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Edited Transcript of VTBR.MZ earnings conference call or presentation 8-May-20 11:00am GMT

Q1 2020 Bank VTB PAO Earnings Call

Moscow May 31, 2020 (Thomson StreetEvents) -- Edited Transcript of Bank VTB PAO earnings conference call or presentation Friday, May 8, 2020 at 11:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Dmitry Pyanov

VTB Bank (public joint-stock company) - Member of Management Board

* Leonid Vakeyev

VTB Bank (public joint-stock company) - MD, Head of IR

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Conference Call Participants

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* Alan Ramsey Webborn

Societe Generale Cross Asset Research - Equity Analyst

* Andrey Klapko

Gazprombank (Joint Stock Company), Research Division - Senior Banking Analyst

* Andrey Pavlov-Rusinov

Goldman Sachs Group Inc., Research Division - Research Analyst

* Elena Tsareva

BCS Financial Group, Research Division - Senior Banking Analyst

* Mikhail Ganelin

Aton LLC, Research Division - Senior Analyst of Finance, Information Technology, Transport

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Presentation

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Operator [1]

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[Interpreted] Ladies and gentlemen, we are happy to welcome you at VTB Group's conference call to disclose IFRS financial results for the first quarter of 2020. This conference call is going to be recorded. Over to Mr. Leonid Vakeyev, Head of IR.

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Leonid Vakeyev, VTB Bank (public joint-stock company) - MD, Head of IR [2]

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[Interpreted] Good afternoon. We are happy to welcome you at our conference call to disclose the first quarter 2020 financial results. Our speaker today is a member of the management board, Mr. Dmitriy Pianov. We are going to start with a quick overview of our financial results and then happy to take your questions.

Please be reminded. We have this conference call in both Russian and English and the English languages is provided simultaneously. We are going to take questions regardless of the language they are asked in, in the order of their arrival. Over to Mr. Pianov.

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [3]

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[Interpreted] Colleagues, I'm very happy to welcome you at our conference call to disclose IFRS financial results for the first quarter of 2020 for VTB Group. I hope everyone on the line stays in good health and feels well. This is the most important thing in the turbulent times of today. We have prepped a quick deck for you. I'm going to take you through the most important slides so that you could check out further details in the annex or in the Q&A session.

Traditionally, many corporations start their quarterly disclosure with an overview of their modus operandi change given the pandemic, explaining how many remote rec stations they have set up and so on and so forth. We have prepped all the dedicated data as well. Given the novelty factor of these particular parts -- this particular part of the deck is not particularly high. We decided to put them into the annex, starting from Page 18. Should you have any specific questions, I will be very happy to address those in the Q&A session.

Now I'd like to take you to Page 1 of the presentation to explain our key performance highlights for the first quarter. We have net income of RUB 39.8 billion, which is 14% less than the same quarter of 2019. And that is in line of 9.5% return on capital -- 9.5%. And our performance for the first quarter is [dubey] on the one hand, we have a very strong dynamics in the key banking income. On the one hand -- on the other hand, the financial results have demonstrated certain anomalies related to either market volatility in the first quarter or -- well, effectively manifest the credit risk of non-financial asset impairment, I'm going to explain that in a short while.

Starting with the strongest side first. Take a look at Page 1. Here, you can see double-digit growth in our key performance indicators, such as the banking income like net interest income is up by 15% year-on-year to reach nearly RUB 120 billion. And the net interest income is also reflected in the net interest margin as well. In Q4, it was 3.5%. As you can see, the top right-hand and as at the end of first quarter 2020, the net interest margin is as high as 3.6%, which is 40 basis points up vis-à-vis the first quarter of 2019.

Another important element of our banking income is net commission income, it's up by 48% year-on-year to reach RUB 28 billion. The key growth driver here, as we explained at the full year call, is the bancassurance product, which we transformed and that was manifested in the first -- in the [first] quarter 2020 as well as in the fourth quarter 2019. That allows us to recognize upfront the bancassurance commission, which was not the case in the first quarter 2019.

Let's proceed to the other income line. Optically, it's up by 12%. But here, we have the first anomaly, reflecting the macro environment of the first quarter. Within the other income line, we have pretty much a netting exercise of one-off positive vis-à-vis one-off negative factors.

Here, within the other income line, we have the revaluation of our current FX position, open FX position in the amount of nearly RUB 36 billion. At the same time, we have a negative RUB 38 billion that's the loss from devaluation of our noncore assets. And the dominating factor within this revaluation exercise is our asset, which is a sporting center, sporting complex, hotel and the apartment complex, which altogether called VTB Arena. That represents 46% of the impairment within the [quarter].

