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

Q3 2019 Turkiye Vakiflar Bankasi TAO Earnings Call

Istanbul Dec 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Turkiye Vakiflar Bankasi TAO earnings conference call or presentation Friday, November 8, 2019 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ali Tahan

Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR

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Conference Call Participants

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* Alan Ramsey Webborn

Societe Generale Cross Asset Research - Equity Analyst

* Deniz Gasimli

Goldman Sachs Group Inc., Research Division - Associate

* Mehmet Sevim

JP Morgan Chase & Co, Research Division - Associate

* Ovunc Gursoy

BNP Paribas, Research Division - Research Analyst

* Simon Nellis

Citigroup Inc, Research Division - MD and Director

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Presentation

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [1]

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Good afternoon, everybody. I am Ali Tahan, Head of International Banking and Investor Relations. Welcome to VakifBank 2019 Third Quarter Earnings Announcement Conference Call. I have all the Investor Relations team with me. Nihan, Head of Investor Relations; Yasemin, Yusuf, Berna, Mümtaz and Nagehan. For those of you who are not aware of the recent developments at VakifBank, we had some organizational changes. Mustafa Bey, the former Head of International Banking and Investor Relations to whom I work together since 2011 just left the bank and took a bigger responsibility at the Ministry of Finance and Treasury. Mustafa Bey has now a very important role in his new career compared to his position at VakifBank and as a friend, as a colleague, we are very glad to see somebody among us, somebody from VakifBank appointed to such important position within the state bureaucracy. With this occasion, we would like to thank him again for all his efforts and contributions to us personally as well as to VakifBank and his pioneer role, especially in Turkish debt capital market activities in general.

Going forward, together with me and Nihan, our team will continue to establish good level of communication with Investor Relations work as we learned and internalized from Mustafa Bey.

Turning back to financials. I will start with the investor presentation, as usual, and then carry on with Q&A section. I will try to keep the presentation part as short as possible so that more time can be dedicated for the more interactive Q&A session.

Starting the presentation in the third page. This quarter, our quarterly net income came above than the market consensus of TRY 443 million at TRY 503 million. This above the month consensus net income came even though despite the quarterly effective tax rate of almost 36%. If the quarterly effective tax rate very much or above much more normalized level,, then our quarterly net income would be much higher.

And this quarter net income growth first 9-month cumulative net income number to TRY 1,522,000,000 and before deducting the provisioning, our pre-provisioning operating profit of the quarter came above than TRY 2 billion, which brought the first 9 month pre-provisioning operating profit number to above than TRY 5 billion. As usual, the conservative state bank operating in Turkey, we continue to have above-than-sector average coverage ratios. Our NPL coverage ratio came at almost 71%, which is almost 5 percentage points higher than the sector average. I believe this strong number is still one of the best among peer group as well as our total NPL coverage ratio also materialized at almost by 97%, again, one of the best numbers compared to peer group in Turkey.

On Page 3, you can see the key highlights of third quarter 2019. Among the important part of the third quarter, we may discuss about the sound net interest margin expansion. Our reported quarterly net interest margin came at 4.08% versus 3.55% in the previous quarter and our net interest margin [reporting-wise] could be even higher at 4.25% if we wouldn't have any additional CPI adjustment. As you can see on the footnote, October to October CPI estimate, this quarter has been revised down to 9% versus 10.5% in second quarter. This is also creating additional pressure on the profitability, but still despite additional CPI adjustments and despite additional tax regime we have above the market consensus net income during the quarter. And a similar net interest margin expansion also was visible on swap-adjusted net interest margin side. Our quarterly swap-adjusted net interest margin reached to almost 2.9% versus 2.2% in the previous quarter. So in this area, we have almost 70 bps improvement on a quarterly basis.

Another strong area of the quarter came from the fee and commission income side. Cumulative fee income growth came in at strong 88% and quarterly fee income growth also came at 28% Q-on-Q. And thanks to this strong fee and commission income performance since the beginning of the year, we witnessed all-time high fee-related KPI numbers. Fee to total revenues for the first time came at 25% and Fee-to-OpEx ratio reached all-time high level at almost 66%.

