the last year also we're successful in recovering some bigger loans. The more we recover and the more we write off on the cases where we do not see any prospects, the less is remaining in the book, if you like. So the chances on positive side is less when you have a reduced portfolio of problem loans. And we are currently in the trend that we are reducing our problem loans.

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Andrew Keeley, Sberbank CIB Investment Research - Head of Financial Institutions Research & Senior Analyst [9]

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Okay. All right. That's clear. And I have a second question on your fee income. Now obviously you explained some degree why the year-on-year fee income growth is well -- or contraction in fee income is coming from this lower fees kind of derived from bank transfers, but also when you look at your kind of net bank payment card fee growth, I mean, I think the contraction in the first half of the year was almost 20% year-on-year, and I was just wondering whether you can just give us a bit more color as to kind of what's going on there, why that is so weak? And just any kind of sense of whether you feel that you're going to be getting back to kind of positive year-on-year fee income dynamics any time soon. Would be interesting to hear your thoughts.

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [10]

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Thank you for your question, Andrew. Just a moment, please.

Yes. We still think that the majority of reasons on fee and commission dynamics is related to integration process. Because as we said before when the customers were paying from Halyk to KKB and vice versa, that was considered as external payments and now, it will be considered as payments within the bank whereby the cost of that would be -- the fee for the customer would be basically 0. Also, we during integration process had to look to unify the tariff for the same customers and for the benefit of the customers, in many cases the tariffs was set at the lower level like have some overlap on the corporate customers and on some products and in many cases, we have to choose the tariff scheme, which is the customer in Zurich in one of the bank and which was the lowest. Yes, there were some dynamics in terms high increase in fees and commission expenses compared to fees and commission income. That was -- said compared to the tariff policy. We looking into that. And if you see the remaining for the second quarter, actually, our fees and commission income in nominal terms increased higher than the nominal increase in fees and commission expense. So we see that on accretive basis, the fees and commission -- net fees and commission income start increasing. So we think that the integration situation has been left behind, and we are ready to gain more on the fees and commission income.

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Andrew Keeley, Sberbank CIB Investment Research - Head of Financial Institutions Research & Senior Analyst [11]

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Okay. I mean so you would think that you would be returning to kind of positive growth certainly next year in terms of the overall fee and commission income, is that fair?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [12]

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Yes. In terms of direction-wise, yes.

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Andrew Keeley, Sberbank CIB Investment Research - Head of Financial Institutions Research & Senior Analyst [13]

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Okay. I have a couple other questions. On your retail lending, there's quite a contrast between mortgages and consumer. Your mortgages are basically contracting and your consumer are growing quite strongly. Can you just give us a little bit more color as to why that's the case? And whether you expect kind of directions in those 2 segments to kind of continue as they currently are?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [14]

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Yes. In terms of consumer lending growth, I think, it's the sector -- general sector-specific that we see a high increase in the consumer lending. And from that perspective, we -- I think are getting positive from our wider network, which we have across the city -- across the country, sorry. That's why we see that our consumer loans in this increased more than -- by 5% in the second quarter. And also, this is the seasonal increase because typically you see high demand for the consumer -- for the consumer loans in the second quarter.

In terms of the mortgages, we are increasing the new mortgage loans, partly because of the new government program. But the -- because we will continue to lend mortgage even in a situation when other banks were not providing any mortgage and that was specifically during last 5 or 6 years when we're probably the only commercial bank, which was active on the mortgage area. We see that amount of mortgage loans, which are being repaid, is exceeding at this point of time, the new mortgage generation. And certainly, there is still some problem loans on the mortgage side, as we continue to workout, repay and then working on repayment of mortgages and that also contributed to decrease in the mortgage for the first half of this year.

