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Edited Transcript of OTP.BU earnings conference call or presentation 3-Mar-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 OTP Bank Nyrt Earnings Call

Budapest Mar 3, 2017 (Thomson StreetEvents) -- Edited Transcript of OTP Bank Nyrt earnings conference call or presentation Friday, March 3, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Laszlo Bencsik

OTP Bank Nyrt - CFO & Strategic Officer

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Conference Call Participants

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* Paul Formanko

JP Morgan - Analyst

* Pawel Dziedzic

Goldman Sachs - Analyst

* Simon Nellis

Citibank - Analyst

* Margarita Streltses

UBS - Analyst

* Anna Marshall

JPMorgan - Analyst

* Andrzej Nowaczek

HSBC - Analyst

* Gabor Kemeny

Autonomous Research - Analyst

* Anubhav Srivastava

Societe Generale - Analyst

* David Taranto

Bank of America Merrill Lynch - Analyst

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Presentation

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Operator [1]

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Good afternoon and welcome to the OTP Bank conference call. My name is Tyler. I'll be the coordinator for your call today. I want to hand over to Paul Formanko to begin.

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Paul Formanko, JP Morgan - Analyst [2]

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Thank you, Tyler. Hello everyone. Thank you very much for dialing in. This is Paul Formanko from JP Morgan in London. It's a great pleasure to have Laszlo Bencsik, OTP Bank's Chief Financial and Strategic Officer with us today. Laszlo, over to you, please.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [3]

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Thank you, Paul. Good afternoon or good morning depending where you are and thank you for joining this conference call, which is about the full-year results of OTP Group in 2016. We have the usual setup here. So I'm going to first briefly go through the presentation, which is available on the website, and then obviously you will have time to ask your questions. So, the presentation starts on page 3 with a section on the overall investment rationale, which consists of five pillars. This we introduced two con calls before I believe so I'm not going to bore you with the same story line again. But just to reiterate the most important messages on page 3 maybe worth spending a few words on this part of the story as well. So, return on equity has returned to attractive levels. Indeed in 2016 we made 15.3% return on equity and this is on accounting profit over total equity.

And if we were to adjust to the leverage ratio or the common equity Tier 1 ratio, which we also targeted at 12.5% so assuming a 12.5% common equity Tier 1 ratio, it would have been 17.9% so that would have been the return on equity if we had this higher level of leverage on equity. So, this we believe is a pretty good performance and we continue to uphold this target. Originally it was meant to be for 2017. If you remember, we communicated this target in 2015 and it was meant to be for 2017, but we are very happy and satisfied that we actually managed to reach it or overdeliver on this target earlier one year already in 2016. Point two, new era of structurally low risk environment has commenced. Indeed if you look at our risk cost rates last year, it dropped down to 1.1% all year which is structurally lower than the previous levels above 3% which we used to have for quite a number of years starting in 2009 and ending in 2015.

And the first year was last year and the ratio dropped down again to a more kind of normalized level for the cycle to 1.1%. After years of deleveraging, loan volume growth starting in Hungary. This is probably the best news we had last year and that is that loan growth indeed started in Hungary and it was not modest at all. Even without the impact of the acquisition we made, performing loan volumes grew by 5% last year in Hungary. This is a stark difference to the gloomy years we used to have before last year and actually indeed opened a new area of loan growth in Hungary. Strong capital and liquidity position. The year-end common equity Tier 1 ratio, the reported one is 13.5%, but this does not include the 2016 results and the expected dividends because we can only include according to the new regulation audited numbers, which are approved by the AGM and this is going to only happen in April.

If we included the last year results, the results which you see in this presentation the unaudited results, then we would have had 15.8% common equity Tier 1 ratio including last year results minus the intended dividend payments. And digital, yes, we do continue on digital developments. We are coming out to the markets with various initiatives in Hungary, which we believe continue to deliver additional value to our customers. Now jumping to the more kind of detailed and the merit part of this presentation starting on page 14 where we detail the annual and the quarterly results. On page 14, you see the overall accounting profit which more than tripled last year and the adjusted number which is basically related to the core business activity of the Group. The growth was 67%. Obviously adjustments turned into slightly positive after a hefty negative number back in 2015.

As you can see in this chart, that obviously helped accounting profits to improve. And in terms of the business, the core business activity was as usual business activity as you can see also in this slide. If we separate the Group into two sub groups, one being Russia and Ukraine and the other one being the rest of the CE countries, then the CE countries more or less delivered the same results even with a slight decline whereas there is substantial turnaround and improvement in case of Russia and Ukraine where the previously very negative minus HUF60 billion number in 2015 turned into positive HUF25 billion in 2016. Now obviously this helped the growth of the contribution of our non-Hungarian businesses to the overall Group results, which increased back to 38%. We used to target years ago roughly 50% and last year we made again a step back to this sort of step forward in order to get to this more kind of balanced structure in the Group.

On page 16, you see the individual results. The core OTP Hungary remained basically flat. Bulgaria DSK Bank somewhat declined, but this is mostly due to the one-off provisions we made or risk costs we incurred in the last quarter. Romania slightly improved. Croatia improved actually a lot compared to itself. In Slovakia and Montenegro, we turned again negative. Unfortunately we decided to put extra provisions next to the loans which are in these countries in our factoring companies so these are the long-time non-performing loans, which we have not been able to recover so far and with the time elapsing, the probabilities of returns on these portfolios actually declined so therefore we made an adjustment. So these are not related to recent deteriorations in the portfolio quality, but more to kind of old events where we changed the expected probability of returns and expected returns themselves at the year-end.