During the quarter, strong core revenue generation capacity remained intact. Our core banking revenues coming from net interest income and net fee and commission income increased by almost 16% year-on-year and within the share of total revenues, the share of this core banking revenues came at almost 90% on a cumulative basis, reflecting the high-quality revenue generation capacity of the bank.

During third quarter, liquidity levels and LtD ratios continued to improve. Total liquidity coverage ratio came at 134%. And more importantly, hard currency liquidity coverage ratio reached to 508%. Both of them came very stronger and higher than BRSA requirement. At the same time, despite relatively faster lending growth on a Q-on-Q basis, still we managed to further decrease our total LtD, total loan-to-deposit ratio came down to 113% from 117% in the second quarter. And more importantly, Turkish loan-to-deposit ratio came down to 130% from 136% a quarter ago.

On the solvency side, this quarter, we had one capital transaction. During the mid-September, VakifBank as a requirement of its pioneer role in the debt capital market activities materialized the first-ever TLREF indexed Tier 2 issues out of Turkey, again with 10 Non-Call 5 structure and total amount of TRY 725 million. It was still sold out to domestic corporate investors. And thanks to this, our total CAR came flat Q-on-Q at 17% and Tier 1 ratio also came strong at almost 13.8%.

On Page 4, you can see the P&L details, both on a cumulative basis as well as quarterly basis. I'm just tapping this page just to be more efficient in terms of timing.

On Page 5, you can see the breakdown of revenues in terms of core banking revenues and other revenue items.

And as you can see, total revenues are up by 8% year-on-year basis and core banking revenues are up by almost 16% year-on-year basis. Within this revenue breakdown on the right-hand side below chart, you can also see the change on pre-provisioning. This quarter, we released TRY 65 million pre-provisioning, but still we have above than TRY 850 million pre-provisioning outstanding amount. And going forward for the rest of the year, we don't want to touch to this amount, and we would like to use it for upcoming years and periods.

On Page 6, you can see net interest margin, spreads and swaps. Our reported net interest margin on a quarterly basis improved 53 basis points Q-on-Q from 3.55% to 4.08%, and it is also in line with our guidance of a more than 4% net interest margin for the second half of the year.

And on a similar basis, our swap-adjusted net interest margin improved almost 70 basis points Q-on-Q from 2.2% to almost 2.9%. And this swap-adjusted net interest margin is also expected to be with our guidance of above than 3% in the second half of the year, and we are very happy to say that each and every day because of the additional cost of funding decline, our additional and margin -- net interest margin keeps going improving. And therefore, as of today, we can happily to say that we will beat our net interest margin guidance for the second half of the year.

In terms of the components of net interest margin, this quarter on the core spread side we have additional Turkish lira core spread improvement of 35 basis points, which is mainly coming from the relatively lower cost of funding. And on top of the improvement on the core spread side, Turkish lira core spread side, we also benefited from our money market funding activities. As you can see on the right-hand side of the chart, we put detailed information related to both total money market funding volume as well as cost of debt. While on a Q-on-Q basis, total money market funding increased -- decreased from TRY 45 billion to TRY 43 billion. Cost of this money market funding activities decreased in a sizable manner from average 24% in second quarter to lower than 16.5% in the third quarter, and similar items can also be extended for the swap leverage. Swap leverage in terms of the swap volume came down to less than TRY 1 billion in terms of the swap cost, but average swap usage increased from almost TRY 21 billion to more than TRY 23 billion, but despite this average swap usage, swap cost on a quarterly basis further came down. Both declined on the swap cost as well as the cost of money market funding activities also help us in terms of quarter net interest margin on top of the improvement on the Turkish lira core spread side.

And during Q4, we are very happy to see that our net interest margin keeps improving. You may also see detailed information and the breakdown of fee and commission income growth, eye-catching fee income growth further accelerated via retail lending during the third quarter. Total fee income growth came at almost 89% and quarterly net commission income growth came at almost 29%. And thanks to both strong fee and commission income growth, fee-related KPIs like fee to total revenues and fee to operating expense materialized at all-time levels in terms of fees, total revenues as of first 9 months, it is above than 23%. And for your information based on our guidance back 2017, '18 and '19 we would simply think that we are behind to competition in terms of fee generation capacity. And as of today, we are very happy to see that compared to prior periods in Turkey, a catch-up story is materializing on the fee side.