Our logics in this exercise is as follows. This asset is valued at fair value under certain financial model, which is based on the income and the income yielding lines within the financial models is mainly about the number of sporting events or concerts held at the stadium. And the revenue from these events as well as selling advertisement at the stadium. Judging from our experience, the ban imposed against any mass sporting gatherings or cultural events would last for a relatively longer time. So we are reflecting a reduced volume of such events in 2020 as well as in 2021. This translates into lower expected revenue stream from such events and lower sales of advertising. That means we'll be slower in achieving our financial model's targets.

Judging from international experience, the mass event ban seems to be the #1 measure in terms of efficiency as a containment response to the COVID-19 and those countries that are getting out of their lockdown, still maintaining the massive and then -- and that serves to prove that our assumption is valid. Hence, a question may arrive, whether we would exclude the possibility for similar impairment exercises in 2020 and the following quarter as well. We cannot exclude that because the assets affected so far, only those valued at the income-based approach. Now as soon as other events unfold, we may see a negative revaluation for the assets valued at the comparative written based methods.

So here we have RUB 163 billion of net operating income, as you can see on the left-hand side, and we proceed to another anomaly, which is provision charge for that and other assets. Provision charge in the first quarter for VTB Group stands at RUB 45 billion. That's tripling the number year-on-year. And it's 1.5% of the cost of risk. Within the additional provision charges, we have a new element added. That is called the so-called macro adjustment. According to IFRS 9, the new IFRS 9 effectively suggests that we increase provisions in our portfolio to corporates and individuals should the macro environment deteriorate. So within the EUR 45 billion of provision charge, we have RUB 10 billion of the macro adjustment. Out of the EUR 10 billion of the macro adjustment, RUB 7 billion translate into the macro adjustment for the corporate portfolio and RUB 3 billion represents the macro adjustment for retail loans.

Now in order to set up such a provision charge, we needed to have a certain assumption on how the macro environment is going to unfold in our key country of operations, which is Russia. Well, at this point in time, this is an extremely challenging exercise, frankly speaking. The validity of macro forecasts and their value -- well, the values in our forecasts are important but the pace of their reviews is also quite high. As we proceeded with a RUB 10 billion macro adjustment, we based their judgment on the assumption of a moderate decline of the country's GDP by about 2%, with the average oil price standing at $35 per barrel and the FX standing at RUB 74 per dollar on the year average. Now should the following quarter demonstrate that our assumptions had been too optimistic, we may allow for the possibility to increase the macro adjustment looking forward.

Now another line here, we have staff and administrative expenses. Here, we have an increase of 5.6 percentage points year-on-year, with the staffing and administrative expenses line standing at RUB 64 billion per quarter, including the tax, profit tax, regards to the net profit of RUB 39.8 billion, which is exactly the number I mentioned at the beginning of the presentation.

We can proceed now to Page #2. Our balance sheet. Well, I'm going to focus only on the loans. Loans to individuals, they're up by 4%. As you can see, these are not affected at all but by the ruble FX dynamics vis-à-vis the dollar. They are pretty much all in rubles and that's pretty much the market increase in the first quarter of 2020. Now loans to legal entities, here, we have a larger share of FX-denominated loans and we have a 6% increase, which includes adjustment for FX revaluation or a 1% decline if the FX revaluation is excluded. So that's slightly less than the market growth.

Now let me comment on Pages 3 and 4. Here, we would like to demonstrate, and it's very important to us, whether the credit risk has been reflected and triggered in the accounts for the first quarter. We have a clearer understanding and that's our opinion that the COVID-19 related crisis is effectively the credit risk based crisis for the banking industry. That's why we focus too much on that factor. And I would like to share my view on the asset quality as well as the provision charges, and effectively, how we reflect in the provision charge, the asset's quality and whether we see a manifestation of the credit risks and the affected industries or in retail loans or corporate loans for that matter.

Now Page 3. Here, we have an important statement to take the definition of affected industries as outlined in government regulations, you can see the list of affected industries on the right-hand side of Page 3. We have also calculated the share of our corporate credit portfolio, which is exposed to the affected industry. That translates into 3% of loans to legal entities, as you can observe in the right-hand side bottom, that's important. And one other important point. So far, we have not seen any manifestation of any deterioration in our borrowers or [their forms]. There is an increase of about 12% that's in the NPL side, but that's FX-based change. The new share, the share of new NPLs is only a few in the legal entity segment, and it's 4.9% versus 4.7% end of last year.

Now allowance for loan impairment is rather comfortable at 6.4%. And before you ask, I can tell you that we are going to provide a simplified approach to macro adjustment forecasting for VTB Group in case our assumptions on the economic decline prove wrong. As I have mentioned, the provision charge includes RUB 10 billion of the macro adjustment, which is based on the assumption of 2% GDP decline. In a very simplified -- in a simplified way but with a high degree of precision, I can tell you that should the GDP of the country come down 7% year-on-year, the provision charge would change pro rata in a linear fashion. Like if it's not 2%, our current assumption, but rather 4%, then the macro adjustment would be effectively doubled, roughly doubled, looking forward in the following quarters, should that scenario unfold.