Leasing, which is mostly the Hungarian car financing business with Merkantil Bank, had a very good year last year and made more than 100% improvement in profit. And fund management did a very good job again especially in Hungary despite the quite difficult environment with the low rates. It's not very easy to make fund investment products attractive in such an environment in Hungary and despite this, they made quite a good result last year. And then Russia and Ukraine, which is obviously very good turnaround story and I'm going to detail this all in the following part of the presentation. Going to page 17, you see the one-off items. Last year, there were a couple of changes compared to 2015. The one very important change was that the bank tax declined substantially in Hungary and instead of being close to HUF30 billion, it went down to HUF13.9 million altogether. This also includes the Banka Srbija in Slovakia by the way.

And then the other big difference is that we did not have items like what we had in 2015 namely the extra cost of converting the Romanian and Swiss mortgages or converting the Croatian and Swiss mortgages or the like. These type of events did not happen. In fact we had one positive event and that was the Visa transaction you probably remember, which created revenues. And then we had basically as you can see here three line items, which are more related to tax changes or impact of tax and that was basically the goodwill write-off and the positive tax shield impact on the overall results, which we made primarily related to our foreign subsidiaries. And there are two items, one over the period in the third quarter that is related to shifting from Hungarian Accounting Standards to IFRS in Hungary. This actually has already happened.

So, January 1 this year we switched to IFRS accounting in our local books as well so we no longer publish Hungarian Accounting Standard statements and that actually eliminates this difference between the two accounting standards, which had the biggest impact on our profits and that is the treatment of investments in other companies which were treated differently and therefore created a difference in the tax regime. And since now this difference had to be eliminated because we switched from one system to another, we have this impact of HUF5.8 billion negative or additional tax payment. The other thing, which you see here as revaluation of the deferred taxes recognized in the P&L due to corporate tax rate cut. In Hungary you probably know the tax rate was cut down to 9% and therefore the deferred tax assets and liabilities had to be re-evaluated according to this new rate and that resulted in a HUF6.1 billion negative effect coming through the P&L.

But on the other hand there was this HUF3.4 billion positive impact, which did not come through the P&L, only appeared in the equity that related to the available for sales portfolio evaluation fair value adjustment kind of deferred tax items. So you have to add the two in order to get the total amount, but negative HUF6.1 billion appeared in the P&L. Going forward to our P&L and the main items. Total income year-on-year declined by 2%. The quarter-on-quarter last quarter was plus 5%. Obviously the total income decline did not come as a surprise as we expected margin compression within the whole Group especially Hungary and in Bulgaria and it did actually happen. So, this is a combination of compressing margins and increasing volumes. The good thing is that fees and commissions and other income increased and somewhat balanced the negative impact of the NII decrease. Cost increase was 2%.

This we more or less indicated before as the expectation. And risk cost drop dramatically instead of HUF220 billion, we were down to HUF93 billion last year and actually there was a kind of peak or spike in the magnitude of HUF48 billion in the last quarter, which brought up the annual number to this level. I'm going to talk about of this in more detail about these items in the course of the presentation and give you much more flavor on these changes. Miscellaneous items, actually all these three were quite important. But there was one [slack] coming from the regulatory changes in Romania related to the Swiss franc mortgages. There was this new legislation coming from the outgoing Parliament before it was dismissed last year before the elections and it actually stated that we had to convert all the previously existed Swiss mortgages into local currency at the exchange rate when these loans were originated.

Now the Constitutional Court canceled the whole legislation so it was not just an amendment. It's actually canceled and made invalid as a whole, which means that we do not need extra provisioning for this problem. Two very good events happened on the front of acquisitions. One was the conclusion, as you can see on page 20, of the AXA merger. Here we actually acquired portfolios not an entity. So we have not brought a bank, we brought portfolios and these portfolios contributed to our mortgage volumes primarily in Hungary. So, we are very quite happy about this. This increased our market share by almost 3 percentage point and it does contribute to a sizable amount of our mortgage book and will have quite positive effect on the earnings going forward in Hungary. And the other important event on the acquisition front was, as you can see on page 21, we made an agreement with Societe Generale that we acquired a bank in Croatia.

It's called Splitska Banka, which covers mostly the Istria peninsula, the northern part of the Adriatic coastline. As you probably know, our Bank is stronger in the kind of middle and southern part of the Adriatic coastline. So by this acquisition, first of all we will jump from Number 8 to Number 4 bank and our market share will increase overall in the country from 4% to 11% and therefore create a bank which we believe will be sizable enough to provide the returns which we require from our performing Group members. And actually in the [cuesta] region, our regional market share will even be higher than this 11%. And this is a part of the country, which is certainly quite prosperous and developing and this is where most of the tourism revenues are generated. So, we are quite content with this strategic move and we believe that this really changes our stance or standing in Croatia and definitely contributes positively to the overall Group performance and profitability.

In the following few slides as usual, I'm going to say a few words about the P&L line items broken down by the countries where we operate. Total income as you can see year-on-year declined 2%, quarter-on-quarter up 5%. The annual decline was the composition of somewhat lower income in Hungary; Bulgaria increase; and Russia in HUF terms, but in local currency terms actually there was an increase; and then Croatia actually increased 12% which was very good; and we had a few countries; Romania, Serbia, and Montenegro; where we had a bigger decline. In Romania, it is primarily related to this conversion of the Swiss mortgages which we started back in 2015. This decision was made and basically in the first quarter, early second quarter we converted 75% of the portfolios into either local currency or euro loans but with a lower margin. In Serbia basically this was due to the NIM compression, which is driven by the lower rate environment which also happened there.

Going further to the net interest income, there are a few points which are important to make in order for you to fully understand the dynamics here and we basically listed them on this page. So, there are some technicalities to be understood in order to fully understand what's going on. Basically we had a HUF1.9 billion item appearing in the NII of the core and also in the core, there's a similar negative amount in the other net non-interest income if you look at page 25 and these come in pairs, basically it's related to the structural change we made in the P&L. If you look on the exhibit in the analyst tables Exhibit 16, you will see that there was a new line created called gains and losses on derivative financial instruments. So, basically we grouped within the P&L all the items related to gains and losses on derivative financial instruments and that mandatory a negative item was taken out from the NII and this actually increased the NII in Hungary.