On Page 8, you can see detailed information related to OpEx and cost-income ratios. Cumulative OpEx growth came at 23% almost as of September and quarterly OpEx growth came at 2.8%. This quarter, total branch number decreased to 946. This quarter, we had 5 branch shutdown. And going forward, for the Q4 and for the entire 2019, we are expecting our OpEx growth will be lower than 20% on a year-on-year basis.

This page, starting Page 9, we may switch to asset side. On Page 9, you can see detailed information related to lending growth and loan breakdown. Quarterly lending growth numbers can be seen at the right-hand side low chart. This quarter, we had a relatively faster growth on retail segment, specifically, both in general purpose consumer lending as well as the deduction mortgage lending and retail lending was the main driver of Turkish lending growth. And if you can see on the left-hand side, all quarterly lending growth came from Turkish lira side. Turkish lira loans are up by 10% Q-on-Q. And most of that growth came from retail lending from both GPL as well as from mortgages. We had 5% contraction in our FC spending quarterly and short-term Turkish lira business lending was another area of quarterly lending growth.

You may also see detailed information related to currency breakdown, portfolio breakdown and breakdown of FC loans in this page.

On Page 10, you may also see detailed information related to sectoral breakdown of cash lending and as usual, we are also putting additional and detailed information related to construction sector as well as energy sector as these are the segments concerned -- where the concerns relatively higher. And we are also putting additional information on the CGF loans. CGF loans still coming down in terms of the outstanding amount, given the fact that each and every month, we are collecting from the principal. CGF exposure came down to TRY 21 billion from almost TRY 22 billion, one quarter ago. So therefore, especially SME lending coming from CGF loans seems to be on negative territory on a quarterly basis.

Page 11 and 12 is related to asset quality. NPL recognition move strengthens our balance sheet position. This quarter did it increase, both in our NPL ratio as well as the share of Stage 2 loans in our total portfolio on a quarterly basis. NPL ratio came at 5.2%. And Stage 2 ratios further increased to 12%. And some part of the NPL recognition, which was announced by BRSA, reflected in third quarter financials. And some of them will be reflected in the final quarter of the year. As of year-end, we are expecting our year-end NPL ratio will be above than 6%. And at the same time, the share of Stage 2 loans will be coming down to 10% to 11%. We believe both numbers, more or less, will be in line with our initial guidance in terms of asset quality.

And at the right-hand side of the page, you can see the sectoral breakdown of Stage 3 loans, NPL and Stage 2 loans. As you can see on those sectoral breakdown, the share of construction is increasing, especially within the NPL portfolio. And especially in third quarter, the share of energy loans also increased to 6%. This is related to the fact that this quarter, we had one NPL loan coming from the energy sector, which was in Stage 2 in the previous quarter.

On Page 12, you can see net cost of risk and coverage ratios. This quarter, our quarterly net cost of risk came slightly higher than 200 basis points, which brought cumulative net cost of risk number to 168 basis points area. And in terms of the coverage ratio, our NPL-specific coverage ratio came at almost 71%. This is significantly higher than the sector coverage ratio of almost 66%. But more importantly, the coverage ratio of Stage 2 increased from 6.3 to 7.3. So in this sense Stage 2 coverage ratio further increased, while the specific coverage of NPLs started to be above than the sector average, and we are expecting in the final quarter of the year, especially, NPL-specific coverage ratio to further going up to close to 75% area.

On Page 3 -- on Page 13, you may also see detailed information related to deposit growth. This quarter, our deposit growth came stronger than lending growth. Total deposit growth came at 7.2%. And this deposit growth mainly came from Turkish lira effect. We had flattish FX deposit growth. However, we had almost 15% Turkish lira growth on the quarterly basis. And in terms of the currency breakdown, 58% of total deposits are coming from local currency, while the remaining 42% is in the form of hard currency and compare to sector, these numbers are slightly different, given the fact that in terms of the sectoral breakdown of deposits, FX deposits have a bigger share compared to share of local currency. And another good news on the deposit side is coming from the demand deposits. Demand deposit growth came even stronger at 37% year-on-year, which brought the share of demand deposits to 20% area within the total deposit portfolio.

