GARANTİ BANK and YAPI KREDI BANK

MOST & LEAST PREFERRED LIST AMENDMENT: Replacing Garanti Bank <GARAN TI> with Yapi Kredi Bank <YKBNK TI> in the Most Preferred List

We are replacing Garanti Bank with Yapi Kredi Bank in our Most Preferred List as Garanti Bank’s 2Q12 results surprised us on the downside in terms of asset quality performance. The quarterly NPL generation of TL225mn came well above our expectations. The above sector deposit costs of Garanti Bank especially on the TL front in 1H12 also raises questions on the necessity of the subdebt repayment in 1Q12. We also find the management’s 2012 loan growth and NIM guidance optimistic. We believe that 14% loan growth is more reasonable for Garanti Bank in 2012 assuming a stable currency for the rest of the year, which implies 9% loan growth for 2H12. At the conference call, Garanti Bank management maintained its 20bps YoY improvement guidance for 2012. Considering that inflation switched to a declining trend in May, our 8.5% YoY inflation projection for October-end implies 28% contraction in CPI linker yields in 2H12 compared to its 1H12 level. In order to reach the 20bps YoY NIM improvement, we calculate that Garanti Bank should

attain 4.1% NIM in 2H12, which implies a 20bps decline compared to its 1H12 level. Considering the decline in CPI linker yields in 2H12, the management’s full-year NIM guidance implies that the bank should improve its loan-deposit spreads by another 20bps in 2H12 compared to its 1H12 level.  We believe that any potential improvement in loan-deposit spreads (on the back of declining deposit costs) can only be achieved with sluggish loan growth. In that sense, lower deposit costs may result in a QoQ widening in loan-deposit spreads in 3Q12 in line with Garanti Bank management guidance, yet spreads should definitely contract QoQ in 4Q12 on higher deposit costs and lower loan yields. Thus, we also attach lower probability to a 20bps improvement in Garanti Bank’s loan deposit spreads in 2H12 over its 1H12 level, which makes the 20bps YoY NIM improvement guidance hard to achieve as well. It is also worth to add that we expect Garanti Bank’s CPI linker yields to fall from 19.7% in 2Q12 to 3.4% level in 3Q12, leading to a post-tax TL300mn negative impact in 3Q12 financials.

We are adding Yapi Kredi Bank to our Most Preferred List as YKB’s 2Q12 results surprised us on the upside at the operational level. The quarterly improvement in the bank’s liquidity level and the strong NIM improvement came as a positive surprise to us in 2Q12 financials. We also welcome the bank’s efforts to narrow its duration gap through increasing the average duration of its liabilities and its efforts to support its CAR through changing the valuation methodology for its subsidiaries and putting its non-core assets (the insurance and pension arm) up for sale. We also expect YKB to stand out with its earnings performance in 3Q12 as the declining trend in deposit costs will benefit YKB the most. YKB will also be relatively less affected from the declining CPI linker yields in 3Q12 thanks to its limited CPI linker exposure. At the conference call, YKB revised its previously flattish NIM guidance up to 20-30bps YoY improvement in NIM for 2012. The management projects fees to contract by 5% YoY in 2012 due to the negative impact of the documentation and asset management fee regulations. The management also guided that on a like for like comparison, fees would have been 10-15% higher YoY in 2012. Management also believes that the YoY fee growth comparison among banks is misleading as some banks are collecting documentation fees in other names such as intelligence fees on which accrual accounting is not applied. Should BRSA bring a standard for all banks, those banks that have booked their fee revenues more conservatively up to now, such as Vakifbank, Yapi Kredi Bank and Garanti Bank will be the main beneficiaries. In terms of opex, The management feels comfortable on the asset quality front, expecting a manageable 30-40bps increase in NPL ratio in 2012 and a cost of risk of below 100bps in 2012. YKB targets above sector loan and deposit growth of 17% and 16% respectively in 2012. Note that in 1H12 YKB’s loans grew by 6%, while its deposits grew by 4%. Thus, the management expects better loan and deposit growth for 2H12 and better NPL collection performance as its NPL ratio is already up by 30bps in 1H12. We believe that the improvement in Yapi Kredi Bank’s liquidity in 2Q12 will strengthen its hand in achieving above sector loan growth in 2H12. The favourable trend in the bank’s loans under close follow up also provides a better picture for the NPL generation in 2H12. Thus, we believe the worst is already over for the bank.