Now an even more important metric, which would allow you to keep a close eye on the asset quality of our credit portfolio is the so-called migration through different stages, buckets, that's Page 4. We decided to provide you with a more granular breakdown of the stages and legal entities as well as individuals: Stage 1, Stage 2 and Stage 3. And clearly, once Stage 1 moves down to Stage 2 or migrate into Stage 2, that is a clear manifestation of deterioration in credit quality. Like if a legal entity or an individual approaches us, requesting restructuring exercise at their own initiative or as sponsored by the government, then they would migrate from Stage 1 to Stage 2.

And it can -- and the same is -- it's pretty much the same exercise for legal entity as well as individuals. And you can see that Stage 2 is somewhat growing, while Stage 1 is somewhat reducing. And given that it's a lifetime loan forecast provisioning rather than 12 months provisioning, well that's still insignificant impact in Q1, but we expect a more significant impact in the second quarter and an even more significant impact in the third quarter once corporate accounts arrive. So that would be a better indicator of the credit quality for the legal entities.

And then Page 5, regulatory capital and capital adequacy. Please be reminded that we mostly manage N20 indicator for VTB Group, that's total capital adequacy, and that is the object of adjustments and the targeted 11.5% according to the regulations. As of the 1st of April 2020, the N20 number stands at 12%, as you can see on Page 5. The actual number of 12% actually includes the regulatory forbearance measures, which the Central Bank had announced earlier. Now if you take all the -- if you don't round that up, so it's 11.98% as of the 1st of April. So we used this first forbearance measure, which is fixing the FX rate.

The Central Bank allows the banking industry to fix the FX rate as of the 1st of March 2020, which is say about RUB 67 per dollar. Had we not applied this forbearance measure, we would have seen a reduction by 0.08%. So instead of 11.98%, we would have got a 11.90%. One other forbearance measures is the withdrawal of prudential offers for mortgages. That's an additional 0.13% in our N20 capital adequacy. So if that were to be canceled, it would be 11.77% rather than 11.98%.

In terms of further measures with the Central Bank getting softer -- harder on the capital adequacy, we say what we have discussed during the last goal we had on the full year of 2019, we considered different buffers for different tiers of systemic importance rather than a single one or the macroprudential buffers for the mortgages and such like adjustments. Well, the Central Bank has officially decided to postpone introduction of this measure for an uncertain period of time. Anyway, we are protected to a degree from further deterioration on the capital adequacy side.

In terms of the regulations getting softer, VTB Group has such particular hopes on implementation of Basel 3.5 for retail loans as well. Clearly, that project, that draft regulation is not yet made public on the Central Bank's website, but our internal models allow us to model the effect as of the 1st of August 2020. And the material effect from that would be releasing the capital and improving our capital adequacy by 0.35%, 0.35 percentage points. No further changes in regulations are expected in the course of this year.

Now the following Slide #6, following slide in this section, 2020 guidance. You can see that certain elements of our former forecast announced in February when we disclosed the full year results remain unchanged. We see from what we had previously, net interest margin that's confirmed as well as cost-to-income ratio, that's also confirmed. It's quite possible to achieve these. Why so? The net interest margin of 3.4%, which is on par with the previous year depends mainly on the key rate as set forth by the market regulator. And we see only a limited risk of the interest -- the key rate notched up. Our forecast provides for a reduced key rate looking forward into the year-end. So that further supports our net interest margin.

On top of that, the Central Bank as well as the Deposit Insurance Agency have announced reduced contribution to the deposit insurance system, which is effectively a supporting measure for our net interest margin. Cost-to-income ratio, about 40%, that target is also confirmed. We demonstrated 39-plus percent in the first quarter, so that pretty much continues the trend of the previous year. Nonetheless, the cost of risk, uncertainty as well as further impairment of our noncore assets allow us to suggest that 2 important metrics would be under review. The cost of risk, which we had targeted at less than 1%, and we have 1.5% as at the end of the first quarter. Well, obviously, we'll be expecting further manifestation of the prices on the part of our borrowers in the course of Q2 and Q3. And obviously, the net profit, which is affected by the cost of risk as well as further impairment of noncore assets, which has quite high probability, frankly speaking.