On Page 14, we may see the detailed information related to nondeposit funding sources. As we discussed, this quarter, we had 2 important nondeposit funding transactions. One of them was related to capital with TLREF index Tier 2 note issues of TRY 725 million. It was the first-ever TLREF Index capital issues out of Turkey. And another important transaction came from the DPR securitization part in mid-October, actually, not in third quarter, but in mid-October in the middle of political discussions, we successfully completed DPR securitization issuance of $417 million amount, with final maturity of 7 years. And it is also helping us in terms of increasing the duration and the maturity of our external debt profile.

At the last page, I just want to take your attention. It's related to capital. While the details can be seen on Page 15, this TLREF Index Tier 2 issuance had 25 basis points positive impact in our Tier 2 ratio, and it was the main driver of quarterly flattish total CAR ratio and Tier 1 ratio also came strong at 13.8%, and CET1 ratio came at 10.6%, which is significantly higher than the BRSA requirement. And as usual, we are also putting additional sensitivity analyzers in terms of the change in the quality deposit or in terms of the change in interest rates. You can see also growth sensitivity analysis in our capital structure.

And for the sake of the time, I just want to stop here and leave the floor to operator again to move to Q&A section.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We already have some questions. We have the first one from Deniz Gasimli from Goldman Sachs.

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

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I have few questions from my side, I have 3 questions. One on fee income. Obviously, it's been a very strong performance year-to-date, up 90%, which I believe is driven by payment system, by loans and by the auto loans component where you charge a participation fee for the auto loan campaign that's helping you with the fee income. So I just want to understand what's the kind of the outlook for fees going forward now that rates are coming down, which should probably impact payment system interchange fees as well. So now that fees are up 90%, where do you see fees in the fourth quarter in terms of the growth and where do you see it in 2020 because obviously 90% seems like too good of a number to be sustainable in a way? So where do you see sustainable fee income growth is the question.

Second point would be on balance sheet growth. On the lira side, we saw 10% loan growth, 14% deposit growth. So want to understand what's the like strategy behind balance sheet growth this quarter and by the end of the year, where do you see it maybe in 2020? And would you -- maybe would you have preferred to grow your deposit book less, but -- and maybe pay less for -- in terms of deposit costs? Or was the -- was your priority to increase your -- to improve your Turkish loan-to-deposit ratio? And last question would be if -- I mean you gave some guidance numbers for the end of the year, but just if you could summarize your expectations by year-end, be very helpful.

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [3]

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Thank you, Deniz. Let me first start with the first question. In terms of fee income, as of September, we are up by almost 90% as already mentioned compared to same period of the previous year. This quarter, very frankly speaking, retail lending was the main driver of this relatively strong quarterly performance because when we were announcing the second quarter financials, we were guiding that fee income growth may not be such strong in the second half of the year compared to first half of the year. But due to retail lending growth, especially coming from both GPL as well as from residential mortgage lending, during third quarter, strong fee performance maintained. However, for the entire year of 2019, it is not easy to deliver 90%. There will be some normalization in the Q4, especially taken into account the high base effect of Q4 2018, but still, we are expecting above than 75% year-on-year fee income growth at minimum, I mean, for 2019 compared to 2018.

And that number itself is above than what we were guiding in the beginning of the year. But the good thing is, the bank is giving much more importance to fee income by especially creating synergy with our subsidiaries, and by also pushing our portfolio managers in the retail side, SME side and corporate side to collect more fees. So transactional fees apart from lending-related fees are also contributing to this fee income performance. So lending-related fees, transactional fees as well as fees related to our subsidiaries, they are all supporting at the same time. Speaking of the next year in terms of fee income, we didn't finalize the budget yet. We are still discussing internally the numbers for next year. We will be sharing those details once it is ready. But of course, this strong performance is not sustainable. There will be some normalization in terms of fee income.

