Georgian Banks - Resilient Enough to Survive Challenging Times

At the behest of the cautious local regulator, Georgia's banks front-loaded provisions in 1Q20 to a greater degree than pretty much any global peers, posting the equivalent of over 7% annualized cost of risk. While Georgia itself has been pretty mildly impacted by Covid-19, the pandemic has had a devastating near-term impact on the country's crucial tourism industry. Importantly, however, the economic impact should be mitigated by multilateral financing support, with $1.5 bln in public sector support already committed, which should plug most of the holes in the budget and current account. After an initial sharp selloff in the spring, the local currency has also partly recovered. Georgian bank stocks have had a tough run in recent weeks, but we think that the selloff and current low valuations look overdone. Profitability should pick up in 2Q20 - we think both banks can remain profitable this year with around 10% ROE and without the need for capital calls. While a key unknown is when and how quickly tourism will rebound, our 6% GDP contraction bakes in much of this year's tourism business being lost. Our base case is for a strong rebound in the economy and the banks' earnings in 2021, albeit not back to pre-crisis levels, but one implying around just 3.5 2021 P/E multiples for both. Taking a 12-month view, we think the risk/reward mix at the current prices looks favorable, and we have a BUY on both stocks, with a GBP14.00 TP for both banks. > Economy battered, but not broken. The Georgian economy looks set to contract by around 6% this year, due to a large degree to lost tourism/transport revenues, which account for around 20% of GDP. On the positive side, the Georgian lari has recovered much of its spring losses, and fiscal stimulus should largely be covered by borrowing from IFIs. We see the economy rebounding in 2021, with 5% GDP growth.> Banks have taken substantial up-front hits. Both banks have taken substantial up-front provisioning in 1Q20, which we think covers them for all but a very severe further Covid-related economic shock. We expect the two banks to remain profitable in 2020, posting around 10% ROE, with earnings recovery coming through in 2021-22, by which stage ROEs should be around 16-18%. Given their important role in providing credit to the economy, we think the NBG will retain a pragmatic approach to these banks' capital needs, which at this stage look manageable even in the case of additional provisioning being required. > Risk/reward favorable, BUY. While earnings visibility remains low, we see the risk/reward for both banks as favorable at current levels, with heavy front-loaded provisioning done, the prospect of profitability recovering from 2Q20, and the two stocks trading around a 3.5 2021 P/E, well below historical averages. Near-term, we are keeping an eye on the economic recovery and the lari, as well as October's parliamentary elections, but we think the depressed share prices offer a good entry level on a 12-month-plus horizon. We have a BUY on both stocks.