We would also be happy to share our updated assumptions, our view on the market, for both loans to legal entities and individuals' retail loans. Now we have 2 forecast scenarios. The basic scenario suggests that the country's economy is going to start recovery and growth in the third quarter this year, while the stress scenario only suggests that the recovery would be started in the fourth quarter 2020, end of 2020. That materially changes the market dynamics for both retail and corporate loans. Retail loans still have a positive growth of plus 2% in the basic scenario, while in the stress scenario, they demonstrated negative growth of 3%.

While loans to legal entities have pretty much the same trend of minus 1% and that was based on the FX ruble to dollar assumptions in the stress scenario and the devaluation, the exercise and the stress scenario, which would keep our portfolio [in turn]. Given the weak market in terms of future growth for both legal entities and retail loans, we would be able to grow, in fact, above the market, given how low the market is.

And finally, before I proceed to your questions, let me explain our situation with the dividends. As you know, the Central Bank of Russia has recommended that we postpone the General Meeting of Shareholders to September. That's when the shareholders are to vote on the dividends. And here's our vision. In order to comply with all the regulatory provisions, we need to decide on the dividends about 1 month, 2 months before the general meeting that is about August. So formally speaking, the management team has not withdrawn its previous recommendation to pay 50% of last year's net profit.

Now what could affect any potential changes in the management team's position? Well, first and foremost, it's about further manifestation of the credit risk and the country's economy as well as impairment of nonfinancial assets. And one other important thing is modeling of the capital adequacy for VTB Group after all the forbearance measures had been canceled in the future because all Central Bank's announcements suggest saying that these forbearance measures are temporary. At the same time, we have discretionary measures, discretionary tools available for us to reduce the dividends under certain conditions.

On top of that, all government support plans that have been introduced or are being designed to be introduced in the future could affect negatively our capital position in the future. So our current version is to adjust the preference shares owned by -- dividends for preference shares owned by the government. The dividend for such shares could be adjusted by the amount of government support programs that have been designed and verified, of course, for their affected industries.

We clearly understand that the profit number for 2020 would be skewed as compared to what we'd call a normal year before the crisis, at least by the amount of impairment and by the amount of the provision charge. So our target is to go through 2020 with a strong core performance, fully safe on the provision side, having done provisions against the industries and borrowers who demonstrate negative performance on the solvency, maintaining the capital and have least damage to the shareholders when it comes to the dividend. So the management team is working towards that end. And I believe the upcoming quarters are going to demonstrate to us how strong is the crisis for the banking industry, whether it's going to be less significant or more significant than the previous crisis we had.

In my quick presentation, I have tried to outline that VTB is well prepared in terms of the credit risk upcoming, given the provisions already set up as well as generating core banking income, which could be required to finance further provision charges or further impairment.

Thank you for your attention. I'm ready to take your questions now.

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Questions and Answers

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Operator [1]

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[Interpreted] (Operator Instructions) And our first question comes from the English line from Mr. Alan Webborn from Societe Generale.

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Alan Ramsey Webborn, Societe Generale Cross Asset Research - Equity Analyst [2]

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Could I just ask a couple of questions. I mean, firstly, could you just sort of confirm that my understanding is right that what you're saying is that the RUB 10 billion provision within the RUB 45 billion was related to a 2% GDP contraction. If that GDP contraction was [4%], you'd need to take an extra EUR 10 billion. Is that correct? That was the first question.

The second question was in terms of the -- when you talked about the preference dividend, did you mean that the preference dividend could be adjusted in -- I didn't quite understand what you meant in terms of adjusted for the government help given to affected industries. Could you just explain that a bit more? And would the intention be still to keep parity between the preference and the ordinary dividends, if you were to do that? That would be the second question.

And the third question was in terms of the moratoria that are on offer in various parts of your business? Is there any sort of day 1 impact on your net interest income? Are we going to see that in Q2? And that's it.

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [3]

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[Interpreted] Thank you for questions. Regarding your first question, yes, your understanding is absolutely correct. The current macro adjustment is RUB 10 billion. That's within the RUB 45 billion of provision charge. That is based on the assumption of 2% GDP decline in the course of 2020. And to put it simply, there is a linear correlation should the GDP come down further, let's say 2x 2% or 4%, then we'll have the macro adjustment doubled in the following quarter. So on top of the RUB 10 billion, we'll have another one for RUB 10 billion, and there will be a total of RUB 20 billion. So your understanding is correct.

Now your second question, the dividend. While net profit under IFRS for 2019 stood at RUB 201 billion, our dividend policy provides for 50% payout ratio so that we distribute to shareholders, the dividend preceding from the principle of equalizing dividend yield. So that means RUB 101 billion are to be paid as dividend, of which about -- hold on. About RUB 80 billion would be due to the government via different classes of shares, including preference shares and their shareholding and ordinary shares. So if everything were going to plan, we would have used these numbers.

