- Chairman’s Statement
- CEO’s Statement
Extract from 2017 Annual Report
This is expected to be the last BGEO annual report. The forthcoming demerger of the Group, announced in July 2017, reflects both the end of an era and the start of a new one. The Board and management team are convinced that we are on the right strategic path. In fulfilling our fiduciary duties to you, the Board regularly examines strategic options. We elected to split the Group into two independent businesses: the Bank and an investment vehicle, which we call Georgia Capital.
If we do it right, we could be at the eve of a major jump in value creation. We will have created three large groups, all quoted on the London Stock Exchange, each with their own Board, management, and strategic logic. It is an opportunity to deliver better service to our clients, better development to our employees, more growth of the corporate sector of the country, and finally significant financial return to our shareholders. Each management team and the Boards will focus on the development of one kind of business.
In my letter, I have traditionally followed a set structure. First, a few words on Georgia; then on the strategy of the Group; and then on people – Board and top management. Irakli Gilauri, our CEO, and others will expand on the detail of the businesses.
Economically, Georgia is doing exceptionally well in a difficult region and world. I believe three key factors make the Georgian situation positive in the long term:
1. Macroeconomic stability. Prudent monetary and fiscal policies have led to almost 5% real GDP growth during 2017. This has allowed the first ever issuance of offshore local currency bonds by Bank of Georgia.
2. Many healthy and developing sectors, in line with Government policies:
a. The financial sector, of which we are part
b. Infrastructure development, especially in the power sector
c. Healthcare, where we participate in the universal healthcare access policies of Government
d. Finally, and more long term, the Government has a programme to improve education, and to make the public sector more efficient.
3. Good Government
a. Strong anti-corruption policies. According to Transparency International, Georgia has maintained its ranking as a low bribery environment — on a par with many European Union member states
b. Georgia’s ease of doing business ranking was 9th out of 190 countries in the world, in 2018, up from 16th last year. Here again an excellent result
c. Fiscal development. The corporate tax reforms, effectively eliminating corporate income tax for all re-invested or retained earnings, started at the beginning of the year and have already yielded GEL 600-650 million cash buffer for corporate re-investment in the first year on the policy’s adoption. The reform efforts also envisage capital market development and pension reform. Georgia is on the right path, and these are developments which take time
d. Reduction of the fiscal deficit. The Government is determined to reduce its fiscal deficit, on the back of reducing non-essential current spending. The 2018 draft budget is an illustration that Government delivers on its commitments; as was the case in 2017.
The proof of this economic progress lies in the fact that we were able do the first ever Lari Eurobond issuance and that Moody’s has upgraded both Georgia and Bank of Georgia to a level two notches below investment grade. The strategy of creating a “mini Singapore” within the region is moving forward day by day. Singapore was not created in one day.
Politically, things are as calm as they can be with Russia. The New York Times reported last year on Russia’s attempts to provoke Georgia on the boundaries of Abkhazia and South Ossetia – all true; but we also see that Russia is doing more business with Georgia, specifically in terms of transport links and increased tourism flows. Elsewhere, Turkey remains Georgia’s largest trade partner, whilst the development of trading links with Iran are likely to take more time than we originally thought. At the same time, Georgia signed a free trade agreement with China and now has access to a market of 1.4 billion consumers, with zero tariffs, without additional customs fees and without any transition period.
Internally, it is important to remember that Georgia is still a pluralist and free country. It is taking the habits of democracies, albeit with one party dominance: historically the UNM party, and Georgian Dream now. We have a Government which is supportive and has very competent public servants. Finally, investors should not forget that the United States and the European Union exercise strong external checks and balances – they do not want to lose Georgia as a rare democratic success story. They showed their confidence in the country by granting Georgia visa-free entry to the 26 countries of the Schengen Area.
The thinking behind our decision to break-up the Group into two separate businesses, each expected to be quoted on the premium segment of the London Stock Exchange, deserves to be explained.
It did not come from the analysis of a conglomerate discount, and the expectation that we would see a valuation bump because of the transaction. The value creation boost for the two entities is derived from our belief that we will run them better— with higher ROE and higher growth. The logic is simple: first, complexity creates confusion, simplicity creates focus. Second, each entity will be freer to pursue its own growth strategy without worrying about “the Group”. We can already see the effects of this decision. One example is our insurance subsidiary which has already signed a number of distribution agreements with banks other than the Bank of Georgia. This might not have happened if we had decided to stay in the “previous structure”.
Both entities have substantial potential of earnings and sales growth.
The Bank is repositioning its portfolio away from straight lending to corporates which require capital and see their margins diminishing. It behooves us to find innovative ways to serve the corporate segment much more profitably. We are also moving into the high net-worth segments, where we can attract wealth from the region. We will continue to reduce costs. Finally, digital technologies offer us an opportunity that we have not yet exploited. The Bank has a very good management team with Kaha Kiknavelidze as its leader, and they are at work on this strategy. I will become Chairman of the Bank and this will be my only Board appointment.
The non-banking business within BGEO will become an investment company — Georgia Capital — which will include real estate, energy, utility, beverages, and insurance. It will also have listed stakes in the healthcare business and the Bank. The value proposition to investors is “the best vehicle for emerging growth opportunities in Georgia, selected by people with unsurpassed understanding of the local landscape, and managers/entrepreneurs”. Georgia Capital will be run like a private equity fund with one exception. The interest of its investors will be aligned with those of its “Partners”. In fact, its CEO will be paid exclusively in shares vesting over six years, and his executive team will have a similar compensation structure. Irakli Gilauri will leave the Group and the Bank, to head this company as Chairman and CEO. The Board is made up of old hands, such as David Morrison and Kim Bradley and a number of new recruits: Caroline Brown, William Huyett, Massimo Salvadori and Jyrki Talvitie.
The healthcare company, GHG, is a stand-alone entity today, with its own Board and separate stock market listing. It has much potential that you can read about in its own annual report.
Board quality and composition have been one of my main preoccupations: we have an opportunity to build a new Board for Georgia Capital and to reinforce the Boards of the Bank and the healthcare company. We have tried to prioritise skills and experience as well as gender diversity. We need Board members who will spend time on the ground in Georgia. We have attracted Cecil Quillen to the Bank’s Board and are actively seeking an additional member. All of our Board members are T-shaped, capable of broad judgement and all bring a speciality to the company. The composition of the two new Boards and the experience and qualifications of their members are set forth on page 19 of this Report.
Unfortunately, at the outset, we will still have only one woman on each of our boards. Our goal is to correct that yesterday. We are still seeking to achieve the diversity targets at board level expected of a company of our size, and as chairman, I make this a personal priority. It has been a war for talent.
Corporate culture and human capital have increasingly become the cornerstone of our success. We would not be able to breakup if we had not developed capable leaders to take over. One of the key components of our talent or human resource development strategy has been our incentive system. Its intent is to incentivise management to create value on a long-term basis: more than 85% of management’s compensation is in shares that vest over a three-to-five-year period – discouraging quick earnings temptations.
This year we have moved further into changing our corporate culture in every one of the entities. We want to go from solo performance executives to executives who thrive on teamwork. We have instituted personal development programmes starting at the very top and cascading to the lower level of the hierarchy. Meritocracy and trust are what we aim to achieve. This starts with top managers’ behaviour and talk. It is reinforced by training programmes which teach both self-development, how to give and receive feedback, as well as how to dialogue rather than impose. All this will not be enough if good behaviour is not encouraged and bad behavior not tolerated. The Board and I take a particular interest in seeing this through.
Before closing, I would like to thank Irakli Gilauri for his leadership as Chief Executive Officer. During his tenure at BGEO, Irakli has taken a Georgia quoted bank and transformed it into the organisation with multiple businesses which we have today. He did not do it alone. He attracted and developed many executives who all lead their own businesses today, and are developing in turn a set of new leaders. His final act will be to achieve the break-up successfully. The Board of Directors and I are truly grateful for his leadership over the years he has been with the company.
Extract from 2017 Annual Report
In what is expected to be my final letter to BGEO Group shareholders I would like to talk about three subjects:
1. The outstanding performance of the Group
2. Simplicity is a key ingredient to our future success, which drove our difficult decision to demerge
3. Our determined and high-achieving Board
BGEO Group delivered another extremely strong performance during 2017 that resulted in record profit for the year of GEL 463 million, and earnings per share of GEL 11.61, an increase of 11.5% year-on-year. Group revenues increased by 23.7% to GEL 1.1 billion. Book value per share at the end of 2017 was GEL 65.22, up 15.2% year-on-year. This reflects excellent performance from our Banking Business as well as strong momentum and strategic delivery from our Investment Businesses, which were supported by Georgia’s strong macroeconomic performance and business outlook.
In the Banking Business, 2017 was characterised by strong franchise growth in Retail Banking operations, particularly in the fourth quarter. This reflected the continued strong performance of our retail business in all segments and an increase in retail lending during the year of 29.3%. In addition, in 3Q17 we completed our three-year programme to reduce concentration risk in our Corporate Bank and consequently started to deliver corporate lending growth in the last quarter of the year. Loan yields have remained stable, and net interest margins have therefore stayed robust at 7.3%. Costs have remained well-controlled, whilst ensuring continued investment in building an increasingly strong customer franchise. The Banking Business cost of risk ratio in 2017 was 2.2%, in line with our medium-term cost of risk expectations, and a significant reduction from 2.7% in 2016. In addition, we have continued to improve our asset quality and provisions coverage ratios. The Return on Average Equity in the Banking Business continued to improve, and stood at 25.2% for the year, and 27.8% in the fourth quarter.
We have again delivered on all of our key strategic priorities. 2017 revenue growth of 17.5% was particularly supported by strong Retail Banking franchise growth, where revenue increased by 24.4% and customer lending continues to grow at more than 20% per annum. This offset the anticipated decline in the Corporate Investment Banking loan portfolio, as we wound down the banking relationship with a small number of significant corporate borrowers, earlier in 2017. Importantly, this helped us to make strong progress in reducing concentration risk in the Corporate Investment Banking, and we lowered the concentration of our top ten corporate borrowers to only 10.7% of our lending portfolio. We have now exceeded our targeted rebalancing of the retail/corporate portfolio mix to further improve the return profile of the Banking Business. Retail Banking now represents 68% of the Bank’s customer lending and Corporate Investment Banking represents 32%.
In addition to the strong retail lending growth, Retail Banking made strong progress in implementing its customer-centric approach with the launch of its new loyalty reward programme Plus+ in July 2017, and continued investment in digital growth. Our product to client ratio also improved from 2.0 to 2.2 during the second half of 2017. In July 2017, we won the exclusive right to modernise public transport payment system in Tbilisi and continue as the sole provider of the Tbilisi Metro’s payment support systems for the next ten years. In addition, Solo, our premium banking brand, has continued to deliver strong growth momentum, with customer numbers increasing to 32,104, up 66.6% over the last 12 months. Solo is on track to achieving its target of 40,000 Solo clients by the end of 2018.
The improving growth and strength of the Georgian economy continue to support asset quality. In addition to the reduction to 2.2% in the cost of risk ratio mentioned above, we were able to reduce the ratio of NPLs to Gross Loans, which fell from 4.2% in December 2016, to 3.8% in December 2017. Our NPL coverage ratio also improved – from 86.7% at the end of December 2016, to 92.7% at the end of 2017.
The Group’s capital and funding position remain strong, with capital being held both in the regulated Banking Business and at the holding company level. At the end of 2017, liquid assets totalling GEL 310 million were held at the holding company level. Within the Banking Business, the NBG (Basel II) Tier 1 Capital Adequacy ratio increased by 120 basis points to 10.3% during the year, reflecting both the continued de-dollarisation of the Banking Business lending portfolio and the Banking Business’ high return on average equity and internal capital generation.
The National Bank of Georgia is currently in the process of transitioning to Basel III standards, and introduced new capital adequacy requirements in December 2017. On the basis of new regulation, the NBG (Basel III) Tier 1 capital adequacy ratio was 12.4% at 31 December 2017, compared to a new minimum Tier 1 capital requirement of 9.9%, which is expected to increase to 11.4% on 31 December 2018. Bank of Georgia has strong capital ratios and high levels of internal capital generation. As a result, the transition to Basel III is not expected to affect the Bank’s growth expectations or existing dividend payout policy.
The group’s Investment Business continued to deliver strong growth and performance, with EBITDA growing 55.7% year-on-year, and profit before non-recurring items and income tax, including discontinued operations, increasing by 21.4% over the same period.
We now expect that, in line with our planned exit strategy for the business, it is highly probable that the Group will own less than a 50% stake in Georgia Healthcare Group (“GHG”) at the end of 2018. As a result, GHG is now reported under “discontinued operations” in the Group’s consolidated income statement. Within the business, GHG delivered a year of strong progress towards its planned investment and business roll-out in all key areas of the Georgian healthcare system. GHG delivered net revenues of GEL 745.7 million during the year, an increase of 76.0%, reflecting a combination of solid organic growth and the impact of acquisitions. The healthcare services EBITDA margin continues to be strong at 26.4%, notwithstanding the dilutive effect of the significant roll-out of the two major hospital renovations – Tbilisi Referral Hospital and Deka – and the ongoing roll-out of a nationwide chain of polyclinics (outpatient clinics). In the pharmacy business, we have made significant progress towards the integration of our two recently acquired businesses, whilst avoiding any significant business disruption. As a result, the EBITDA margin of 8.6% for the year has already exceeded our target of a margin of “more than 8%”.
Our water utility and energy business, GGU, continued to focus on improving efficiencies in the water utility business and delivered a 6.1% year-on-year growth in revenues during the year, whilst achieving a 52% EBITDA margin. GGU has also continued to achieve efficiencies in its own energy consumption, to free up electricity for third-party sales, and has started a number of investments in additional capacity for electricity generation with the goal to establish a renewable energy platform. During 2017, GGU commenced construction of one of two planned hydro power plants targeting c.100MW of additional capacity over the next few years.
Our real estate business, m2 Real Estate, continues to demonstrate its strong execution skills to unlock value in the real estate development business. During 2017, m2 sold 629 apartments with a total sales value of US$ 49.1 million, in addition to further increasing its portfolio of yielding assets. In addition, the real estate business continued to execute on its strategy of developing 1,000 hotel rooms by the end of 2020. In the fourth quarter of 2017, we acquired the shell of approximately 100-room hotel, and in February 2018 we launched a 152-room Ramada Encore hotel in central Tbilisi. As part of our “asset light” strategy, m2 signed its largest ever franchise agreement to construct and develop a residential complex under the m2 brand name on a third-party land plot in a densely populated Tbilisi suburb. Additionally, m2’s construction arm gained its first major third-party construction agreement to construct the shell and core of a new shopping mall and business centre in Tbilisi’s Saburtalo district. These developments underpin an extremely successful year for the real estate business, and provide significant growth potential over the next few years.
Our property and casualty insurance business, Aldagi, continues development of a strong portfolio of new products, supporting 24.6% year-on-year growth in net earned premiums during 2017 and Aldagi’s position as the clear market leader in the fast-developing Georgian P&C insurance market. Over the last few months, Aldagi has also enhanced its distribution capabilities by signing major third-party partnership agreements with two Georgian banks – Liberty Bank and Credo Bank – which will support the further diversification of Aldagi’s multi-channel distribution network. These contracts would not have materialised had it not been for the proposed demerger.
Our beverage business, Teliani, increased its revenues by 102.5% year-on-year, continued to diversify its distribution portfolio and launched its mainstream beer and lemonade production during 2017.
The Group Board expects to recommend a regular annual dividend for 2017 totalling c.GEL 120 million. This is in the range of our regular dividend payout ratio target of 25-40% paid from the Banking Business profits. Since 2010, the Group has grown its annual dividend per share by 40% CAGR on a GEL basis, and by 32% CAGR on a Dollar basis. If the expected demerger is successfully implemented as planned, it is intended that Bank of Georgia Group PLC (the then new parent company of the Banking Business), will instead, shortly after the demerger is completed, declare and pay a dividend in a similar aggregate amount to shareholders then on the record. In the event that the demerger is for any reason not completed it is intended, subject to shareholder approval, that the Board would implement the payment of this dividend, which would represent a payment of GEL 3.1 per share, payable in British Pounds Sterling at the prevailing rate, a 19.2% increase over the 2016 dividend.
In addition to the regular annual dividend paid to shareholders, US$5.0 million was returned to shareholders by way of the buyback and cancellation of 115,608 shares during 2017, as part of the existing Board approved US$50 million buyback and cancellation programme. During 2017, the Group Employee Benefits Trust also purchased shares in the market totalling US$34.1 million.
In July 2017, the Group announced its intention to demerge BGEO Group PLC into two separate London-listed businesses: a banking business, Bank of Georgia Group PLC, and an investment business, Georgia Capital PLC. On 12 February 2018, the Group announced that the Board has approved the implementation of the demerger, which is subject to shareholder approval at a General Meeting expected to be held in April 2018. The demerger is expected to complete before the end of June 2018. The main benefit of the demerger is to simplify the structure, which in turn will enable the Boards and management teams of the respective businesses greater focus on strategy setting and execution. It was not an easy decision to separate the Group, but simplicity will bring so much benefit that it has clearly out-weighed all the potential downsides.
In its final year before the forthcoming demerger, and supported by the continued macroeconomic performance of Georgia, BGEO Group has delivered a record breaking performance in terms of profitability and growth. Growth and return momentum is there for both the Banking and the Investment Businesses.
Our Board’s role in the success of the Group may not always be apparent to our shareholders or the broader community – but it is pivotal. Each Board member’s dedication, vision, rationalism and collaboration have made an important contribution to our development into the world-class institution we have become. Special thanks go to Neil Janin, our Chairman whose leadership of the board and active involvement in strategy setting and mentoring of senior management has been critical in the success of our Group. The good news is that Neil will continue to be the Chairman of Bank of Georgia. We have continued our commitment to a strong and independent governance structure and have managed to put first-class independent Boards and management teams in both businesses and I am confident that under the proposed governance structure following the demerger both companies independently will prosper even more and will continue their excellent recent track record for many years to come.
In what is expected to be my final letter to shareholders, I would like to thank you for your continuous support and loyalty. I have very much enjoyed meeting you on roadshows, which served as very good guidance for me personally. I have learned a great deal over the past 13 years of being an executive of a publicly listed company and believe, with your help, a lot more learning will follow in the years ahead. I am very much looking forward to meeting you to discuss our strategy in my new capacity as CEO of the first publicly listed investment company from the region..
Chief Executive Officer
- Chairman’s Statement
- CEO’s Statement
Extract from 2016 Annual Report
The business and political mood is upbeat in Georgia, and my coverage of the four topics of this letter reflects these positive conditions. I will start with the economic and political overview, followed by a discussion on our Group strategy, talent development, and then board development. The CEO letter that follows will go into more specific details on each of our businesses.
Economics and Politics: A few months ago, Georgia once again demonstrated its commitment to European standards and norms by ensuring the successful delivery of 2016’s democratic parliamentary elections. As expected, the Georgian people overwhelmingly supported the incumbent government. The elections turned out to be open, clean, and transparent with a very clear mandate for the incoming government. Most of the population believe that economic development is the way to prosperity and progress and this national consensus is the key to political stability.
After the elections, Georgia’s ruling Georgian Dream party introduced a package of legislative changes to support the implementation of the Government’s four-pillar reform programme (introduced in February 2016) to boost growth and enhance the economy’s resilience to external shocks. The programme includes new tax benefits, infrastructure schemes, governance reforms and the modernisation of the education system. Corporate tax reform was enacted and effective as of January 2017, undistributed profits are tax free, ensuring a significant potential boost to Georgia’s investments and economic growth.
The country continues to be very business friendly. The World Bank ranks Georgia 16th out 189 economies in terms of ease of doing business, up from 23rd position a year ago. With its business-friendly environment, stable Government, developed infrastructure, stable energy supply, flexible labour legislation, stable and profitable banking sector, strategic geography and a Government committed to addressing structural improvements in the economy through its four-pillar reform programme, Georgia is well positioned to become a significant regional hub economy.
In fact, we expect GDP to grow 4.3% in 2017 compared to 2.7% in 2016. The number of visitors to Georgia increased at a 22.1% CAGR over 2007-2016 and tourism inflows stood at US$ 2.2 billion (15.1% of GDP) in 2016. The Government plans to enhance Georgia’s positioning as a four season tourism location through improving the connectivity of different regions with an aim to enhance their untapped potential. Despite the fact that many countries faced reduced capital inflows during the recent economic turbulence, FDI into Georgia has remained relatively secure thanks to the business-friendly environment as well as strategic infrastructure projects. In 2016 FDI inflow to Georgia was up 5.2% y-o-y and totalled US$1.6 billion (11.5% of GDP).
International relations are on the right track. Georgia’s accession to the visa free programme with the EU was a concrete benefit for all to see. Moreover, the Government continues to constructively manage its relation with Russia. Tourists from, and exports to, Russia have increased 12.0% to 1.0 million persons and 26.6% to US$ 206.2 million last year, respectively, while the share in Georgia’s total still remains low at 16.3% for tourists and 9.8% for exports. On the regional front, Turkey’s situation has had some effect on Georgian economy. In contrast, recovery in other regional economies, particularly in Russia through its positive spillovers on Georgia’s major trading partners, is strengthening Georgia’s growth outlook. To summarise the situation: Georgia is boringly tranquil, in a neighborhood in turmoil. This bodes well for Georgia’s strategy to become a regional business hub.
Group strategy: Last year, we informed you of our new two-pronged strategy. Firstly, we would continue to make Bank of Georgia an excellent institution, and secondly, we would buy assets in Georgia cheaply, grow them, and then sell them to investors at a higher price.
We continue to view BGEO as a vehicle whose goal is to maximise the value of its assets for its shareholders. This means that we will continue to pursue our “buy low, sell high” asset strategy. GHG is a very good example of how we want to execute this strategy. Importantly, we don’t consider any of our activities “core” anymore – including the Bank. This is why we call ourselves: a Georgia Focused Investment Platform.
Let me give you a review of our main strategic priorities, while Irakli, our CEO, will talk in more detail about the strategic goals for each of our businesses in his letter.
- The Bank has become an excellent institution both in terms of innovation and cost management. We aim to become the best in class when the transformation of our retail bank is completed. In addition, we believe that regional wealth management holds a potential that we have not yet exploited. We believe Galt and Taggart and the corporate bank have the best investment banking capabilities in the country. These capabilities should translate into a more dynamic and profitable corporate banking segment. Today, the banking market is a two-player market – a market we share with a good competitor.
- GHG has three main strategic priorities: launch new services at hospitals to grow revenue from planned treatments, grow market share in outpatient clinics – a market which is highly fragmented, and digitalise healthcare system to accomplish further efficiency and more importantly, better quality of care. We are leading the improvement of healthcare in the country, by establishing new standards and developing new operating models and procedures which don’t exist in Georgia yet. Additionally, we have an open dialogue with the regulatory authorities to establish rules and regulations to reach significantly improved health care practice for the population of Georgia. Finally, we believe that our presence in hospitals, policlinics, pharmacies, and insurance holds enormous profitably, especially using digital technologies. GHG does not have the same market value as our Bank yet, but it holds much promise.
- In the utility and energy arena, we bought, at a good price, a water utility with many improvement opportunities. This year and next, we will be on the lookout for more acquisition opportunities in the areas of energy and utilities. Additionally, we aim to develop hydro, solar and wind energy production. Georgia could become a clean energy producer, and should become an electricity trading hub. We intend to be a major player in this emergent market. Again, we will follow our usual investment strategy, and seek to realise the value created through an IPO in a few years’ time.
It should be clear that we are continuing to pursue and expand a strategy announced in the past. We believe Georgia is too small to attract private equity investment. This is where we can play a significant role, providing capital and management talent, our two traditional strengths. At BGEO, our new slogan, Georgia Focused Investment Platform, reflects this mindset.
Talent development: For many years, we have defined our key assets as access to capital and to Georgian talent. We have built the credibility to tap capital markets, having raised over US$ 1.4 billion up until now. Now we must make an even more concerted effort to develop talent. We need that talent to develop the “cheap” assets that we are acquiring. Our CEOs at GHG, m2 and GGU, as well as many other top executives at the Group, came out of the Bank’s management pool, but we need to accelerate the growth of this talent pool if we want to continue to grow and develop staff properly. We need to continue to align our talent strategy with our business objectives.
