The FINANCIAL -- TBC headed into 1Q15 in perfect financial health and with ambitious growth and efficiency targets. The completion of the Bank Constanta merger significantly enhances TBC’s prospects in the retail and SME/micro segments, which the lender views as key mid-term growth pillars.
Still, the macro shocks that emerged in 4Q14 are creating some discomfort – the economy’s deceleration may cause a temporary slowdown in asset growth, while the lari depreciation implies a higher cost of credit risk related to FX loans, SP Advisors, full-service investment house commented.
“We expect growth in core earnings to steadily outpace operating revenues, but a temporary increase in the cost of risk (projected at 2% this year) will restrain net income growth to the 14-15% range in 2015 vs. 28% last year. ROE is poised to temporarily fall below the bank’s 18% target (we project 16.6%), solely on a surge in equity following last year’s IPO. With the lari depreciation resulting in a one-off increase in RWA, TBC will see its Basel 2/3 Tier 1 ratio decline to close to 11% in 2015, still well above the NBG’s 8.5% minimum. The bank is also determined to maintain its 25% dividend payout ratio unchanged. We lower our price target for TBC shares to USD 14.4/DR from USD 19.9/DR, to reflect the effects of the lari depreciation – both net income and equity will be squeezed in USD terms. With 22% upside, we maintain our BUY recommendation”, agency said.
A successful 2014 puts down a solid base for 2015…
Last year was a year of accomplishments for TBC Bank. The lender raised USD 96 mln in new equity in a USD 256 mln IPO in June (the remainder represents proceeds to selling shareholders) – the largest ever Georgian placement. The bank grew assets 21.8% yoy, outpacing the sector’s 19.4% growth rate, bringing its market share by assets up to 26.3%. TBC also strengthened its retail banking position – it entered 2014 as the No. 1 bank by volume of deposits from individuals, and in the past year also became the largest retail lender. As at end-2014, TBC held a 33.7% share of total retail deposits (vs. 33.1% in 2013) and accounted for 29.7% of retail loans (vs. 27.7% in 2013). Finally, TBC completed the acquisition and consolidation of Bank Constanta after settling a dispute with Constanta’s former minority shareholders. The full merging of the two banks’ IT systems, HR operations, and finance operations was practically completed in 2014 and the bank officially announced the merger in late January 2015.
…but macroeconomic headwinds pose a challenge
Agency believes that this year will be more challenging for Georgia’s banking sector. “The country’s economy has been facing headwinds since September 2014 that are likely to persist though end-2015. Regional turmoil prompted by currency depreciations and declines in household purchasing power in Russia and Ukraine is the key factor driving Georgia’s weakening macro environment. A major external shock resulted in a material slowdown of economic activities (GDP growth slowed to 0.5% yoy in January from an unimpressive 1.6% in 4Q14), a deterioration of external account positions (the merchandise trade deficit widened to USD 1.67 bln in 4Q14 from USD 1.45 bln a year before), and a lari depreciation to GEL 2.22/USD currently from GEL 1.75/USD at end-September 2014. Overall we project Georgian economic growth at 2.1% in 2015 and an end-2015 exchange rate of GEL 2.3/USD”.
Lari weakness is a headache, but not yet critical for the banking sector
The lari depreciation will likely drive a deterioration in loan servicing discipline for un-hedged businesses and households that borrowed in FX. Georgia’s largest banks have already claimed they will address that risk by extending loan maturities as needed to prevent a significant hike in debt servicing-to-income ratios for borrowers. Looking forward, the recent FX rate shock will likely discourage many borrowers from taking FX risks and should favor (at a cost) a de-dollarization of banks’ balance sheets, agency said.
As of January 2015, 63% of the sector’s loan portfolio was FX-denominated.
“With regards to possible loan losses, we expect they won’t be critical thanks to a traditionally strict debt servicing discipline among borrowers and tough loan servicing enforcement instruments in place. Georgian banks also boast strong income-generating capacity (ROE of 15.8% in 2014) and are sufficiently capitalized (Tier 1 of 13.6% under Basel 2 standards, above the 8.5% minimum) to absorb reasonably high loan losses without any risk of breaching minimum regulatory thresholds.
In terms of liquidity, the key consequence of the lari’s weakening may be a temporary desire by households to withdraw deposits in local currency and convert them into USD. GEL deposits shrank 4% mom in January, which is still broadly in-line with the seasonal trend based on past years. Still, the stability of GEL deposits will be a key marker and should be watched closely over the next couple of months”.