Then comes the new factor of the government introducing support measures to a number of affected industries or borrowers. Those government support programs could result in further losses, which we had not envisaged in the past. Taking the government support plans already announced, those losses are mostly focused on payment, call it interest payment holidays. We have the federal law on interest payment holidays for individuals. So that loss could be dozens of billions of rubles under certain scenarios. By the time of the decision-making, that -- August, so we would be looking to reduce the government's share of the dividend by the amount of the loss that VTB Group and the bank incurs by -- because of the government support programs, which will be known by the time when we make our decision on the dividend.

So if we assume that the loss related to government support plans would be RUB 20 billion, then the RUB 80 billion of dividends due to the government would be reduced by RUB 20 billion should the government agree. So we'll pay RUB 60 billion rather than RUB 80 billion as compared to the original targets of RUB 80 billion.

So -- and your third question now -- we do allow that certain moratorium, certain industries could have a deferred effect on solvency of legal entities. And that could vary depending on the size of a particular legal entity and their liquidity cushion available. So you can't really draw any generalist conclusion. That's exactly the uncertainty we have for Q2 and mostly Q3. That's our understanding, mostly Q3. Because in Q3, we'll be getting corporate accounts for Q2, reflecting the drops in revenues and any issues with solvency of our borrowers. So that effect could come. That's a possibility and a manifestation of this possibility is already factored in into the cost of risk modeling looking forward and better understanding would arrive by the time of the third quarter, okay?

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Operator [4]

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[Interpreted] Our next question comes from Andrey Rusinov, Goldman Sachs.

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Andrey Pavlov-Rusinov, Goldman Sachs Group Inc., Research Division - Research Analyst [5]

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[Interpreted] Andrey Pavlov-Rusinov from Goldman Sachs, speaking on the Russian line. I have a few questions. First of all, I'd like to discuss the interest payment holidays and how you calculate the potential negative effect of that, please explain. You have given us a target of dozens of billions rubles. So what assumptions is that based on -- for the small businesses or for the retail loans? And again, why is the effect because of the lower interest payments in the first 6 months of the program? Or is that about deferral of interest payment at -- to the time of the end-of-life for the loan. So the NPV for the loan would be getting [down].

And one other question is about your slide, that's one of the last slides in the deck on your SME support programs. You have quite large numbers in new loans, more than RUB 250 billion, if I calculate that right. So that's a very material portion of your SME portfolio, representing about 25% -- nearly 25% of that. So how do we understand that number? And why such huge demand for such programs. I understand that other banks are suggesting the demand for such programs is much less significant. Please answer these questions, and I'll have more for you after you have answered.

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [6]

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[Interpreted] Regarding question one, the financial effect from the interest payment holidays is related to Federal Law 106, a very recent federal law, which dates back to early April. That federal law would result in most negative impact from individuals, retail loans and related interest payment holidays, like according to the law should the person affected lose 30% or more of their income, and they have a mortgage or a car loan as well as consumer loan. So effectively, even those who have relatively small exposure, they are entitled to cut out as they [lock] off, so 6% of the interest payment, which are deferred to the loan's end of life.

So that equivalently translates to a 6% at 0 rate under a mortgage, a car loan or a consumer loan. So that's dozens of billions rubles, which is about the change of the NPV as you have rightly put in your question, and that is especially about longer-term loans, say, mortgages. Based on the assumption of a certain volume of applications and that's an expert opinion so far, how large that demand is going to be where the borrowers are potentially eligible. I hope you understand my answer. So basically, yes, you're right, that's change of NPV for the 6% of the exposure.

Now your question -- second question about our support to SMEs. Please take a look at that slide. The number of RUB 264 billion, which you are saying is quite high, but that's VTB Bank and VTB Group support plans. That's effectively about a request for gradual restructuring and that's a very flexible tool to meet the demands of the borrowers. Now that's a number that has been approved and that's not the government support plan, as you can see that reflected higher just in the chart above. I clearly understand that the credit risk, which I have talked upon, is going to be spread in a very much uneven fashion across different industries and segments of the corporate portfolio, mostly small and medium enterprises are going to be affected. And their share, their relatively large share of flexible restructuring request and that's more flexible than the government support program. So that number effectively reflects the higher risk, the high credit risk in this portion of the credit portfolio.

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Andrey Pavlov-Rusinov, Goldman Sachs Group Inc., Research Division - Research Analyst [7]

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[Interpreted] I have a few follow-up questions about your expectations. I know they are uncertain, but nonetheless. So could you comment on the pandemic in general and how that is going to affect your net fee and commission income for the upcoming couple of quarters as well as some regulatory pressure on acquiring commissions. And one more thing about your higher expenses, the bank's higher expenses. Recently, you announced some measures like going you're to pay reduced bonuses to your management team. How that is going to affect your staff and administrative expenses line and whether there are other measures available to save on that line, and that supports the net [profit of 10%].