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Andrew Keeley, Sberbank CIB Investment Research - Head of Financial Institutions Research & Senior Analyst [15]

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Okay. And just final quick question. Although I have a feeling I know what your answer would be. Is there any update on this potential sell-down by the main shareholder? Obviously, this was first muted back in May and was not heard a great deal since. Can you give us anything on that?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [16]

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Nothing has changed as -- at least as we know from Halyk Bank side since the announcement. Yes, to reiterate the -- Almas said that they're looking to consider, sell part of the shares but to remain the controlling shareholder and they guided the -- subject to the favorable market conditions. So since then, there was no further announcements from their side. So I think I cannot add anything on top of that at this point of time.

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Operator [17]

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Our next question comes from Tunde Ojo, Harding Loevner

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Babatunde Ojo, Harding Loevner LP - Portfolio Manager of Frontier Emerging Markets, Analyst of Frontier Emerging Markets & Partner [18]

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Congratulations on a very strong result. Two questions for me please. The first is on the realization of cost synergies from the KKB acquisition. And my understanding is the synergies are going to be -- they're going to start from this year given that the integration was last year. Can you quantify on the first half how much cost synergies you've realized from this merger? And what is left to be done in terms of operational, IT and sort of branch optimizations and other sort of synergies that you intend to realize going forward? That's my first question.

The second is on the loan growth. I was expecting somewhat higher loan growth guidance for Halyk Bank and even the entire banking system as a whole given that the Kazakhstan economic growth is recovering, real GDP of about 4%. If I lay that over on inflation of about 5%, I would have expected the loan growth should be around 10% or even mid-teens and just seen 7% growth, I was wondering what in your view is limiting loan growth in Kazakhstan and for Halyk specifically as well.

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [19]

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Yes, Tunde. Thank you very much for your questions. One moment, please.

Tunde, unfortunately I do not have this particular presentation between myself, but we provided, I think, during the Capital Markets Day, the information on this images, which we realized and you can find that presentation on our website. But as a general guidance, what I can say that we start realizing synergies immediately we acquired KKB. So even before we merged with KKB, we already started looking at the possibilities to reduce our cost basically, it's coming from 2 sources, so reducing the number of branches and outlets and secondly, reducing the number 50s. And already during 2017, the second half, we realized certain synergies. So by the time of -- we made the legal merger, part of the synergies has been realized, but still you can look on the Slide 10 of this presentation operating cost. You see that even despite the increase of the salaries starting from March of this year, still the salary and other employees benefits cost reduced by KZT 1 billion. So even if you would exclude the recent increase of salaries, then the reduce would be by KZT 2 billion, which is roughly 10% decrease for the second half alone and that is not the whole synergy because it's set even before the second half of last year, a part of the tenge has been realized. But I encourage you to look through that presentation, which I mentioned. And if you have remaining questions, we are ready to reconnect with you.

Regarding the loan growth, as you see, the growth in Kazakhstan is driven by different sectors and some of the sectors which are driving increase is actually the sectors which are -- which represented by extraction sector like oil and gas, metals and mining and not all of the companies -- I would say, typically the companies which are creating this extraction sector are tend to borrow either through their parent companies or their borrowing on the debt capital markets from foreign banks. So when we talk about the growth of the Kazakh banking sector, it's the logic sense limited to the sectors, which are outside the extraction sector, with probably some few exceptions.

If you look, for example, for the growth of GDP, so we have preliminary growth figures for the first half of this year. And this GDP growth constitutes of 4.2%. But if you look through different sectors, they grew with different dynamics. Like, for example, extraction of ferrous metals increased by 17% and this is exactly sector, which are not fully reliant on the Kazakh banking sector as a funding source. Some other sectors which are typically you will find within Kazakh banking portfolio like for example trade increased by 7.5%. Transportation increased by 5.4%. Construction increased by 11.5%, but again part of construction increased was related to activities on Tengiz oil. And again this is the big project on the western part of Kazakhstan oil and gas field. And it's entirely funded by international investors. Part of that related -- part of construction activities again related to construction on Aktogay production and this is the facility of KAZ Minerals. And then KAZ Minerals is funding itself from Chinese Development Bank. So you see many of sectors and many of growth drivers is funded by external sources and unfortunately, it doesn't allow Kazakh banks to fully realize the potential of growth.

