TBC Bank reported record high quarterly net income of GEL 45.6 mln (+34% yoy) in 3Q14, taking 9M net income 33% yoy higher to GEL 118.4 mln (USD 67.6 mln). We believe the 9M result puts the bank on pace to deliver full-year earnings approximately 2-3% above the most bullish analyst's projection on Bloomberg (GEL 152 mln). The bank took full advantage of surging demand for credit, growing its loan book 26% yoy without compromising quality. The balance sheet expansion and strict cost control led to a record low C/I ratio of 44.8% in the 3Q (net of one-off expenses). We set our 12M target price at USD 19.9/DR (vs. USD 19.8/DR previously) and maintain our BUY recommendation.

ROE little affected despite IPO-related boost in equity

The record 3Q net income helped keep ROE little changed (19.2% in the 3Q vs. 19.0% in the 2Q and 20% in the 1Q14) despite a substantial increase in equity (due to the bank's June IPO) and a related decrease in leverage (assets-to-equity ratio stood at 5.2x as of September vs. 6.1x as of March. The greater earnings-generating power stems from improved operating efficiency and a decline in the cost of risk.

Asset growth still unabated, lending focus continues shifting to retail/SME

Assets grew by an impressive 5.1% qoq and 25.6% yoy and the loan book expanded even faster (+5.2% qoq and 25.8% yoy). TBC outpaced the sector's growth rate in the 3Q – its share in the total loan book advanced 0.3pp qoq to 27.0%. We expect loan origination will remain slightly stronger than the sector average for at least the next 6 months as the bank continues deploying IPO cash proceeds into new loans. On the downside, the pace of growth should decelerate – an uptick in lending rates in Georgia in 2014 follows a relatively weak 2013 (due to sluggish economic growth and political instability). We see loan portfolio growth leveling out at 17-18% over the next two quarters.

In-line with plans, TBC continued to focus on retail lending (gross loan book up 7.7% qoq in the segment) and SME lending (up 5.1%) while corporate loans added just 2.2% qoq. The share of corporate loans fell 0.9 pp qoq (-4.8 pp yoy) to 33.6% and is likely to keep shrinking further.

Deposits maintained their robust growth rate (+2.5% qoq, +14.9% yoy) and were the key source of funding for the bank. Facilities from credit institutions grew 15.2% qoq (represented mainly by borrowings from local banks) and were used for short-term liquidity management. TBC's loans-to-deposits ratio increased 2.3pp qoq (+8.9pp yoy) to 103% and we see this ratio rising further to 105% by end-2014. It's becoming abundantly clear that Georgian banks can't rely solely on internal funding if they hope to maintain the targeted pace of loan book growth (TBC Bank targets c. 20% p.a. in the mid-term).

NIM to be watched closely, no concerns on C/I and cost of risk

Competition for new borrowers and deposits (to a lesser extent) is pushing the NIM down for TBC (8.3% in 3Q14 vs. 8.6% in 3Q13) and the whole banking sector. A further narrowing of the NIM is broadly expected and TBC management acknowledges it may contract by 0.5-1.5pp from the current level in the mid-term.

C/I in the current year is being affected by one-offs related to the IPO and the settlement of a dispute with former shareholders in Bank Constanta, TBC Bank's subsidiary. Normalized C/I (net of the Constanta fees) stood at a record low 44.8% in the 3Q (49.3% with one-offs included). Yet, management has hinted at a seasonal increase in operating expenses in the 4Q (including bonuses), which makes us downgrade our 2014E C/I ratio to 49% from 48% previously. The bank is certain to improve the ratio in 2015 (to 46.5-47.0%, by our estimates). While the completion of the merger with Constanta planned for 1Q15 will require higher operating expenses, they should be fully offset by revenue growth.

Cost of risk stood at a mere 0.7% in the 3Q, significantly below the normalized level, affected by reversal of provisions in corporate segment (related to improvement of financial health of certain borrowers) and SME (on reduction in overdue loans). Management reiterated its guidance for cost of risk over the mid-term in the range of 1.2-1.6%. We thus remain comfortable with our assumptions for cost of risk at 1.4-1.5% for both 2014 and 2015.

Target price little changed, maintaining BUY recommendation

TBC is on pace to outperform our initial expectations for 2014 net income as its loan book is expanding at a faster-than-expected rate. We upgrade our projection for average loan portfolio growth in 2014/15 to 18.1% from 17.2% previously. We keep estimate for 2014 NIM unchanged at 8.4% but decrease it by 0.5pp to 7.9% for 2015. This leads us to marginally downgrade our 2015E net income projection (to GEL 178 mln vs. GEL 184 mln previously). Accounting for these forecast updates, we leave our 12M TP virtually unchanged at USD 19.9/DR (vs. USD 19.8 previously) and maintain a BUY recommendation on the stock.

The economy is broadly healthy, IMF program provides additional comfort

The Georgian economy has maintained its robust growth – real GDP is up 5.9% yoy in 9M14 and we see this rate being maintained over the mid-term. Inflation accelerated to 3.4% yoy in October, driven primarily by prices for food staples, and will stay close to 5% (the NBG's new inflation target starting from 2015) next year, by our expectations. The exchange rate has remained stable in the range of GEL 1.72-1.77/USD in the 3Q even though the NBG has remained on the sidelines in terms of large-scale FX market interventions. The NBG's reserves recovered 8% in the 3Q to USD 2.7 bln (and stayed little changed in October). With an active IMF program on track, the government and the central bank have all the tools in hand to head off any possible macroeconomic shocks.

Valuation summary

We set the 12-month target price for TBC Bank at USD 19.9/DR, implying upside of 36%. Our price target is a simple average of fair values based on DCF and comparative valuation methodologies. We maintain a BUY recommendation on the stock.

DCF valuation

Our DCF valuation model yields a 12-month target price of USD 22.3/DR, implying 53% upside to the current price.

For modeling purposes we assume the value for shareholders is comprised of net income that the bank can distribute as dividends. Assuming the bank maintains a minimum Tier 1 capital ratio of 8.5% as required by the NBG under the new Basel 2-3 framework, a portion of net income has to be retained and is not available for shareholders. We nevertheless note that in reality TBC Bank will target a much higher minimum Tier 1 capital ratio of about 12.5%, as indicated by management's guidance.

We use a cost of equity of 15.5%, which is comprised of a sovereign Eurobond yield of c. 5.0%, corporate bond premium of 2%, equity risk premium of 6%, and company-specific premium of 2.5%. The company-specific premium reflects TBC's lack of a track record in terms of equity trading in public markets. This premium will be phased out in the future.

Peer-based valuation

We estimate the fair value for TBC based on a median 2015E P/B multiple for the peer group (50% weight) and the same multiple for Bank of Georgia (50% weight). We arrive at an average fair value of USD 17.4/DR.

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