So, this is a one-off structural event which happened. There was a similar kind of in its nature being a one-off event in the Hungarian Merkantil, the leasing company, HUF1.5 billion. This is related to the accounting standard changes and we recognized in the P&L the previous off-balance sheet accrued interest revenues. So, this had a one-off HUF1.5 billion impact. And there's another one here on the corporate center line, which is not a one-off. It's going to be a recurring item that this corporate center, that's where we have basically the Group financing and certain elements of our Group level liabilities, which were originally created for financing the expansion of the Group; namely the lower Tier 2 bonds which matured in September, the ICES, and the perpetual bonds. Now we paid back the lower Tier 2 funding. And then the ICES and the perpetual bonds, in both cases there was a step down so they turned from fixed to variable rate loans and there is quite a material change or a decrease in the amount of interest we have to pay.

And the quarterly impact of this lower cost of funding is actually HUF2.4 billion. This is going to continue in the future this difference so this is not just a one-off. And then finally, there's another item which relates to the net interest income and also the other net non-interest income and it's basically related to an elimination. There's an intragroup transaction swap agreements between OTP Bank and DSK Bank and overall it doesn't have any impact on the total revenues, but it does have an impact on the structure. So, we made the eliminations for the entire year in the last quarter and decreased net interest income and increased other net non-interest income by the similar amount roughly HUF4.1 billion. So, this is again a one-off structural change we made in the statements. Now going to the net fee and commission income. Two interesting developments here, which were kind of material I would say.

One is that we booked in the last quarter the entire refunds or cash backs where we paid on the credit cards for the entire year in the last quarter. And then our fund management guys, as I said, did a good job last year and there was a success fee they received from the funds they managed so that had a kind of increase in the performance in the last quarter. This is seasonal. The success fee comes each year in the last quarter; sometimes it's higher, sometimes it's lower. Last year's was quite exceptionally high I would say, which reflects the good relative performance to the market. Other non-interest income, again there's this HUF1.9 billion negative which is related to the previously explained change in the P&L structure. In Bulgaria we had HUF1.4 billion positive one-off. Again this was kind of an accounting methodology improvement or change and this was related to the factoring volumes and their recognized income. Again this is a one-off item and this is related to accounting methodology change there.

And finally on this line, which I also mentioned, these are the eliminations of the FX swaps between OTP core and DSK, which also appear in the other net non-interest income. So, these are just flavors for certain add-ons for you to better understand probably the dynamics on the revenue side. Having all this in mind, if we turn to page 26, we see the net interest margin development that was fairly stable in Hungary on a quarterly basis and the annual rate was 3.36%. Now this actually highlights one interesting feature of the way we calculate these ratios because we always say if we look at the period and we calculate the net interest margin obviously the NII is clear, it's the kind of daily basis accounted net interest income. But on the other hand, the denominator is the beginning and end of period numbers average and that creates this funny result that the annual number was actually 3.36% whereas each of the quarters were above this ratio.

And by the way this is also true if you look at the Group net interest income margin, it ended up being 4.74% despite the fact that all quarters were higher than December. We might kind of change this actually in the foreseeable future to introduce another way of calculating these numbers besides the way we show them now. But nevertheless if you just look at the quarterly developments, it was stable in the core in Hungary. Russia slight improvement. DSK Bulgaria continued to decline and unfortunately this trend will not stop here, we expect this to continue into 2017 as well. Ukraine was on a quarterly basis fairly stable. If you look at the volume dynamics in page 28, overall here you can see the quarterly developments in the upper part of the page and the yearly on the lower part. So in the lower part on the yearly basis, as you can see, we grew by 6%. Now if you take out the impact of the AXA acquisition, then it was only 3% but this 3% is actually great compared to the previous years.

We are extremely happy about the 5% growth in Hungary without the acquisition, which is primarily driven by corporate growth. As you can see on this chart, it's very obvious that corporate was the primary driver of loan growth throughout last year; 14% Hungary, 14% Bulgaria, Russia 20% but unfortunately it's a very small volume but nevertheless it started to grow, 7% Ukraine, 6% Romania, 14% Serbia. So almost across the whole Group, we had quite a strong corporate performance whereas the whole year mortgage was still negative and consumer was kind of okay especially in Hungary 4% and we are quite happy that actually Russia was plus 1% due to the very strong fourth quarter result of 10% growth, which makes us believe that the market is getting back to growth again after again a very sharp adjustment which we saw in the previous two years.

Moving to deposits, year-on-year growth 6% mostly coming year- end. This is partially due to the fact that in Russia, Ukraine payments came earlier before the year-end and there were different one-offs here and there. But all-in-all, I think we can say that especially our retail customers are quite fond of OTP especially in Hungary, Bulgaria where we don't really pay an interest on deposits and despite this, we see a continuous inflow of deposit volumes and we believe it shows that our customers are happy with the services. The transactional and account services we provide and they trust OTP Group, even if you don't pay very lucrative returns on their deposits.

Plus page 30, overall, 2% nominal growth, if we adjust by the exchange rate then it was higher 4%. In Hungary, part of this came from the payments to these different protection funds, the deposits and investment, resolution fund and so on, which increased by HUF3 billion last year. And across the Board, we have to -- basically we had to start increasing wages as wage inflation kicked in quite strongly in most of these countries and obviously we enjoy the benefits of this trend on the revenue side by higher sales and higher transactions and due to higher consumption, but on the other side, we clearly have to adjust our wages and try to keep or be in the competition for talent in these countries, which is actually getting tough because some countries, especially Hungary for instance is a good example of developing shortage on the labor supply front.