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Babatunde Ojo, Harding Loevner LP - Portfolio Manager of Frontier Emerging Markets, Analyst of Frontier Emerging Markets & Partner [20]

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In fact, that's very helpful for me. So in your view, when do you think the sector that will directly benefit the banking sector or start accelerating in terms of growth and then the bank like Halyk, of course, would then benefit from their end and then you can start growing double-digit. Do you think -- are you seeing that happening next year? Or you're still looking at single-digit loan growth in the first year in the future?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [21]

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Still I want to add it to my previous message is that still we're able to have -- in the cases, on some of the projects, which were drivers of the growth this year, we're able to directly participate, but some of them, we participate indirectly because still running with the project means that the companies are hiring the contractors, they're hiring subcontractors and which, therefore, is the customers of Halyk Bank or other Kazakh banks. So we're still able to certain extent gain from the growth projects, but not to 100% as I said.

With regards to mix, yes, probably, it's a bit premature to say because as you see in current environment with globalization, a lot of elements might influence develop Kazakh economy, including development of oil price or developments of Russian ruble and in the environment when there are a lot of frequent changes like trade wars, the political issues probably looking for the next year, it's a bit premature, if you talk about from the particular figures. If the figures remaining -- or if the situation remain as this, we expect that we will continue to grow at the same pace as we're experiencing this year so far.

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Babatunde Ojo, Harding Loevner LP - Portfolio Manager of Frontier Emerging Markets, Analyst of Frontier Emerging Markets & Partner [22]

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This year so far. Okay. And just lastly, for me, do you think the interest rate in Kazakhstan is still somewhat high enough to deter corporates from demanding more loans? Is interest rate a factor in this equation I was just talking about or in your view now?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [23]

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In terms of the rates, they originally reducing in Kazakhstan for the last probably 3 years. That was a reduction on both deposit side and credit side. The development on -- further develop on the interest rates, will depend, how the dynamic situation will continue. As you know, probably National Bank is reducing corridor's inflation. For example, last couple of years ago, the corridor was between 6% and 8%. Last year, it was 5% to 7%. Starting from this year, they lowered the corridor 4% to 6%. Current inflation is standing at level of 5.4%, but there are some...

(technical difficulty)

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Babatunde Ojo, Harding Loevner LP - Portfolio Manager of Frontier Emerging Markets, Analyst of Frontier Emerging Markets & Partner [24]

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Hello?

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Operator [25]

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Please hold the line. The conference will resume shortly.

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [26]

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Yes. Hello. I think we've been disconnected. What I wanted to say on the rate is that it will depend on the dynamics of inflation. While inflation has lowered to the level of 5.4% and this stays within the corridor of 4% to 6%, we see that, for example, on food inflation year-over-year is standing at the level of 8%. So the National Bank's sales in the recent statement that if they would see further pressure on inflation, they even might consider increasing the base rate. So for me, first, we have to look at inflation and then depending on inflation dynamic, we'll see the direction of interest rates.

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Babatunde Ojo, Harding Loevner LP - Portfolio Manager of Frontier Emerging Markets, Analyst of Frontier Emerging Markets & Partner [27]

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Yes. Okay. I think for me the direction of my question is, are your customers complaining about the interest rate being too high? Or do you think they're comfortable at this level?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [28]

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I think currently, rates if we take, for example, 10-year horizon probably currently the rates are not -- probably, they're not the cheapest, but I think they're around the average rates. So the current rate for corporate and SME customers, they would allow opinion to finance their ongoing needs and even look into the capital expenditures. Obviously, if the rates would lower then it would increase activity, but in our opinion it's not, which is the main factor, which might dampen the business activity.