“The key long-term implication of the lari depreciation is a material increase in the loans-to-GDP ratio for Georgia, which we see reaching 50% by end-2015 (up 7pp yoy), in-line with the CEE average of 50-55%. A hike in the loans-to-GDP ratio usually implies weaker sustainable (i.e. without compromising quality) loan portfolio growth in the long-run. That said, the Georgian economy should still see rapid growth – we project nominal GDP growth at 11% over the mid-term which means banks can enjoy decent and comfortable annual growth of 14-15%, following this year’s deceleration to 12-13% (in FX-adjusted terms)”.
TBC’s healthy growth will continue, but the pace may wane
“We expect TBC Bank will see another year of decent growth in 2015, even though the pace of loan book expansion will not match last year’s outstanding 25%. On the demand side, growth will be constrained by a slowdown in economic activity – businesses and households may revise borrowing plans against the uncertainty over future income. On the supply side, the bank should toughen underwriting standards for FX facilities and have a higher rate of loan application rejections. We see TBC’s loan book adding 29% yoy, but c. 15pp will result from FX effects, with 14pp of real growth. TBC should slightly outpace the sector thanks to its reinforced sales capacity following the rebranding and introduction of new loan products (mainly for the retail and SME/micro segments) at former Bank Constanta branches. Looking forward, we see TBC’s loan book growth at 16% (net of FX effects) over the next 5 years, below the 20% rate targeted by management”.
“In 2014, TBC Bank moved to further diversity its loan portfolio – the share of corporate loans fell 5.9pp yoy to 33.2% as retail loans added 4.2pp to 45.0%. The SME and micro lending segments lagged only slightly behind retail loans and their combined share increased 1.7pp yoy to 21.8%. The retail and SME/micro segments will remain the key focus for lending activities at TBC and will drive loan book growth over the mid-term. The ambitious merger with Constanta and an ongoing rebranding campaign is a timely event that will allow TBC to grab more market share in a concentrated but competitive banking sector. The lender’s micro division has also been reinforced by the acquisition of GEL 39 mln in micro facilities from ProCredit Bank Georgia (1.1% of TBC’s total end-2014 gross loans and 14.4% of its micro facilities) with a view to strengthening its customer base. In terms of the corporate portfolio, we see its share sliding from 33.2% in 2014 to 27-29% over the next 5 years. We believe the bank should start investing more to maintain its foothold among corporates, even though it treats the corporate segment as non-core”.
No constraints on the funding side
“TBC enjoyed steady inflows of customer funding last year, but the pace still lagged loan book growth. Client accounts were up 15% in 2014 (vs. a 27% yoy increase in the loan book), taking the net loans/deposits ratio up 10pp yoy to 107%. Apart from deposits, loan book growth was supported by a post-IPO increase in equity and wholesale funding”.
“We see customer deposit growth maintaining last year’s pace, with real growth at 15-16% yoy (+33% yoy including the FX effect). The Georgian banking sector continues to enjoy an environment of low deposit interest rates and TBC has maintained yields on term GEL deposits unchanged for more than the past 6 months. Meanwhile, the bank upped FX deposit rates 0.5pp along the curve. TBC continues to enjoy strong customer loyalty and has the privilege of keeping rates on retail term accounts consistently below those of Bank of Georgia, its key competitor. Despite that, TBC has been outpacing BoG substantially in terms of deposit base growth over the past couple of years. TBC’s average deposit rate stood at an all-time low of 3.7% in 2014 vs. 5.5% in 2013. The rate may rise 20-30 bps in 2015, according to our estimates, on a general increase in interest rates due to macro shocks”.
“Wholesale funding remains easily available for TBC from IFIs – the bank is one of the country’s few high-quality corporates capable of raising and digesting sizable funding facilities. The bank recently secured a three-year GEL 100 mln loan from Asian Development Bank, the largest-ever local currency loan granted to a Georgian bank. Accessing a GEL-denominated credit facility is a step towards balance sheet de-dollarization, although we admit that sizable GEL wholesale funding is unlikely to become a consistently available option in the near future given that Georgia’s financial market remains tiny. Wholesale loans (incl. from IFIs) will remain dominated by USD facilities in the coming years. TBC’s deposit structure is gradually shifting towards GEL facilities – 69% in the 4Q vs. 71% in 3Q – but this trend may be temporarily interrupted due to heightened FX volatility and a continued gradual lari depreciation. We see the ratio of customer deposits/total liabilities remaining at close to 75% in the long run”.