One of the key components of our talent or human resource development strategy has been our incentive system. Its intent is to incentivise management to create value on a long term basis: c.85% of management’s compensation is in shares that vest over 3-5 year period – discouraging quick earnings temptations. The unvested shares are normally “clawed-back” if a manager is fired for cause which includes a broad range of misconduct and this fully aligns shareholders’ and managements’ interests in the long-term. This system also encourages teamwork. Shareholders’ interests are perfectly aligned with those of top management.
Incentive systems are important but don’t create talent. Until now, we have brought back talent who had trained abroad and developed others on the job. Today, we want our talent strategy to provide a supply of leader/managers to newly created positions. In effect, we need to build a pipeline of talent. We have named a new Chief Talent Officer, whose background is not personnel management, and given him this mission. He will ensure that BGEO further strengthens its culture of meritocracy, teamwork, and that it continues to develop a strong pipeline of capable managers ready to take the available positions.
The essence of a meritocracy is having employees feeling free to share their ideas and being evaluated and rewarded for their performance. This requires dialogue which we will promote by the spreading of the habit of coaching – up and down the hierarchy. We would like to see constructive feedback and frequent developmental discussions between managers and their direct reports. This is not an idle talk. Most of our top managers have chosen to be coached by external coaches in the past years. We believe that a coaching culture starts at the top. Our top managers are urged to coach their direct reports, and to encourage such behaviour to cascade down through the organisation.
This effort is reinforced by the development of a teamwork culture. This is a culture that is characterised within and across functions for the greater good of the institution. Our incentive system encourages that and we have started to implement a leadership development programme whose aim is to foster trust across horizontal managers.
We already see the results of these efforts in a few of our business units, namely, Bank of Georgia, m2, GHG, and elsewhere. Our next step is to align our HR systems and integrate such habits throughout the organisation. We would like our leadership programmes to initially cover 60 of our top managers, followed by the next 400. We believe that no other private institution is as large or as professional in Georgia as BGEO. We must become the talent development engine of the country. Georgian institutions and corporates need managerial talent. If we don’t lead, then who will?
The Board. Our board is constituted of capable individuals who are T shaped. They all were chosen for the quality of their analysis and their judgment, the horizontal T, and for their deep specialty, the vertical of the T. I described their talent in my letter to shareholders last year. As our businesses diversify across the industries in the Georgian economy, the talent pool to supervise them must adapt. In the case of GHG, we have built a separate board with the requisite talent and continue to enrich it.
We will also be adding two new board and/or committee members with IFRS experience – one to each of the BGEO and GHG boards. As we continue to refresh our Board, increasing female Board representation remains a priority. We were not successful in advancing that priority in 2016, but aim to make good on our promise this year and next.
Attracting talent to our boards remains key. We must build the capacity of the board to guide and supervise all our business entities. It is not economical at this stage to build full-fledged boards for the smaller ones, but in the fullness of time, we will need to do so. As Chairman, I am keenly aware that the Board’s responsibilities and capabilities must evolve to adapt and support our strategy.
I would like to thank investors who have given us their confidence and money from early on. I speak on the boards’ and managements’ behalf when I assure you that we are committed aiming to offer you a good return on your investment. I would like to also underline that your investment continues to develop BGEO Group, the country of Georgia and its population through better healthcare, housing, utilities, banking services, and economic development in general. It is also providing strong support to the people employed by all our companies.
Extract from 2016 Annual Report
Georgia continued to achieve consistent improvements in its macroeconomic performance and improved levels of business confidence, and the Group delivered another year of strong business performance with over 30% basic earnings per share growth, and improved returns in both the banking business and the investment businesses. With the economy seemingly on the rebound in 2017 as measured by levels of business confidence, a number of recent strategic initiatives and acquisitions are expected to continue to deliver excellent performance in 2017 and beyond. In this annual letter, I will therefore update you on our medium-term strategic goals.
The Group will continue to focus on capturing growth opportunities in the rapidly growing Georgian economy. Our ‘4x20’ strategy will continue to be targeted over the medium-term to deliver:
• A return on average equity in the Banking Business of at least 20%
• Retail Banking customer lending growth of at least 20% per annum
• A minimum targeted Internal Rate of Return of 20% on investments in the Group’s investment businesses, and
• A maximum 20% profit contribution, of the Group’s profits, from our investment businesses
The Group will continue to aim to maintain a regular dividend payout ratio from the Banking Business profits in the 25%-40% range. Since the introduction of dividends in 2010, the Group has managed to grow its annual dividend per share by 51.6% CAGR. At the 2017 Annual General Meeting the Board intends to recommend an annual regular dividend for 2016 of GEL 2.6 per share payable in British Pounds Sterling at the prevailing rate. This is within the range of our regular dividend payout ratio target of 25-40% paid from the Banking Business profits, and represents an 8.3% increase over the 2015 dividend.
2016 marked the first ever issuance of Eurobonds at the holding company level, through which we raised US$ 350 million, with a coupon of 6.00%, due 2023. Overall, the Group’s capital and funding position continues to be very strong, with capital being held both in the regulated banking business and at the holding company level. Within the bank, the NBG (Basel 2/3) Tier 1 Capital Adequacy ratio was 10.1%1, comfortably ahead of the Bank’s minimum capital requirement. In addition, as of 31 March 2017, GEL 335.2 million liquid assets were held at the Group level.
As a result of the Group’s strong capital position, excess levels of liquidity and high level of internal capital generation, in November 2016 the Board approved a $50 million share buyback and cancellation programme, to be completed over a two year period, in addition to the regular annual dividend to be paid to shareholders. Over the last few months, the Group Employee Benefits Trust has also purchased shares in the market totalling approximately US$ 20 million.
A recent development in the Georgian Government’s tax policy is now effective, and applies the profit tax (currently set at 15%) only to distributed profits. Undistributed profits will no longer be subject to the profits tax. As a result, approximately GEL 500-600 million equity will be left to profit-generating corporates that are expected to profitably reinvest this capital. This tax policy amendment took effect for most companies on 1 January 2017, and for certain financial companies (including banks and insurance companies) it is expected to take effect from 1 January 2019. This will reduce the effective tax rate of the Group’s non-banking businesses in 2017, and the entire Group in 2019. In addition, the Bank expects to benefit from the general improved creditworthiness of its entire corporate portfolio. The impact of these changes has led to a number of deferred tax adjustments that increased profits in 2016 by GEL 63.8 million.
Despite some regional headwinds, the Georgian economy remained resilient during 2016, with estimated GDP growth of 2.7% for the year. Foreign Direct Investments were solid at 11.5% of GDP and tourist numbers – a significant driver of US Dollar inflows for the country – continued to rise throughout the year. Inflation remained well controlled at 1.8% at the end of 2016.
Turning to the business, let me talk about our two business lines – the Banking Business and the Investment Businesses – separately:
The Bank delivered another very strong year in 2016, characterised by the expected strong growth in the retail bank, and a repositioning of the corporate bank to further reduce concentration risk. Customer lending increased by 24.5% during the year, with 39.5% growth in the retail bank and 8.3% growth in the corporate investment bank. The Return on Average Equity in the banking business increased from 21.7% in 2015, to 22.1% in 2016.
Over the next few years, Bank of Georgia aims to shift the mix of its customer lending to become 65% retail and 35% corporate (currently 61% retail; 39% corporate) with the product per client ratio in the mass retail banking targeted to increase to 3.0 products, from a current 1.7 products.
We are now running a client-centric, multi-brand strategy in our Retail Bank. Over the past decade, Retail Banking has delivered a stellar performance by reaching c.2.1 million clients, delivering exceptional loan book growth and achieving its ROAE targets. While we were targeting these milestones, the Bank was product-centric with an active client acquisition approach. Having over two million clients now, this phase is less prevalent and we target stronger growth through increasing the product to client ratio by introducing our client centric model while running a multi-brand strategy for different segments of population.
Our Express brand caters to the emerging retail segment and offers predominantly transactional banking services to clients through small-format, Express branches, ATMs and Express Pay Terminals. In this segment, the Bank will aim to double the number of transactions over the next 2-3 years.
Our Solo brand caters to the mass affluent segment and offers exclusive products and the finest lounge-style environment at our newly designed Solo lounges, together with new lifestyle opportunities, such as exclusive events and handpicked lifestyle products. Solo already has very encouraging early signs: we have invested only US$ 11.5 million in this new concept since its launch in April 2015 and we have almost doubled the annual net profit to GEL 25.3 million. In this segment, the Bank will aim to increase the number of Solo clients to 40,000 (19,267 as at 31 December 2016).
Our Bank of Georgia brand caters to the mass retail segment. This is our flagship brand and our most significant profit contributor. We are currently transforming our service delivery to mass retail clients from a product-centric to a customer-centric one. The client centric approach has also had very encouraging early signs and in 24 pilot branches, sales have increased threefold. Going forward, expanding express branches will be very important to move out transaction focused clients from flagship branches and allow our universal bankers to cross-sell and increase the product to client ratio. We will be launching the first fully transformed branch in April 2017.
The Bank will continue to reduce concentration risk in the corporate lending portfolio, with the support of the Investment Management business. The target is for the top ten borrowers to represent less than 10% of the total loan portfolio (currently 11.8%). Georgia is becoming the service hub of the region and Bank of Georgia is in a great position to capture wealth management clients from throughout the region. In 2016, we have attracted more than 150 clients from 68 countries and we plan to step up these efforts. The Bank’s aim is to develop a significant regional private banking franchise to reach AUM of GEL 2.5 billion (currently GEL 1.6 billion). In this regard, we leverage superior knowledge and capital markets capabilities in the Georgian and neighbouring markets both in terms of reach and the expertise that we have accumulated during the past several years through our corporate advisory, research and brokerage practices united under Galt & Taggart – a wholly-owned subsidiary of the Group, which is at the forefront of capital markets development in the county.
At the end of 2016, we announced a number of appointments that further strengthened the management team of the Bank.
We appointed Kaha Kiknavelidze as CEO of the Bank. Kaha has been on the BGEO board for 8 years and knows the Group and management very well. At the same time he brings new perspectives to the executive team who have worked together for a very long time – the mix of old/new blood is important to bring new topics for discussion to the table. Kaha has over 15 years of experience in financial services in a number of roles at UBS and Troika Dialog. Prior to his current role, he was the founder and Managing Partner of Rioni Capital Partners LLP, a London-based investment management company.
We also have two new members in the executive management team of the Bank. David Tsiklauri was appointed to the position of Deputy CEO at the Bank, and leads the Bank’s Corporate Investment Banking Department. David has extensive experience in banking as well as the corporate segment in Georgia, having worked as the Deputy CEO in charge of Corporate Banking at TBC Bank and as Vice President of the Capital Markets and Treasury Solutions team at Deutsche Bank. Ramaz Kukuladze was appointed Deputy CEO at the Bank, and leads the Bank’s SME and Solo businesses. Ramaz has extensive experience in the financial services industry and wide experience with and a deep knowledge of the segments that he is leading. Prior to joining the Bank, Ramaz worked at Bank Republic Société Générale where he led the bank’s corporate and retail business as Deputy CEO.
I am confident that the strengthened executive team of the Bank will deliver on the opportunity to build on the Bank’s recent strong growth by further developing its presence and profitability in both the retail and corporate banking sectors in Georgia.
The Group’s Investment Businesses continued to deliver very strong earnings performances in 2016, with strong organic growth supported by the impact of recent acquisitions – specifically (1) the addition to our healthcare business Georgia Healthcare Group (GHG) of the GPC pharmacy business following its acquisition during the second quarter, and (2) the second half consolidation of our utility and energy business Georgia Global Utilities, GGU, following the acquisition of the remaining 75% equity stake in GGU for a cash consideration of $70 million in July 2016. EBITDA from the investment businesses increased by 71.1% to GEL 132.6 million in 2016.
In the healthcare business, Georgia Healthcare Group, GHG, we are present in whole healthcare ecosystem, which in size is GEL 3.4bln, with a best in class management team and access to capital. We see three key opportunities in healthcare business: Firstly, continue the introduction of new services in our hospitals, which should further strengthen our leading market position. Secondly, expand in the outpatient segment where the market is highly fragmented. We see the same opportunity now in the fragmented outpatient sector that we saw in the hospital business number of years ago. Lastly, we see an opportunity in digitilisation of healthcare services by creating electronic patient records and advising our patients in maintaining a healthy lifestyle. Our scale is important to deliver on our targets of delivering good quality healthcare at affordable prices.
In m2 Real Estate we are targeting an internal rate of return of c.40%+, whilst delivering a capital return to the Group of US$ 20-25 million in 2019/20. As we have previously declared, we are no longer buying land plots as our aim is to develop third party land. In essence our aim is to evolve m2 from a real estate developer into a real estate asset manager.
In the beverage business, Teliani, we are launching beer production and will be opportunistically expanding the beverage business in order to penetrate the retail network by offering a diversified product base, as well as enlarging the business to achieve economies of scale and cost advantage. Our primary exit strategy is expected to be a trade sale.
In the utility and energy business, GGU, we aim to achieve EBITDA of more than GEL 80 million in 2018, whilst establishing a renewable energy platform, targeting 200MW operating, 57MW ready-to-build,150MW in the pipeline for the hydro power plants; and 20-20MW ready-to-build wind farms and solar photovoltaic stations. All of this by 2019 with a targeted IRR in excess of 20%. GGU has a significant opportunity to increase its operational cash flow over the next few years from a combination of improving cash collection rates, increasing energy efficiency and reducing water loss rates, and by the development of renewable energy resources. We are aiming to prepare the combined utility and renewable energy business for an IPO in approximately 2-3 years.
As we start to prepare GGU for an IPO, we have further strengthened the GGU team and appointed Archil Gachechiladze as the CEO of GGU. Having been with the Group for almost 8 years in various roles, Archil has an outstanding execution track record with the Bank and, just as importantly, he is very passionate about the business of GGU having initiated our investment in the utility and energy business. We are also consolidating the Group’s utilities and energy businesses under GGU, the two investments that the Group made separately.
Last but not least, I would like to reiterate our commitment to the highest level of corporate governance which is a foundation for accessing management and capital. A key focus for me – and my board – is to grow and develop talent. Coaching and a feedback culture has become part of BGEO. Helping each other to succeed is the core principle of our management team. We understand very clearly that we are in the same boat as our shareholders and our mandate is very clear: to create sustainable shareholder value.
Chief Executive Officer
- Chairman’s Statement
- CEO’s Statement
“I am proud to announce that BGEO performed very well, reporting GEL 310.9 million in profit, which demonstrates year over year growth of 29.1%. This is particularly impressive considering the challenges we have faced in 2015, including weak oil prices, foreign exchange fluctuations, and a complex political context. The Group’s results are presented in our CEO’s letter and in various sections of this report.”
Through this letter, I would like to cover four important points:
1. the current economic and political situation in Georgia is solid and its outlook promising;
2. the strategy announced last year is more relevant than ever;
3. the role of corporate governance is a keystone of our way of doing business; and
4. talent management and incentives drive our performance.
I will elaborate on each of these messages below.
Politics and the economy
Last year we witnessed a democratic, peaceful change of government. The political situation in Georgia is still complicated, but a helpful way to look at it is across two levels: firstly, on a domestic basis, and secondly, on an international one, with a particular emphasis on its relationship with Russia.
Let me start by going over a few facts about the situation within the country. The recent appointment of a strong prime minister has brought about a number of initiatives, including a fourpoint plan to speed up economic growth. Highlights include a reform of the education system, which aims to create professional higher education systems in line with the demands of the labour market, tax code amendments aimed at further liberalizing tax and customs procedures, policies to speed up the implementation of infrastructure projects, and governance reform to allow legal entities to receive services based on a single window principle, similarly to how individuals currently receive services at public service halls in Georgia.
In addition, governance of the country has progressed. Firstly, the judiciary system has been reformed, and the courts in Georgia are now independent. Secondly, the President has created an institutionally distinct office for the Presidency, which reinforces checks and balances. Thirdly, the Central Bank now has a respected new governor with an IMF background and an independent board has been named to check its power. Finally, the country enjoys independent TV stations and newspapers, representing many points of views.
We will have the next Parliamentary elections in October 2016, which could either lead to a more pluralistic political situation or a reelection of the current government. It is difficult to predict the outcome, but on the whole the country has been moving in the right direction with a peaceful and democratic change of government. The new government favours competence over loyalty, and a reaffirmation of its pro-Western position with the signing and implementation of an EU association agreement. Finally, the assets of the country are being developed, principally tourism and water. This points to a promising path ahead, although not necessarily a predictable one.
On the international front, relations with Russia have improved and Russia has been focusing on other fronts. The majority of the population, 70% to be precise, would not trade today for yesterday. Georgia will continue its quest for NATO membership, ensuring close cooperation but probably not accession.
Most promising for Georgia is the entry of Iran into the community of nations. On the Iranian New Year in 2016, numerous tourists could be seen in Tbilisi. One can hope that investments might follow and that Georgia could become an important trade partner to this nation.
In fact, Georgia could do extremely well. The country’s success will be built on tourism, rich ecology and casinos. It will require a service infrastructure of hotels, banks and eventually hospitals. It will also bring investment in transportation, pipelines, railroads, and ports to connect to its neighbours. The industrial strategy of this country is right. It is pragmatic and, if anything, it is too prudent. Most importantly, BGEO plays a crucial role in it. One could say that what is good for Georgia is good for BGEO.
Our new strategy is promising
Last year we adopted a two-pronged strategy. Firstly, we would continue to make the Bank of Georgia a cost and innovation leader. The Bank is our most precious asset and it continues to perform well and deliver as you will read later in this report. Secondly, we aim to buy assets in Georgia cheaply, grow them, and sell them to investors at a higher price. This way we will make money for our shareholders, bring money in the local economy, and provide foreign investors with an opportunity to own high-yielding assets.
Let me start with the Bank. We appointed a new CEO for Bank of Georgia, Murtaz Kikoria, and promoted Irakli Gilauri to Chairman of the Bank. We wanted to have one person concentrate on minding the day to day affairs of the Bank, allowing Irakli Gilauri to focus on our new ventures. Murtaz is the orchestra conductor we need to lead and support the very strong cast of top executives of the Bank. With the support of Irakli Gilauri, his mission is to make sure that the Bank continues to perform and transform itself. The Bank’s agenda is full. In the retail bank, we are preparing to change the approach of our main branches from a product to a client one. This means that we will focus on client needs in order to propose suitable products, rather than push products to all clients in an indiscriminate manner. It involves a major cultural change and a transformation of our processes, the configuration of our branches and most importantly the mindset of our employees. We have also decided to merge the areas of corporate banking, investment banking, and wealth management. We are well regarded in this domain, and have accumulated a wealth of knowledge and capital markets capabilities in the Georgian and neighbouring markets during the past several years through our corporate advisory, research and brokerage practices united under Galt & Taggart. Galt & Taggart research aims to help decision makers – policymakers, International financial institutions, businesses and foreign investors – appreciate the opportunities of investing in Georgia and the South Caucasus. In this context, our wealth management/investment banking business has plenty of room to grow.
Our 2015 highlight was the successful IPO of Georgia Healthcare Group PLC on the London Stock Exchange. We were able to float c.35% of GHG and raise US$ 100 million that we will invest to grow GHG further. What we are doing in health care is a good illustration of the uniqueness of our strategy, which has three components. Firstly, we can buy assets cheaper than others. Why? Assets in Georgia are small and owned by individuals who need a lot of hand-holding in Georgian - something that foreign buyers have neither the ability nor the time to do. We may have bought more than 40 hospitals, but they were bought one by one, often from local doctors who made their own decisions, and would not just sell to anyone with money.
Secondly, we provided our health care subsidiary with very capable managers, starting with its CEO Nikoloz Gamkrelidze. Nick is a good example of a manager who developed his skills over the course of his career at the Bank of Georgia. We grow this talent within the Bank, as it is difficult to find local managers capable of executing sophisticated strategies. Otherwise, we sometimes attract Georgian talent from Europe or the US. These people will only return if they are offered a sizeable challenge, a promise of personal development, attractive incentives, and an overall feeling that they are contributing to the well-being of the country. Small, family owned companies cannot do that, nor can foreign investors. We are putting a special emphasis on talent in this annual report.
Thirdly, we have implemented world class governance systems including a robust Board. If you look at the Board of GHG, you will see a mixture of members who have experience in Georgia, as well as new independent members chosen for their competence and judgment. In this specific case: insurance, medicine, medical supply, and hospital management. We intend to replicate this set up in all areas that we are committed to developing.
GHG is not our only investment. Irakli Gilauri will give you a short description of our portfolio investments, which include real estate, utilities, power generation, and consumer goods. We look at our portfolio of investments as trees in a forest: some are mature and solid, others are promising saplings. When we see an opportunity to create value, we will not hesitate to bet on it. Similarly, if we cannot see potential, we will hold back. Unlike a private equity firm, we are under no pressure or obligation to invest any of our reserves, and if we cannot find interesting opportunities, we will return the money to shareholders, either through dividends or stock buybacks.
Corporate governance and talent development
The Board plays an important role in our companies. The BGEO board is composed of an array of highly competent individuals with complementary skill sets needed to run our businesses. The board works collectively with management to set the strategy and review operations. In fact, we set aside days every year to review asset allocation and investments. We encourage dialogue and discussion before taking any decision.
Additionally, each member is encouraged to interact with management members as advisors. The nature of contribution varies, from providing expertise and judgement to coaching and development. Allow me to introduce them to you: Hanna Loikkanen is very experienced investor in Russia and the CJS. She brings her wisdom and judgment as an investment manager to evaluating our investments. David Morrison, the Board’s vice chairman, is our guardian. He is aware of our fiduciary responsibilities and regulatory obligations, making sure we do the right things the right way. His long tenure at Sullivan and Cromwell in New York, Paris and Frankfurt serves him well in this regard. Al Breach is an outstanding macro-economic investor. His point of view is invaluable in making funding decisions and advising the Bank on its asset and liability management. Kaha Kiknavelidze is also a macro investor who, as a Georgian, gives us an insight into the local economy which we would not otherwise have. Tamaz Georgadze is the second Georgian on our Board with a specialty in digital and retail banking. He heads his own very successful FinTech company based in Berlin, and was one of the foremost retail banking experts at McKinsey. Kim Bradley is our real estate guru, with 25 years’ experience behind him in multiple markets. One of the contributions he made to m2 , our Strategic report Overview real estate subsidiary, was helping them build their risk management system and manage their liquidity risk. Last but not least, Bozidar Djelic, with an extensive experience in government, as a banker, and as advisor to a number of countries, helps us with government relations, capital markets, and provides the group with a rich perspective and judgment in this region.
My job is to manage the Board, ensure that we have the right people on the board and in leadership positions in the key areas of the Bank, and facilitate and frame discussions on all areas, but especially on strategy and execution. It is worth mentioning that the board meets without the CEO at every board meeting and that we run regular third party evaluations of our effectiveness and continue to rank very highly. We still lack the diversity that we would like to see, but we are working on it. We had promised to onboard two women, but have only invited one so far. We are actively searching.
Finally, the Board of course fulfils its fiduciary duties. We have meaningful discussions in the committees, as you will see in the reports of the Chairmen of each committee below.
Succession planning and Talent management
This is a young company and the top managers of the organization are the ones who built it. The Board is aware and concerned by the necessity of preparing a new generation of leaders for the long term. It is our highest priority today. We have encouraged the bank to change the scope of its human resources strategy and to develop a pipeline of leaders at an early stage. Promising employees should be tracked and developed by giving them appropriate opportunities and timely leadership and technical training.
For those already at the top, the incentive system is as follows: our partners, 15 in total, take home the minimum they need to live well, with the rest being stock vesting in five years. If they make the shareholders rich in the long term, they too will be rich. There are no ways for executives to finesse the system and play the short term. Above all, no cash, just stock vesting in five years. It is not an appropriate incentive system for every company. For ours, a young growing company, it works and keeps everyone’s mind focused on making money for shareholders. Beyond top management, we are committed to building a culture where personal growth and development are encouraged. We are making a point to show you our top 100 executives in this report. We have made changes to our human resources management and we intend to reinforce our capacity to attract, develop and promote talent in all areas of the group. We have named one of our most creative executives as head of HR, with a precise mandate.