The good thing is from the medium-term outlook, we are very happy to see that our fee income targets are fulfilling because just to remind you, a couple of years ago, we were having only 10% or 11% of our total revenues coming from fee income. Today, we are much more comparable to our peer group banks with above than 20% share. So in this sense, we are very happy to deliver a catch-up story on the fee income side. And after a very strong 2019 base effect, it will not be easy to perform a similar number for next year for sure. But more or less, I think it will be similar to our lending growth, let's say. I mean we didn't make the budget yet. But in case that, we will have like 15% lending growth for next year, just to give you an idea. Our lending growth -- our fee income growth will be more or less in line with the lending cost. I hope this is helpful for your first question.

Related to second question in terms of the Turkish lira balance sheet growth, we were selective in terms of TL lending growth as we are eager to grow more on both GPL lending as well as residential mortgage lending, both because of their relatively lower cost of risk nature because at the end of the day, residential mortgages are still the best part of the asset classification in Turkey, as you know. And on top of that thanks to our payroll business, we are extremely confident in terms of the high asset quality of our GPL lending because most of our GPL lending goes to payroll clients. And the good thing, deliberately, we increased our market share in those 2 segments, especially. And today, all the loans we extended during the third quarter are in the money. We are generating positive net interest margin because each and every day, cost of funding on the Turkish lira side is coming strong. And therefore, these kinds of lending growth on the Turkish lira side will further support us in terms of the net interest margin expansion in Q4.

And the deposit growth, on the Turkish lira side was even stronger than Turkish lira lending growth and the Turkish lira deposit growth, first of all, was very strong during the quarter, sector wise speaking. It was not something VakifBank-specific, sector wise speaking also, unlike the previous quarters, this quarter, we had very good level of Turkish lira deposit growth. But on top of that, we also have additional Turkish lira deposit growth that can be attributable to the fact that this additional TL deposit growth was linked to Turkish lira lending growth. In other words, Turkish lira lending growth created Turkish lira deposit growth. It was totally linked to one another. And therefore, we ended up with relatively faster TL deposit growth than TL lending growth which was automatically helping cost in terms of TL loan-to-deposit ratio, and the TL loan-to-deposit ratio decline was the automatical outcome of this reality.

In terms of the guidance for 2019, I just touched a couple of points during the presentation part. Let me try to summarize those. Let me first start with the profitability. In the first 9 months of the year, our average net interest -- our average ROE came at 7%, but we believe Q4 will be way stronger than the average of 2019 in terms of the profitability. And therefore, strong Q4 will bring 2019 average ROE number to above than 8% area. So in this sense, ROE will be stronger in Q4 compared to first 3 quarters of the year, and it will be primarily driven by net interest margin expansion. We are expecting additional net interest margin expansion in Q4 on top of Q3 numbers, driven by additional cost of Turkish lira decline as well as additional decline in terms of money market funding, all of them are supporting us in terms of profitability and net interest margin.

In terms of the OpEx growth, as of September, we are above than 22%, but due to high base effect of 2018 Q4, we are expecting our OpEx growth will be lower than 20% for the entire year of 2019. And in terms of the asset quality, we are expecting our NPL ratio will be above than 6%. But at the same time, the share of Stage 2 ratio will be coming 10% to 11% area from 12% as of September. So there will be some decline from Stage 2 point of view, but there will be additional increase in our NPL ratio, and we will see additional NPL coverage ratio increase in terms of specific coverage ratio as well as total coverage ratio even though, despite this NPL coverage ratio increase in Q4, still we are much more optimistic and positive for the P&L and the profitability of Q4. I hope (inaudible) thank you, thank you, Deniz.

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Deniz Gasimli, Goldman Sachs Group Inc., Research Division - Associate [4]

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Just to clarify on the fee income earlier, you said you see full year growth around 75%. Am I right? I missed it.

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [5]

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Yes, you are right. I mean as of now, it is not easy to maintain 90%. But on the -- to be on the conservative side, we can say that given the fact that Q4 '18 is also creating [a base] effect, realistic expectation is above than 75%.

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Operator [6]

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(Operator Instructions) We have the second question from Ovunc Gursoy from TEB BNP.

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Ovunc Gursoy, BNP Paribas, Research Division - Research Analyst [7]

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I have 2 quick questions. The first one is about these BRSA-stipulated NPL loans. How is the process going? How much of it already you booked in this quarter? And how would it be in the last quarter? And about pre-provisions, I see you have released TRY 178 million pre-provisions? And how will be your -- for the last quarter, will you reverse more? Or what will be your strategy about provisioning side considering that you expect some increase in your NPL coverage in the fourth quarter?

