Shareholder Letters

Extract from 2012 Annual Report 

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. 

Neil Janin
Chairman

Extract from 2012 Annual Report 

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.

Irakli Gilauri
Chief Executive Officer of Bank of Georgia Holdings