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Babatunde Ojo, Harding Loevner LP - Portfolio Manager of Frontier Emerging Markets, Analyst of Frontier Emerging Markets & Partner [29]

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Got it. Okay. And just last one if you don't mind, me chipping one more. Is -- what's the size of your restructured book right now as at end of June?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [30]

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It's around 8.6%.

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Operator [31]

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Our next question comes from Svetlana Aslanova, VTB Capital.

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Svetlana Aslanova, VTB Capital, Research Division - Equities Analyst [32]

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I have several questions. First of all, I would like to know what is your outlook for NIM performance. From what we saw in the second quarter, you have higher share of KKB and term deposits, which might bear high interest cost for you. And we also saw quite rapid growth of consumer loans and corporate loans that outperformed the sector. So what do you think will be the trends in the second half of the year for NIM based on these changes? And I also wanted to ask, looking at your results on insurance operations, can we consider that those KZT 2 billion of net result is a kind of run level -- normalized level for the coming quarters?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [33]

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Svetlana, we do not think that this changes would materially impact our net interest margin dynamics. So we didn't -- we're not changing the guidance for the year. So we still think that it would stay around 5%. And for the first half, as you noticed, our NIM according to our calculation is standing at 5.1%. Regarding your second question, please allow us 1 minute.

Probably, we do not have a specific figure, but the first and second quarter more normalized in terms of the insurance -- net insurance income. The exact figure will depend on how reserves are created and they are unwinded. There are some specific rules according to regulation. So that might to a certain extent affect the results of particular quarter, but the results are more or less normalized for this period of the year.

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Svetlana Aslanova, VTB Capital, Research Division - Equities Analyst [34]

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Okay. And still on NIM. So basically, am I right then assuming that in the second half, NIM will slightly decline, both reported and risk-adjusted? Or you can consider it will stay relatively stable?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [35]

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It probably stay within relatively stable because we are seeing approximately 5%, so that also would include certain variations. But we cannot see any factor might materially alter the results, which we have just posted. And on risk-adjusted, you mean was it including the provisions? We already, I think, covered this during discussions of cost of risk.

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Operator [36]

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(Operator Instructions) Conrad Scheurkogel, Artha Capital.

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Conrad Scheurkogel, Artha Capital Management, Inc. - Research Analyst [37]

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I just want you to provide a little more detail on the deposit side where you mentioned that you have seen a outflow because there has been a requirement for customers to finance ongoing needs. That seems like a very high-level comment. Can you provide more granularity on that specific trend in the deposit book?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [38]

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Yes. Conrad, thank you for your question. Basically, under that definition, we can provide more granularity. There was one customer, which used the proceeds in order to repay outstanding Eurobond, so that was a significant amount. The second customer actually used that funds in order -- it's a big contractor in one of the biggest projects, which currently undergoing and it received financing from nonbanking sources, but it used that funds in order to buy capital goods in this project. And there are number of customers, which moved their deposits from Kazakh banks. It was not only actually in Halyk, but they moved dollar deposits from Kazakh banks into foreign banks. So basically probably there are 3 biggest reasons, but we also see a number of other customers, which use their funds in some financing of their needs, the working capital or capital expenditures.

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Conrad Scheurkogel, Artha Capital Management, Inc. - Research Analyst [39]

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Okay. That's very helpful. So I guess when -- if it's such large ticket item, it sounds one-off in nature. Does that mean we can expect the deposit balances to remain more static going forward?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [40]

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Yes. We think so.