Regarding succession, the Board has a definite plan of what we would do in the case that our current CEO is no longer able to continue. He has been key to our success. However, we are building the bench behind Irakli Gilauri by promoting more people to positions that cover duties he was doing directly. We cannot replace Irakli Gilauri, but we can build talent around him and introduce a way of doing business that will become BGEO’s trademark and culture. Irakli is keen to see that happen and is showing the way to all his team.
I hope this letter has helped inform our shareholders of the current situation of BGEO and its promising outlook. While the strategy and future of group is solid and the political context promising, investing in operations in countries such as Georgia can still feel daunting. Therefore as a final point, I wanted to highlight our liquidity situation which will allow us to weather whatever storm may come in our path and enable us to achieve long term success. Irakli Gilauri elaborates on this below.
At the 2016 Annual General Meeting, the Board intends to recommend an annual dividend of GEL 2.4 per share payable in British Pound Sterling at the prevailing rate. This is in the range of our payout ratio target of 25-40% and represents a 14% increase over the 2014 dividend.
I feel very fortunate and proud to be part of the remarkable journey of this institution and this country. I am proud of the work accomplished by CEO Irakli Gilauri and his entire management team. I am touched by their desire to not only build a great company, but also do well for the country. Finally, I am grateful for the investors who trust them with their money. I think they too can be proud and take comfort in the returns on their investment.
“As a leitmotif to this letter I would like to draw your attention to people working for your company and long term vision we have for each of our business lines.”
• People working for the Group; and
• Strategic decisions made by the Board in the past 5-7 years.
These two factors – the people working for your company and the long term vision we have for each of our business lines – will be a leitmotif to this letter, in which I focus on: strategy – for our Banking and Investment Businesses as well as for the Group in terms of capital returns and allocations; and talent development.
Two key metrics we measure our Banking Business performance against are Return on Average Equity (ROAE) and retail loan book growth, each targeted at the 20% level. As outlined in detail later in this report, both targets were achieved by a considerable margin; we grew the retail loan book by 35% and delivered c. 22% ROAE. To further improve profitability we set a 3-year target to increase the share of Retail Banking lending in the overall loan book, from the current 56% to a targeted 65% level. Bank of Georgia is also well positioned in terms of both capital and liquidity to deliver on its growth strategy. Let me outline the background as well as the strategy going forward for each of the banking segments:
Retail Banking delivered a stellar performance by reaching c. 2 million clients, delivering loan book growth and ROAE targets. The acquisition and successful integration of PrivatBank Georgia played a major role.
• Under the Bank of Georgia brand, we are serving mass retail clients. We have historically been very much a product-driven organisation, which helped us in acquiring new clients. However, we now have a relationship with c. 2 million clients and our challenge for the next three years is to increase the product to client ratio from a current low of 1.7 to 3.0. To this end, we intend to shift our business model from product to client centric. In 2016, we would like to move to a focused service model in 10 branches, where clients have a single touchpoint to acquire products and receive consultation. In the medium-term, we intend to convert the Bank of Georgia brand into a single touchpoint front office organisation.
Retail Banking is headed by Mikheil Gomarteli, who joined the Bank 19 years ago and his first job was to sell debit cards door-to-door. Before heading Retail Banking, Mikheil worked in almost every position in the bank: teller, credit analyst, and headed our reporting and budgeting, marketing, and branch management departments. Mikheil is leading a group of excellent Retail Bankers and their insideout knowledge of Retail Banking and detailed understanding of business are invaluable for the further success of the business line.
Our Corporate Bank has increased its ROAE from 12% in 2014 to 16% in 2015. We believe the current risk return profile of corporate business is not as attractive as the Bank runs a relatively concentrated loan book, with the top 10 exposures accounting for 12.4% of total loan book. Therefore, our major strategic goal is to deconcentrate the corporate loan book, while stepping up our investment Banking Business by issuing corporate bonds in the local market. We have already made progress in this regard in 2015; we have decreased concentration from 15.7% in 2014 to 12.4% in 2015, and at the same time issued bonds worth US$ 63 million in the local market. Going forward, we are also targeting to syndicate out our large exposures to local and international players.
In order to further capture synergies between the corporate banking and investment management (investment banking and wealth management franchises) and expedite the process of developing the local capital market, we have decided to merge these two business lines.
The Bank’s cost discipline:
Our three-year target is to maintain a 35% cost to income ratio. Effective implementation of the client-centric model in Retail Banking as well as digitalisation will have a positive contribution to the low Cost to Income ratio going forward.
Tornike Gogichaishvili heads our operations overseeing operating and capital expenditures and his contribution to the 36% cost to income ratio is tremendous. Tornike joined the Group in 2006 and soon became CEO of our insurance business. Tornike also played a crucial role in capturing efficiencies in our Ukrainian banking subsidiary. Tornike has been heading the Bank’s operations business since 2010. His deep understanding of business and processes is the key to successfully capturing further cost efficiencies going forward.
In the year of a major depreciation against the US Dollar, I would like to focus on credit risk as it is by far the largest risk category that any bank is exposed to.
Our risk department is best in class. They have passed the test of prudence and control both in 2008 during the global financial crisis, when cost of risk stayed within the Bank’s net interest margin, as well as in 2015, when the currency lost more than 35% of its value against US dollar compared to predepreciation levels.
Investors often ask me how we retained such a low cost of risk (2.7%), in a year of sharp depreciation in consideration that 72% of our loan book is denominated in foreign currency, mostly US Dollars. The simple answer to this question is that Georgian bank balance sheets have been mainly in US Dollars for the past 20 years or so and we manage currency risk, just as banks with local currency balance sheets manage the interest rate risk. (We have limited interest rate risk in our balance sheet.)
How do we manage the foreign exchange risk? Currency-wise, our balance sheet is matched on both sides. Our clients who have local currency income and loan in US Dollars are exposed to currency risk, which makes us consider carefully how to manage their risk. We manage our clients’ risk in two ways: first, we issue these clients 20% less loan compared to issuing a Georgian Lari loan, in doing so we are creating a depreciation buffer. Secondly, we issue shorter-term loans than we would have issued in the first place and at the same time we keep a positive liquidity gap in our balance sheet, so if there is a need to prolong a loan to our client we have the capability to do so. Under the above credit conditions not many qualify for US Dollar borrowing. One of the reasons for the low penetration of loans compared to GDP is due to this conservative underwriting policy used by Georgian banks.
90% of our corporate loan book is denominated in foreign currency, mainly US Dollars - of which 50% have US Dollar income and the rest do not. Because the Georgian economy is dollarised and a US Dollar proxy economy, when the Georgian Lari weakens all corporate players behave in a similar way: they adjust prices, capture efficiencies and adjust to the new reality. As Georgia is an oil-importing country, Georgian corporates had a big saving from lower oil prices, but the adjustment of prices on their final goods was not as dramatic as it could have been. Hence inflation in the country was recorded below 5% in 2015. Weak corporates, whose businesses were struggling even before depreciation, go out of the business, healthier companies will need some sort of prolongation, but their business continues to generate the cash and service the debt on a monthly basis as they used to do, and strong companies do not even need prolongation. This is exactly what happened during the recent depreciation.
One of our major challenges for 2015 was to make sure that banking continued to perform well as I was handing over the leadership of Banking Business to Murtaz Kikoria.
In last year’s letter to shareholders, I outlined in detail the way we invest in and manage companies. In brief, I would say that the strategy of our Investment Business is very simple: we buy companies or assets cheaply, institutionalising them by allocating and developing top talent in Georgia, eliminating unnecessary costs, growing the companies as market leaders in order to achieve scale-driven cost advantage, and crystalising the value of the them within six years. We invest in small ticket sizes; usually we would not invest more than US$ 25 million in any new opportunity. We also like to stage investments to limit the risks. Once we make sure that an appropriate level of institutionalisation has been achieved in the portfolio company, we may invest in bigger ticket sizes. To this end, we like bolt-on acquisitions to expedite the market leadership and scale-driven cost advantage. Bolt-on acquisitions also enable us to capture cost synergies and eliminate unnecessary costs. The GHG case study in this Annual Report outlines our strategy of doing investments.
In pursuing this strategy, we aim to achieve at least a 20% IRR. The limited access to capital in this small frontier economy is one of the reasons we are able buy cheaply. So, the availability of cash at all times at the Group level is critical to seize opportunities quickly.
Overall, the performance of the Investment Business was exceptional in 2015. We have delivered consolidated profit growth of 81%. The growth was mainly driven by GHG’s superb performance and m2 Real Estate completing its projects ahead of deadline and within budget. The IPO of GHG was the key milestone in the Investment Business as we managed to crystalise the value of our investment and achieve a triple-digit IRR.
The Company targets to achieve this revenue growth by growing its market share by number of beds in the hospital business from the current 27% level to c.30% by the end of 2018. The Company is also in the process of rolling out a national chain of ambulatory clinics where its market share by revenue is currently just 1% and GHG is targeting to grow this to 5% by the end of 2018.
If you want to buy an apartment starting at US$ 29,000 in Tbilisi and have it rented out by m2 , please email us: firstname.lastname@example.org.
Irakli Burdiladze heads our Real Estate Business. Irakli joined Bank of Georgia as CFO in 2006. In 2010, when we decided to develop land which the Bank had repossessed after the 2008/09 crises, Irakli was assigned to spearhead our Real Estate Business. I have met no one more passionate about the Real Estate Business in Georgia than Irakli. Irakli’s strategic thinking, and his excellent people, sales and execution skills enabled him to build a strong cash flow generating institution and I am confident in his ability, with the help of his excellent team, to deliver on our strategy.
Our investment so far in our hydropower station business has been very small, but its prospects are tremendous. We decided to develop hydros in Georgia due to the simple fact that the cost of developing one MW of hydro is at least two times cheaper than in neighbouring countries. At the same time, domestic electricity consumption in Georgia has grown by 3.6% CAGR from 2007 through 2015. As we did not know how to develop hydros ourselves, we have entered into a joint venture with RP Global, an experienced Austrian hydro development company. BGEO Group owns 65% in the joint venture and RP Global owns the remaining equity interest.
Our intention is to build 4 hydro stations by the end of 2019 with total capacity of 105 MW. In addition, we plan to do detailed feasibility studies (ready to build) of additional hydros with a total capacity of 150 MW. We have earmarked US$ 25 million in equity investment over the next 3 years to build the first four 105 MW hydros. After launching the hydros in 2019, we expect to produce a ROAE of 20%+.
After the acquisition of our 25% stake in GGU in December 2014, we initiated senior management changes, which triggered substantial improvements in the operating business.
We are also developing hydro resources using the existing infrastructure of the Company. In 2015 we identified two stations with a total capacity of 16 MW. Building run-on hydros using the GGU infrastructure decreases the cost of development by 20-30%.
We aim to deliver GEL 80 million EBITDA in 2018 by reducing water losses and building new hydros. GGU is expected to pay dividends on the back of its 2016 performance and step up the dividends to at least GEL 20 million per annum from 2018.
GGU is headed by Giorgi Tskhadadze, formerly CFO of Borjomi, a leading beverage company in Georgia. Giorgi has demonstrated an excellent track record in capturing efficiencies and streamlining operations. Giorgi Vakhtangishvili is CFO of GGU. He joined the Company in April 2015, previously serving as the #2 person in m2 Real Estate. His contribution to the success of the GGU turnaround is equally important.
Teliani Valley (beverage business):
Teliani Valley is one of the largest wine producers in the country, selling c. 3 million bottles a year. Its 2015 EBITDA was GEL 3.9 million, a decrease compared to 2014 as currencies lost values sharply, leading to decreased demand in Teliani’s major export markets, such as Ukraine and Kazakhstan. Teliani also operates a leading distribution company, distributing its own as well as third party goods. Teliani is also the distributor of imported Heineken beer.
In 2016, Teliani is launching a beer and soft drinks production line, which will be a major source for its growth. Because of Teliani’s distribution capabilities, Heineken granted Teliani with a 10-year licence to bottle beer for Georgia, Azerbaijan and Armenia.
BGEO Group owns 71% of Teliani and intends to invest US$ 10 million in equity to build the Heineken brewery in Georgia. The brewery will also produce other Heineken brands, mainstream beer and local lemonades. Teliani is targeting to launch beer production by the end of 2016. The brewery will have a capacity of c. 300,000 hectolitres and will be scalable to 500,000 hectolitres. The total project cost is US$ 37 million. The beer market in Georgia is highly concentrated; Efes Group owns 57% of the market share and 35% is owned by a local producer. Going forward, Teliani may become a diversified beverage producer in Georgia.
Shota Kobelia heads Teliani Valley. Shota joined Teliani in 2009. Prior to joining Teliani, Shota was an executive in the Pernod Ricard Group. Shota managed to capture more than 30% market share in bottled wine in Georgia, where competition is much greater than in the beer market. Shota’s leadership and sales skills will be the key for the success of our new investment. The Teliani team is very excited and engaged with the project, together with the Heineken team, to make it successful.
Group strategy: capital returns and allocations
The simple way to look at our strategy is how much capital return we deliver to our shareholders in relation to the cash investment our shareholders make in the Group. Therefore, our aim going forward is not to issue new shares, rather deliver capital returns in order to generate a high return for already invested cash capital by our shareholders.
Obviously sustainability of capital returns over long period of time is essential for the success of our strategy. As you all know, we run two forms of capital return: Ordinary Dividends paid by the Banking Business and Special Capital Returns (SCR), generated by our Investment Business. Let me discuss each form of capital return separately.
Our Banking Business can be viewed as the provider of Ordinary Dividends. On the back of its 2015 financial performance we will be paying GEL 2.4 per share, which represents growth of 14% over 2014 dividends and a payout ratio of 34% compared to 34% in 2014. Bank of Georgia is by far the largest and most valuable asset in our Group, which provides a high quality, stable dividend flow to our shareholders. Implementing the strategy outlined earlier in this letter should improve the quality of ordinary dividend generation capabilities of Bank of Georgia and make it more sustainable over a long period of time.
Special Capital Returns:
We updated our strategy in December 2014 and introduced the Investment Business and the concept of Special Capital Returns. The Investment Business aims to deliver CSRs from divestments of our portfolio of companies. Our aim over a five-year period is to deliver CSRs of at least 50% in aggregate of the ordinary dividends delivered by the Banking Business over 2015-2019 period. We view CSRs in three different forms: cash dividends, BGEO share buy-backs and the potential distribution of shares in our listed portfolio company. We are also aiming to buy-back shares for our management trust, rather than issue new ones – as we historically used to do. The aim is not to increase the Group’s outstanding number of shares from the current 39.5 million level.
As a result of the successful IPO of GHG and the high cash flow generation of our Real Estate Business, we have clear visibility of SCR flow through 2019. The good news is that our existing investments can generate SCRs beyond 2019.
However, we will need to improve the quality of SCR flow over the longer period of time. Therefore, holding a supply of cash to invest in opportunities and wisely re-allocating capital are important to increase the quality and certainty of SCRs over the longer run. That is why our plans regarding our cash buffer and our capital allocation strategy going forward are important.
Cash buffer and capital allocations:
Currently we hold c. US$ 52 million cash at the BGEO Group level, of which US$ 35 million is allocated to our hydro and beverage businesses. Over the mediumterm, we aim to increase the unallocated cash buffer from the current US$ 17 million level to a higher one of US$ 50 million, or 3.5% of market capitalisation of the Group.
We believe this large cash buffer will be an important component to the successful implementation of our strategy and de-risking the Group in case of unexpected crisis. The unallocated cash buffer will be used to seek opportunities either for new ones or opportunities that capitalise on our existing companies for new projects or bolt-on acquisitions. The buffer will also enable us to buy back BGEO shares cheaply during any global capital markets or emerging market turmoil. As we use cash from the buffer, we will be disciplined to replenish it in a short period of time.
As we will be increasing cash levels at the Group level, we will be running a Groupwide treasury management. Therefore, we are in the process of setting up risk management guidelines at the Group level. The basic idea is to run an extremely conservative liquidity management policy. Allocated cash will be invested in Georgian government treasuries and short-term local bonds, while unallocated cash (e.g. US$ 50 million) will be used to invest in short-term US treasuries or EU government bonds.
Growing the intrinsic value of our portfolio companies will be one of my key performance indicators going forward. To this end, internally we are running valuation models for each of the portfolio companies. Valuation of the portfolio companies will also be used when deciding on BGEO share buybacks as well.
The way we manage the Group:
We run a lean management structure at the Group level. We have five senior people working at the Group level, including me, and all of us have multiple functions. I split my time between helping the Bank executives in strategic projects and overlooking portfolio companies in Investment Business by helping top executives with strategic decisions. Levan Kulijanishvili, a long-time veteran at the Bank of Georgia, is a CFO of the Group and Bank of Georgia. Levan’s ability to constantly learn and develop, as well as understand detail has no boundaries. Avto Namicheishvili and Eka Shavgulidze help me to overlook our portfolio companies by active Board participations, monitoring performance of the Group companies and assessing new opportunities. As mentioned above, Avto is also heading our hydro business and helps the Group company lawyers in case they need advice. In addition to her Group role, Eka handles production of all our investor relation communication materials. Eka also handles the Group’s debt capital funding needs. Eka’s exceptional analytical and strategic thinking skills are invaluable for the Group. Michael Oliver is helping me with investor relations. Mike has 25+ years of experience in UK banking and served as Director of IR of Lloyds Banking Group. Mike attends the Group’s strategic meetings and has a deep understanding of Georgia and the BGEO Group, which helps us to communicate the story effectively. Mike’s understanding of our investors’ way of thinking is very important for us in setting up the strategy. He is very passionate with great people skills.
Attracting the very best talent to our Group has always been a top priority. This is how the success of our Group has been built. Good judgement, flawless execution and excellent team spirit is part of our culture. Bank of Georgia serves as a great platform for developing talent within the Group and the Board’s role in this development is tremendous. In addition to their fiduciary duties, Board members act as advisors/ coaches for all of our top executives. We have a diverse Board with sector specialists and we would like to further enlarge it by bringing more sector specialists to help our heads of businesses to grow further.
As our businesses grow and the market evolves, we are in constant need for top talent to deliver on our strategy. We have much more talent available in-house than 11 years ago, when I joined the Bank of Georgia. To this end, we would like to further institutionalise the talent development and formalise our organisation culture. We would like to use the Bank of Georgia University, internal and external talent pools as platforms to develop future leaders by providing leadership, training and coaching, and mentoring by senior executives and the Board members. We also want to attract young talent through our Leadership Programs to develop future leaders for this organisation.
“Helping each other to succeed by learning and providing feedback” is our leadership culture articulated in one sentence. Indeed, we see constant learning and development of management and employees as key to the success of your organisation and we will be investing time and money in it.
Sasha Katsman heads the HR and Branding of the Bank. He has a Groupwide responsibility to institutionalise our talent development programme as well as roll out our leadership culture throughout the organisation. Sasha joined the Bank in 2010 to head the Bank’s marketing department. His exceptional creativity, execution skills and ability to develop has already created substantial value for our organisation. Sasha built our brand and campaign machine. We decided to promote Sasha to deputy CEO of Bank of Georgia to head the Bank’s HR efforts in addition to his branding responsibilities.
To summarise – at the Group level we want to increase the unallocated cash buffer to US$ 50 million to seize the opportunities in our Investment Businesses as they arise, potentially buy-back BGEO stock if it is cheap, and de-risk the Group in case of unexpected crisis. To improve efficiency in Retail Banking, we will be focusing on rolling out the client-centric model and further digitalising our banking services. To improve the risk-return profile of the Corporate and Investment Banking we want to de-concentrate the loan by issuing local bonds and simultaneously stepping up the wealth management business to leverage Georgia becoming the service hub of the region. In Investment Business, our key goal is to institutionalise our businesses by developing our talented management teams, cutting unnecessary costs, and scaling up the businesses through bolt-on acquisitions to expedite scale-driven cost advantage.
In order to succeed in the outlined strategy, we need three things:
1. your continuous support, for which we all at BGEO Group are very grateful
2. our continuous effort to develop and grow talent
3. Georgia to continue on its successful growth path, about which I am more optimistic than ever.
- Chairman’s Statement
- CEO’s Statement
In my Chairman’s letter to shareholders last year, I focused on the many aspects of progress made by Georgia over the last decade. I am pleased that this progress has continued throughout 2014, namely with the Government commitment to the continued effective implementation of the Association Agreement with the EU.
The bank has continued to deliver a strong earnings performance this year. You should also note that we have formalised an inflection of our strategy to capture further growth opportunities within Georgia over the medium term. At the same time, Georgia’s regional trading partners have faced significant geopolitical and economic challenges.
In this letter, I will address the change in the Company’s strategy and the geopolitical issues, before concluding on dividend and governance matters.
Over the last decade, Bank of Georgia has evolved to become the market leader in what is a well regulated and competitive banking sector. In what was a year of substantial challenge, Bank of Georgia has delivered over 11% revenue growth, 15% earnings growth and a 19% return on shareholders’ equity. You will find all details on our performance in these assets in this report.
In 2014, we decided to modify the strategy, structure and governance of the institution to profit from attractive investment opportunities in healthcare and beyond. Why did we choose to follow this strategy when we risked being called by one of the worst epithets possible, that of being a conglomerate?
“One way to think about Bank of Georgia is in terms of capabilities. It has three macro skills: it knows how to execute well; it knows Georgia well; and it is disciplined in thinking in terms of capital allocation and return on capital, as op posed to market share and growth. Moreover, the institution attracts talent and capital beyond its needs.”
Georgia has sectors of the economy which could be developed profitably with an infusion of capital and talent. The first one that we developed, and the closest one to our business of banking, was real estate. We noticed that as the economy picked up after the 2008 crisis, our mortgage portfolio did not keep up with this growth. The reason was that there was no supply of houses as builders/promoters had gone bust, and nobody was building housing any more. The builders had invested their capital in land purchases in a speculative drive, and were totally illiquid when the crisis of 2008 hit. We decided to enter this market as builders and promoters, and supplied the market with apartments. The result was the success of our subsidiary, m2 Real Estate, which provides affordable housing to a growing middle class. You can read all about its excellent performance in this report.
Healthcare was another such sector where we were present through Aldagi, our insurance subsidiary. Universal healthcare was being introduced in the country, and the offering by providers was uneven, inefficient and fragmented. An injection of capital, talent, and best practice could change the industry structure in Georgia, and provide patients with a much higher quality of care. Good assets could be bought relatively cheaply. This made us invest in hospitals and create our wholly-owned subsidiary, GHG, Georgia Healthcare Group. It now has a 22% market share of hospital beds in the country and is currently planning its international stockmarket listing in the second half of 2015.
Our strategy is one of buying potentially very high-quality, but currently underperforming assets, at a cheap price, bringing best practices to them, professionalising their management, and then selling them to the market at a higher price. Having access to top-quality management, corporate governance and capital in a fast-developing country like Georgia creates opportunities to achieve substantial value creation for shareholders. Our CEO Irakli Gilauri, describes in his letter why we can buy cheaply, what sectors look attractive to us today, and the discipline we bring to investment.
“Let me reiterate that the banking businesses – retail, corporate and investment management – will remain our priority and a minimum of 80% of the Group’s earnings. Our goal this year is to prove to the market that this strategy delivers by selling to the market a major share of our healthcare subsidiary. Our shareholders will be free to own this business directly and we will attract new investors who specialise in healthcare.”
The Bank’s structure has been modified to adapt to this strategy. In 2014, we established an investment arm to manage our non-banking businesses, which include our Healthcare operations, our Real Estate subsidiary and our recent pre-IPO purchase of a 25% minority interest in the leading Georgian water utility business. Irakli Gilauri goes into much more detail with regard to the implementation of this strategy later in this Annual Report. The Board is clear that our ability to continue leveraging our market-leading banking franchise, with an emphasis on the higher return retail business, together with a strategy to benefit from other carefully selected investments in the development of the Georgian corporate landscape, will provide clear and sustainable value creation for shareholders.
There is significant information in the body of this Annual Report highlighting the Group’s strategic priorities for 2015 and beyond. This stems from a Board review of the Group’s strategy at the end of 2014 that aims to ensure that capital continues to be allocated effectively, to ensure the sustainability of the Group’s strong returns over the long term. Now let us turn to the context in which we operate.