So this is going to be an ongoing pressure on our costs. I believe it was not just last year, but it will continue into this year and future years that the successful organizations who are growing will have to pay an extra to retain and grow their talent base. We had -- Ukraine was exceptionally high growth and Touch Bank in Russia was exceptionally high growth. Our online bank, the online bank is, obviously, we are ramping up this operation, so it's related to that. And in Ukraine, the inflation was actually 14%, so compared to this, actually in real terms cost decreased, not increase, FX adjusted. And then in Romania, again a 16% decline was due to the results of the merger process. We acquired previously the Millennium Bank in Romania and we started the -- actually we concluded last year the merger and this resulted in with a lower level of cost base.

A few words about some larger and more important subsidiaries or group members, starting with OTP Core in Hungary. Here you see the P&L lines, I've basically talked about all of these and the one-offs which appeared in previous slides. And overall, I think it's important that before tax profit without one-off items actually grew year-on-year by 3%, so the decline in the revenues is 3% decline in revenues and the increase in the costs were actually counterbalanced by the in fact positive risk cost which we had last year.

If you look at the business performance, page 32, just a few highlights. In retail, the growth of the mortgage activity increased disbursements and grew by 40%, new applications by 70%. And here also you can see our market share in new production, it went above 3% in the last quarter. This is -- we are quite extremely happy about this. It's actually quite tough market, all our competitors are very keen on mortgage lending, and this is clearly a very strong priority for all of the banks in the country, and despite this, we managed to further increase our already -- and our market share in the new production. Savings as well, we increased our market share, again, this is a very good development. I already mentioned that we don't pay much in terms of interest for deposits and despite of this, we managed to increase our share in household savings also not just in deposits but that also obviously includes securities products as well.

On the corporate side, again, we are very happy that we continue to increase our market share in corporate lending, very close to 15% now, and very close to actually doubling our market share which we had in 2008, so this is again according to strategy, and we'll continue on this path forward. And I've already said that there is a quite remarkable growth in corporate volumes last year. Bulgaria, I think the most visible event in the fourth quarter, in the last quarter, it was the high provisioning which you see here. It came in two fronts. One was related to loans and risk cost and provisions for loan losses, here we changed the methodology, we made it even more prudent, and increased provisioning for the kind of restructured volumes and which is not necessarily 90 days past due, obviously or not in 90 days past due. And also we created other provisions for potential losses coming from certain legal cases. This is again a very conservative approach we took here and when we looked at all the potential future liabilities, which might come from this angle. And that obviously further increased the provisioning level and the coverage on the portfolios there. I think, the biggest concern in Bulgaria at the moment is the continuous decline in the margins, which we -- basically there's not much we can do, the portfolios get repriced and refinanced and competition is very strong and in this interest rate environment, it's almost inevitable to experience further compressions in the margin.

Russia, a very happy story last year and we are quite content with the performance of the bank. And this is not just the normalization of the risk cost, it's also the volume growth we managed to achieve. As you can see on this slide, POS volumes grew by 17%, cash loan 7%, other loans 6% and only credit cards declined. And this happened in an environment of recessionary environment where consumption was still negative, consumption growth was still negative last year, and despite of these difficult and not very supportive circumstances, we managed to grow these portfolios, which makes us quite happy with the performance of the bank.

And as you can see on page 35, I think there's one number, which is interesting, here it is 33% increase in POS loan disbursements year-on-year, last quarter. So the fourth quarter 2016 compared to fourth quarter 2015 increased by 33%. This is the most important part of the season when the Christmas season, the last quarter and this increase makes us believe that hopefully next year when or for this year in 2017 when GDP growth comes back and also consumption stops declining, hopefully, we'll see even stronger dynamics in volume growth in Russia.

Ukraine, after many years of struggles, we seem to stabilize -- it seem to have a stable situation there. Stable environment, and then it seems this year that it is going to actually improve and we will see kind of material GDP growth, but already last year it was decent, because the previous long-term decline in loan volume stopped. And we managed to pay back basically all of the group funding we wanted to buyback. So this is only a small amount remaining outstanding there. So, the overall risk exposure to Ukraine has tremendously declined, and obviously given the very low level of portfolio deterioration and risk cost, now this actually turn into very, very profitable business. And we are quite hopeful that it will continue to be so this year.

On page 38, some highlights of the risk indicators. Overall, we had 1.1% risk cost rate last year. It peaked in 4Q, which was more I think a one-off and then kind of the usual seasonal pattern, as you could see in previous years. Portfolio deterioration was quite okay, and actually you see all the details on page 39. The actual deterioration was only HUF10 billion because HUF15 billion came in OTP core in Hungary due to the AXA acquisition. So the AXA volumes, obviously part of those volumes were non-performing and they came in as non-performing volumes to our portfolio, but this was not related to business events, so actually the portfolio was stable in Hungary. We had kind of for many years, the lowest level of deterioration in Russia, there was some in Ukraine and the rest was basically zero or negative deterioration. So this is quite, okay. And this reflects in the overall 90 days past due ratios and in the provision levels. Provisioning coverage ratio shows what you can see on page 40, which increased with the exception of Hungary. Basically due to the technicality that is AXA, the non-performing volumes related to the AXA acquisition, we book them net. So, net of provisions basically only the net exposure was booked. And therefore, the coverage is technically zero, but that doesn't mean obviously that -- there's not -- quite high level of coverage on these typically mortgage exposures.

And finally, probably the most interesting slide, which talks about our expectations related to this year to 2017. All in all, we expect quite favorable economic environment in all the countries where we operate and marginal improvement year-on-year in each of these countries and that makes us to believe that you can deliver on the -- at least 15% ROE target which we set back in 2015 -- actually 2015, based on the 12.5% common equity Tier 1 ratio. So that remains our kind of base line target, hopefully we can do better than this.

Now one-offs, we don't expect other than the Hungarian bank tax and the Slovakian bank tax, we are not aware of any other potential developments, but one-offs have this kind of procure nature that they're typically not foreseeable.