NIM to compress slightly on tough competition for high quality borrowers
“TBC kept its interest spread unchanged yoy at 8.2% in 2014 and managed to increase the NIM marginally to 8.5% in 2014. Management has acknowledged that the NIM will remain under pressure and sees it compressing 0.5-1.5pp over the mid-term”.
“As mentioned above, TBC’s average deposit rate shrank 1.8pp yoy to 3.7% in 2014, a historical low. Further downside potential is limited, in our view. In the short-term, the lari depreciation and a related nervousness among households will reverse the trend temporarily (+20-30 bps in 2015). In the long-run, inflation of 4-5% (a level we believe is sustainable) will prevent any major downward adjustment in the deposit interest rate. Loan rates slipped to an average 14.9% in 2014 (-1.7pp yoy), roughly in-line with the decline in deposit rates. Since Georgian banks boast healthy liquidity, competition for quality borrowers will remain high and lending rates should continue to be affected by downward pressure. Nevertheless, heightened risks related to a slowdown in economic activity and a lari depreciation will likely force banks to pass some of the incremental credit risk onto non-prime customers via a markup in interest rate. We see TBC’s NIM declining 0.3pp in 2015”.
Cost of risk to rise on the lari depreciation
“TBC’s end-2014 loan quality was beyond any concern – NPLs stood at a mere 0.5% of the loan portfolio while NPLs and restructured loans totaled 3.7%, also reasonable. However, the current year will be challenging, in our view, owing to the deterioration of the macro environment.
The lari depreciation will affect TBC’s cost of risk in two ways: (i) through an increase in the rate of restructurings and (possibly) defaults by un-hedged borrowers, and (ii) the bank will have to allocate additional provisions on FX-denominated NPLs recognized in past periods in order to keep the NPL coverage ratio unchanged”.
“TBC’s loan portfolio is dominated by FX loans which made up 63% of the end-2014 gross book. Most TBC retail and SME borrowers that were granted loans in foreign currencies are exposed to FX risks – only 22% of individuals and 17% of SMEs have income linked to USD. The ratio is much higher for corporates – about 51% have revenues linked to USD. We expect TBC will address the problem via loan restructurings for both individuals and businesses, mainly by extending maturities. Since we expect Georgian growth to pick up pace already next year, the bulk of borrowers that may face difficulties in 2015 will restore their debt-servicing capacity in the near future”.
“To account for the negative effects of the lari depreciation we have revised our cost of risk assumption for TBC from 1.5% to 2.0% in 2015 and 1.8% in 2016-2017. We believe all credit losses related to the current economic jitters will be revealed over the three years and fully booked.
ROE to return to 18% target in 2016, no change in dividend policy.”
“We see TBC’s net income rising 14% yoy in GEL terms in 2015, but dropping 8% in USD terms. The sole driver of the sharp deceleration in net income growth in GEL terms (from 28% yoy in 2014) is an expected increase in the cost of risk to 2.0% from last year’s 1.6%. Looking at the next 5 years, we project average annual net income growth of 18%.”
“TBC’s ROE is poised to drop to 16.6% in 2015 from last year’s 18.1%, by our estimates. The decline is solely due to the increase in equity following the bank’s IPO in June last year. Over the mid-term TBC’s equity will only be affected by net income retention, and we expect ROE will recover to 18% in 2016, assuming a 25% dividend payout ratio”.
“TBC’s capital base remains solid, with end-2014 Basel 2/3 Tier 1 of 12.4% and a total CAR of 15%. This is still a decline from Tier 1 of 13.6% and total CAR of 16.7% last September, which was driven solely by FX moves. We see the lari weakness and real balance sheet growth boosting risk-weighted assets 35-40%, well below the projected 14% growth in equity. This may temporarily bring the Tier 1 ratio close to 11% before a recovery next year when we expect the lari to stabilize. TBC has reacted by lowering its Tier 1 ratio target to 10.5% from 12.5%, still above the NBG’s floor of 8.5%. The effect of the Constanta merger on capital will be largely neutral – TBC will no longer deduct investments into TBC from its Tier 1 capital, but this will be offset by an increase in RWA. We see the total end-2015 CAR at 14.6%, safely above the 10.5% minimum threshold (13.5% minimum including a capital buffer). The total CAR may be further enhanced with new subordinated loans, which we believe the bank will seek this year. Management has said they will not revise the 25% dividend payout ratio despite the higher depreciation-related pressure on capital, and we believe this policy is unlikely to be changed.”