Georgia remains a steadfast Euro-Atlantic partner – a stance supported by most political parties and a significant majority of the population. In June 2014, Georgia signed an Association Agreement with the European Union, which included provision for a Deep and Comprehensive Free Trade Agreement that will underpin increased future trade growth for Georgia. Additionally, in March 2015, China and Georgia signed an agreement on co-operation for the development of the “New Silk Road Economic Belt”, which further highlights Georgia’s future economic potential. Georgia aims to protect itself from Russian regional dominance. This strategy has been costly in terms of territory lost (about 20%), but successful in terms of economic and standard of living growth (GDP per capita based on PPP more than doubled to $7,700 from 2003–2014).
The current Government has succeeded in having a more open and pragmatic approach towards Russia, while moving the country towards greater integration with the West – a balancing act to say the least. This is not to say that all is done inside the country: the EU expects and civil society would be better served when the currently ongoing judiciary reform will be completed. Nevertheless, we should remember that only 4% of respondents admitted to having paid bribes in Georgia according to the Berlin-based Transparency International’s 2013 Global Corruption Barometer, well ahead of many European countries. In addition, the World Bank’s latest ranking shows Georgia as 15th in the list of countries where it is easiest to do business, between Germany and Canada.
From a macroeconomic perspective, Georgia delivered strong GDP growth in 2014, at an estimated 4.8%. The Georgian Lari depreciated 7.3% against the US Dollar, but appreciated by 5.3% against the Euro, the single largest trading partner currency of Georgia. In early 2015 there has been some further currency weakness, but this now seems to have stabilised. This performance was to be expected and was managed skillfully by the Central Bank, which proved once again its independence. Overall, 2014 saw a particularly robust performance against the backdrop of ongoing geopolitical concerns and macroeconomic and currency devaluation pressures in many of Georgia’s trading partners, and demonstrates the resilience of the Georgian economy. The section on macroeconomics covers our prediction on GDP growth next year, in the face of the situation of Georgia’s trading partners and the country’s attractiveness to foreign investment and tourism. I hope that you will conclude, as we do, that this country, which has transformed itself into an economically liberal, market-oriented democracy, remains very promising.
In conclusion, I want to highlight and acknowledge the significant efforts of the senior management team and the excellent leadership of our Chief Executive – Irakli Gilauri. In addition to their clear delivery against the existing strategy, having nearly tripled earnings and generated substantial returns for shareholders over the last five years, in December 2014 they worked with the Board to update the strategy for the Group and have established a clear strategic direction for the future.
Shareholders should take note of 2 key governance features of the institution: the alignment of interest between management and shareholders, and the division of roles between the Board and management. I will summarise our philosophy below.
Our incentive package to top management features a high percentage of stock vested over a long period of time. This scheme creates a sharply upward sloping wealth curve – the more a company’s stock price improves, the higher the percentage increase to the CEO and his top team’s total wealth. It encourages intelligent risk taking, as it heavily rewards the CEO and his top team to create long-term value, and punishes them if they do not deliver returns to shareholders. In summary, it discourages short-term thinking and risky behaviour, and encourages thinking like an owner manager.
My role as a Chair is to run the Board, and the role of the CEO is to run the Company. One of the Board’s main roles is to be involved in setting the strategy and to monitor the operations of the Company to ensure that it is being run to the benefit of all stakeholders and as mandated. The second important role of the Board is to determine the pay of the CEO and the main executives.
Finally, the Audit Committee, although composed of independent members, reports to the Chair – a further guarantee of independence. It should be clear that having the CEO be also the Chairman of the Board, opens the door for potential abuse in all three cases above. All depends on the quality of the Board. The Group now has a first-class Board of Directors. Their combined experience and support is invaluable to the organisation. The Governance section of this Annual Report highlights, amongst other things, our Board Diversity Policy. Within this policy the Board has stated its aim to increase the number of women on the Board to two within the next two years. To end, I would like to thank the members for their ongoing support and the provision of guidance and mentoring to executive management, at a time of significant economic and geopolitical uncertainty.
At the 2015 Annual General Meeting, the Board intends to recommend an annual dividend of GEL 2.1 per share payable in British Sterling at the prevailing rate. This represents an increase of 5%, compared to an annual dividend of GEL 2.0 last year.
2014 was clearly a year of demonstrable delivery and progress. The Board is pleased with this progress and is confident about the Group’s prospects for 2015 and beyond.
We have posted yet another record year in terms of profit and Earnings Per Share in 2014. You can read about our strong financial performance in this Annual Report. In this letter, rather than focusing on the past, in view of our upgraded strategy and recent regional currency tensions, I would like to focus on three key issues:
1. Regional macro tensions and our response to it.
2. Our upgraded strategy.
3. The way we want to conduct our investment business.
We stay disciplined in the light of a weaker 2015 macro outlook With the oil price decrease and the strength of the US Dollar, we are witnessing significant changes in the region. In particular, capital flows from remittances to Georgia and revenue from exports to regional countries are decreasing. Even though the Georgian economy is well diversified and resilient to external shocks, we believe growth in 2015 will be affected by the weak regional economies. Therefore, we have revised our GDP growth targets for 2015 to be within the 1.5%–3% range. In our view there are three key takeaways from the current environment in the region:
1. Subdued capital flows in the region have had a short-term negative impact on both the Lari and the Georgian economy. The Georgian economy is getting rebased in order to stay competitive in the new reality. However, in the medium to longer term we see lower oil prices as a big positive for Georgia as the country will be saving c.US$450 million from oil imports and on the back of lower oil prices we will witness efficiency pick-ups in a number of different sectors within the economy – making Georgia more competitive.
2. Our view is that this rebasing will not be significant – in the short term, Georgia will weather reduced capital flows better than oil producing countries in the region as due to lower oil prices we are experiencing much lower inflation than our neighbours. Lower inflation is also an outcome of the country’s disciplined fiscal and monetary policies.
3. As dollar capital has been reduced in the region, it seems that Georgia and the Lari are getting more dependent on Eurozone economies and the Euro respectively. Two points can be highlighted in this regard: firstly, the European Union (EU) is our largest trading partner representing more than 26% of trade; and secondly, Georgia recently signed a free trade agreement with the EU.
Our response to this changing and challenging environment in 2015 is to stay disciplined, until we get some clarity in terms of Lari stability and economic growth picking up.
1. Credit and liquidity risk management: On the credit risk side, we are applying stricter underwriting standards and will be slightly increasing interest rates on loans. At the same time, we are proactively re-profiling US Dollar loans to clients with non-US Dollar income. Re-profiling implies effectively increasing the tenor of the loan so that monthly payment in Lari stays at the same level as it was prior to the recent devaluation of the Lari. When re-profiling, we do not change the interest rate of the loan. In Retail Banking, our mortgage loan clients are most likely to apply for re-profiling, as in total we have 7,500 mortgage loans worth of GEL 400 million which are US Dollar loans to Retail Banking clients with non-US Dollar income. We consider re-profiling applications from our corporate, SME and micro borrowers on a case-by-case basis. So far 413 loans totalling GEL 35 million have been re-profiled.
Even though Bank of Georgia enjoys high liquidity and its positive liquidity gap up to six months is GEL 1 billion, we are now working with a number of Development Financial Institutions (DFI) to arrange further long-term loans to improve our Net Loan to Deposits + DFI funding ratio. Because the Euro influence on Lari is increasing and the Lari is effectively becoming a Euro proxy, we will be targeting to raise Euro funding and try to shift US Dollar loans into Euros.
2. Costs: Being extra cost conscious in a volatile environment is the right thing to do. At the same time we are accelerating the integration of the merger with Privatbank in order to start extracting cost synergies sooner than originally planned.
3. Investments: Even though we believe that the Lari has found its new equilibrium, we will further observe the Lari’s stability over a period of time, before we step up investment activities. During this period, we will remain vigilant and will continue to actively analyse and consider different opportunities.
4. Capital expenditure: For our banking operations we are targeting capital expenditure at a lower level than our depreciation charge. Our key projects for 2015 are Privatbank integration (which is not taking much capital expenditure), our Solo roll out (a key driver for our capex budget) and further investment in our IT infrastructure, to increase the reliability of our system. In the Healthcare Business, we will be pursuing a quite aggressive capex programme, and will concentrate most of it on new equipment purchases and developing high-margin businesses.
We upgraded our strategy from 3x20 to 4x20
In December 2014 we upgraded our strategy from 3x20 to 4x20 – the 4th 20% being the minimum level of IRR we target from investments in Georgian corporates. The goal with this upgraded strategy is to create sustainable high returns and high growth generating a strong platform for our shareholders. With this model we are targeting to generate ordinary dividends from the Banking Business and continuous special dividends from the Investment Business. Both businesses are Georgia focused, where average real GDP growth rate was 6.3% from 2003–2014. Most importantly the current management team knows Georgia extremely well as a result of running the largest bank in the country for the past 10 years and the team has demonstrated a track record of successful growth in non-banking businesses such as healthcare and real estate.
Why we upgraded our strategy to 4x20, when at first glance all looked good with a 3x20 strategy?
Our key goal is to continue producing high returns in the long run for our shareholders. Currently, we see that Retail Banking is producing over 30% ROAE while Corporate Banking is producing c.10% ROAE. We do not think that in the long run it is possible for Retail Banking to keep producing 30% ROAE. Therefore, we see the risk of high returns for the Group decreasing over the longer term. At the same time we do not want to be forced to lend to Corporates in order to show you growth of 20% in the total loan book, while growing a business line with an unattractive risk return profile. This is why we announced the 20% growth target for the retail loan book only. It is noteworthy that penetration of retail loans is half of that of corporate loans (when counting in DFI funding and outstanding Eurobonds) at 21% of GDP. Due to the superior returns in Retail Banking, we expect our Retail Business to continue to drive the banking business ROAE. The recent acquisition of Privatbank is in line with our updated strategy to further strengthen our retail franchise by adding c.400,000 clients, stepping up our payments business as well as capturing synergies by merging Privatbank with our existing Express Banking franchise. Our other two pillars of banking business strategy remain unchanged: ROAE at c.20% and Tier I Capital c.20%.
Due to the limited access to capital and management in a small frontier economy such as Georgia, we see a much better risk return profile when investing in Georgian companies than when lending to those same corporates. We also believe that the Group will be adding value for our shareholders by investing in opportunities, which currently are not accessible to our shareholders, changing management and governance, institutionalising and scaling up the companies, and most importantly, unlocking value by exiting from these companies over time. Our Plan A in exit is to take the company public. This way, as far as possible it is our firm intention to create an opportunity for our shareholders to participate in such offerings.
Strategy going forward for the Banking Business
Banking is the crown jewel in our Group and the key driver of profitability. We have three segments in the banking business, of which Retail Banking will drive most of our banking business growth, Corporate Banking and Investment Management will improve our ROAE, with the latter also contributing an increasing share of our fee and commission income.
1. Retail Banking
In our retail business we are covering 1.6 million individual clients and 90,000 SME and Micro clients. In order to capture different segments of our retail client base we are pursuing a multi-brand strategy for mass affluent, mass retail and the emerging bankable population.
a. Under the Solo brand, we are targeting the mass affluent segment. Currently, we have only 8,000 individual clients under the Solo brand. In April, we launched a new strategy, where we will be providing clients with a superior customer experience by giving them access to newly designed Solo lounges and providing them with new lifestyle opportunities. Solo personal bankers will be offering tailor-made solutions for our Solo clients and introducing new financial products such as bonds and other capital market products developed by our investment management team. We estimate that our current market share in this segment is less than 15% and our goal with the new strategy is to significantly increase this market share in the next three to four years.
b. Under the Bank of Georgia brand we target the mass retail segment. This is our flagship brand and most significant profit contributor, with 1.1 million individual clients and 90,000 SME and Micro clients. This segment is very much product driven and our biggest challenge is to change the business model to become more client centric and therefore increase the 1.7 current product to client ratio over time.
c. Under the Express Banking brand we target the emerging bankable population. We are currently estimating the market of a 1.5 million emerging bankable population, which either do not have interaction with a bank or use a limited number of banking products. Privatbank clients are part of the latter and we would like to integrate the majority of 400,000 Privatbank clients within the Express Banking franchise. After the integration we expect the number of Express Banking clients to increase to c.500,000. Under the Express Banking franchise we are scaling up our payments business, which currently is in its nascent stage, by increasing our lower-end merchant footprint and thus giving more people access to card payments. Through Privatbank we will be increasing our footprint from 6,300 merchants to more than 7,500 merchants, increasing our coverage ratio to nearly 85% of the total number of merchants. Also, we are scaling up self-service terminals under the Express Banking franchise. This way, we plan to introduce a more efficient way to access the mass retail segment and allow easy transactional banking to the country’s under-banked population. Currently, country-wide we operate more than 2,200 self-service terminals.
2. Corporate Banking
One critical goal in the Corporate Banking business is to increase ROAE and we plan to do this by de-concentrating our loan book and decreasing the cost of risk. Our experience shows that if, in any given year, one of our top 20 clients has some problems, the Corporate Banking business ROAE gets depressed. Therefore our key goal is to de-concentrate the loan book by:
a. Syndicating loans out.
b. Selling risk.
c. Helping our large corporate clients to access capital by issuing debt securities on the local capital market.
We will focus on further building our fee business through the trade finance franchise, which we believe is the strongest in the region.
3. Investment Management
We expect to grow our fee income by building our local debt capital markets and M&A advisory franchise. As we would like to de-concentrate the corporate loan book in corporate banking, local debt issuance is one way to go in combination with our advisory business enhancing ROAE by generating more offbalance sheet business. On the M&A side we see the need for some sectors to consolidate and Galt & Taggart plans to take a leading role in this consolidation process.
As Georgia has a pay-as-you-go pension system, we believe that our international wealth management franchise can benefit by focusing on the distribution of local debt. So far we see that c.70% of the demand in local paper issuances comes from our international wealth management clients. Further enlargement of the footprint of our international wealth management franchise will be critical for the success of our strategy to build local capital markets. Therefore, we will be investing more in this area.
To summarise our Investment Management strategy, we need to do the following:
a. Enhance ROAE through our investment in the issuance of more debt paper in the local market.
b. Enlarge our wealth management footprint internationally to further strengthen our distribution channels.
The way we invest and manage
As our Investment Strategy is new for our shareholders, I would like to spend more of your time and provide you with more insight into how we plan to conduct investments and manage companies. Let me outline our key principles, which are derived from our experience in running Bank of Georgia: 1. Be opportunistic and disciplined. 2. In scale we trust. 3. Getting our hands dirty. 4. Good governance makes good returns. 5. Liquidity is the king.
Let me expand on each of these points to give you more flavour on how we see our job in investing and managing the companies.
1. Be opportunistic and disciplined
We want to be opportunistic and disciplined when investing, by buying cheaply and in small ticket sizes.
For us buying assets cheaply is the first and most important postulate in our investment strategy. It is difficult to go wrong when you buy assets cheaply. The key questions are:
a. How do we define cheap in a small illiquid market?
b. How do we manage to buy cheaply?
When considering an acquisition, whether it’s pre-IPO or otherwise, we look at multiples of listed peers in the same sector and apply at least a 40% discount. This is our definition of cheap.
Georgia is a small frontier economy and access to capital is limited. It is difficult to find liquidity for any single asset worth more than US$10 million. At the same time, owners of assets are often asset rich but cash poor. Georgia’s GDP has grown on average 12% in nominal terms over the past 10 years and local businesses have been reinvesting over that time to stay competitive.
We like paying dividends to our shareholders as it creates natural self-discipline in buying assets cheaply. Therefore, before investing we will always ask ourselves the question: is it worth investing this money in this company or opportunity or better to pay/increase dividends?
Another reason for us being disciplined is that we are under no pressure to make any new investment as Bank of Georgia is producing good returns. If we do not find a good opportunity we may not invest for two to three years. We are always following different sectors of the economy and if a good opportunity arises we would want to capture it. To this end, we would like to sit on at least US$30 million of cash (under the current market cap) at the holding company level to make sure that cash is available as opportunities arise in our existing business lines or new ones. Also cash is very handy in slower business cycles and can help to buy assets cheaply.
We plan to be disciplined not only in terms of finding new opportunities through investment appraisals and understanding the risk return profile, cyclicality of the business and quality of revenue, but also in terms of the size of the initial investment in any new sector. We believe that our initial investment in any new sector should not exceed c.US$25 million. When and if we get comfortable with the sector, only after that would we allow ourselves to increase the ticket size of the investment. The small size of the investment is important as we are human beings and we may make a mistake. By investing in small ticket sizes we will be far away from betting the house. Making a small mistake is OK, just learn from it – do not bet the house.
To summarise, Georgia was born 10 years ago and different sectors and businesses are in the process of formation, access to capital and management is limited, owners of businesses are cash poor and therefore good opportunities can be captured cheaply. At the same time, we are under no pressure to make new investments and we will be extremely selective and opportunistic and will not commit more than US$25 million in a single investment in a sector where we are not already present. Our dividend policy is the natural self-discipline mechanism for our investment business.
2. In scale we trust
We strongly believe that any investee company and/or sector in which we invest in should be large and scalable. In case of pre-IPO opportunities, EBITDA of the existing business should be at least US$25-50 million – depending on the sector. In the case of greenfield investment, we need to see an opportunity to scale up and achieve US$25-50 million in EBITDA over the next five to six years.
We like to hold and/or target large market shares in any given sector. Our sweet spot is 30% market share in any given sector. This way we will have the scale to be efficient and competitive and at the same time not be overly dominant to attract the attention of regulators. We should be mindful not to abuse the power of a large market share and we should be open to share the benefits of scale with our customers. In a nutshell, we do not mind sharing success with our clients.
We like large, but fragmented, sectors to have an opportunity to consolidate it – like we are doing in the healthcare sector. We also like natural monopolies like GGU. We would consider sectors where you have one dominant player with 50%+ market share. We like simple business models.
We had a bad experience of acquiring small companies in 2005-2007. In a small period of time we acquired 10+ companies in total. The good thing was that capital commitment was limited, but it took too much senior management time and because of the limited size of company we were unable to hire good management teams. The strategy proved to be wrong due to the limited size of the investee companies.
To summarise, achieving superior economies of scale in a small frontier economy is an essential part of the success. It actually significantly diminishes the risk of failure.
3. Getting our hands dirty
Before we undertake an investment we like to take time and get our hands dirty to understand inside out the sector and business we are targeting. Diligence and modelling in excel is the key before entering any business.
Getting things done is the single most important task for our executives. No matter how great our strategy is, we strongly believe that execution is the key. No matter how good the investment opportunity is, we will not pursue it if we do not think that we have a first-class management team to put in place.
At Bank of Georgia we have spent a lot of time building a top-class management team and we have a deep bench of people who have grown and are ready to take bigger responsibilities. One of the reasons we are confident in our strategy is that we have human capital available both on the top and mid-management levels. We spend a lot of time coaching and mentoring our talent and our Board’s role in this process is invaluable.
Along with selling the companies, we will be selling the management team and saying goodbye to our management team, therefore we fully understand that our machine of producing new executives should not stop. Furthermore, for our top talent we have introduced a self-development programme by hiring coaches to help them to better understand their strengths and weaknesses. According to our policy, no matter how good the performance of our top executive is they may get limited bonuses if we do not see progress in executive’s self-development and growing their successor(s).
You have observed rotations in our top management every two to three years. In December 2014, we announced another round of rotation. We would like our top talent to receive experience in different roles and learn and grow. Rotations will continue in the future.
In some of the sectors where we have limited operational experience we would put together a complementary team of talent from our Group and sector specialists from outside the Group. We are confident that talent from within our Group can learn the sector in a short period of time. In the early stage of the investment cycle, the management from the holding company level will spend more time on coaching and guiding the management team. That is exactly what we are doing at Georgian Global Utilities now.
The question we need to ask before entering the new sector is not whether we are the best, but whether our management team is better than that of the next player. This is a relative play game.
At this stage, we do not want to hold more than four investments at any given time, as we are limited in terms of oversight as well as management resources to put in place in more than four companies.
To summarise, similarly to limited access to capital in this country, the availability of management is limited and by being a machine of producing top talent in the country we can add value for our shareholders. We understand that great management teams make great companies, and investing time in growing people continues to be critical for the success of our strategy.
4. Good governance makes good returns
We have already learned that great institutions are not built without robust governance and ultimately without it one cannot deliver sustainable value creation for its shareholders.
We like to institutionalise companies by putting good governance in place. We do not like to bet on one person’s judgement and do not believe that one person can perform magic. Therefore, we believe that first of all the CEO should be surrounded with an outstanding management team from below and a first-class Board from above. Meritocracy, loyalty to institution rather than to individuals is our approach. To this end, our approach is to separate the roles of Chairman and CEO. We operate like this at Bank of Georgia and we truly believe in healthy checks and balances between the Board of Directors and executives. Having separate individuals for the top job on both levels is the key signal we are sending to our shareholders on governance.
We think that a high-quality, diversified independent Board is extremely important for the success of the Company. We see the Board not only as an institution, which is doing its duty of oversight of the management and setting strategy, but also the Board is providing guidance and coaching of our top and mid-level management team.
In our case, the Board’s role of oversight is made relatively straightforward by creating a natural alignment of interest between shareholders and management. For that we award long-term vesting shares (up to five years) to management and make compensation in shares a large proportion of total annual compensation (e.g. 85-90%). This way we create long-term alignment of interest between management and shareholders. If shareholders make money, management makes money and if shareholders lose money, management also loses money. With this simple approach, on top of being executives, the management team feels and acts more like shareholders – because they are.
Even though this compensation structure has a lot of positives as outlined above, it has one main drawback: when share prices rise too rapidly the risk of management becoming arrogant and complacent is high. This is another reason why we think a strong Board is essential to bring management back to reality.
The Nomination Committee is always searching for professionals around the world to make sure that we have all the skill-set available on the Board. For example, currently we are searching for an experienced potential Board member with background in Energy and Utilities to give us more guidance for our GGU investment.
To summarise, we are big believers that robust governance is the source of value creation for our shareholders. The natural and simple alignment of interest between shareholders and management by awarding long-term stock works well for value creation and, finally, we want to have good balance by having separate people as the Chairman and CEO of the Company.
5. Liquidity is the king
According to our investment policy, we target to exit from our investment through a trade sale (full or partial) or IPO in up to six years from the initial investment. Because we are a publicly held company our preferred option is to take the Company public to give the market the opportunity to participate in the future upside.
No matter how well our companies do in terms of operating results, we want to see their exit to unlock the value and with the generated profit pay special dividends and pursue new opportunities – in the event that we see one. According to our strategy we will be targeting three special dividends in the next five years. Our aim for the size of aggregate special dividends is to be at least 50% of ordinary dividends paid by the banking business during these five years.
Because we aim for high returns and not for control, we do not mind selling below the 50% shareholding level at the IPO. We fully understand that liquidity for both incoming investors and our Group is the key. We have learned that increased liquidity of shares itself creates value as shares become accessible to a wider investor universe. This was indeed the case when we converted from our GDR listing to the London Stock Exchange Premium listing in 2012. As shares of Bank of Georgia became more accessible, their value increased while fundamentals did not change.
Unlocking the value through IPO is more critical for us than any money we leave on the table at the IPO. At the end of the day and as far as possible it is our firm intention to create an opportunity for our shareholders to participate in the newly IPO’d company by buying its shares.
As many of you know we are in the process of preparation to IPO our healthcare subsidiary Georgia Healthcare Group. The Board and I have complete confidence that the management will deliver on our stated strategy of doubling 2015 revenue by 2018. Some would argue that we might be better off to take the Company public in two to three years’ time, as more profits are expected to be generated by then. But we want to be disciplined in terms of unlocking value for our shareholders, as set out in our 4x20 strategy, and are targeting an IPO in 2015. I personally am extremely excited about the prospects of the Company. As far as possible, it is our firm intention to allow our shareholders to participate in the IPO and I, for one, will definitely be placing an order.
To summarise, in order for our strategy to work we need to be disciplined in unlocking the value of companies in which we invest and manage. Taking companies public is our preferred option for exit, as it is our intention to give our shareholders an opportunity to participate.
In the end, I would encourage you to visit Georgia and meet our management team. You can meet and get to know our Board members at our annual investor day. We have a saying in Georgia: “It is better to see the place once than hear about it 100 times”. What I promise you is dinner at a restaurant overlooking beautiful old Tbilisi – the place where East meets West at the old Silk Road, from where you will be able to feel the future.