In terms of volume growth, the Group grew last year by 3%. We believe that this ratio, the gross rates will increase this year but nevertheless remain single digit. NIM erosion will continue primarily driven by Bulgaria and also to some extent by Hungary and we expect between 15 bps and 20 bps decline on a year-on-year basis using the existing methodology of calculating these ratios.

Credit quality, given the good environment and the improving asset valuations of collaterals, increasing real wages typically in most of these countries and are very good coverage of the non-performing portfolios. We believe that we have every reason to think that that risk cost this year will be lower than last year, so we expect improvement on that line.

Operating expenses between 3% and 4% growth similar to last year driven by basically wage inflation as I said and also the investments we have to make into developing digital capabilities. In terms of -- kind of broader strategic objectives, we continue to pursue acquisitions. We continue with this goal to try to grow in the countries primarily where we are present and where we don't have the required size, operational size in order to get to the return levels what we expect from ourselves. Obviously, it's hard to predict exactly what's going to happen, but certainly the intention there and we are very busy looking into different opportunities in this country. So hopefully, there will be other deals we will be able to talk about concretely during the course of this year. Now, there's also this kind of expectation for dividend growth, which is 15% nominal growth similar to the last two years. And this, we say, this is the baseline scenario. Assuming that we can go further with additional acquisitions during the course of this year. And obviously, if nothing seems to be on the horizon, then we might revisit this somewhere in the second half of this year, but this is not the baseline assumption and the baseline is that we actually going to nominally increase it by 15%. And additionally, we also do further acquisitions which will get back our capital position to closer to the targeted 12.5% common equity Tier 1 ratio. So all-in-all, this was part of the more formal presentation.

And, I'd like to ask you to ask your questions, if you have any. So please operator, open the floor for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Pawel Dziedzic, Goldman Sachs.

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Pawel Dziedzic, Goldman Sachs - Analyst [2]

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Good afternoon and thank you for the presentation. Just two questions from my side. And they both related to the things that you just mentioned in your conclusion. So, the first one perhaps on M&A, you gave us some information about your acquisition of Splitska, but this mainly relates to the balance sheet size and market share. Can you provide maybe a little bit more insights into what capital and earnings and profitability impact the acquisition might have, or any reasons why so far you've been holding off perhaps on this information?

And separately, can you maybe detail there a little bit more which markets are you currently looking at in terms of this further M&A, and can you rule out full year scenario and I know this is perhaps a hypothetical, but can you rule out a scenario in which actually raise capital in order to complete acquisition, your share price now is a little bit more allowing for such thing to happen. And then a second question is just on NIM and your guidance for 15 to 20 basis points decline. Would you be able to reconcile this maybe a little bit more in detail with NIM trends that you showed us on slide 26 per your core markets. You mentioned that you expect further pressure in Hungary. It seems that on a quarterly basis at least the trends are stable. So maybe the extent of decline there would be very useful to know your thoughts on. And also, how do you really think about further pace of declines in margins in Bulgaria? Thank you.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [3]

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Okay. So details regarding the Splitska transactions will come in due course when we actually have control and then we start kind of including this in our financial statements, but actually Splitska Croatia is a very transparent bank, you pretty much have all the available and public access to all the information of this bank. And so, I don't think it's very difficult to kind of combine the two, but we have not yet indeed presented a very detailed forecast related to the impact, but we will do in time. So this will not be neglected, I promise. Which markets? I mean, there's no secret about this. We have been quite open that we want to grow primarily in the countries where we are underrepresented or where the banks are too small, Romania, Croatia also Montenegro and you might add Slovakia to this, but there's not much in terms of acquisition opportunities as we -- for us at least what being visible there. So primarily Romania, Serbia, Montenegro where we are smaller. And also in countries like Hungary and Bulgaria, where we are big and where we can potentially realize large cost synergies. So these are the countries. I would not entirely rule out the others, but they are certainly not in our focus now. And we -- there are no short-term plans or there are no kind of ongoing processes related outside of our current footprint. Capital increase, I mean, we haven't encountered any opportunity which would justify a reason for an increasing capitals. So basically there is nothing on the horizon which would entail a capital increase. Regarding the margin forecast, I mean indeed this is group level one. And indeed if you go to page 26, you can see that it's likely that this -- as I said, this trend is going to continue in Bulgaria, so the decline we're going to continue in Bulgaria into 2017. And there'll be some further erosion in Hungary, but certainly not -- actually the quarterly changes suggest so far what we can expect for this year. So some erosion, but not drastic, but also in other countries like Ukraine, if anythings, margins will be somewhat lower as the environment improves, and as the rate environment is where normally an inflation comes down. Likewise in Russia, there's some minor potential increase in the rate environment. And all the other countries, which have potentially smaller impacts and then the change will be also smaller, but typically in the other countries as well, we face this headwind in terms of the rate environment being declining.

So across the Board, biggest change continues to happen in Bulgaria. I think that's what I can say. We decided not to give very specific one by one guidance for each bank, but obviously, there's a level of probability here and but the overall 15 to 20, I think this is a good range in which we can expect the overall development and we will have somewhat higher and lower ups and downs compared to what we expect country by country, but they will probably end up to this range on a group level.

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Operator [4]

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Simon Nellis, Citibank.