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [8]

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Thank you, Ovunc. Let me first start with the second quarter -- second question. In terms of the pre-provisioning amount, as you can see on Page 5 in the presentation, this quarter, we released only TRY 65 million. And after this release, outstanding pre-provisioning amount came down to TRY 852 million. As for Q4, our intention is not to touch this pre-provisioning. So as of year-end of 2019, we would like to keep this TRY 852 million pre-provisioning untouched just to create additional flexibility for future P&L adjustments and P&L purposes.

So yes, in the Q3, we had TRY 65 million pre-provisioning credits, but we don't want to release further in Q4. And if needed, some of them may be released in 2020 or beyond. But still, our NPL coverage ratio will further increase during Q4, but despite no touch to pre-provisioning, despite additional NPL coverage ratio increase, thanks to a very strong improvement in our net interest margin levels, we are expecting to deliver relatively strong P&L in Q4 so that our cumulative average ROA number will be above than 8%, which is slightly lower than 7% as of September.

And for the first question, in terms of the NPL recognition, we have a similar number in terms of the TRY 46 billion NPL recognition announcement of BRSA. Our share is in line with our market share within the cash portfolio within the -- compared to our market share and cash lending. We have a similar number out of this TRY 46 billion. Some of them reflected in Q3, but most of them, let's say, will be reflected in Q4. So thanks to this additional NPL inflow from Stage 2 to Stage 3, NPL ratio will continue to increase. We are saying that our year-end NPL ratio will be above than 6%. And due to this migration from Stage 2 to NPL, the share of Stage 2 will come down to 10% to 11%.

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Operator [9]

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We have another question from Simon Nellis from Citibank.

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Simon Nellis, Citigroup Inc, Research Division - MD and Director [10]

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I mean just following up on the asset quality question, I mean Stage 2 loans also went up quite a bit in the third quarter, actually they've been steadily going up for the last 4 quarters. I mean obviously, you're going to see migration into Stage 3 in the fourth quarter. But what's the outlook for further growth in Stage 2 loans going forward? And a related question would be how much provisioning will be required when you migrate loans from Stage 2 to Stage 3 in the fourth quarter? What -- would you expect your risk cost to go up significantly in the fourth quarter?

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [11]

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Thank you, Simon. In terms of the asset quality, in terms of the Stage 2 loans, the increase from second quarter to third quarter, as you can see on Page 11 at the left-hand side of the presentation, the increase in the quarterly Stage 2 came mainly from the increase in past due 30-day loans. Especially in the second quarter, the share of past due 30-day loans were relatively low because of the restructuring. However, during this third quarter, some of those loans migrated from restructuring to past due 30-day loans as they are not in a position to perform their obligations properly. And the increase in past due 30-day loans was the main driver of Stage 2 increase from second quarter to third quarter. And most of the -- all of the NPL migration during Q4 will come from this part within the Stage 2 as you can expect. And in terms of the cost of risk, this quarter it was 204 basis points. We are expecting that number will further increase during Q4 on a quarterly basis. But anyway, because of the denominator effect and because of the relatively good level of collection performance, we don't -- we expect our 2019 net cost of risk number not to be above than 200 basis points. So it will be lower number, 200 basis points for the average of 2019, even though the Q4-specific net cost of risk will be higher than that. The average of 2019 will not be higher than 200 basis points net cost of risk.

And for the next year, I mean the budget, as we discussed, is still under discussion. We are making internal meetings. We are taking the opinions of different head office divisions, and we are trying to understand the asset quality dynamics also. The budget is not ready yet. We will share our expectations once the entire budget process is finalized. But what we can say as of today is next year, given the fact that macro dynamics will be relatively better in terms of GDP, in terms of economic activity, et cetera, in our base case scenario, we expect not to see further net cost of risk ratio increase for 2020 compared to 2019. I mean at this stage, let me do not speculate about NPL ratio and Stage 2 ratio expectations because it is under still discussion. We don't have a firm number and guidance yet in terms of NPL ratio and in terms of Stage 2 ratio, but given the fact that macro dynamics will be relatively in good shape in next year compared to 2019, especially in the second half of 2020, we expect to see a recovery in our net cost of risk ratio. Therefore, average 2020 net cost of risk, hopefully will be a lower number than the average of 2019.