Chief Executive Officer
- Chairman’s Statement
- CEO’s Statement
Bank of Georgia enjoyed another year of record results and this annual report and accounts will provide the details about our strategy, execution and operational and financial performance. In this year's letter I would like to focus on Georgia and summarise developments in the year 2013, which caps the most formative decade in the country's recent history.
Ten years ago, Georgia embarked upon a path of transforming its Soviet-legacy political and economic system into a market-oriented democracy. As the Group’s Board Chairman for nearly four years, I have had a remarkable opportunity to observe and appreciate how Georgia succeeded in tackling the main challenge for a post-Soviet country – corruption, virtually eliminating the country’s Soviet-era bureaucracy and replacing it with efficient and functioning administrative bodies. Among the most noteworthy free-market-oriented reforms behind Georgia’s economic success were simplification of the tax regime, cutting red tape, creating business and an investor friendly environment. We became witnesses to how effectively these measures translated into the turnaround of the country’s economy and the evolution of the private sector into a dynamic business environment. Georgia’s liberal economic regime and ample growth
opportunities have been attracting foreign direct investment and pleasantly surprising foreign visitors, the number of which grew from a mere 300,000 in 2003 to an estimated 5.4 million in 2013, exceeding the 4.5 million population of Georgia. Quite impressively, Georgia enjoyed an average annual growth of 5.9% of its real GDP from 2004 to 2013.
Excluding the Eastern European states, Georgia started 2013 as the first post-Soviet country to change power through peaceful and democratic parliamentary elections. These elections were held in October 2012. The change of power through elections was a new experience for Georgia’s young democracy. 2013 was also a transitional year from a presidential to a parliamentary system of government, which came into force with the Presidential elections at the end of October 2013. Georgia’s Presidential elections were the most free and uneventful elections for the country during its two decades of independence. Although the composition of the new Parliament, with an effective opposition, stalled decisionmaking processes and therefore, economic growth for the most part of the year, it has, more importantly, resulted in greater political pluralism, debate in the Parliament and overall involvement of the non-governmental sector, which are essential components of a functioning democratic state.
It pleases me to note that despite the challenges associated with the transitional period and the change of power, last year has demonstrated the sustainability of the earlier reforms, institutional strength and the maturity of the Georgian society. Democratic values and practices have become a norm for businesses and society in general. Government’s effectiveness during the transition year is evidenced by the continued tight grip on corruption, further improvements in the business environment and stepping up the overdue reform of the judicial system. With the elections and the uncertainties associated with them left behind, the return of Government investment into the economy and increase in business and consumer confidence has led to recovery of economic growth with 7.1% real GDP growth in the fourth quarter of 2013 and 6.7% average growth rate in the first two months of 2014.
Georgia has come a very long way since 2003, and 2013, with its remarkable breakthrough in the political sphere has set the stage for Georgia’s further development, building upon the achievements and strengths of the previous years to ensure its economic progress and the continuing modernisation of the country. To this end, one of the key encouraging signs that I would like to point out is the enactment of the Economic Liberty Act as of 1 January 2014, which will ensure the continuation of the country’s credible fiscal and monetary policy framework. In addition, Georgia is expected to strongly benefit from the signing of the Association Agreement with the European Union, expected in June 2014. This agreement is expected to include a deep and comprehensive free trade agreement that should support Georgia’s economic development and bring the country closer to the West. This may be the most interesting time for Georgia, the Georgians and for those who are investing in Georgia’s future.
Bank of Georgia, the country’s marketleading franchise, is in the right place at the right time to play an important role in Georgia’s unfolding progress and benefit from the economic development of the country. We believe in the effectiveness of our business model and the ability of the management team to execute our strategy and continue delivering high-quality diversified growth.
In conclusion, as a Chairman of the Board of Directors, I would like to note the changes we made on our Board in line with our commitment to the continuous improvement of our corporate governance practices. In 2013, the Board of Directors of BGH resolved to ensure that our Non-Executive Board members would all be fully independent under UK standards. As a result, two Non-Independent Directors, Ian Hague and Hanna Loikkanen resigned, as did Allan Hirst, an Independent Director also left the Board after a nine-year tenure. We are deeply grateful for the devoted services of all three. They have been replaced with three new Independent Non-Executive Directors – Bozidar Djelic, Tamaz Georgadze and Kim Bradley. Please refer to the Governance section of this Annual Report or our website to read about the array of experience and skills these three individuals bring to our team.
I would like to thank my fellow Board members for their support and commitment and congratulate the management team for the strong performance in 2013 and I look forward to new achievements in 2014.
Bank of Georgia I am very pleased to report a record 2013 full year rofit of GEL 209.3 million, up 16.6%, supported by record revenue of Gel 545.5 million. Earnings per share, also a record, stood at GEL 5.93 OR £ 2.07, up 13.6% in lari terms. The return on our shareholders' average equity was 18.6%. 2013 results reflect the robust performance of underlying businesses, balance sheet strength, efficiency gains and strong profitability in spite of slow economic growth throughout most of the year.
Economic growth in Georgia, which has for a number of years been a tailwind for us, was lower than expected and resulted in a slower start to the year. However, we witnessed a significant pick-up in business activity after the Presidential elections in October 2013, which saw the candidate of the ruling Georgian Dream Party win a landslide victory. GDP growth was estimated at 1.7% for the first nine months of 2013, but picked up after the elections to reach 7.1% in the fourth quarter. The future also seems optimistic as the IMF forecasts 5% GDP growth in 2014. The state budget was run at a surplus for the first nine months of 2013. In Q4 2013, in order to reach the target level of deficit for the year, spending accelerated particularly on infrastructure projects, resulting in a large increase in the supply of Lari. This in turn caused a small correction in the GEL/US Dollar exchange rate. In February 2014, however, the Lari reversed some of its losses against the major currencies and started to appreciate. In 2013, the National Bank of Georgia (NBG) remained a net buyer of US Dollars, purchasing US$335 million during the year.
In this letter, I would like to review 2013 by highlighting certain key performance measures, analysing the drivers of the results and the underlying strategic initiatives that we believe are fundamental to our success. Our medium-term strategy continues to centre around the 3x20 story that aims at achieving a 20% growth rate in our loan book, 20% Return on Average Equity and a 20% Tier I Capital ratio.
Below, I will start with three strategic initiatives launched over the last several years, which are now driving the diversification of our revenue that shapes our performance.
We began implementing our Express Banking strategy in 2012 by rolling out small-format, Express branches offering predominantly transactional banking services to clients through ATMs and Express Pay Terminals. The aim was to make banking relationships simple, faster, cheaper and convenient for both our existing customers and for the emerging bankable population. A Self-Service Terminal can be described as a small bank by itself as it allows a wide array of payment services ranging from current account top-ups and loan repayments to utility bill payments and metro ticket purchases. In 2013, we installed 764 new Express Pay Terminals throughout Tbilisi resulting in 985 total Express Pay Terminals as of the end of the year. We are now leaders in Georgia in the payment systems market. We have combined our travel card for the Tbilisi bus and metro (of which we are the sole provider) and our contactless card with a loyalty programme linked to the customer’s current account to create an “Express Card” and have issued over 240,000 such cards in 2013. At the end of the year we had more than 430,000 Express cards outstanding. The effects of the successful execution of our Express Banking strategy are numerous and far reaching and are now expressed in our financial performance that I will be describing below.
Started in 2010 from bad loans, our real estate strategy was to transform those loans into a successful business, and the process has been a textbook case of turning a problem into an opportunity. Our m2 Real Estate operation, which develops real estate property previously repossessed by the Bank, had a 40% IRR in 2013 and has become an integral part of the Bank’s mortgage strategy, supporting the mortgage loan book development.
During the past few years, with a view to diversifying our revenue streams and growing our non-interest income, we have taken decisive steps to grow and vertically integrate our Insurance and Healthcare businesses. BGH and Aldagi are currently preparing to list Aldagi’s Healthcare-related business on an international stock exchange. In 2013, Aldagi, our Insurance and Healthcare subsidiary, contributed 10.9% to our Company’s revenue and 12.0% to its profit.
As a result mainly of these, but also of less visible strategic actions, we delivered another exceptional year in terms of profitability, despite the backdrop of a slower-growth economic environment. At 7.8%, NIM held up better than we expected, withstanding the downward pressure from excess liquidity throughout the year that was largely a function of the subdued loan demand prevailing for most of the year. We attribute the resilience of our NIM to a number of factors, including our established market leadership that translates into superior distribution capability and pricing power. The most important contributor to our strong NIM in 2013, however, was the markedly reduced Cost of Funding. In the first half of 2013, we substantially reduced deposit rates, which significantly drove down our overall Cost of Deposits from 7.3% to 5.6%. It is important to note, however, that these deposit rate cuts have not compromised the inflow of deposits as the client deposit balances increased by 18.5% year-on-year. In addition, despite the lower deposit rates offered by the Bank compared to the market, our market share in retail deposits declined by only 0.7%. We consider these developments to be a true testament to the strength of our franchise and the brand name of our company. The reduction of deposit costs, combined with the superior access to capital markets demonstrated by the issuance of the 2017 Eurobond tap of US$150 million, enabled us to price the oversubscribed placement with a low interest rate level of 6.125%. Last, but not least, the increase in current account balances was made possible by the roll-out of the Express Banking strategy. Compared to last year, Retail Banking current account balances grew by GEL 89.6 million, up by 45.7%. We intend to continue decreasing our Cost of Funding, one of the main competitive advantages and central to our profitability. Our Express Banking strategy is expected to further increase our current account balances – the cheapest source of funding. In addition, our superior access to capital markets will enable us to maintain our flexibility in optimising our liability structure.
2013 was the fourth straight year that we have combined business growth with improved efficiency as evidenced by a declining Cost to Income ratio. This year, our revenue growth of 9.5% compares to 2.0% growth of our operating expenses, certainly a result of the overall vigilance with our costs across the board. More importantly, the improved efficiency is linked to our Express Banking strategy. We became a formidable player on the retail market through expansion by means of low-cost Express branches that has paved the way for transactional banking. The existing full-scale branches are now focusing on offering value-added products, while technology-intensive Express branches enable us to offer basic banking products and services at minimal cost. In addition, one of the strategic objectives of Express Banking, which is to bring the previously un-banked/emerging bankable population to Bank of Georgia, is now bearing fruit. The tailor-made products and services that became accessible for our new clients at our Express branches is a powerful and low-cost client acquisition method. In 2013, the number of new clients joining the Bank exceeded 190,000, up 18% from last year. Our improved cost efficiency is one of the main reasons our banking operation was able to service its substantially increased client base without growing its headcount, which focuses on IT and remote banking services. On a stand-alone basis, Bank of Georgia’s full-time employees decreased by 4.3%.
Going forward, cost discipline will remain a main focus. We are targeting to reduce our Cost to Income ratio to approximately 37% in the next three years. We believe the Express Banking strategy will be the main contributor to the further improvement. The development of Express Technologies will allow us to scale up the business with minimum operating costs.
Loan Book Growth and Improving Asset Quality
The strength and the efficiency of this growing franchise is the cornerstone of our solid competitive position and is also linked to our ability to grow our loan book in the low loan demand cycle in 2013. As the largest bank in the country, Bank of Georgia is best positioned to benefit from the de-dollarisation trends that have translated into a pick-up of Lari denominated credit growth. In addition, our competitive strength on the liability side as evidenced in the ability to reduce funding costs without compromising deposit funding, allowed us to achieve 13.9% loan book growth that cost us 130 bps on the Loan Yield, which compares to the 170 bps reduction of our Cost of Deposits. The result was that we didn’t compromise our profitability as demonstrated by the continuing strength of our NIM. We are constantly keeping a watchful eye on asset quality by following prudent risk management policies. Strongly supported by our diversified loan book, our NPLs grew by only 14.7%, comparing favourably to the loan book growth rate. Our Cost of Risk for the year stayed at the top of our targeted range at 1.4%, while our Q4 2013 Cost of Risk of an annualised 0.9% was a noteworthy improvement over the Q3 2013 Cost of Risk of 1.6%, also attributable to the slowdown of the economy in the first half of the year.
Strategic Initiatives Going Forward
Building upon our 3x20 strategy adopted in 2011, we are set to deliver on our key strategic priorities for the next three years. We are determined to maintain our market leadership, which gives us economies of scale as well as superior distribution and pricing power. Our market leadership is built on our strong Retail Banking and Corporate Banking businesses, which together are the backbone of the Bank of Georgia franchise. We see the strong growth potential of Solo Banking, our premier banking business, by means of increasing our currently relatively low penetration in the mass affluent segment. The expansion of our Solo Banking will be strongly supported by the offerings of our Investment Management products and services. The further development of our Express Banking business, which is at the heart of our retail strategy, is directly linked to Express Technologies, and we intend to continue investing in IT, which we consider pivotal for the future of the banking industry. We plan to build the growth on the back of further diversified revenue sources. Knowledge and understanding of the market, both Georgian and regional, and proven superior access to international capital will be the drivers of our Investment Management business growth. In 2013, we have combined our wealth management, research, advisory, and brokerage businesses under Investment Management. We intend to launch our first Investment Management products during 2014 and plan to continue to build upon them with the aim to create an important fee-generating business. Expansion through our payments business in Georgia has already started, and the newest addition is the Express Merchant business, which is an additional revenue source of income from small retailers that are not yet part of the card payment system. We will be focusing on turning payment systems into a significant base for our revenue generation and we are also preparing to leverage our knowledge of IT and payment business by beginning to export IT and payment business outside of Georgia. Looking back, I am proud of how much has been achieved. Entrepreneurial spirit is at the heart of Bank of Georgia’s culture and is one of our strongest assets. It has resulted in the creation of a very strong franchise that will be very difficult to match and even harder to displace. Such success in turn has created a new important task for us. We now have to manage the size, which in our case means striking the right balance as we seek to maintain our entrepreneurial spirit as we further institutionalise our achievements. In 2014, this will be one of our main tasks. Our first step to this end is the recently launched Bank of Georgia University that will help with the identification and development of talent within the Group. 2013 was a momentous year in terms of share price performance, which increased 113% since year-end 2012, outpacing most of our peers. In 2013, Bank of Georgia was the third largest growth stock in the FTSE 250. Average daily liquidity increased by more than 65% to 200,000 shares in 2013. Our long-term investors, namely East Capital and Firebird, significantly reduced their holdings, which led to the widening of our institutional shareholder base, contributing to the improvements in stock liquidity and free float. Our shareholder base is now far more diversified than a year ago: non-emerging market focused institutional shareholders make up c. 36% of our shareholder base compared to just 15% a year ago.
At the 2014 AGM, the Board intends to recommend an annual dividend of GEL 2.0 per share payable in British Pounds Sterling at the prevailing rate. This represents an increase of 33.3%, compared to the annual dividend of GEL 1.5 per share last year, a payout ratio of 33.7% and a dividend yield for shareholders of 2.9%, calculated on the basis of the year-end 2013 results and using the 31 December 2013 share price of £23.95.
I would like to thank the members of our Board for their engagement and invaluable input and congratulate the management team and more than 11,000 employees of the Group for the strong performance this year. We are looking forward to a busy and exciting year ahead of us. The key strategic initiatives that we undertook a few years ago are gaining momentum and while we made considerable progress this past year, I believe we have much more work ahead of us to realise the great potential of the Bank of Georgia Group. We are confident in our competitive position and remain focused on delivering value to our shareholders, lenders, customers and employees.
As part of a number of significant changes in regulations in the UK, this Annual Report contains a Strategic Report, which is set out on pages 10 to 27. The Strategic Report has been reviewed and approved by the Board of Directors of BGH on 10 April 2014 and I hereby sign the Strategic Report on behalf of the Board of Directors of BGH.
Chief Executive Officer
- Chairman’s Statement
- CEO’s Statement
Four reasons why we are the leading bank in Georgia:
1. Our values drive our business
2. Our products and services are right for the market we are in
3. We have a strong and robust governance structure
4. Our Executive Management team is focused on delivering results
In 2012, Bank of Georgia Holdings has made strong progress in a number of areas that underpin future growth in its revenues, earnings and delivering value to its shareholders. The Board is delighted with the Group’s progress in a year in which it delivered record earnings of GEL 179.6 million.
Our executive management team, led by Irakli Gilauri, has developed and implemented a growth-focused strategy that is generating high levels of business and earnings growth, with strong profitability and returns whilst maintaining a conservative balance sheet with high levels of capital and liquidity – levels that are substantially in excess of minimum regulatory requirements. This strategy clearly works and, as a result, the Group continues to get stronger and stronger.
On behalf of the entire Board, I thank Irakli and the management team for plotting and maintaining the sound strategic course – with challenging goals – for Bank of Georgia. Irakli’s personal integrity and commitment to the values of the Group are clearly recognised, highly regarded and reflected throughout the organisation.
In my letter to shareholders last year I talked about Georgia’s recent progress in the eradication of corruption and in delivering market-oriented reforms that have underpinned Georgia’s macroeconomic development over the last decade. This economic progress has continued to be delivered throughout 2012 and into 2013, notwithstanding a period of uncertainty around the time of the country’s parliamentary elections in October 2012.
In 2012, Georgia remained firmly on the path of economic growth, recording an estimated 6.1% real GDP growth during the year. This economic growth reflects three main pillars: Georgia’s economic liberalisation and strong fiscal and monetary framework, ongoing macro-economic stability and Georgia’s welcoming business environment resulting from recent growth oriented reforms.
Growth in tourism continues to be an important driver of Georgia’s economic progress, with the number of foreign visitors growing by 56% to a total of an estimated 4.4 million visitors in 2012 compared to 2011. Net remittances and foreign direct investment remained robust and are expected to continue to be so into 2013 and beyond. In January and February 2013, the number of foreign visitors continued to increase significantly with 37% year-on-year growth compared to January and February 2012. Georgia benefits significantly from its liberal economic policies and its positioning as the logistics and tourism hub for the Caucasus region. The country’s Liberty Act ensures the continuation of the country’s credible fiscal and monetary policy framework. With effect from 2014, Georgia’s government expenditure as a percentage of GDP will be capped at 30%, the budget deficit as a percentage of GDP will be capped at 3%, and overall Government debt to GDP will be capped at 60%. In addition, recent growth oriented economic reforms, such as eradication of regulation and red tape and eradication of administrative corruption, among others, will continue to benefit the economy for years to come. 2012 was also a breakthrough period in the Deep and Comprehensive Free Trade Area negotiations with the European Commission, which is now expected to lead to the successful conclusion of negotiations during 2013, and to the initiation of free trade with the European Union within two years.
In December 2012, the Parliament of Georgia approved Georgia’s state budget for 2013. The budget revenues are projected at GEL 7.4 billion, while the total state expenditure budget (including acquisition of non-financial assets) is expected to be GEL 7.9 billion. The forecast budget deficit, as a percentage of GDP, is 2.9%, and Government debt to GDP is targeted to be 33.1%. Real GDP growth is budgeted to be c.6%, and average inflation is expected to be c.3%. Whilst 2012 was another year of economic progress in Georgia, it is in the political sphere that a truly remarkable breakthrough was achieved. Following the victory of the Georgian Dream coalition in the October 2012 parliamentary elections, there was a relatively smooth transition to a Government run by the Georgian Dream coalition – a rare democratic achievement among former members of the post-Soviet CIS. The new Government is now clearly ‘up and running’, progress is being demonstrated in many areas and it is encouraging to see good levels of inward investment continue, high and growing levels of tourists visiting Georgia and, perhaps most notably, significant signs of a substantial improvement in both diplomatic and economic relations with Russia – over time I believe this will be extremely beneficial to the people and economy of Georgia. Whilst the last October elections plainly represented a significant source of uncertainty for businesses and consumers in Georgia, having seen these more recent developments in the country, it feels like this period of uncertainly is now behind us.
Throughout 2012, Bank of Georgia has remained firm and true to its core values and principles. Among the many reasons why Bank of Georgia continues to be, by any measure, the leading bank in Georgia, I would highlight these: – Our key values drive our business – Our products and services are appropriate for the markets in which we operate – We have a strong and robust governance structure, and – Our executive management remains clearly focused on delivering high quality, sustainable, results.
The Group recognises that we live in a time when the external environment constantly challenges us to develop innovative solutions that drive both value for our customers and sustainable profits for our shareholders. Many of the ways in which the Group is responding to this challenge are explored in greater detail in the Chief Executive’s statement and elsewhere in this Annual Report. I will mention only a few of the key areas of progress made by the Group. In Retail Banking, our Express Banking strategy is revolutionising Georgian financial services markets and is increasingly been used to bring more, previously unbanked, customers into the banking sector.
Management’s focus on cost efficiency and delivering positive operational leverage is also an important strategic priority. By constantly looking to improve efficiency, and focusing on leveraging new technologies and efficiencies such as Straight-Through Processing, the Bank again delivered revenue growth that is more than double the rate of expense growth. In a maturing financial services market, which we expect to be characterised over the next decade by falling interest rates, management has made reducing the Group’s cost of funds a priority. Over the last 12 months this has been highlighted by a strong focus on reducing deposit rates across all business sectors, as well as the issuance of a five-year Eurobond in July 2012 which, when combined, supported both a significantly reduced cost of funds and, consequently, an increase in the Bank’s net interest margin. This emphasis on strong balance sheet management will, I believe, continue to support strong margins over the next few years. Our strong earnings performance and level of profitability has produced high rates of internal capital generation. Our capital ratios substantially exceed our current capital requirements and proposed future needs. This has enabled the Board to recommend a more than doubled dividend of GEL 1.50 per share, and announce an expected dividend payout ratio going forward of 25%-40% of earnings.
Finally, our listing on the premium segment of the London Stock Exchange in February 2012 has achieved its key objectives. The average daily liquidity of Bank of Georgia Holdings shares has increased substantially, the Group has improved access to global capital markets and we have experienced a significant diversification of our institutional shareholder base, with particularly noticeable increases in our UK and US shareholder bases. The value of these improvements was both demonstrated and further enhanced in March 2013 by the successful placement of a 10% equity holding by East Capital Financials Fund, which is in the process of closing. The Board believes that both Georgia and Bank of Georgia remain well positioned to build on the successes of 2012, in 2013 and beyond. The Bank of Georgia business model has a demonstrated flexibility and ability to generate high quality organic growth in a number of different economic environments. Georgia’s economy is in good shape and I cannot think of a bank better placed to take advantage of the opportunities that will arise in our core businesses over the next few years.
Leveraging our offer for the long term
In 2012 your Company reported another record profit of GEL 179.6 million, an increase of 32.3% from the profit delivered by Bank of Georgia in 2011. This strong progress continues to reflect the strength of the Bank’s earnings power and resulted in a ROAE of 19.1%, up from 18.3%, and EPS growth of 17.6% to GEL 5.22, reflecting a strong business performance, significantly reduced cost of funds and improved efficiency across the business. On 28 February 2012, Bank of Georgia Holdings started trading on the LSE Main Market and in June 2012 became a FTSE 250 constituent company. This has markedly improved the liquidity of your stock, positively affecting the price of BGEO LN, which grew 86.0% since the premium listing almost one year ago on the back of an average trading volume of approximately 103,000 shares per day (GBP 1.5 million). We have a well-diversified shareholder base which includes our long-time investors across various geographies and the addition of many new non-emerging markets focused institutional investors, who now make up approximately 15% of our investor base. As the Chairman mentions in his statement, we were particularly pleased with the recent successful placing of the East Capital private equity stake, with a diverse range of high quality institutional investors.
