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BBVA: HYPERINFLATION ACCOUNTING IN TURKEY (ANÁLISIS BANCO SABADELL)

After yesterday’s closing bell, BBVA confirmed that it will apply IAS 29 to its Turkey accounts (adjustments for hyperinflationary economies) effective 01 January’22.
According to this regulation, IAS 29 should be applied when a series of quantitative and qualitative criteria are met. Among the former, hyperinflation accumulated over the previous 3 years must exceed 100%, a threshold Turkey passed in Fen’22. Among the qualitative criteria there are several, such as widespread use of a strong currency instead of the local currency. The IASC has not yet declared the Turkish economy hyperinflationary, but it did include the country on a watchlist on 26 April. Nevertheless, BBVA has decided to apply the standard in advance.
Hyperinflation accounting requires an initial recognition, in this case as of 01 January (with an impact on the balance sheet) and a subsequent updating of accounts (balance sheet and P&L) with the evolution of inflation each quarter. The initial impact (non-monetary assets minus non-monetary liabilities) means an increase to net assets (and therefore on TE and CET1). This positive impact continues to be updated with inflation over subsequent periods.
Over the subsequent periods, every quarter a negative adjustment on P&L is included in order to reflect the loss of purchasing power from the net monetary position (monetary assets minus monetary liabilities) according to inflation over the period, and a positive adjustment of the same amount on assets. The impact from this update is therefore neutral on TE and capital. Furthermore, some items on the P&L account are reclassified (inflation-linked bonds) and all the different lines on the statement are updated with inflation for the quarter.
The impacts, to be reflected on 2Q’22 results, are the following:
 Initial revaluation on the Balance Sheet: the BV of Garanti is increased by € 254 M (to € 3.343 Bn), with an impact of around +0.7% on TE (€ +0.04/sh.) and +19bps on CET1 (from 12.07% in 1Q’22).
 Restatement of the P&L statement: the Net Profit generated in Turkey in 1Q’22 (€ 249 M) is adjusted to a € -75 M loss, thus recognising an impact of € -324 M on Net Profit (€ -880 M gross from the adjusted net monetary position vs. € -550 M BS(e) in 2022e). Thus, this means 1Q’22 Net Profit for the consolidated group of € 1.33 Bn (-19% vs. reported), subtracting -3pp from annualised RoTE (to ~12.7%). We should point out that the calculations have been made with a 49.8% stake in Garanti (vs. 86% starting with the TOB, which ended in April’22).
 These adjustments have been made using the exchange rate as of 31 March (16.28 TRY) and Turkey’s official inflation as of the end of March (+22.8% vs. +35.6% accumulated in May’22). Assuming an inflation rate of ~+60% for the full year (BBVA’s base-case scenario), the bank expects the contribution from Garanti’s earnings in 2022 to be marginal but with a positive impact on TE.
 Despite this, BBVA confirms the targets’24, which imply a RoTE of 14% (vs. ~12% BS(e) assuming a € 600 M contribution from Turkey (and 10.5% excl. this contribution). In our view, it will be difficult for BBVA to offset Turkey’s ~1.5pp contribution to the RoTE, and it will be necessary for the country to solve its economic situation in order for BBVA to be able to deliver.
MARKET IMPACT
Our Net Profit’22 estimate assumes a gross impact of €-550 M from hyperinflation on PBT, vs. the €-880 M impact announced in 1Q’22, which is expected to increase over the next few quarters. In this regard, if we assumed the guidance of a marginal contribution from Turkey in 2022e (vs. our estimate of € 754 M), the group’s Net Profit’22 BS(e) would fall by -14% to €~4.1 Bn, with a similar impact on EPS, in accordance with a 50% payout policy. In this scenario, we estimate the DPS’22 at € 0.309/sh., which still implies a 7% yield.
The hyperinflation accounting was already expected by the market, and thus, we do not expect a very negative impact on the share price today. In the medium-term, once earnings expectations are adjusted, we expect this aspect to cease to be a drag on the stock, which recently hit a low of € 4.15/sh. this year, having performed in line with the sector YTD (-14%), despite not having an exposure to the war conflict in Ukraine. Th stock is trading at a P/E’22 ratio adjusted for hyperinflation of ~6.6x and a P/TE of 0.6x (vs. 7.7x and 0.7x for peers), and thus, we believe that the Turkish risk is largely priced in. In this regard, the discount could narrow somewhat, although we believe that, beyond the accounting impact, management and value creation is very complicated in a hyperinflationary economy, meaning that we do not expect BBVA to outperform until the Turkish economy begins to show signs of stabilisation, and we continue to prefer Santander.