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Simon Nellis, Citibank - Analyst [5]

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Hi, Laszlo. Thanks for the call. I guess my first question would be on the provisioning. There was a big increase in the other provisions, but I didn't see much disclosure in the release on what was driving that. If you could give some backdrop to that? I'd also be interested in knowing how you think things will pan out in Russia. I think, they proposed higher risk weights on high margin consumer loans. Has that gone through yet? Do you expect it to go through and what the impact could be on the business and how much additional capital you might have to send to Russia, those would be my first two questions and the last question just maybe, if you have any visibility on the impact of IFRS 9 and then some of the provisions -- extra provisions that you've taken this year, is it related to IFRS 9 or not? Thank you.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [6]

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So, the other risk cost which you mentioned in provisioning, it was basically centered around two entities one in Bulgaria and I already kind of touched upon this in the presentation. So these are potential legal claims, which are not actually in progress at the moment, but are potential and we kind of exercise extra caution here and created provisions against those. The other one was actually in the corporate sector and is related to certain tax risks in related to financing -- the previous financing of our subsidiaries in case of one country there, the tax authorities questioned our policies, our tax treatment, so to say. And this is again a potential liability which might come through as a negative line and that we provisioned for this. Nevertheless, thus, I'm quite hopeful and we are working very heavily on pursuing our interest and actually avoid paying this extra tax. Capital regulation, I'm sure, you referred to the new regulation, which came to force actually March 1, which increases the risk weights for the higher APR loans in Russia. I mean, this is obviously forward-looking regulations which implies only to the new disbursements. We definitely don't foresee any additional capital requirements for the Russian banks. So we believe that it's more than -- the level of capital it generates and the current level of capitalization is more than enough to cover these extra capital requirements there, but indeed this is going to result in kind of lower level of capital adequacy ratio in Russia in the future, but we believe that it will not entail capital increase in Russia IFRS 9. Yes, as much as possible we do kind of gradually prepare for IFRS 9. And indeed some of the changes in methodologies try to kind of preempt the IFRS 9 changes. To the extent it is allowed in the current standard, the current standard specifies IBNR provisioning which is a broad definition of this, but under this umbrella we try to kind of already get closer provision levels to what we expect under IFRS 9. And the overexpectation is that we will not need additional provisions due to introduction of IFRS 9. We are actually quite advanced in our calculations and methodological developments, so now we have actually more grant to and numbers to justify this expectation, but obviously, this is an ongoing process. The methodology is not rock solid yet, we are in very active discussions with the regulator and our auditors to kind of finalize all the details of this method and do the calculations, but high level, well I can tell you that we don't expect additional provisions coming at year-end due to switching to IFRS 9.

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Simon Nellis, Citibank - Analyst [7]

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Okay. Actually on the first question, I see that also in OTP Core, you had a HUF6 billion other provision, which -- could you say what was behind that? And then on the Russian risk weights, could you tell us what the average risk weight is for your newly disbursed loans on average, roughly?

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [8]

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So in -- regarding the Hungarian other risk cost, this was related to the IFRS changing to IFRS and that's then IFRS apparently treated these items differently, where we had to change our accounting methodologies to recognize certain expected losses due to other item. So that was a kind of one-off.

In the Russian book. I mean, the current average risk weights, I don't it by heart actually. And again, the increase is coming gradually. So, it's not that from one day to another, we will have to increase the risk weights of our risk weighted assets that have come through new production.

Now the -- to give you a flavor of the potentially expected impact is between 2 percentage and 2.5 percentage point, based on the capital adequacy ratio. So if, let's say, by the end of next year or when more or less the whole impact of this increase of risk-weighted asset come through the portfolio, so basically in two years, this is the magnitude of the expected impact. Obviously, it will depend on the type of loans and the APR levels of these loans, this is changing all the time and the capital allocation to different APR categories changes all the time, but the overall magnitude, we expect to be in this range between 2 percentage to 2.5 percentage point basically in two years' time horizon. So the change will happen through this two years period gradually.

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Operator [9]

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Margarita Streltses, UBS.

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Margarita Streltses, UBS - Analyst [10]

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Thank you very much for the presentation. Just quickly follow-up on the previous question. Do you expect this new risk weighting is actually to impact the net interest margin in Russia because it seems to discourage the high yield lending? And in Hungary, can you give us an indication for the average rate on HTM book? I think last year it was around 5.8%. Can you maybe let us know what it is at the moment and also what proportion of net interest margin pressure next year you expect to come from this? Thank you.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [11]

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In Russia, the purpose of this regulatory change is obviously I think to discourage high APR lending or make high APR lending more difficult or more costly or only allow high APR lending to entities which are capitalized. And indeed there is a trend on the market and we try to kind of follow this trend to try to focus more on lower APR and lower risk products because higher APR is usually high risk and lower APR is usually low risk so it's not necessarily true that the high APR product is more profitable than a low APR product. Having said that, just because of these changes, short term we don't change our product portfolio mix. We are very well capitalized in Russia and we also make at or above 20% return on equity. So, we are quite comfortable in terms of our capital position in Russia and this has a lot of room and it allows to continue our current practices if otherwise this is justified business. So we ourselves don't change immediately the product mix, but nevertheless we do intend to if possible lower the APRs and actually target a better quality customer segment and at the same time continue or even improve the level of profitability. As I understand your second question was the hold to maturity portfolio average years, right? That in the last quarter was 5%.

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Margarita Streltses, UBS - Analyst [12]

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And what proportion of net interest margin pressure in Hungary next year do you expect to be driven by the declining rates on HTM book and what proportion should come from negative interbank rates just roughly?

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [13]

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There's a relatively small amount maturing for the hold to maturity portfolio. Most of the margin pressure on a year-on-year basis comes from the lower reference rate so that's the problem. The reference rate today is between 20 basis points, 30 basis points, which is considerably lower than a year ago. And basically all of our variable loans, most of the Hungarian corporate book, and all of the local currency so most of the mortgage book is variable and it is linked to the reference rate, which is interbank rates and this decline and it's much lower than it was on average last year and this is the most important factor.

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Operator [14]

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Anna Marshall, JPMorgan.