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Operator [12]

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(Operator Instructions) We have a question from Sevim from JPMorgan.

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Mehmet Sevim, JP Morgan Chase & Co, Research Division - Associate [13]

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Just a follow-up question on the previous fee question, please. It's quite interesting that cash loans are still the main avenue of growth. Is this because you're simply lending at healthy levels? Or are you still able to introduce new fees to customers as you're catching up with your competitors? And on a related note, I also wanted to ask, have you done any preliminary analysis of the new caps on the merchant fees? And if so, can you share that with us? And finally, sorry if I missed that, but can you please elaborate also on the higher effective tax rate this quarter? Is this just a reversal of previous gains? Or is there any other reason?

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [14]

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Thank you, Mehmet. So let me first start with the effective tax rate question. Actually, yes, this quarter, it came strong at 32% almost. But if you look at on a cumulative basis, I believe cumulative tax rate came in line with the tax regime in Turkey, which is almost 22%. So in this sense, on a cumulative basis, we are much or less in line with the overall tax regime. But second quarter was lower-than-usual rate. But this quarter is above than the usual rate. And this is all related to mark-to-market gains coming from securities portfolio because of the additional increase on a quarterly basis coming from our security portfolio, our available for sale portfolio. This quarter's quarterly effective tax rate came higher than the normal course.

Related to merchant fees, of course, the regulatory change on the merchant fees also creating some negative impact in terms of the P&L, but annual number of this regulatory change is less than TRY 100 million per year. That's the overall impact of merchant fee regulation change in our situation. This less than TRY 100 million is the annual number. So you can make the calculations accordingly.

I just forgot to note your first question. Can you repeat the first question again, Mehmet, please?

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Mehmet Sevim, JP Morgan Chase & Co, Research Division - Associate [15]

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Yes, sir. I was just asking on the growth of cash flow and fees. Is this because you're simply lending at healthy levels? Or are you still able to introduce new fees to customers? And actually, how does it compare to your, maybe status as a state bank? Are you -- will you be able to grow cash loan fees further from these levels?

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [16]

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Thank you. Thank you, Mehmet. Well, actually, given the fact that our GPL lending loans, especially during third quarter as well as our residential mortgage loans, we offer to our customers were relatively attractive in terms of the interest point of view. Those rates were relatively lower compared to especially private peers. However, what we decided to do is that negative gap between ideal interest rate, let's say, versus realized interest rate was compensated by higher fee charges as a prerequisite and as a precondition. We decided to sell additional fee packages coming from insurance side, coming from different products, et cetera and the ones who try to benefit from those rates as a precondition have to buy both products. And those are the main reasons, actually, why still we are having almost 29% quarterly lending growth -- fee growth. So that was the story behind this cash loan-related fee growth and for your information, those fees are not one-off. These are not one-off loans or one-off -- sorry, these are not one-off fees where we are charging the customers in the beginning of lending process. These fees have to be charged as long as the life of the loan is staying within our balance sheet.

Let's say that a customer is applying for a 5-year residential mortgage, then during this 5-year period of time, the customers have to renew, let's say, every year their fee packages or they have to renew every year their insurance packages. So it is a precondition of the contract we are signing with the customer. And that was creating additional fee income for us. But of course, those key numbers are not sustainable. And next year, it will be normalizing back again. But the good thing is, thanks to this dedication and thanks to this commitment on the fee income side, fee part is no longer a weak part of VakifBank story. I mean this is my eighth year in the VakifBank Investor Relations part. One of the best parts of VakifBank's story is if we focus on certain areas, if we identify a problem, we may find a solution in a very quick period of time. I remember in the beginning of my IR career compared to other banks, we were relatively weaker in terms of net interest margin and profitability. That problem, for example, no longer on the table, especially during the periods between 2015 to 2018, we were one of the most profitable Bank of Turkey.