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [8]

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[Interpreted] Let me take that one by one, starting with net fee and commission income. Here's our situation. The regulatory pressure you are referring to in your question, relates to those parts of our fees and commissions that have never been strong in our portfolio, and we only have a single-digit market share here. So they're going to be a negative impact but it's not going to be material when it comes to our accounts. Requiring, say, and a lower commission for Internet base [declining], that would be less than RUB 1 billion, which is not material for the Group.

A more important driver here is reduced business activity in the country. Our stress test of the net fee and commission income demonstrate that we consider the share of insurance commissions as well as CIB commissions and commissions on capital markets. Now our stress test still demonstrate double-digit commission income growth year-on-year, thanks to improved products that we offer and thanks to the full year effect of the new bancassurance product present in our portfolio as compared to 2019, where the revised bancassurance product was only available in the fourth quarter [alone].

Generally speaking, the negative impact will be there, but it will be less than RUB 10 billion, just a few billion rubles. So we still maintain a expectation of double-digit net fee and commission income growth year-on-year, given the drivers I have just explained.

And could you please remind me of your following question?

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Andrey Pavlov-Rusinov, Goldman Sachs Group Inc., Research Division - Research Analyst [9]

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[Interpreted] The staff -- the operating expenses.

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [10]

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[Interpreted] Okay. Here, we have a very diverse environment of expenses with variable trends. Like we are going to have some lines, which will be effectively offering further room to improvement and for improvements and staff and personnel expenses is going to be such aligned. So we're going to save on that further in 2020. At the same time, we invest heavily into IT upgrades and the IT-related costs are exposed, quite unfortunately, to the main currencies such as the U.S. dollar, where we have a negative result here because the FX-denominated expenses are going to be revaluated in the ruble terms. On top of that, we have an expected expenses for hygiene and sanitary measures. These are not material, but still.

So given the current situation, we're going to save on training, business travel and all sorts of forum and meetings, starting with the St. Pete's Economic Forum and the like, we're going to save on cleaning services because our staff is operating from home and we'll be saving on lease and technical support. But nonetheless, we will not be able to see a reduction in operating expenses because we are going to invest into IT upgrades. We have not suspended any upgrade projects. We have not suspended any investments related to improving the multichannel offering and improving the IT landscape and technical and technological overhaul and upgrades. So we would assume a 5% growth year-on-year in ruble terms, 2020 vis-à-vis 2019. That's pretty much in line with what we had in the first quarter.

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Andrey Pavlov-Rusinov, Goldman Sachs Group Inc., Research Division - Research Analyst [11]

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[Interpreted] This has been very helpful. And just a quick follow-up. Regarding your fair value loan portfolio. Q1 was very volatile in terms of commodity markets and also there is currencies. Nonetheless, we did not observe any major effect on your P&L from such loans. Could you please explain why is that? You have corporate loans but which of these are reflected in the fair value line? And why didn't you see any major movement in that line, unlike many of your peers?

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [12]

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[Interpreted] Okay. Let's consider which loans we have as part of the fair value line. We have a special class called FOZs, the federal loan bonds, which are related to the Bank of Moscow's [summation]. Given that we own a majority of that issue, we account for that as a loan. So there is no built-in derivative and we don't see any major volatility. So effectively, [federal] loans -- it's not about any particular single criteria, like payment of the principal and the interest because of the structure of such loans and because of the parameters of particular borrowers, so these have not manifested as due for impairments, and they have not lost in value in the first quarter.

This doesn't mean, however, that it's going to stay like that in the following quarters. Nonetheless, we believe our fair value loan portfolio is very healthy. Given that it is dominated by the FOZs, the federal bonds.

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Operator [13]

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[Interpreted] And the next question comes from Mr. Andrey Klapko from Gazprombank.

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Andrey Klapko, Gazprombank (Joint Stock Company), Research Division - Senior Banking Analyst [14]

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[Interpreted] Dmitriy, Leonid, I have 2 questions from my side. My first question relates to the increase in corporate loans of negative 1%, which you have announced as your stress case as well as base case, do you provide for any increase as part of the government support plans, such as 0 interest loans or loans to the affected industries? And the -- because the Central Bank of Russia is still suggesting a positive growth in corporate loan portfolio in the course of 2020.

And my other question relates to the payment holidays. I'm wondering how much you'd be losing for your mortgage portfolio and your consumer loans portfolio, any estimate would be very helpful.

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [15]

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[Interpreted] Okay. Responding to your first question, yes, the assessment of market decline does factor in our expectation of loans to legal entities under government support plans. With the exception of loans to pay salaries, the demand for particular additional credit support programs is rather weak. In a large degree, that is explained by strong regulations and low flexibility to adjust these products for the demands of particular borrower. So the answer to your question is, yes, in a nonmaterial volume.