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Anna Marshall, JPMorgan - Analyst [15]

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So, firstly on lending growth so your overall guidance is that loan growth is expected to accelerate and you've made some comments about Hungary and Russia, but could you please further discuss dynamics by country? The next question is on Touch Bank, could you provide an update on this project? Are you happy with the progress so far and when could it turn profitable? And the final question is on Ukraine so now that the subsidiary is profitable and it has paid back most of the intragroup funding, what are your plans going forward and how do you see the banking sector in the country develop? Thank you.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [16]

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Sorry to disappoint, but I'm not going to give you exact loan growth forecasts for each Group member. On a kind of broad high level, some highlights. Obviously we talk about this trend change in Hungary regarding mortgages. We had seven years of negative loan growth in mortgages, which stopped in the second half of last year and we are quite hopeful that this will turn into growth. So, this is going to be one difference compared to last year. Other than that, we expect consumer lending to be strong across the Board especially improving in Russia. So last year we had only 1% overall growth, but this was a result of the first two quarters being very negative and the third quarter being more or less flat and the last quarter being very strong 10%. So, here we are quite hopeful that we see much higher growth than what we saw last year in terms of 1%. So, that can be one driver.

But across the Group, consumer lending should be reasonably strong given the real wages growth, consumption growth which we expect in all of these countries. Corporate last year was really incredible performance especially in Hungary, Bulgaria. It would be great to repeat this. It will be actually difficult to repeat this. We try hard, but there's obviously an ever-increasing competition driving down the margins and in some cases to levels where we don't feel comfortable in that kind of risk benefit comparison. So, we'll see how far we can get. Certainly demand is there, the question is how much appetite we have in terms of going to kind of very low levels of new corporate lending in terms of margins. Touch Bank, the very recent results; December, January, February; seem quite promising especially compared to what we had seen up until December last year, which were not very encouraging.

So to be very honest, the initial results we were not very happy with again what we had seen up until November, December last year; but the last couple of months actually look much, much better. Obviously what we are struggling with is customer acquisition and the price of customer acquisition. We believe that by now we have a very good and very high service level operation and value proposition. So, it's actually working very fine. The customer satisfaction level seem to be very good. So, the users like it and we have a lot of interest in using it and the growing number of transactional customers. What we have not been very successful with and this was part of the original business plan, it's selling unsecured loans basically credit cards and cash loans or cash on card products.

This we have not been able to solve yet how to attract good quality demand because again we have quite high level of demand, but the quality is not what we exactly expect. So, this is the front where we have to find other ways and new ways to tap into quality demand client groups. So, this is an ongoing challenge. We are quite hopeful of actually the environment because last year we shouldn't forget that GDP growth was negative, consumption declined. So last year was not a very prosperous year for Russia and as the economic environment improves, this consumption is going to improve. This year we expect increasing demand for consumer loans, unsecured loans, and then this will hopefully create further demand for our services there. So, again the very recent experiences are more and more encouraging and operations seem to be good and the services seem to be quite okay. So, we are quite happy with that.

So, that's more or less where we stand. When we break even, that's difficult and honestly I wouldn't be very specific on this because the business models and the revenue stream changes quite fast. So, I hope that during the course of this year we'll be able to better gauge the prospects of this business and have kind of exact and hopefully very precise expectation size going to develop. Ukraine, we are quite happy with what we have at the moment there. Again Group funding is down to very low levels so the overall risk is quite contained and limited. It's extremely profitable at the moment. It doesn't need Group funding and it doesn't need capital, it actually generates capital. The business is quite tilted towards local currency lending so at least in retail we technically don't have any FX loans and even in our corporate books we have a majority of the funding now in local currency.

And we are regarded as one of the very reliable and strong banks and certainly our customers seem to value the stability, which we provide and the reliability which we provide and there's a lot going on in the markets there with some of the banks. Probably you know the developments what happened in the last quarter with one of the banks having serious problems. So, this is a quite dynamic environment where we stand as a stable and reliable partner for our customers. And the short-term expectations for the Ukrainian economy seem quite promising so we hope that they will materialize and then we can continue to generate these good returns there, but no immediate plans other than continuing what we are doing.

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Operator [17]

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Andrzej Nowaczek, HSBC.

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Andrzej Nowaczek, HSBC - Analyst [18]

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My question is on the smaller markets. We rarely talk about Serbia, Slovakia, or Montenegro; but it looks like these operations are not getting any better, losses in Slovakia and Montenegrin in Q4 are probably the evidence of that. Obviously as you say you'd like to buy more assets in these countries, but if you fail to get engaged in M&A, would you be willing to sell these operations and are there any prospective buyers?

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [19]

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Today we are more in the buying mode than selling and there are buyers for assets in Serbia and Montenegro certainly and probably also in Slovakia, but there are not much process ongoing. So, there is interest for assets certainly. But again our strategy at the moment is to grow through acquisitions. We believe that we are at the beginning of a growth period in the region with actually quite stable and relatively high growth potential and reasonably contained low risk and asset valuations are still in a meaningful range. So, we believe that this is actually the time to buy and not necessarily the time to sell. We believe that asset valuations will go higher actually we believe sooner than later and then that can create an environment where we might consider other strategies as well especially if we don't succeed in buying anything. But at the moment, the strong focus is on acquisitions and we believe that all the factors support that and we hope that we will make the right moves. Obviously we don't buy everything what is in the market. You probably heard about recent transaction which happened and actually a bigger transaction where we did not win the tender for that asset. So, those events happen. So, we don't buy for any price and we are quite selective.

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Andrzej Nowaczek, HSBC - Analyst [20]

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And more specifically on Montenegro, what happened there in the fourth quarter? It looks like the loss is quite substantial and of course back into 2010 you were making huge losses in Montenegro, small market, but a problem market.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [21]

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As I said, Montenegro and Slovakia last quarter, you saw high provisioning in both of these countries. This provisioning, especially Montenegro, it was related to all defaults which defaulted many years ago where we had certain expectations towards recoveries on these exposures, but they have not yet materialized and we decided to revisit this and actually adjust our level of conservativeness to the experience that we have had during the last couple of years. So, this was just revaluation of the long time ago defaulted assets or exposures in Montenegro and it's not related to recent deterioration of the portfolio or recent events.

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Operator [22]

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Gabor Kemeny, Autonomous Research.