2012 was a momentous year for Georgia as well. Following the parliamentary elections in October 2012, we witnessed a democratic passing of power for the first time in the country’s history. The new government has asserted its commitment to improve further Georgia’s investor and business friendly policies and in December 2012 the newly-elected Parliament approved a well-balanced budget for 2013 that forecasts 6% real GDP growth, further improvements in general government debt ratios and a continuous focus on infrastructure sector development. In Q4 2012, the uncertainty in respect of the change of political leadership resulted in a relative slow-down of corporate business lending growth throughout the Georgian banking sector. While we may continue to see this trend of slower growth over the next few months, we have been encouraged by higher levels of business activity in the first few months of 2013. Our revenue in 2012 totalled GEL 498.3 million, up 21.9% (revenue adjusted for a one-off currency hedge gain in 2011) compared to 2011. The significant increase in revenue was due to the robust performance of our businesses and the effects of our diversified sources of growth. Strong interest income was driven by growth in both the retail and corporate loan books, especially in the first nine months of the year. Fee income increased 14.8% to GEL 86.5 million, reflecting our leadership in money transmission payments and the superior fee generating capabilities of our Corporate Banking business. We enjoy an estimated 50% market share in card acquiring business in Georgia, have unmatched client reach through the largest network of ATMs and Express Pay terminals and American Express card exclusivity in Georgia. During 2012, Bank of Georgia launched contactless Express cards for the first time in Georgia, and further developed our Express cards and associated loyalty programmes that are unique in Georgia and increasingly serve as the metro, bus and mini-bus transportation payment systems. The Bank has also significantly enhanced its already market leading branch network, adding 30 Express branches to bring the total Express and Metro branches to 63, and also more than doubled the number of Express Pay terminals, which are increasingly being used for bank transactions such as credit card and consumer loan repayments, cash deposits, utility bill payments and mobile telephone top up payments. Our Insurance and Healthcare businesses, which had an eventful year in terms of M&A activity, contributed 11.0% to the consolidated revenue and 8.7% to the consolidated profit and is becoming an increasingly meaningful source of the Bank’s income.
Our affordable housing business successfully completed its pilot project, contributing GEL 15.5 million to the mortgage loan book and m2 Real Estate, our real estate subsidiary, realised a profit of GEL 1.7 million. Non-interest income amounted to 43.0% of revenue, an achievement that is particularly striking compared to four years ago, when this ratio stood at 34.3%.
We have become more efficient. For the past five quarters we have consistently delivered strong positive operating leverage, as our operating costs have regularly increased at only half the rate of our revenue growth. Several factors behind this achievement are described below. We successfully strengthened and expanded further our retail franchise through our Express Banking strategy, which entails the rollout out of cost-efficient small-sized express branches, avoiding the need to build costly flagship branches, to continue to serve our ever-increasing client base. With Express Banking in place, we have pushed further the ongoing shift to transactional banking by means of a wide-range of electronic channels, away from regular or flagship branches, which are now focusing on selling more value-added products and services. We have continued to invest in IT to minimise and, in certain cases, eliminate document flow, and stepped-up optimisation of the centralised retail banking back office. These developments coupled with the ongoing cost control measures that we already have in place, have resulted in a substantial improvement in the Retail Banking cost to income ratio to 44% from 51% last year while the Corporate Banking cost to income ratio improved to 33% from 43% in 2011. The increasing benefits we are delivering from these improved efficiencies are expected to underpin further improvements in our cost to income ratio over the next few years. It has been a rewarding and exciting experience to observe the effects of economies of scale. Credit quality has continued to be robust, albeit the cost of credit risk was at the top end of our expected range, increasing by GEL 22.5 million to GEL 44.7 million, or 1.3% of the loan book. This largely reflected the absence of last year’s releases and recoveries, and an increase in the Retail Banking impairment charge as a result of the job reductions made by a large payroll client during the first half of the year. We did however see an increase in corporate provisions in the fourth quarter, reflecting the impact of a provision of GEL 14.2 million relating to one single corporate credit. This was offset however by the impact of the 2008 and 2009 stress years dropping out of our Retail Banking provision methodology.
Buttressing the Chairman’s comments in his letter, I would also like to highlight the excellent progress we have made against our liability management objectives. Throughout the year we have consistently sought to optimise our funding structure and cost base. Our strong branding and preeminence in the retail segment has enabled aggressive deposit pricing on the back of the Bank’s growing retail deposit base, while the more competitive corporate environment led to the outflow of expensive Lari corporate deposits, allowing us to replace them with less-costly long-term international borrowing. The funding profile of Corporate Banking has improved markedly as the Corporate Banking cost of deposits declined to a historic low of 6.2% in the fourth quarter of 2012, also benefiting from superior access to trade finance lines, which provides substantially cheaper long-term
funding. Overall, the Bank’s cost of funds decreased to 7.3% from 8.0% last year, and was as low as 6.6% in the fourth quarter of 2012.
In 2013, we do not expect any changes to the fundamentals of our business strategy. We intend to continue to focus on the Georgian market, with Retail Banking and Corporate Banking driving profitability. The full effects of our recent scaling up of the business are still to be realised, as more customers shift to electronic channels. The introduction of a sophisticated CRM system will enhance product penetration and boost revenues per client, thus further improving our efficiency. In Corporate Banking we intend to expand our export and trade finance businesses and to build on our strong fee generating capabilities, supported by research and advisory services. We are set to build our regional asset management business on the currently of assets under management US$365.3 million-strong wealth management platform.
The potential health insurance reform in Georgia, the structure of which is still under consideration, envisages the provision of basic healthcare coverage for the entire Georgian population in addition to existing state-subsidised socially vulnerable groups. We expect these reforms to be a positive factor for the healthcare revenues of Aldagi BCI, the country’s leading healthcare provider. While we are pleased with our progress in cost optimisation in 2012, we see lots of opportunities to further improve efficiency and to ensure that our costs continue to increase at a lower rate than our revenue growth. In 2013, we will be vigilant of our asset quality and continue to enhance our risk management practices.
At the end of December 2012, the Bank’s Total Capital ratio, on a Basel I basis, was 27.0% and the Tier I Capital ratio was 22.0%. This reflects a very strong capital position with capital ratios significantly exceeding the Bank’s minimum capital requirements. The Group is well positioned to improve its performance in 2013 and this, combined with continued strong profitability and capital ratios, has led the Board to review the Group’s dividend policy. The Board has decided to recommend an annual dividend of GEL 1.5 per share payable in British Sterling at the prevailing rate subject to approval by shareholders at the AGM. This represents a significant increase of 114.3%, compared to the annual dividend of GEL 0.70 per share last year, a payout ratio of 28.7% and a dividend yield for shareholders of 5.5%, calculated based on the Group’s 2012 results and using the 31 December 2012 share price of GBP 10.30. Going forward, the Board will aim to maintain a dividend payout ratio in the 25%-40% range. The success of the Group continues to be built on the strong contributions of thousands within the management and employee teams, and I am grateful for all their efforts and achievements during 2012. Their consistently superior work over the last few years has, I am confident, positioned Bank of Georgia to continue to perform strongly in the future, as the leading bank in Georgia.
Chief Executive Officer of Bank of Georgia Holdings
- Chairman’s Statement
- CEO’s Statement
2011 has been a remarkable year for your bank. Bank of Georgia joined the register of the London Stock Exchange premium listed companies following the tender offer announced by its UK – incorporated holding company in December 2011. The high level of participation in the tender offer reflected strong support from shareholders and on 28 February 2012, a wide range of investors, previously restricted in trading overseas securities, gained access to the extraordinary story of Bank of Georgia, which has great opportunities as a leveraged play on the vibrant and growing economy of Georgia.
In my letter to you last year I talked about Georgia’s economy as a success story in the eradication of corruption that could serve as an example for many others. In 2011, Georgia continued to stand out as a country that can boast one of the world’s lowest corruption and crime rates, well-functioning public institutions, prudent banking regulation and a dynamic and growing private sector poised to benefit from the healthy fundamentals of the growth economy and significant inward investment into the country. This year, I would like to touch upon selected economic metrics and main growth drivers of this country that, I believe, is still one of the most notable and rare examples of an investor and business friendly environment.
Despite extremely challenging global economic conditions and low growth in many parts of the world, in 2011, Georgia achieved an estimated 7% real GDP growth to US$14 bn, and foreign exchange reserves that grew 25% to a record US$2.8 million. The country maintained external public debt at a comfortable level of 29% of GDP, decreased its budget deficit from 6.6% of GDP in 2010 to 3.7% in 2011 and annual inflation of 2%.
The market-oriented reforms of the past several years have not only helped Georgia weather the crisis of 2008, but have created a solid foundation for the country’s development. Significant ongoing investment in infrastructure is aimed at enabling Georgia reap the benefits of being the transit and logistics hub of the region and substantially develop growth areas such as hydroelectric power and tourism; distinctive competitive advantages of the country. Already an established regional energy transit hub, Georgia serves as a transport corridor to two crude oil pipelines, one of them the world’s second largest, and two gas pipelines, transporting oil and gas to Europe through Turkey.
As a cheap producer of hydroelectric power than its neighboring countries, Georgia, which enjoys significant untapped hydropower capabilities is gearing up for taking full advantage of these hydroelectric power opportunities. Ongoing investments, both domestic and foreign, in hydropower generating plants and, more importantly, the completion of a new power transmission line to Turkey, will allow Georgia to increase its total transmission capacity 15-fold from the current 1.3TWH and, as a result, will notably increase its electricity exports over the next few years.
Bold investments in tourism-related infrastructure have been bearing fruit for the second consecutive year. 2011 clearly marks the come-back of Georgia, the top tourist destination in Soviet times, as a desired place to visit, with number of tourists rising from approximately 700,000 in 2006 to nearly 3 million in 2011. Foreign tourism revenues are estimated at US$937 million in 2011, a number that is expected to keep growing along with the expected increase in tourists, estimated by the Government to reach 5 million per annum by 2015.
Tourism revenues, now approaching the level of net remittances of US$1.2 billion, the more traditional source of capital inflow for the country, are expected to become a more significant source of capital inflow. Tourism revenues and the steady increase in revenues from exports are expected to gradually diminish Georgia’s reliance on the foreign direct investment (FDI) and donor funding. In 2011, FDI reached circa US$1 billion and is estimated to reach US$1.6 billion by 2015. Diversified across various sectors, FDI is supporting ongoing investments in capital intensive areas (such as hydropower transmission assets), that are also benefiting from donor funding. Approximately US$2 billion of US$4.5 bn pledged donor funds remain undisbursed.
More importantly, strong support from the international community took a more meaningful and tangible shape in 2011. Free Trade Agreements with the EU, currently in the negotiation phase and with the US, currently under discussion, once in place can significantly boost new markets for Georgian products that will lead to further integration of the country with the Western world translating into increased exports and investments to Georgia from these countries. Another important consideration for investors is the continuation of Georgia’s liberal policy and ease of doing business. The country’s unrelenting commitment to market-oriented development has been underpinned by the ratification of the Liberty Act that will ensure that, from 2014, Government expenditure is capped at 30% of GDP, budget deficit below 3% of GDP and Government debt does not exceed 60% of GDP.
The stabilisation in Georgia’s political landscape, both international and domestic, is also worth noting. The WTO accession by Russia, which became possible only after Georgian removal of its objection, will probably not result in Georgian products entering Russian market in the immediate future, but serves as an indication of a step in the right direction. The upcoming parliamentary elections in October 2012 are not expected to bring significant changes – with the President currently enjoying a 79% approval rating, according to the public opinion survey conducted by US firm Greenberg Quinlan Rosner, and with the broad spectrum of the opposition parties in favour of the continuation of recent economic reforms.
Georgia’s achievements have not gone unnoticed by the international community. In the fourth quarter 2011, S&P and Fitch Ratings upgraded the country’s ratings at a time many countries have been downgraded by the same agencies. S&P raised Georgia`s Long-Term Foreign and Local Currency Ratings to “BB-“ and Fitch Ratings upgraded Georgia’s Longterm foreign and local currency Issuer Default Ratings to ‘BB-’ from ‘B+, noting the country’s strong growth performance, strong progress in controlling fiscal deficit and reduction of inflation, among other factors.
With these important elements in place, stemming from the far-reaching reforms enacted several years ago, Georgia offers unique and rewarding opportunities for inward investments. In this report, you will find more information on the stellar performance of your bank, which has an ever-growing role to play in the development of the Georgian economy. I hope in 2012 many of you will join me and many other gratified observers, in our shared anticipation and enthusiasm for the future of Georgia and Bank of Georgia. Irakli Gilauri has built a strong and extremely motivated management team that is well positioned to deliver another excellent business performance in 2012.
Chairman of the Supervisory Board of Bank of Georgia
Chairman of Bank of Georgia Holdings plc Board
A Year to Remember
Dear fellow shareholders,
On 28 February 2012, we announced that Bank of Georgia Holdings plc, now the parent company of your bank, was admitted to trading on the premium segment of the main market of the London Stock Exchange. This is, undoubtedly, one of the most notable milestones in your bank’s history, and is a clear demonstration of the confidence and trust this company has built amongst its shareholders, who strongly supported the move to the premium listing. We firmly believe that as a UK-incorporated company listed on the premium market, we will offer shareholders great governance and transparency combined with exposure to the fast growing Georgian economy and well regulated banking sector.
More importantly, your bank is, as always, focused on delivering strong results. In 2011, Bank of Georgia’s profit from continuing operations increased 82.6% to a record GEL 151 million. Our return on equity of 20.4% was supported by the revenue growth of 27.3% and compares to a return on equity 13.5% in 2010. Earnings per share grew 78.1% to GEL 4.95, or US$2.96 or GBP1.92.
Throughout last year we made significant progress against the strategic objectives set out for 2011. We strengthened our balance sheet, as client deposits grew to GEL 2,554 million increasing GEL 549 million, comfortably financing the net loan book growth of GEL 250 million, to GEL 2,616 million. The resulting 102.4% Loan to Deposit ratio, leverage at
4.7x and Tier I Capital ratio (BIS) of 19.9%, translates into the strongest and most conservative balance sheet in the history of the bank. Our cost of risk more than halved to 0.9%, whilst non performing lending balances reduced by 17.3%, reflecting the impact of our prudent risk management disciplines demonstrated and the improved economic conditions in Georgia.
Strong growth notwithstanding, our focus on positive operating leverage has remained a consistent priority. Our 27.3% revenue growth significantly exceeded operating cost growth of 8.9% and led to a markedly improved Cost to Income ratio of 49.3%, a significant improvement from 57.6% in 2010.
We have invested in organic growth of our key strategic businesses throughout the year. We further extended our reach in retail banking by issuing more than 325,000 new debit and credit cards; increased our lending presence at contracted merchants through Point of Sales desks from 99 desks to 179 desks, resulting in the POS loans outstanding increasing to GEL 25 million from GEL 6 million last year; In December we launched Express Banking - small-format service points. Express branches will free up our branches for higher valueadded services, while making simple banking transactions easy for our clients. More than 5,000 corporate accounts were opened during the year, compared to less than 2,000 opened in 2010, and the volume of client funds managed by our wealth management business increased almost five times to approximately GEL 450 million.
As a group, we will continue to invest in areas that drive future growth. In my last year’s letter, I talked about our resolve to capture the growth opportunities in Georgia’s insurance and healthcare sectors, presented by the underpenetrated and fragmented insurance market, and to further enhance the vertical integration of the life and non-life insurance business of Aldagi BCI, the bank’s insurance subsidiary, and its healthcare business. To this end, Aldagi BCI has acquired the assets and liabilities of the twelfth largest insurance company in Georgia and the merger of MFC, its healthcare provider subsidiary, the largest healthcare provider in Georgia, is also worth of noting. MFC is now the country’s largest healthcare provider, with Aldagi BCI retaining a controlling interest.
Our strong business performance has continued to strengthen our leadership positions across our customer franchise and we remain confident that we have all the right elements in place to take full advantage of the growth opportunities presented by the significantly improving operating environment in Georgia, which has delivered a consistently strong macroeconomic performance over the last decade. Robust and sustainable key economic drivers in Georgia have created a mid-teens nominal GDP growth expectation over the medium term, and Bank of Georgia is exceptionally well placed to benefit from this improved macroeconomic outlook. As a leveraged play on the growing Georgian economy, with leading market shares in lending, deposits and current account banking, Bank of Georgia remains uniquely placed to benefit over the next few years in what is a rapidly growing, highly capitalised and profitable banking market. We are well capitalised and highly liquid, and remain determined to maintain our focus on our core strategic businesses that are retail banking, corporate banking and wealth management. We will be taking resolute steps towards improving our company’s agility and efficiency to become a more lean and effective company, with a sharp focus on doing what we are best at. We remain confident in our 3x 20% strategy, which implies 20% plus metric for our return on equity, Tier I capital strength and business growth, the latter driven by customer lending growth, as well as increased cross-selling and contribution from our synergistic businesses. Our progressive dividend policy will ensure we maintain strong capital management disciplines during what promises to be an exciting period of strong growth.
We are exceptionally well placed to continue to deliver a strong performance in 2012 and beyond, which we believe will translate into an improved valuation of your stock. Bank of Georgia Holdings is expected to become a component of the FTSE All Share Index in June 2012, and we also hope to be included in the FTSE 250 index in the near future. In conclusion, I would like to note that none of the achievements of the past year would have been possible without the irreplaceable support and guidance from our Supervisory Board members, and the professionalism and dedication of the management and employees who remain constantly focused on fully realising the potential of your bank. I would like to thank each one them and, most importantly, our shareholders who have supported us throughout this truly memorable year.
Chief Executive Officer of Bank of Georgia Holdings
- Chairman’s Statement
- CEO’s Statement
It is my pleasure to write you for the first time since joining Bank of Georgia as Chairman of the Supervisory Board in June 2010. I joined the bank after retiring from a career at McKinsey and Company where I had the chance to work with financial institutions worldwide, though not in Georgia. Allow me this first time to share with you my thoughts with respect to the past year, the outlook for the future and most importantly the environment of Georgia, where the Bank of Georgia continues on its remarkable journey.
During the past year I had a chance to observe how young and determined country like Georgia fares with the effects of global financial crisis and to appreciate its government’s resolve to stay on the free market path. It is this path that helped propel its once failing economy to the emerging economic success that it enjoys today. The most noteworthy accomplishment is the implementation of stunning reforms, which resulted in the eradication of corruption. This is a story that needs to be told to serve as an example for others.
Also of note, is the government’s commitment to ensuring a business and investor friendly environment. These efforts were recognized by the international community, which in 2008, in the midst of global financial crisis, pledged US$ 4.5 billion, or 40% of Georgia’s GDP, helping the country cope with the crisis and providing it with the means to continue to invest in its future.
Georgia ended 2010 with a respectable 6.4% real GDP growth, external debt level of 38% of GDP, stabilized currency and record level of foreign currency reserves at US$ 2 billion that continued to grow to US$ 2.5 billion by March 2011. With more than US$2.0 billion of donor funds still to flow into the country, Georgia is gearing to establish itself as a regional energy hub by utilizing the vast untapped hydro power potential.
Having eliminated corruption, a plague still tormenting the countries in the region, Georgia, with its liberal tax regime and abundant growth opportunities, has the right elements in place to become the destination of foreign investments, as Georgian economy advances and once the perception of risks diminishes. To this end, 2011 started on a positive note. Only several weeks ago, Georgia successfully placed its second US$ 500 million 10-year benchmark Eurobonds. With the yield of 7.125%, the new Eurobond is 37.5 bps lower than the yield of the existing shorter term 2013 Eurobonds. The improved pricing and the strong demand reflected in the deal 5.3 times oversubscribed serve as a testament of the increased investor confidence towards the country. In line with the improved investor sentiment, Fitch Ratings and Standard & Poor’s, both of which have assigned ‘B+’ sovereign rating, have upgraded their respective outlooks from stable to positive in March and April 2011, respectively.
For Bank of Georgia, the country’s largest bank, 2010 was a defining year in many ways. Having demonstrated its resilience in the times of global financial disruption, the bank weathered the tough economic environment without resorting to capital injection. More importantly, Bank of Georgia used its strength to capture the opportunities arising during the bad times and came out stronger from the crisis, reinforcing its leadership role on its home market. The sensible deployment of excess liquidity that we conservatively maintained during the downturn resulted in the healthy growth of the loan book and the improved loan quality in 2010. The country’s most trusted top brand, Bank of Georgia attracted a record volume of client deposits both locally and internationally. These accomplishments, coupled with the increased efficiency, have led to the significant market share gains to the record high 36% by assets and by loans and 32% by deposits by the end of the year. Also, notably, international credit rating agencies have revised their ratings of Bank of Georgia. In August 2010, Fitch Ratings upgraded the bank’s long-term foreign and local currency default ratings from ‘B’ to ‘B+’, the sovereign level. In January 2011, Moody’s Investor Services, rated Bank of Georgia at ‘B1’, an improvement from B3. As of today, all three global credit rating agencies maintain stable outlook for Bank of Georgia.
The ability to align the strategy to the shifting trends in this fast-growing emerging market is one of the main success factors of Bank of Georgia. Acting upon the changed circumstances in our markets of operation, we made decisions that we believe
will benefit our bank and our shareholders: the exit from the loss-making Ukrainian banking operation will not only improve the bank’s consolidated operating performance, but more importantly, it will free-up valuable management resource to allow us sharpen our focus on the considerable opportunities that the growing Georgian economy offers – the commitment we underlined as part of our strategy.
With its undisputedly leading banking franchise, Bank of Georgia is well-poised to continue to grow organically as the country’s still modest banking sector loan penetration of less than 30% of GDP increases along with the expected growth of its economy. Furthermore, our new Georgia-focused strategy entails the continuation of the vertical integration of our market-leading insurance and healthcare businesses, aiming at capturing the opportunities that we envisage to come from the rapid growth of the underpenetrated insurance market, to be further boosted by the ongoing integration with the healthcare business. In addition, we have announced about our move into Georgia’s affordable housing sector through our real estate subsidiary. The already allocated capital through the repossessed properties allows us to fill in the gap between the demand driven by significant housing shortage and the inability of real estate developers to satisfy such demand. We expect the insurance and real estate to contribute meaningfully to your bank’s earnings over the next few years. You will get more details about the bank’s performance in 2010 in the CEO’s letter and other sections that follow in this report.
Corporate Governance was the focus of much of the Supervisory Board’s attention in 2010. The move to a two-tier governance structure a year ago has aligned the Bank with international best practices. My fellow non-executive Supervisory Board members bring world-class investment, economic, legal and banking business expertise to the table, complementing the capable and talented group of executives that make up the Management Board of your bank. Building upon the bank’s established results-oriented culture of teamwork and openness, we have put in place an Executive Compensation Policy which implemented the decision to abandon cash-based bonus compensation to replace it with a share based compensation scheme with the long-term share vesting program.
We started 2011 with confidence in our ability to continue building on our strength that will enable us capture the growth opportunities presented on our home market. Our short-to-medium term strategy entails aggressively pursuing these growth opportunities that we strongly believe will augment the Bank’s growth to translate into increased shareholder value for our fellow shareholders. While 2010 saw a stellar growth of the Bank’s share price of 142%, bringing it above its IPO price at the year-end, Bank of Georgia shares still trade at a substantial discount to CIS banks in terms of both PE and BV multiple. Having demonstrated the ability of turning challenges into opportunities, in 2011 we are looking forward to continue delivering results through superior execution of the strategy we believe will lead to fair valuation of your stock.
In closing, I would like to congratulate each member of the Supervisory Board, the management and the employees with the strong 2010 results and thank them for the remarkable efforts that made Bank of Georgia’s success possible. In 2011 I am looking forward to working with this dedicated team and a highly engaged Supervisory Board as we continue to realize the full potential of your bank.
Chairman of the Supervisory Board
Focusing on the important
Dear Fellow Shareholders,
It is my pleasure to present you Bank of Georgia’s results for 2010, which was a strong and important year for your bank. In 2010 the bank achieved a record operating income of GEL 346.9 million, a 17% increase from 2009, and earned a record net income of GEL 82.7, beating the announced management target of GEL 72 million. Looking back in the context of the past three challenging years, 2010 marks the end of the downturn and further strengthening your bank’s industry leading position on its home market.
More importantly, these difficult times have demonstrated your bank’s ability to achieve a remarkable balance between size and efficiency. The country’s leading bank in terms of loans, deposits and other important metrics, tackled various challenges arising from difficult and changing environment by means of timely and decisive, yet sensible actions that only efficient companies with lean structures can afford. We ended 2010 with healthy revenue streams, positive operating leverage, reduced risks and our capital and liquidity levels remain strong. With these drivers of profitability in place we enter the future from a strong position. I would hereby like to share our vision for the next three years, which has been communicated to our shareholders at our Investor Days and various investor meetings.