Thereafter, we had relatively weaker in terms of capital and solvency ratios, thanks to especially active role of our relevant head office divisions and in this sense, we would like to name and support the agent because he was also a bit active in terms of those capital transactions. We also solved this problem. And again, we are very happy to see that VakifBank is solving another structural problem, which is coming from the fee side. So my point is, our DNA and our structural mindset, let's say, once we are identifying the problem, we are pretty good in terms of creating new solutions to those problems. And fee side is another example of this situation, simply.

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Operator [17]

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We have one last question from Alan Webborn from SG.

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

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Could you just talk us through where you are in terms of TL sort of loan yields on the stock, how you see the trends into Q4 and also on the deposit side as well? So just give me an idea of the dynamics in terms of how much things have come down and what you think the dynamics will be further in Q4, that would be really helpful.

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [19]

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Thank you, Alan. Actually, although net interest margin will be the strongest in terms of quarterly performance in Q4. So Q4, our net interest margin will be definitely the best quarterly net interest margin compared to first 3 quarters of the year. It is not easy to quantify the numbers in terms of loan yields and deposit costs, but what we can tell to you at this stage, during Q4, Turkish lira loans yields will be slightly lower compared to third quarter numbers. So in this sense, there will be a decline in our Turkish lira loan yields in average in Q4 compared to Q3. But on the other hand, there will be also more decline in terms of cost of funding on the Turkish lira side, driven by lower cost of Turkish lira deposits and the decline in the cost of deposits will be significantly higher compared to the decline in our Turkish lira loan yield contraction. And therefore, net-net, our TL cost split will increase on a quarterly basis. But at this stage, I am not in a position to quantify those numbers.

And at this stage, if we don't have additional question on the audio, we have questions on the website. And to operator, [could you] -- we may continue with the questions on the website.

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Operator [20]

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Yes, we have no further question on the conference call, so you can continue on the written questions.

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [21]

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The question on the base line. Alex Dooler from Debtwire. He is asking it has been said that if you decide to call your TRY 500 million 2025 Tier 2 subordinated bond in 2020, you will not issue a new bond following this due to market conditions. If this is true, how will you ensure strong liquidity and equity in the business following the call of those specific bond.

Thank you. Same question also came from -- [Frank] from New York City. [Clint] from [North Abbott], Clint is also asking about the same bond. Can you please comment on VakifBank '25 bond? When do you expect to make a decision and announcement on the call?

Thank you very much, guys. In terms of this specific bond, we haven't yet decided a firm decision. We are still at the same position compared to one quarter ago. And we are still making assessment internally in terms of the advantages and disadvantages of deciding on call or not to call and/or any other options. So hopefully, in the month of December, you may hear from our side in terms of the decision we are coming up with. But at this stage, we are talking internally, we are talking to regulator, and we are talking to DCM guys of different banks, and we are evaluating all possible solutions. But at this stage, there is nothing new compared to our stance and approach from where we were a quarter ago.

And in terms of the first question, yes, as of today, the indicative pricing of a new fresh Tier 2 in dollar doesn't make sense because the price increase is not at acceptable level. We would like to be a regular issue on the DCM side through different products and ideas. But unfortunately, as of today, indicative IPT level for a fresh 10 Non-Call 5 Tier 2 is not attractive prices. Therefore, we don't have appetite for a fresh issuance, but it doesn't necessarily mean that we will not call it. It may still be possible. So we are still evaluating all possible options at this stage. And hopefully, in a short period of time, we will inform properly and equally all investors and third parties at the same time.

And we don't have any further questions on the website. And operator, if we don't have any audio questions, I just want to thank to everybody for the patience and interest on VakifBank.

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Operator [22]

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Yes, there is no further question on the conference call as well.

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Ali Tahan, Türkiye Vakiflar Bankasi Türk Anonim Ortakligi - Manager of International Banking & IR [23]

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Okay. Thank you. Thank you, everybody, and hope to do more conference call going forward altogether. If you have any follow-up questions or if you have any questions in your mind, please do not hesitate to contact with me and/or Nihan and other IR team. We are at your disposal at any time. And thank you very much your -- thank you very much for your time during this Friday afternoon. Thank you. Thank you very much.

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Operator [24]

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