My answer to your second question on the financial effect, the payment holidays, interest payment holidays, here's the situation. The loss of interest income throughout the lifetime of a loan, let's say, consumer loan. And our understanding that would be about RUB 18 billion, given the loan portfolio, subject to potential restructurings standing at around RUB 600 billion. So you can check these 2 numbers and understand the shares. The share of losses, share of the portfolio.

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Andrey Klapko, Gazprombank (Joint Stock Company), Research Division - Senior Banking Analyst [16]

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[Interpreted] And question is does this include mortgages as well?

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [17]

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[Interpreted] Out of the RUB 18 billion I mentioned, RUB 12 billion are related to mortgages because of the longer lifetime of the loan and the larger size of mortgage loans.

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Operator [18]

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[Interpreted] Next question comes from Mikhail Ganelin, Aton on the Russian line.

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Mikhail Ganelin, Aton LLC, Research Division - Senior Analyst of Finance, Information Technology, Transport [19]

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[Interpreted] Mikhail Ganelin speaking. I have a question regarding the dynamics of your net interest margin. I'm looking at this chart, and I see that your corporate deposits has seen a much lower interest rate in the first quarter, it's very much down. Why is that? And that's my first question.

My second question related to the same subject. The Central Bank currently has the key rate at 5.5%, so I would assume 5.0% or less by the end of the year. It's going to come down. Hence my question, what's happening to your net interest margin? Did I get it right that your expectation is to see the net interest margin to drop significantly in the following quarter? Do you see any opportunity to reduce your cost of funding equally -- it's rather about 2021 than 2020, which is your comfortable level of net interest margin, given that the key rates would be rather low?

And one other question. What's your share of credit portfolio? Has a variable rate attached?

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [20]

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[Interpreted] Let me take your questions one by one. Now why the deposit rates coming down in Q1? That's a combination of factors. On the one hand, we see a lower dollar interest rate, given that the Fed has taken the key rate down. And secondly, since dollar-denominated liabilities are being pushed out of our balance sheet, we can take a look. We had started well ahead, and we had been below the market, and that had been a dedicated effort from our team.

We had been pushing out this kind of liability from our balance sheet, given limited demand for this type of currency on the loan side and given a more expensive cost of funding for ruble-denominated funding, let's say, a swap deal take a term deposit in dollars and you swap and you pay to the deposit insurance agency on top, so that comes at a cost. Now I'm going to follow through with that strategy as soon as the -- as long as the demand remains like this unless something happens, but the dollar rates will be pushing out the relatively expensive dollar-denominated liabilities.

And one other factor is increased share of demand deposits. As compared -- in Q1 as compared to the end of year 2019. Well, the measures announced by the Russian government to introduce taxation or increase the tax rate for consumer deposits. That has resulted in withdrawal of deposits. And then the government came up with a clarification that this measure would be introduced only as of the 1st of January next year. But in the meanwhile, many deposits -- many term deposits have been converted into demand deposits. And then again, we moved our rates in line with the key rate of the Russian Central Bank, sometimes acting preemptively since we could understand what's the Supervisory Council of the Bank of Russia would do on the key rate. So these are probably the 3 drivers, which contributed to delay in cost of funding.

Now does this mean that our net interest margin is confirmed on par with previous year. You can say whether this is too conservative. Well, our base case provides for a lower key rate of the Central Bank until the end of the year and before the end of the year, and that is going to support our net interest margin, of course. And another supporting factor here is the change that kicks in, in the third quarter because we will have to pay less to the deposit insurance system, which would further reduce their cost of funding for new deposits. At the same time, this is offset by the fall in net commission income -- by the fall in commission income because of the payment holidays, interest payment holidays, as we mentioned. So this combination of factors suggest that we maintain rather than increase our net interest margin target.

Beyond 2020, our strategy does provide for such a development. In fact, we need to be successful in our strategy of going digital so that VTB Bank becomes your daily bank for daily use for retail and corporate clients alike. This is supposed to result in increased demand deposits in our portfolio. Even the key rates expectations on the downside as well beyond 2020, we still maintain the tower net interest margin would be flat vis-à-vis our forecast because the lower key rates would result in lower cost of funding. But it's not taking that cost of funding to 0. And while our success in the improvement areas I just outlined and the increased share of demand deposits would result in current accounts as well would allow us to support the interest margin until the end of 2020 and beyond that.

Regarding your other question about the share of loans with variable rates, floating rates. Well, this only applies to loans to legal entities. In ruble terms, that's 54%. 54% of the portfolio and 45% in dollars and 77% in euro and other currencies.