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Conrad Scheurkogel, Artha Capital Management, Inc. - Research Analyst [41]

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Okay. And then the second question I have is somewhat more high level. If I step away and I look at the business model, your capital formation is strong. You did indicate that you're going to look across the border at a number of M&A activity. Then on the loan growth side, it's not dramatically strong. So we're probably going to end up with a balance sheet with extremely capital -- strong capital levels by the end of the year. You did indicate you're going to pay higher dividends going forward. But this must clearly provide a lot more upside for us as shareholders to expect the dividend payout of larger than 50%. Can you comment on that?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [42]

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Yes. Generally, you -- I think are right that in this situation, when our return on equity is far above 20% in situation when our risk-weighted assets are not growing more than -- by 10%. This -- if we would be paying 50% as we did this year, then we still would be sensation of further accumulating capital increasing -- capital adequacy ratio. We think that we already are strongly capitalized financial institution. So we do not have intention to show that deal to the capital institution. We do not see particular need for that. That's why during -- in June this year, the Board of Directors made the decision to amend dividend policy where the corridor has been increased from 50% to 100%. So we think that we have all the possibility to increase dividend payouts with minimum level of 50%. The particular figure would depend on the prospects on particular results of particular year as usual areas where we look -- during -- determining the particular dividend payout ratio for particular year.

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Conrad Scheurkogel, Artha Capital Management, Inc. - Research Analyst [43]

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Okay. Would you be prepared to give us a guidance on how we should think about capital ratios at the end of the year?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [44]

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Yes. Normally, we do not have a particular target on capital adequacy ratio because it depends on different factors and one of them is difference between how capital adequacy ratio is calculated according to National Bank guidance and -- for example, how the rating agencies are looking to that. So there's different risk weight depending on the composition product-wise and sector-wise of our grade portfolio. So we're looking at different factors when we're determining whether we have sufficient capital or we have possibility to pay out, but the level which we have at this point of time is -- in our view, is more than sufficient to allow distribution of dividends above that figure.

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Operator [45]

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Our next question comes from Ivan Kachkovski, Renaissance Capital.

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Ivan Kachkovski, Renaissance Capital, Research Division - Research Analyst [46]

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It's Ivan from Ren Cap. I have a couple of questions. My first one would be on the AQR in Kazakhstan. Could you share us any details that you know about the exercise, what are your expectations and potential implications for both Halyk and the sector in your view? And my second question would be a bit more high-level discussion. I mean if you could just give us some color on how competitive balance is evolving in the sector? I mean some banks were going through the cleanup and some ownership changes earlier this year. So if you could just maybe highlight a little bit how this has effected so far competition in corporate lending, in mortgages and in consumer lending, it would be very helpful.

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [47]

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Thank you, Ivan. Regarding your first question on AQR, the process has already started. Actually, National Bank choose 14 banks, the top 14 banks, which is actually half of the banking sector in terms of the number of banks, but in terms of credit portfolio, they're covering close to 90%. So pretty much significant coverage of credit portfolio of Kazakh banks. Because actual AQR started just few weeks ago, at this point of time, it's probably too premature to say what the potential outcomes might be. Only we can say that the exercise is very comprehensive, very intense, and it's taking a lot of resources of parties, which are participating in this project. So we have to wait until the results. And National Bank expects that the preliminary results would be at the end of this year, and probably, it might take some more time in order to discuss with them.

In terms of your second question, how the recent trends in the banking sector is affecting competition. So far this year, we see situation when First Heartland Bank acquired Jýsan Bank or they actually became related banks actually. We do not see that particular event impacted the competition. From other activities, we know that Kassa Nova merged into Forte. Again, they were banks within same group. No change. And the most recent one is merger of 3 banks. Each of them are outside top 20. So no impacts on the competition really from these particular 3 events.

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Operator [48]

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Our next question comes from Elena Tsareva, BCS Global Market.

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Elena Tsareva, BCS Financial Group, Research Division - Senior Banking Analyst [49]

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This is Tsareva from BCS. I have just several follow-up questions. First in on dividends. Could you just advice the due diligence policy is effective this year and if there is any like possibility constraints to pay theoretically more than 50% as a payout for this year for the income of this year? This is my first question.