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Gabor Kemeny, Autonomous Research - Analyst [23]

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A follow-up question on the Hungarian margins, you gave us some useful sensitivities in the previous call on the potential impact from the higher reference rate from the higher interbank rates and you just mentioned that this is an issue going forward, I think you said like HUF1.5 billion NII impact from a 10 basis points drop. Is this just your best estimate?

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [24]

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If you only look at this variable, yes.

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Gabor Kemeny, Autonomous Research - Analyst [25]

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Okay. I guess the book level dropped something 60 basis points, 70 basis points in the last few months so shall we then assume something like a HUF9 billion annually NII impact in Hungary from this? Would you consider this a fair estimate?

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [26]

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It's not only those three months, not all of the loans are linked to this three months interbank rate. There are other elements there so it's slightly less, actually better. But in principal, yes, this is the magnitude related to this very particular change. But there are other changes in our asset structure, some of them are positive. We actually reduced quite substantially the amount at the Central Bank and the amount at the base rate and at the overnight rate and we increased the share of government bonds in our liquid portfolio, which has a positive impact somewhat counterbalancing this. But yes, basically this holds.

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Gabor Kemeny, Autonomous Research - Analyst [27]

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And when you say your Group margins could drop like 15 basis points, 20 basis points this year, do you assume that the book level will stay at the current level of around 20 basis points?

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [28]

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Yes.

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Gabor Kemeny, Autonomous Research - Analyst [29]

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Okay. And secondly on the capital and dividend, just a bit of a conceptual question. Your dividend guidance suggests that you are kind of accumulating capital for potential acquisitions. You clearly have capacity to increase the dividend more than 15% next year. So, why would you not pay more dividend and raise equity when you need additional capital for potential acquisitions? Your shares are trading well above book value at quite attractive valuation, presumably you would buy something at a much lower valuation.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [30]

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I think this is very theoretical. There was one question already related to this. The type of acquisition targets what we are talking about are in this kind of size range, which we believe we can cover or afford from the capital what we generate so that doesn't justify a capital increase. I don't even fully understand the question. So we would rather pay 25%, somewhat more dividend and increase capital. I don't quite get it.

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Gabor Kemeny, Autonomous Research - Analyst [31]

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You pay out your potential excess capital and once you need any further capital for acquisitions, you can easily raise at a quite attractive valuation based on where you share price is right now.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [32]

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I don't quite see the difference from a shareholder point of view. There's a lot of noise and hustle raising capital and clearly we don't need it. So thank you for the question, but honestly I don't quite see it as a feasible alternative what we suggest now. I think what we suggest now is yes, to retain part of the capital we generate for potential acquisitions. And as I've said, if there's nothing on the horizon, then we might even change this as soon as during the course of this year. So it might happen if you don't see any target and by the second half of this year or by the end of this year, then we will come up with a different strategy related to our equity. And then it's not just the extra dividends what we might consider, we might consider share buybacks or other ways to return value to our shareholders and this is not in the very distant future. Again as I said, we are willing to revisit this if we don't see any acquisition opportunity during the course of this year. So, this 15% is the baseline what we communicate assuming that we can in the short term find other value creating acquisition targets during the course of this year.

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Operator [33]

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David Taranto, Bank of America Merrill Lynch.

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David Taranto, Bank of America Merrill Lynch - Analyst [34]

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My question is related to mortgage spreads in Hungary. What is the current spreads on new production and do you see some sort of risks stemming from the regulation or competition given the positive differential with the peers in Central Europe? Thank you very much.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [35]

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The new spread is above 4%. I think this should be the benchmark rather in the region than an outlier. Mortgage lending can in extreme situations go down to very low margin levels like what we see in Slovakia. That rather scares me honestly. I think the key to stable long-term sustainable banking sector is margins which cover the cyclical risk cost and cost of capital and on top of that provide okay returns to shareholders. So, I think what we have in Hungary that should be the normal rather than what we see for instance in Slovakia which is I think extreme and potentially not sustainable over 20, 30 years horizons because that's what mortgages are sought for. Nevertheless, obviously there's a threat that competitors or even regulatory measures interfere. That I don't know. We'll try our best to provide the best value to our customers and at the same time maintain margins which assure the long-term security of the bank and also the sector as well especially Hungary.

I think we have a special kind of extra responsibility in the sense being the largest bank to try to protect the safety and the quality of the sector. But nevertheless, you are right that the competition might force us to go into lower margins. Actually there's quite intense competition at the moment. Every bank is very keen on selling more and I'm sure if you ask around our competitor friends, they will say that the prime target in Hungary is to increase mortgage lending and this is our most important target as well for this year. So, I expect very fierce and very intense competition. So, we will see where we get. Certainly I don't expect margins to increase. If anything, they will decrease to which extent, I don't know. This depends on our competitors. I hope that there will not be an interference, an intrusion to market pricing and I very much hope that the regulator does not do that because that usually is not a good thing to interfere with this method into a very competitive market. So, we will see.

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Operator [36]

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Anubhav Srivastava, Societe Generale.

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Anubhav Srivastava, Societe Generale - Analyst [37]

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This is Anubhav Srivastava from Societe Generale. As you suggested that you expect lower risk cost going ahead so checking if this includes any write-backs especially in Hungary on mortgages?

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [38]

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Yes, indeed we expect overall on a Group level lower risk cost in this year than last year and yes, in Hungary write-backs can happen and do happen actually. If you look back last year in Hungary, we had positive risk cost and we do have recoveries also on the mortgage book.

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Operator [39]

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We have no further questions on the phone lines.

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Laszlo Bencsik, OTP Bank Nyrt - CFO & Strategic Officer [40]

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Thank you very much. Thank you for joining this conference call. Thank you for your very good questions. And hope to have you back during the next interim report conference call, which will be on May 12. I wish you all the best, a very good weekend. Thank you very much. Bye bye.

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Operator [41]

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That does conclude today's call. Thank you for joining and enjoy the rest of your day.