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Operator [21]

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[Interpreted] The next question is coming from Elena Tsareva, BCS Global markets.

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Elena Tsareva, BCS Financial Group, Research Division - Senior Banking Analyst [22]

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[Interpreted] I have a few questions, and let me start with the first one. Could you clarify, like in the first quarter, you have RUB 450 billion in derivatives positions, so is that related in any way to your financial result in the first quarter? So please explain -- please comment on the structure of your position on the derivative side.

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [23]

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[Interpreted] Elena, it's a very straightforward question. Given the increased volatility in commodity and FX markets in Q1 2020, we saw an increase of the positive and negative volatility in the derivatives. This is absolutely P&L neutral, frankly speaking. So once the asset side and the liability side and the derivatives grow due to increased volatility, it's still [been the] P&L neutral.

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Elena Tsareva, BCS Financial Group, Research Division - Senior Banking Analyst [24]

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[Interpreted] And as far as the impairment on noncore assets are concerned, you are suggesting that further impairments could be coming in the following quarters. Could you give more insight into that? What do you consider to be noncore on your balance sheet? And could you comment specifically, which particular industries are -- and special risk?

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [25]

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[Interpreted] Okay. Let me give you a more detailed insight into our noncore assets. It's not about loans. When I say noncore, this doesn't mean any particular loans to any particular noncore industries. When I say noncore, we mean nonfinancial assets, which result from the crisis of 2008, 2009 or related to the liabilities of the Bank of Moscow. So that's land, that's development projects, real estate development projects, effectively the collateral of defaulted loans. And why you call these nonfinancial assets? These are not related to any securities or financial instruments or loans for that matter. They are mostly investment-type real estate property.

Now as of the end of Q1, we revaluated only those assets who -- which are based on -- which proceed from the income-based model because we have an understanding how to model the revenue flows looking forward and how to calculate the fair value, what we have not done as yet is devaluating the noncore asset value, where we have the comparative model, like when we have an analogous asset and based on that analog, we evaluate our asset as well. Why? Because there is no analog but there would be analogs coming up in the future.

So what's important is how fast an asset could be sold given the activity in the market and the property market and how many transactions there are, we see risk attached to land plots, which is land plots in the Moscow region, closer and further removed from the cities -- from the city of Moscow. As soon as we get an understanding of the price of similar land plots and once we have an understanding of how much the land market in the Moscow region has come down, we do not exclude the possibility of devaluating these land plots downward.

The size could hardly be estimated at this point, but our stress test demonstrates it's dozens of billions of rubles.

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Operator [26]

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[Interpreted] Next question comes from [Ilyar Fumichol], [Jens Capital].

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Unidentified Analyst, [27]

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[Interpreted] [Ilyar Fumichol], speaking on the Russian line. I only have one, and that relates to the dividend policy. You're suggesting you have one idea is about reducing the dividends for preferred or preference shares by the amount of your losses related to government support programs, do you allow for any change in the dividend on ordinary shares? Or is that a no-go for you?

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Dmitry Pyanov, VTB Bank (public joint-stock company) - Member of Management Board [28]

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[Interpreted] I have tried to explain how they're going to approach the dividend discussion. Let me repeat it. The dividend size calculated earlier could potentially be affected by the following. One is the amount of losses pertaining to the government support programs to the affected industries or borrowers. That's one thing.

One other thing is our model and exercise for capital adequacy for VTB Group, given the forbearance measures and they withdraw, or implementation of all the provisions and in the capital adequacy calculation and offers and also the impairment as well. The regulator prevents us from paying the dividend, should we fail to meet the adequacy ratio targets. In which case, we would be obliged to recalculate the dividend, in which case the dividend for ordinary shares could also be affected. In fact, we are going to try to ensure no negative impact on -- to the holders of ordinary shares. But excluding that is not an option given the severity of this currently unfolding crisis.

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Operator [29]

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[Interpreted] And we don't seem to have any further questions. Ladies and gentlemen, since we don't have any further questions, please, over to the speakers for some concluding remarks.

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Leonid Vakeyev, VTB Bank (public joint-stock company) - MD, Head of IR [30]

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[Interpreted] Thank you to all participants of this call. As Dmitriy put it at the start of our conference call, I hope that you stay in good health. And so do your close ones. So please follow all the lockdown rules as we do. We are going to stay in touch with you by all means, and we'll be happy to respond to any of your questions. Looking forward, please don't hesitate to reach out to our IR team or the PR team, in case you have any further questions. Pretty soon we're going to disclose our 4 months operating results, so please follow our updates. Again, thank you for participating in our conference call. Thank you, and goodbye.

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Operator [31]

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[Interpreted] This concludes our call today. You may now hang up.

[Portions of this transcript that are marked Interpreted were spoken by an interpreter present on the live call.]