At the beginning of 2010 we set out to deliver results that were outlined as part of our strategic priorities for the year. These priorities were growing the loan book following the deleveraging in 2009, decreasing our funding costs and improving our operating efficiency. The superiority of our lending machine was demonstrated by the 41.6% growth of the loan book enabling us to take away 4% share from the rest of the market in Georgia, which grew 14% in terms of loans during the year. Notably, our cost of risk were reduced while loan yield remained largely flat. On the back of continuous inflow of funds into the country, our client deposits grew by GEL 732.2 million, or 57.5% to a record level of GEL 2.0 billion, also gaining 4% market share by client deposits. As a result of the stellar growth of the client deposits in Georgia, which was also supported by the successful attraction of funds internationally by our wealth management operations, we are happy to report the further strengthened balance sheet structure. As of the year-end, Net Loan to Client Deposit Ratio was down to 117.3% from 130.6% a year ago. The successful reduction of interest rates on deposits to the average of 6.6% at the year-end have led to the decline of our cost of funding as the composition of our liabilities changed with cheaper deposits replacing wholesale funding. These developments and the excess liquidity allowed us to announce a tender offer to buyback Eurobonds maturing in 2012, further diminishing our reliance on expensive external wholesale funding.
2010 saw the improvement of the bank’s loan quality. Along with the recovery of Georgia’s economy, our non-performing loans represent 4.7% of the loan book compared to 7.7% in 2009 and our cost of risk of 1.8% is approaching the pre-crisis level.
In 2010 we committed ourselves to a constant strife towards efficiency. The effectiveness of the cost cutting measures implemented across the board and the benefits arising from technological advancements made us more efficient as demonstrated in the decline of our Cost Income ratio from 93.3% last year to 58.9% in 2010, and the increase of operating leverage, despite the high-cost burden incurred by BG Bank, Ukraine’s operations. We are confident that the full advantages from the increased products offerings, distribution channels, full deployment of the new IT systems and the efficiencies of scale are yet to be realized, especially as retail lending accelerates. We remain committed to decreasing our expense base bringing our consolidated Cost/Income ratio below our current standalone Cost/Income ratio of 49%.
The performance of Bank of Georgia and the markets where we operate prompted us to revisit our strategy over the short-andmedium term and gave us the foundation to put in place a structure and a strategy in the context of our strengths, weaknesses and opportunities. First and foremost, our new strategy is based on our strong belief in investing sensibly where we see opportunities and where we are confident of our execution capabilities. The continuity of the Georgia’s economic advancement and the ample growth opportunities it offers calls for our laser-sharp focus on our home market. This focus, we believe is the foundation of our strength and our ability to deliver to our clients and shareholders.
In line with the new strategy, we sold our equity interest in BG Bank in Ukraine, a decision that we believe will further improve our efficiency and allow us concentrate on the profitable growth of our Georgian business. The strong balance sheet, superior retail and corporate banking and insurance franchise positions the bank strongly to leverage on the growth of the Georgian economy, which will ultimately benefit our shareholders more than the pursuit of international expansion.
Our new strategy aims at delivering a ROAE of more than 20% and doubling our loan book by year-end 2013. Having grown by 6.4% in 2010, Georgia’s real GDP is estimated to grow by 5.0% on average over the next three years. The decreasing interest rate environment and the growing corporate sector is expected to boost the banking sector lending, which is estimated to reach at least 40% of GDP from as low as current 29%. These reasonable and conservative assumptions provide us with immense role to play in the advancement of the country and our track record of execution and the market leading position puts us in the right place to capitalize on the organic growth of Georgian banking sector.
Bank of Georgia includes businesses that have strong positions in their respective promising sectors, but are not entirely central to our core business. Aldagi BCI (ABCI), the bank’s insurance subsidiary and the country’s leading insurance services provider, has made remarkable progress over the past several years. The backward integration of its rapidly growing health insurance business with healthcare business contributed considerably to ABCI’s strong performance in 2010, producing 26% return on equity. Georgia’s fragmented and underpenetrated health and life insurance sector is now gearing up for growth strongly supported by government programs, which envisage the establishment of small and mid-sized hospitals by private insurance companies. With healthcare spending accounting for 8% of Georgia’s GDP and only 0.8% of GDP currently being spent through health insurance, ABCI, the country’s top insurer, is strongly positioned to capture most of the healthcare spending and up-sell insurance products creating synergies between insurance business and healthcare provider. To this end, we decided to further enhance the vertical integration of ABCI with the view to enlarge the current business model currently consisting of six outpatient clinics and one mid-sized hospital operated by ABCI. The advantages that come from the advancements in the vertical integration and the increased insurance penetration are expected to raise ABCI’s contribution to your bank’s net income from five per cent in 2010 to more than 10% by 2013.
Another growth opportunity we are well-positioned to capitalize on is presented to us by the housing shortage, legacy of the Soviet era, and the near absence of primary supply to satisfy a large and growing demand for housing, as the financial crisis negatively affected the country’s top three real estate developers. Such unsatisfied demand for new housing has translated into the slowdown of our mortgage book growth, an issue we are prepared to address by making a move into affordable housing business through SBRE, our real estate subsidiary. As a result of the crisis, we couldn’t avoid allocating the capital through number of repossessed land plots, and we are successfully implementing a pilot project selling studio apartments. We intend to outsource architecture and construction works and plan to engage in the project management and sales of these apartments through our superior distribution channels of 143 branches and 1,500 sales force. We estimate to sell up to 2,000 units over the next three years, which will not only help boost our mortgage lending, but is expected to contribute more than 10% to our consolidated net income in the next few years.
Our drive for value creation has prompted us to consider a move to a holding structure. As Bank of Georgia’s shareholder you have exposure to non-banking businesses, such as insurance and real estate, which have already grown and will continue to grow to the levels that will contribute more meaningfully to your bank’s earnings. The separation of these businesses from banking operations and bringing them together under one holding structure, will not only free up capital of the core banking franchise, but will help maximize the value of each one of them separately. The new structure, we believe, will result in greater accountability of performance and will help fully realize your company’s earnings power. We are working with our advisors on the optimal structure and the procedures for such move to ensure that it serves the best interests of our businesses and our shareholders. We will report on our progress as we move along this path.
In conclusion, strong performance in 2010 has positioned us strongly to capture the growth opportunities in our priority market and emphasized our task to ensure even better performance in the years to come.
Finally, I would like to thank our world-class supervisory board members for their support and invaluable guidance, my fellow management board members and the employees for their dedicated work and congratulate them with our achievements.
Chief Executive Officer
- CEO’s Statement
Turning the Corner
Dear Shareholders, 2009 was an extraordinary year for Bank of Georgia. The Bank started the year with a tremendous task of tackling challenges such as deleveraging, tight liquidity, weakening of asset quality and significant deterioration of the Ukrainian economy, the results of global economic crisis and volatile operating environment. Throughout the year, we remained focused on maintaining strong balance sheet, succeeded in recovering and then growing our deposits to the record high level in Georgia, and finished the year with ample liquidity that will allow us to capture opportunities that lie ahead. We responded to the challenge of the weakening of the loan book by tightening our lending standards and reducing our lending activity for the most part of the year, have continued prudent provisioning of our loan book and have observed the stabilized NPLs as the market conditions towards the end of the year became more supportive of economic growth. As the Georgian economy started to show signs of recovery in the second half of 2009, we acted accordingly and stepped up our lending activity.
We maintained (and continue to maintain) strength that enables us to operate in any environment by sustaining strong capital adequacy ratios, whether measured by BIS or National Bank of Georgia standards and high liquidity. As of 31 December 2009, our Tier I Capital Adequacy Ratio was 22.4% and our Total Capital Adequacy Ratio was 34.7%. According the National Bank of Georgia standards, these ratios were 19.7% and 16.8%, respectively. Our tight liquidity management in the first half of the year resulted in high liquidity levels maintained during the second half. We ended the year with the liquidity ratio well above 30%, which compares to 20% minimum liquidity ratio required by the regulator and excess liquidity of GEL 226.5 million, or 12.4% of gross loans.
The economic downturn that lasted for the most part of the year negatively affected our 2009 results. To large extent, this year’s performance was marred by two issues. The first was goodwill writedown in the amount of GEL 73.1 million, predominantly due to the entire goodwill write-off associated with BG Bank, our subsidiary in Ukraine. The second resulted from the loan impairment charge, which declined 3.2% compared to 2008 reflecting the improved but still weak economic environment in the second half of the year, was still significant at GEL 118.9 million. As a result, in 2009 Bank of Georgia reported Net Loss of GEL 98.9 million, or 3.0 per share, a decrease from 2008 Net Income of GEL 174 thousand, or GEL 0.1 per share.
Review of the Key Developments in 2009
Managing through the economic downturn was the top of the agenda in 2009. Georgian operating environment in 2009 was undergoing the negative effects of global financial crisis, military conflict with Russia in summer 2008, one-off 17% currency devaluation against the U.S.$. in November 2008 and internal political crisis that lasted through May 2009. We started the year with our top priorities adjusted to such environment. These priorities were: risk management, preserving liquidity, focus on efficiency, and reduction of the Bank’s involvement in non-core assets, as part of our short-to-medium term strategy.
Even though we were managing the Bank during the downturn in 2009, we never stopped investing in our future. We took significant steps forward in terms of IT development and further strengthened the Bank’s management team.
One of the most significant developments in the area of risk management was proactively working with our corporate and retail clients facing repayment difficulties and temporary tightening our lending activity. Corporate recovery and retail loan restructuring groups were operational from the beginning of the year and served as an important tool for enhanced credit portfolio management. Our efforts, supported by improving market environment in Georgia in the second half of the year, started to bear fruit as NPLs peaked at GEL 145 million in November and NPLs as percent of gross loans started to decline reaching 7.7% in Q4 2009. The conservative lending policy maintained by us throughout most of the year, resulted in the decline of the gross loan book by 14.8% to GEL 1,828 million as of December 2009.
As a result of the system-wide decline in banking deposits in Georgia in 2008 that continued in the first months of 2009, rebuilding our deposit base was a strategically imperative task. We never stopped offering innovative retail deposit products such as “Green Deposits” and “Investment Deposits”, now popular products on the Georgian market, and have kept on working consistently with the corporate clients offering attractive flexible deposit terms and bundled loan and deposit products. Our Wealth Management business grew markedly during the year and now plays a more significant role in our strategy. Responding to the urgency of attracting deposits, in February 2009 we started to operate our Wealth Management office in Tel Aviv (now covering Jordan as well) and most recently in Kiev. As a result, deposits from non-residents account for 60.4% of Wealth Management deposits and for 19.5% of total deposits, as of the end of 2009. Wealth Management deposits grew by 68.6% in 2009 and made up 12.8% of the Bank’s total deposits.
These efforts, supported by the commencement of the inflow of donor funds, pledged by international community to help Georgia recover the aftermath of war, produced noteworthy results. As of 31 December 2009 the Bank’s client deposits reached the record high level of GEL 1,273 million and loan to deposit ratio declined to 131% from 171% in 2008.
Global economic downturn prompted many banks, including Georgian ones, to significantly dilute their shareholders and/or seek rescue packages from their respective governments. We take pride in the fact that Bank of Georgia did not require government support and our shareholders’ dilution is capped at 10% should our lenders convert the U.S.$. 52 million subordinated convertible loan portion of U.S.$. 200 million loan package we received in the beginning of 2009. The U.S.$. 200 million loan package from IFC and EBRD, consisting of U.S.$ 100 million senior loan, U.S.$ 48 million subordinated loan and U.S.$ 52 subordinated convertible loan, helped us with our liquidity and allowed us repay in aggregate U.S.$ 253.5 million of international debt funding. This includes U.S.$ 140 million Loan Passthrough Notes, part of which was repurchased by the Bank on favorable terms before the settlement of the remaining outstanding balance in June 2009. With this transaction we largely completed our international wholesale debt repayment obligations until 2012.
The tough economic conditions prompted us to reorganize our retail business in Georgia by adjusting it to declining retail lending volumes in 2008. In December 2008, we discontinued and/or downscaled those retail business lines that were most impacted by the economic slowdown and modified our retail strategy. But most importantly, we kept our core retail infrastructure and personnel, the price we had to pay in 2009 to get back in retail business in 2010 in an efficient and timely manner. Our new strategic priority entails an aggressive targeting of the mass affluent client base in Georgia and maximizing revenue per client by means of improved client service, cost control and efficiency. To this end, we launched for the first time in Georgia, Premier Banking, under the brand name “Solo”, which is a comprehensive personal banking service for the affluent client base. As part of our mass affluent retail banking strategy, we
secured a multi-year agreement on an exclusive basis for issuing and acquiring American Express cards in Georgia and started issuing AmEx credit cards in November 2009.
Our insurance franchise remains to be the strongest on the market, with the market share exceeding 20%. 2009 was an exceptional year for Aldagi BCI, the Banks’ insurance subsidiary in Georgia, which has returned to profitability as a result of cost-control and efficiency improvements during the year as well as better claims management.
Throughout the turbulent year, Bank of Georgia continued to support more than 850,000 clients in all of its markets of operation. As of December 2009, we served more than 730,000 retail, 82,000 corporate and 1,429 wealth management clients through 141 branches and 382 ATMs in Georgia, the largest footprint in the country.
Towards Higher Operating Efficiency
We maintained our relentless focus on operating costs and operating efficiency. As a result of various cost cutting initiatives across the board as well as the effects of the reorganization of Retail Banking, we successfully decreased our salaries and SG&A costs, traditionally our largest operating cost items, by 11% in 2009.
The slowdown in business activity and excess liquidity enabled us to seize opportunities that will increase our efficiency going forward. In 2009, we commenced the implementation of the core banking system, Temenos24, stateof-the-art core banking software acquired in September 2009. This fully integrated platform will enable us to simplify and streamline our infrastructure and increase our efficiency. The timing of this acquisition is also noteworthy. The agreement with Temenos in the midst of the global banking crisis has enabled us to capture an estimated project IRR of 20%. This year we already started to deploy Softscape, a fully automated talent management system acquired in October 2009, which will enable Bank of Georgia to maximize its workforce potential by means of the integrated system that could be rolled out with multiple languages to support our entire multi-national organization. It will also provide Bank of Georgia with a powerful analytics tool to enable strategic insights into the data for employee development and performance improvement.
Another technological advancement of the year is CRIF Decision Solution acquired by the Bank in October 2009 to provide and develop the Bank’s loan origination system. This state-of-the-art technology available on the market will allow us capture cross-border synergies through centralized decision making, will enhance the time to market while keeping risks under control, streamline the Bank’s client acquisition processes and will serve as robust suite of tools to support the Bank’s customer management processes.
In a move to improve our governance, we have introduced a classical twotier board structure with the Management Board, led by the Chief Executive Officer, and the Supervisory Board comprising only non-executive directors, including the Chairman. We believe the new governance structure to be more effective, as the line-up of the management team is now complete.
Our Supervisory Board was further strengthened by the additions of David Morrison in June 2009 as a Supervisory Board member and Al Breach, who has been engaged by the Bank in November 2009 as an advisor to the Supervisory Board. The Supervisory Board intends to propose Al’s candidacy for the Supervisory Board membership at the next AGM. David, business lawyer, formerly one of the managing partners at Sullivan & Cromwell, prestigious international law firm, adds an important dimension to the Bank’s Supervisory
Board. Al, who is a highly respected strategist and economist, formerly Head of Research at UBS Russia, gives the Bank access to world class macro-economic insight.
I would like to use this opportunity to thank Nicholas Enukidze, who has served as a Chairman of Bank of Georgia for more than two years, for his major contributions during probably one of the most challenging periods in the Bank’s history. Nicholas will be stepping down from his executive function at the next AGM in line with the changes in our governance. Correspondingly, I will be resigning from the Supervisory Board to continue to serve, together with my deputies on the Management Board, as CEO.
In 2009, we further strengthened and realigned the Bank’s management team by both attracting high-caliber individuals and through internal promotions, which provides depth for the future development of our officers. The two notable senior appointments include Archil Gachechiladze, who has worked at Merchant Banking Fund of Lehman Brothers in London prior to returning to Georgia, as Deputy CEO for Corporate Banking in Georgia and Nikoloz Shurgaia, formerly Principal Banker at EBRD in London, as Chairman of the Board of Belarusky Narodny Bank (BNB), Bank of Georgia’s banking subsidiary in Belarus. Both Archil and Nikoloz bring invaluable local and international experience to their leadership roles.
Our international banking operations have been further enhanced by the appointment of Murtaz Kikoria as acting CEO of BG Bank since June 2009. Prior to this appointment Murtaz served Deputy CEO in charge of Compliance at Bank of Georgia and previously served as Principal EBRD Banker and Head of Banking Supervision at the National Bank of Georgia.
International Banking Subsidiaries
Continued financial challenges and difficult operating environment in Ukraine prompted us to revisit our Ukrainian banking strategy and re-assess our opportunities in this market. BG Bank, our Ukrainian banking subsidiary has suffered sizeable losses. During the year, we have shifted away from retail banking and have implemented cost-control measures closing down 9 branches and reducing the headcount by 165. We intend to further downscale the operations of BG Bank, bringing it down to predominantly trade finance operations with an aim of capturing part of the U.S.$ 1 billion trade between Georgia and Ukraine. BG Bank will also focus, together with BG Capital, the Bank’s brokerage subsidiary, on private banking services, launched in Kiev in September 2009.
We remain optimistic about the future of Belarus and its economy. We have confirmed our commitment to BNB and have completed the buyout of the minority stake in December 2009. In order to meet the new minimum regulatory capital requirement set by the National Bank of the Republic of Belarus we have also increased BNB’s capital by approximately EUR 10.4 million. As a result of these investments, Bank of Georgia now controls 99.98% of BNB’s shares outstanding.
Divesting from non-core business
We have made good progress in refocusing Bank of Georgia on its core businesses and the sale of our stake in GTAM was an important step in this direction. We will also continue to explore our options in respect of both Liberty Consumer and SB Real Estate, with an aim to further reduce the Bank’s exposure to these non-core assets.
I would also like to note that our achievements in 2009 have been recognized by leading financial publications. Bank of Georgia was named the Bank of the Year by The Banker for the fifth consecutive year, The Best Bank in Georgia by Global Finance for the third consecutive year and received The Best Bank in Georgia Award for Excellence from Euromoney for the fourth consecutive time.
The 2009 results reflect a tough operating environment during the economic downturn and Bank of Georgia’s ability to realign its business to the challenges presented. We have ended the year with most of the critical elements for success in place – strong capital and liquidity, respected brand, scale, superior distribution network, large and growing client base, world-class Supervisory Board, high-caliber management team and last but not least, professional and dedicated staff. I am privileged to have the opportunity to lead our business through the challenges and, I am confident, remarkable achievements that lie ahead.
Our Priorities in 2010
2010 started with the positive signs of the improving operating environment. The preliminary data for Q1 2010 for Georgia are quite encouraging. VAT collections, the indicator closely correlated with GDP growth, increased by 15% year on year and tax revenues rose 13% year on year. Trade balance deficit in the first two months in 2010 decreased by 19% year on year, as a result of the increase of exports by 10% and the decline of imports by 2%, compared to the same period in 2009. End of period inflation rose to 5.8% in the first quarter, up from 3.0% in 2009, indicating increased economic activity in the country. These first macro indicators give us reason to believe that Georgia’s 2010 real GDP growth rate is likely to exceed 2%, as estimated by IMF. Only couple of weeks ago, S&P raised Georgia’s sovereign rating from ‘B’ to ‘B+’, an upgrade that reflects the strengthening of economic structure of the country relative to peers and its growth prospects. We are confident that Georgia with its liberal economic system and low corruption level has a competitive advantage in the region and is strongly positioned to embark on rapid, long-term sustainable growth.
Based on the most conservative growth assumptions for Georgia’s economy, we are targeting 2010 Net Income of GEL 72 million, as announced in November 2009. Our assumptions are subject to the 2% real GDP growth, moderate inflation rate of 3.2%, exchange rate stability and sustained geopolitical stability in the region in 2010.
In 2010 our strategic priorities are clear. One of our biggest challenges remains the loan book growth, the task that we will be focusing on relentlessly during the year. We will continue to grow retail business through differentiated products and services to target different retail segment with particular emphasis on mass affluent segment. The exclusive right for AmEx card issuance gives Bank of Georgia competitive advantage for penetrating the mass affluent segment and our superior retail banking franchise positions us strongly to benefit from the expected growth of retail lending in Georgia, which currently is estimated to be as low as 8% of GDP.
On the back of deleveraging in 2009, we expect the lending to the corporate sector to pick up in 2010, the process we already observe in the first few months of the year. In the corporate sector in Georgia we see opportunities in underleveraged utility sector (circa 9% loans to sector GDP), healthcare sector, which is currently under privatization and will need funding for growth (circa 2% to sector GDP), food processing and agribusiness that are expected to substitute imports in this segment and Hydropower sector, which is gearing for exports to Turkey. We will also be putting emphasis on the SME sector, where we have the lowest market share at about 15%.
We have every intention to build on the success of our wealth management business abroad and intend to expand wealth management business even further by building presence in developed countries.
Cost containment is another most important challenge, especially during the
time of growth. Our investments in technology, described in detail earlier, are expected to increase our operational efficiency and improve service for our clients.
In December 2009, we announced our intention to resume distribution of dividends, subject to achieving 2010 financial targets outlined above. We intend to recommend GEL 0.30 dividend per share payable in 2011 in respect to 2010 financial year performance. Our first priority, as always, is to invest our capital in organic growth and when makes sense to make valuable acquisitions. The new dividend policy is a mechanism aimed to further increase our capital management discipline as we embark upon the growth at the right price.
Chief Executive Officer
- Chairman’s Statement
2008 was a very eventful and difficult year for Georgia. During the year we witnessed highly emotional presidential and parliamentary elections, military conflict between Russia and Georgia (the “Conflict”) and the worst financial and economic crisis in recent history, which resulted in sharp economic slowdown, capital markets dislocation and currency devaluation in our principal markets.
On behalf of Bank of Georgia’s supervisory board I would like to thank our employees for remarkable commitment and courage displayed in these difficult and dangerous conditions and our shareholders for the understanding and support they showed us despite our declining share price.
In this volatile market environment we had to act quickly to adjust the bank’s strategy and business model to new realities. In 2006 and 2007 our strategy aimed at rapid growth, market share gains and expansion into new markets and business lines were shaped by favorable capital markets and strong economic growth across the region. In 2008, tightening credit markets and slowing economy prompted us to first scale down our balance sheet growth and expansion targets and then, following the Conflict in August and the start of global financial and economic crisis, altogether reassess our business priorities.
Today Bank of Georgia is focused on operational efficiency, liquidity and risk management.
In Q4 2008 we announced a significant reorganization of our banking business in Georgia, which involved major scaling down of the Bank’s retail lending businesses resulting in the reduction of the Bank’s headcount by about 19%. Similar cost optimization measures were also implemented at the Bank’s subsidiaries in Georgia and abroad.
The development of the Bank’s IT systems is critical for further improving our operating efficiency and positioning the bank for future growth. In 2008 we launched several important IT projects across the group, which once completed will help us become more cost efficient, improve group’s management and position us to capture growth opportunities once the economy and the markets turn. Our liquidity position is solid. We have been maintaining liquidity ratios significantly above the NBG requirement. US$240 million of long-term financing raised from EBRD, IFC and OPIC allowed us to comfortably meet our wholesale funding obligations and careful management of our loan book has helped us offset outflow of deposits due to the Conflict and economic downturn.
Unfortunately, weakening of the loan portfolio is unavoidable in this difficult economic environment. We have responded to this challenge by tightening our lending standards, reducing our lending volumes and strengthening our risk management department. We created specialized corporate and retail restructuring teams which work on developing a customer-focused loan restructuring solutions in Georgia and appointed new head of risk at BG Bank in Ukraine. Our decision to reduce Bank’s exposure to Georgian real estate development and construction industries taken in early 2008 is a key factor determining lower level of NPLs at BOG compared to our peers. Managing risk will undoubtedly remain one of our top management priorities throughout 2009.
Banking stocks have shown very poor performance across the globe. Unfortunately, our stock was no exception. Fall in our share price due to the global financial crisis was amplified by impact of the Conflict. As shareholders, members of our management team fully shared the disappointment felt by our shareholders. I would like to assure you that in these extreme market conditions, the bank’s management remains fully focused on delivering shareholder value.
Chairman of the Supervisory Board
- Chairman’s Statement
- CEO’s Statement
2007 was a very successful and eventful year for Bank of Georgia. We further consolidated our market position in Georgia, becoming the undisputed leader of the Georgian banking industry. Our assets increased by 143%, revenue by 111% and net income by 183% and our return on average equity reached 16.2%.
We finished 2007 with over 705,000 retail and 100,000 corporate current accounts. We opened 17 new branches and installed 126 new ATMs in Georgia.