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [50]

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Yes. As I said, well, we amended the dividend policy to pay dividend from 50% to 100% of net income. Obviously during making any decision on payout, we are looking at any contractual limitations. At this point of time, we have covenants set in our Eurobond issues, which limit dividend payments to 50%. One of the bond is maturing January 2021. So if we're making -- would be making decision for results of 2019 that bond would still -- would be outstanding. But when we would be making decision for the year 2020, and we would make decision in March -- the worst would be making decision or recommendation in March 2021. By that time, this bond already would mature. We have another bond outstanding, which also have that limitation, but these bonds while maturing in 2022, it is -- have option -- the bank have option for early repayment. And as you know, first quarter this year, we made a decision to prepare KZT 200 million of that amount. There's still KZT 550 million outstanding, but as I said, the bank can make partial or full repayments anytime when it decides. So we don't see the limitation of that particular bond as a big hurdle.

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Elena Tsareva, BCS Financial Group, Research Division - Senior Banking Analyst [51]

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Hello?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [52]

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And I think you also said that -- you also asked whether there is limitations to pay more than 100%. I probably didn't understood your question correctly.

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Elena Tsareva, BCS Financial Group, Research Division - Senior Banking Analyst [53]

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No. I was asking about paying above 50%. Yes, but it is a concern you've used about [500] (inaudible) could be helpful.

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [54]

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We do not currently, situations where we would be making some one-off big payments because we don't think that it's benefiting either the bank or our investors.

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Elena Tsareva, BCS Financial Group, Research Division - Senior Banking Analyst [55]

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Fair enough. And you said it like one of the bonds has option for early redemption. But the second one, which matures like January 2020 doesn't have any early redemption opportunity and you don't intend to redeem it?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [56]

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On the bond which is maturing January '21, there is no prepayment options. That was the bond, which was issued by Halyk Bank itself, but it's maturing within 17 months.

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Elena Tsareva, BCS Financial Group, Research Division - Senior Banking Analyst [57]

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Understood. And just small follow-up on deposits. So given all this explanations you gave about in the second quarter, what is like your strategy in terms of deposits given you have like very, very liquid balance sheet, and particularly you don't need to check more deposits, so what is the strategy may be in terms of interest rates in terms of volumes, how you manage policy in this year?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [58]

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Well, there is no change to the policies. Generally, we tend to keep justification of our deposit sources. This is important to have from risk perspective despite funding sources. But also we're trying to be on lower sides compared to the competition. So we're planning to keep this -- to find the balance between justification and to lower cost of funds when we see these possibilities. Generally, on the retail customers and the corporate customers, we would charge deposit rates, which particularly would be cheaper than the average on the market.

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Elena Tsareva, BCS Financial Group, Research Division - Senior Banking Analyst [59]

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Yes. Understood. And just a small like question on Uzbekistan. So just -- you just recently entered the market there, but maybe you can share your views. What are the opportunities you see there and how you think you can benefit there as well?

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Murat Uzakbaevich Koshenov, Joint Stock Company Halyk Savings Bank of Kazakhstan - Deputy Chairman of the Management Board [60]

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Yes. We have developments in this -- May this year, we received the license, full banking license to operate in Uzbekistan. And already last month, the bank starts operation, start activities with the customers and they're already start granting loans. So the first loan has been granted a few weeks ago. So the bank is up and running. It start operating with activities with corporate customers and private entrepreneurs on providing cash management. The bank is working on introducing the Internet bank. So hopefully, it would also be running in near future. And later on, we also would look -- would also look into opportunities to work with private individuals. So we see the bank -- the market as a very interesting, and we see big prospects in this market.

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Operator [61]

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

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Mira Kasenova, Joint Stock Company Halyk Savings Bank of Kazakhstan - Head of Financial Institutions & and International Relations [62]

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Yes. Ladies and gentlemen, thank you very much for participating on our call today, and as usual, our IR team remains open for any further questions. Thank you very much. Bye.

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Operator [63]

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This concludes today's conference call. Thank you for your participation. You may now disconnect.