In February 2007 we became the first Georgian entity to issue an international Eurobond – US$200 million, and in August we issued our first international syndicated loan – US$123.5 million.
In October 2007 we completed the acquisition of Universal Bank of Development and Partnership (UBDP) in Ukraine, our first significant acquisition outside Georgia, establishing Bank of Georgia as an important regional player in European CIS markets.
Recognizing the management challenges presented by such rapid growth and development, we continued the “institutionalization” of Bank of Georgia by further refining our management structure and processes and attracting top talent from Georgia and around the world to strengthen our management team at all levels. The depth and strength of our team was confirmed by a smooth management transition following Lado Gurgenidze’s resignation as Chairman of the Supervisory Board to become Prime Minister of Georgia
In recognition of our achievements in 2007 we received, for the second consecutive year, The Bank of the Year Award from The Banker and for the third consecutive year The Best Bank in Georgia Award for Excellence from Euromoney.
The global financial crisis which started in the summer of 2007 had a limited effect on the Bank’s operational performance in 2007, although its impact on our strategy and outlook for the near future will be more significant.
Aggressive domestic and international growth has been the foundation of Bank of Georgia’s strategy in recent years. Whilst we will certainly continue to focus on growth, our approach to achieving it has become more measured in light of the changed global market environment.
As the leading Georgian financial institution we are uniquely positioned to remain the primary beneficiary of the rapidly growing demand for lending products from Georgian retail and corporate clients. However, in this challenging market environment rapid asset growth should be combined with an even more disciplined approach to risk and capital management and operational efficiency.
Successful integration of our Ukrainian business is a key priority of our international strategy in 2008. Developing an advanced, offshore private banking offering in markets with large Georgian communities which could provide an important new source of client deposits and fee income for the Bank, is another important aspect of our international strategy. We will also continue to assess, in a disciplined and focused manner, market-entry opportunities in selected CIS countries. In order not to overstretch the Bank’s management and financial resources, we intend to make no more than one acquisition in 2008.
This is my first letter to you as Chairman of the Supervisory Board and I would like to assure you that despite the challenging market conditions and changes in the Bank’s management, our discipline and focus remain sharp and delivering shareholder value remains our top priority.
I would like to thank our Board for its continuous support and active engagement, and also our employees, whose dedication and professionalism make Bank of Georgia’s success possible.
Chairman of the Supervisory Board
2007 was another record year for Bank of Georgia. Without a doubt Bank of Georgia benefited significantly from the opportunities stemming from Georgia’s rapidly developing economy, growing inflow of foreign investment and increasingly liberal business environment, but we also succeeded in managing our rapid growth, improving operating efficiency and developing new products and services to capture a larger market share of customers' wallet.
Our revenue increased to GEL 235.8 million up by 110.5% compared to GEL 112.0 million in 2006. Our net income reached GEL 75.6 million up by 182.5% from GEL 26.8 million in 2006. Fully diluted earnings per share grew by 103.4% to GEL 2.95 per share (US$ 1.85), compared to GEL 1.45 (US$ 0.85) in 2006. The return on average equity reached 16.2%, up from 11.5% in 2006. Bank of Georgia’s total assets were up by 143.4% from GEL1,213.3 in 2006 to GEL 2,953.6 in 2007, our loan portfolio grew by 144.7% from GEL 684.8 million in 2006 to GEL 1,675.7 million in 2007. Our client deposits increased by 142.2% from GEL 559.6 million in 2006 to GEL 1,355.5 million in 2007. Our Tier I Capital Adequacy Ratio calculated by BIS standards stood at 25.0% and Total Capital Adequacy Ratio at 22.0%.
I am also very pleased to report that this record financial performance was accompanied by strengthened asset quality, resulting in a decrease of NPLs / Gross Loans ratio from 2.3% in 2006 to 1.5% in 2007 and improvement of operational efficiency, leading to a decrease of our consolidated Cost / Income ratio from 56.5% in 2006 to 54.6% in 2007.
In 2007 we significantly advanced our position on the Georgian market. We gained approximately 7.0% market share by assets, approximately 6.1% market share by gross loans and approximately 6.8% market share by client deposits, reaching market share of
35.4%, 32.7% and 31.4% by total assets, gross loans, and client deposits, respectively.
Our relentless stride towards achieving excellence in Retail Banking is bearing fruit. In 2007 we acquired more than 163,000 retail clients in Georgia, bringing the total number of retail current accounts in Georgia to over 705,000 by year end; at the same time we increased our product-to-client ratio from 2.20 in 2006 to 3.02 in 2007. We attracted more than 16,000 new corporate clients in Georgia, including several of Georgia’s top companies. In addition, we continued improving our software systems and thereby our capability to support increasing client business.
To support our commitment to expanding our Georgian business as well as international reach, we pursued an aggressive recruitment policy in 2007, bringing 2,234 new bankers, salespeople and other employees into our group.
In 2007 we continued developing selected non-banking business lines, investing human and/or financial capital to ensure that each of them achieves leadership in its specific direction, development objectives and delivers value.
2007 marked an important turning point for the Wealth Management business of Bank of Georgia. The decision was made to strengthen the group by focusing efforts beyond the core banking competencies and to work towards delivering a broader Wealth Management platform to clients. While the relationship-based Wealth Management service model is still central for every client relationship, more aggressive growth within Georgia will come from delivering true Wealth Management via a holistic approach of providing integrated advice regarding banking, investing and asset management. In a move to significantly enhance the appeal of our wealth management services to international clients we appointed Deborah Fairlamb, who joined us from UBS Private Banking in New York, as head of Wealth Management to spearhead business development efforts in order to expand our group’s wealth management offering internationally.
Outside Georgia we plan to focus on countries with significant Georgian communities. Our Wealth Management services will be offered through Bank of Georgia’s international representative offices, which will serve as an important channel for acquiring new non-resident clients. Our first international representative Wealth Management office will open in 2008.
In June 2007 we successfully concluded the merger of BCI Insurance Company with Aldagi, Georgia’s leading insurance company, with BCI acquiring Aldagi in December 2006. The combined entity now operates under the name Aldagi BCI and is the market leader with 35% market share by gross premiums written.
In October 2007 Bank of Georgia successfully completed its first cross-border transaction by acquiring UBDP in Ukraine.
Also in October 2007 we established Galt & Taggart Asset Management (GTAM), Bank of Georgia’s asset management arm, as a separate legal and operating unit. By 31 December 2007 GTAM had approximately GEL 120 million (US$ 75 million) under management.
Performance in 2007
The following describes Bank of Georgia’s key business lines and their performance in 2007.
Retail Banking comprises Bank of Georgia’s retail banking business in Georgia. As of year end 2007 Retail Banking served more than 583,000 clients and operated the country’s leading distribution network of 117 branches, 250 ATMs, 1,594 Point-of-sale (POS) terminals, and a state-of-the art call center. Retail Banking offers a range of products and services to clients, including retail loans; retail deposits; issuance and processing of credit and other bank cards; ATMs; Internet and SMS banking services; payment of utility bills; money transfers and remittances; and payroll services to corporate clients, etc.
We also offer a wide-range of retail lending products, such as mortgage loans for the purchase and renovation of residences, general consumer loans, consumer POS loans offered at merchants’ stores, auto loans, and micro-financing loans available to entrepreneurs and small businesses, etc.
In 2007 we engaged Allen International, a UK based integrated strategic design consultancy, to develop our brand concept and identity, and to standardize branch design and retail marketing strategy. Allen International completed their assignment in the fourth quarter of 2007. Based on Allen International’s recommendations, we remodeled four pilot branches, including two pioneering mortgage centers in Georgia. Following completion, all four branches started operations at the beginning of 2008.
In accordance with our strategy to have a presence in every region of Georgia, we added 17 branches and service centers throughout the country and plan to open a further 30 in 2008. These new branches will be designed according to Allen International’s recommendations. Establishing close relationships with merchants is an important part of our retail strategy. We currently work closely, at their outlets, with 30 automobile dealers and 640 retailers providing car loans and POS express loans.
The Bank’s 24 hour, state-of-the-art customer service call center, staffed by 25 employees as of 31 December 2007, is accessible to customers both by telephone and online. The significant growth in Bank of Georgia’s retail banking business in Georgia is primarily the result of expansion of the Bank’s retail customer base and branch network, its emphasis on sale of packaged products, extensive co-branding, third party alliances and increased demand for payroll services from corporate customers.
Selected highlights of Retail Banking in 2007
Acquired over 163,000 new clients, bringing the total number of Bank of Georgia’s retail clients to 583,500 at year end 2007. Opened 17 new branches and 126 ATMs bringing the total number of branches to 117 and ATMs to 250. Increased the branch salesforce by 86% to 1,036 staff. Increased the number of POS terminals by 1,123 bringing the total number of POS terminals to 1,594 at year end 2007. Increased number of debit cards outstanding by 88.2% to approximately 530,000 and number of credit cards outstanding from 356 in 2006 to 108,616 in 2007.
Increased the number of Internet banking users from 37,377 in 2006 to 114,612 in 2007 and SMS banking users from 13,705 to 39,703.
Corporate and Investment Banking (CIB) includes Bank of Georgia’s corporate client business in Georgia, which provides a range of services to more than 64,000 clients in Georgia, including large corporate, small and medium-size companies, NGOs and governmental entities, through an integrated client coverage model. CIB offers a range of products and services, including corporate lending; current and deposit accounts; account administration and cash management services; payroll services; trade finance operations; foreign exchange transactions; and leasing. In addition, through Bank of Georgia’s investment banking subsidiary Galt & Taggart Securities, CIB provides a full range of investment banking services. CIB’s corporate lending products include working capital loans, fixed asset financing, revolving credit lines, overdrafts, project financing and SME loans. CIB loans are typically secured by real estate, liquid inventory or equipment and can be denominated in GEL, US$, EUR and GBP.
Our trade finance products include pre-export financing, import financing, issuing and confirming letters of credit and stand-by letters of credit, as well as the provision of guarantees. Our treasury offers currency conversion operations to our clients and enjoys the lead position with a 34% share of the foreign exchange market in Georgia.
Our leasing services are conducted through Bank of Georgia’s wholly-owned leasing subsidiary Georgian Leasing Company (GLC), the second-largest leasing company in Georgia by lease portfolio. 2007 was another year of top corporate client acquisitions. In 2007 we attracted Georgian Oil & Gas Corporation, a dominant player in gas transportation; Heidelberg Cement Georgia; Coca-Cola Bottlers Georgia Group Companies; UAE-Based Rakeen Development; and EnergoPro Georgia among others.
Selected highlights of CIB in 2007
Deepened the implementation of the client coverage model as the number of clients served by dedicated relationship bankers increased from 3,606 in 2006 to 4,659 in 2007.
Expanded the number of corporate clients using the Bank’s payroll services to over 700 from 480 in 2006, i.e. 150,000 clients for Retail Banking.
Acquired over 16,000 new corporate clients bringing the total num-ber of corporate clients to over 64,000 up 35.9% from 2006 . Increased the number of GLC’s leasing projects by 140% from 55 in 2006 to 132 in 2007.
Our Wealth Management team provides relationship-based private banking services to affluent Georgian and foreign individuals. During 2007 the number of our Wealth Management clients increased by 47.8% and at year end 2007 our Wealth Management team had 1,291 clients from 36 different countries.
In 2008 we intend to grow our Wealth Management business rapidly and commence offering our Wealth Management products outside Georgia, focusing on countries with large Georgian communities. In 2007 we laid the foundations for this expansion by launching tax and real estate advisory services and initiating activities to establish internal and client education programs, as well as developing a Wealth Management IT support platform.
Going forward, we intend to develop Wealth Management as a panregional unit led by Bank of Georgia group’s head of Wealth Management, a position created in 2007. Deborah Fairlamb, who joined us from UBS Private Banking in New York, was appointed to this position in May 2007.
Galt & Taggart Securities is a wholly-owned investment banking subsidiary of Bank of Georgia. Galt & Taggart Securities provides agency brokerage, sales and trading and research services to its institutional and private clients, as well as, equity and debt capital raising and mergers and acquisitions advisory services to its corporate clients. Galt & Taggart Securities is also engaged in proprietary investing and trading.
In 2007 Galt & Taggart Securities Georgia continued to hold the leading position in equities trading in Georgia, with approximately 63% of market share in terms of trading volume on the Georgian Stock Exchange. Galt & Taggart Securities Ukraine was established in November 2006 and was developed into a strong sales and trading, research and corporate finance outfit during 2007. In 2007 Galt & Taggart Securities Ukraine achieved #19 position in terms of trading volume in Ukraine, with approximately 1.2% of Ukrainian market share.
Selected Highlights of Galt & Taggart Securities in 2007
Dmitry Kasatkin, formerly a director at ABN AMRO’ corporate finance team in London, joined Galt & Taggart Securities in March 2007, initially as head of corporate finance and then as Chief Executive Officer.
In May 2007 Galt & Taggart Securities led the IPO of Teliani Valley, Georgia’s leading wine-maker, on the Georgian Stock Exchange. In October 2007 Galt & Taggart Securities assisted Bank of Georgia to complete the acquisition of UBDP in Ukraine.
2007 marked the inception GTAM, comprising the Bank’s asset management activities. Through GTAM we provide individual and institutional investors with investment capability across all major asset classes through both universal and tailor-made products.
GTAM currently acts as an investment adviser to several funds, with a primary focus on Georgia. Of these, the biggest are Galt & Taggart Capital (GTC), a private equity vehicle for the country’s consumer sector, Caucasus Energy & Infrastructure (CEI) - for the energy & infrastructure sectors of the economy, and SB Real Estate (SBRE) - for real estate. In addition, GTAM manages the country’s second largest Aldagi BCI pension fund and Iavnana endowment fund.
Selected highlights of GTAM in 2007
In March and September 2007 conducted two rights issues for Galt & Taggart Capital (GTC) and raised a cumulative GEL 10.8 million.
In November 2007 launched Georgia’s first ever endowment in cooperation with Paata Burchuladze’s International Charity Foundation, Iavnana.
In February 2008 raised US$50 million for Caucasus Energy & Infrastructure. In 2007 assets under management of Aldagi BCI Pension Fund grew 142% to GEL 1.2 million, while the number of pension fund participants increased by 77% to 3,820. As of 31 December 2007, market capitalization of GTC was GEL 78.6 million, an increase of 46.4% from 2006. Aldagi BCI is the Georgian insurance market leader, with approximately 35% market share as of 31 December 2007. Bank of Georgia provides insurance-related products and services through Aldagi BCI, its insurance subsidiary (formerly BCI).
Aldagi BCI provides a wide range of corporate and consumer insurance and related products in four areas: property and casualty liability, including general third party liability; motor third party liability, carriers liability, professional indemnity, bankers blanket bond, product liability and employer liability; personal risks, including health insurance, personal accident, travel and term life insurance; and performance bonds and guarantees. The consumer insurance brand Chemebi, is an umbrella brand for five consumer insurance product lines – motor insurance, life, health insurance, property insurance and travel insurance. In 2007 the number of Aldagi BCI's retail insurance clients increased by 120.1% to 60,671. Aldagi BCI also increased its number of branches from 10 in 2006 to 13 in 2007 and stepped up selling consumer products through the Bank’s branches. Aldagi BCI also operates Aldagi BCI Assistance, a 24-hour telephone helpline for its health insurance customers.
Aldagi BCI cooperates with a number of internationally renowned reinsurers such as Hannover Re., Munich Re., AIG, Lloyd’s and SCOR.
Major Acquisition in 2007
In the fourth quarter of 2007 we completed the acquisition of a 98.8% equity interest in UBDP, a mid-sized bank in Ukraine. The aggregate consideration paid for the 98.8% equity interest amounted to US$ 81.7 million, i.e. P/BV (2006A) of 2.15x, based on UBDP’s 2006 Audited IFRS financial results.
UBDP, which is headquartered in Kiev, served over 30,000 retail and over 2,100 corporate clients as of 31 December 2007. As at year end 2007, UBDP’s total assets and shareholders’ equity stood at GEL 356.8 million and GEL 70.0 million respectively.
In 2007 we focused on comprehensive understanding of UBDP’s business processes, enhancement of its organizational structure and hiring and integration with our businesses. Since the acquisition of UBDP in October 2007 we have added two new branches, bringing the total to 40 branches and service centers located in five oblasts (regions) of Ukraine.
UBDP will continue to operate as a standalone bank, owned and controlled by Bank of Georgia.
Opportunities and Challenges
In 2008 we envisage a number of key opportunities:
- Continuing aggressive build-out of our Retail Banking business in Georgia, benefiting from booming demand for consumer lending products combined with low consumer indebtedness. Leveraging our marketleading franchise and taking advantage of the efficiencies of scale made available by the increased number of clients and distribution channels.
- Continuing the development of our Corporate and Investment Banking business in Georgia, capitalizing on Georgia’s rapid economic growth and inflow of foreign investment. Further refining our integrated client coverage model, focusing on fee generating products
- Capturing private banking business opportunities outside Georgia, focusing on countries with sizeable Georgian communities. … and also some key challenges:
- Continuing the “institutionalization” of Bank of Georgia, hiring new, experienced managers and refining management processes and procedures.
- Restructuring our newly-acquired Ukrainian subsidiary and integrating it effectively into Bank of Georgia group.
- Maintaining a balanced funding base by combining reasonably priced wholesale and deposit funding despite the current uncertainty in global financial markets. Taking into consideration our top-class management team, I am confident that despite the challenging global environment, we will achieve our objectives in 2008 and beyond by maintaining focus, discipline and a positive approach that will deliver outstanding results and excellent value.
Chief Executive Officer
- Chairman’s Statement
Dear fellow shareholders,
I am writing this letter for our 2006 annual report, our first since we listed GDRs on the London Stock Exchange, in the Istanbul airport lounge, en route from Warsaw, where I met at an investor conference many of the leaders of Poland’s dynamic asset management industry – on whose success we hope to model our efforts in Ukraine and Georgia, to Baku, where I will speak to a large group of my peers about our Eurobond debut issuance experience. In many ways, this is a measure of how far we have come since our team has accepted the responsibility of managing your bank in October 2004.
Bank of Georgia in 2006
2006 has been another remarkable year for Bank of Georgia. Our annual revenue grew 77% to GEL 112 million, which, through our operating leverage, resulted in an increase of 97% in net income, to GEL 27 million, or GEL 1.445 per share on a fully diluted basis.
Riding the crest of the wave of Georgia’s economic renewal, we continued to enjoy rapid top-line and bottomline growth across almost all of our businesses - most of it organic. The growth in earnings was of high quality, as we continued to invest aggressively in our future, adding 1,051 people to our headcount and 50 branches to our footprint, as our domestic client base nearly tripled in 2006.
In keeping with our pioneering tradition, we continued innovating and introducing advanced financial services products to the Georgian businesses and consumers. In 2006, we launched Chemebi, our umbrella consumer insurance brand and product platform, launched pointof-sale consumer loans and attained unequivocal market leadership in this segment, and introduced our first credit card product.
Where it made sense, we acquired assets aiming at consolidating our domestic market leadership, such as the assets and liabilities of Intellect Bank and Aldagi, the leading Georgian insurance company. While recognizing the very considerable domestic growth opportunities afforded to us by Georgia’s continued robust economic performance, we reached across the borders where we saw an early opportunity to be competitive and capture further room for profitable growth, with us acquiring a strategic 9.9% stake in a Ukrainian bank and Galt & Taggart Securities establishing its subsidiary in the promising Ukrainian market.
While capitalising aggressively on the various growth opportunities, we continued to focus on asset quality, maintaining a sound risk profile and opting for inorganic growth only when convinced of our ability to execute. In many cases, this measured and responsible approach resulted in judgment calls that curtailed revenue growth in some areas such as insurance and may have appeared, to an outsider, very conservative. We recognize, however, the importance of progressing down the growth path in a prudent and balanced manner. In 2006, your bank became and still remains the only Georgian entity to be rated by all three global rating agencies. We look forward to maintaining our prudent approach so that we continue to be rated at the sovereign ceiling and improve our ratings as our home market matures and the perception of risks consequently subsides.
Ultimately, the quality of our leadership team and our staff who work with them will determine the scope of our success. We have succeeded in 2006 in recruiting a number of high-caliber individuals and I am pleased to report the rapid development of our talented managers. We have fostered a culture of openness, respect and teamwork, grounded in our performance-based compensation structure which aligns the managers’ interests with those of the shareholders, and it is a pleasure to observe this dynamic group during regular reviews of our various businesses, group-wide strengths and weaknesses and the exciting new opportunities Georgia and selected neighbouring markets offer.
Our achievements continued to be recognized internationally in 2006 as we became the recipient of The Bank of the Year Award by The Banker and The Best Bank in Georgia 2006 Award for Excellence from Euromoney. However, the recognition of our efforts that we value the most has come from you, dear fellow shareholders; as the market has increasingly recognized our market-leading position in Georgia and the growth profile this affords us, our share price grew 383% in 2006.
I hope after reading this letter and reviewing our 2006 and current results, you will share my optimism about our prospects and enormous potential of the Bank of Georgia franchise – domestically and, in selected cases, in neighbouring markets.
With our broad product range and rapidly growing client base comprising over 50,000 legal entities and 500,000 consumers in Georgia (over 10% of the population), we are very well positioned to capture a growing share of wallet of our clients through clever, targeted cross-selling and continuous innovation. Our product-to-client ratio in retail banking improved in 2006 from 1.8 to 2.2 (even as our client base nearly tripled) and, considering that for many of our clients this is the fi rst and in most cases the only fi - nancial services relationship they have, it is up to us to succeed or fail in driving the product-to-client ratio to above 3.0 and possibly up to 4.0.
As we continue to invest in our market-leading domestic distribution footprint, we have every possibility to achieve relevance through ubiquity to an even larger base of Georgian consumers.
Having pioneered the integrated client coverage of corporate clients in Georgia, it is up to us to succeed (or fail) in increasing our share of wallet further by learning to work even better together. The continued rapid growth and increasing sophistication of our large and medium corporate clients make our value-added capabilities, such as trade fi nance, investment banking and asset management – in which we are head and shoulders above our competitors
– increasingly relevant.
Our insurance franchise is the strongest in the market, with pro forma market share exceeding 40%. Based on prior track record, I anticipate that the integration of Aldagi will be completed successfully, following which we will look at ways of accelerating top-line and bottom-line growth of the business.
We have established ourselves as the undisputed domestic leader in wealth management, with a niche appeal to sophisticated non-resident private clients.
I am encouraged by our fi rst steps in asset management and am confi dent that it is within our power to lead the Georgian market through the inevitable phase of deposit substitution and growing popularity of investment products.
Galt & Taggart Securities, which continues to dominate the domestic investment banking market, has established itself successfully in Ukraine and, alongside our wealth management and nascent asset management businesses, is blaz
ing the trail looking for opportunities to further expand our regional footprint.
While we continue to screen the region for acquisition opportunities to augment our rapid organic growth, we will only invest our capital if the price is commensurate with the scope and business logic of the opportunity and if we are confi dent of our ability to execute on the integration and subsequent growth.
Considering the extent of our domestic market leadership, it may get lonely at the top, but let me assure you that the leadership team of your bank is far from resting on its laurels. We regularly benchmark our performance across a wide range of fi nancial and operating metrics against a broad peer group of 39 banks from the EMEA region, including South Africa, CEE, Israel, Russia, Kazakhstan and Turkey. Our objective is to be, by 2009, fi rmly in the second quartile by all these metrics.
We have begun 2007 highly capitalised, with Total Capital Adequacy Ratio (BIS) of 35%. Furthermore, our engagement with the investor and lender community, high transparency and responsible way of conducting business ensure our growing credibility in, and domestically unrivalled access to, the international debt and equity capital markets. This leaves us well-prepared to capitalise on organic and inorganic growth opportunities.
I started this letter by stating that we have come a very long way since October 2004. As I contemplate our future prospects, I believe we have most, if not all, critical elements of sustained success – a robust strategic position, respected and popular brand, large and growing loyal client base, scale, distribution, risk management framework capital, and, last but not least – supportive shareholder base, experienced and engaged Supervisory Board, highcalibre managerial talent and professional, dedicated staff. All this augurs well for our future. I am privileged and thankful for the opportunity to have led this company through this remarkable period.
Chairman of the Supervisory Board