Credicorp Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 9.13 | About: Credicorp, Ltd. (BAP)

Credicorp Ltd. (NYSE:BAP)

Q2 2013 Earnings Call

August 9, 2013 10:30 AM ET

Executives

Alvaro Correa – CFO

Walter Bayly – General Manager

Analysts

Thiago Batista – Itaú BBA

Carlos Macedo – Goldman Sachs

Tito Labarta – Deutsche Bank

Jose Barria – Bank of America Merrill Lynch

Philip Finch – UBS

Mariel Santiago – HSBC

Saúl Martinez – JPMorgan

Boris Molina – Santander

Operator

Welcome to the second quarter 2013 Credicorp Earnings Conference Call. My name is Lorena and I will be your operator for today’s call. At this time all participants are in a listen only mode. Later we will conduct a question-and-answer session.

I will now turn the call over to Mr. Alvaro Correa, Chief Financial Operator from Credicorp. Mr. Correa you may begin.

Alvaro Correa

Thank you, Lorena. Good morning and welcome to Credicorp’s second quarter earnings results conference for 2013.

As you will see along this presentation the main message that we want to convey today is that even though our results for the quarter have been severely affected by the devaluation of Nuevo Sol, the core business activities of Credicorp have performed well and the company is well positioned to continue capturing the growth opportunities that lay ahead.

A stronger devaluation of the local currency was recorded this second quarter which reached 7.5% and added to the 1.5% devaluation of the first quarter resulted in a total of 9% devaluation for the first half of the year. This volatility of the local currency in our market surpassed all precedents in the last 20 years. These variations were initially attributable to changes in Central Bank’s policy and then to the fact that the U.S. dollar has strengthened worldwide.

In the past and as long as U.S. dollar remained dominant currency in the different businesses of Credicorp this exposure was small and easily managed. However as the local currency gained importance and began dominate in Credicorp’s core businesses, our corporation became more exposed to currency fluctuations when reported in U.S. dollars.

Even more so, given that we maintain the policy of keeping our equity in both currencies as a way of protecting capital. Therefore, the result of this second quarter incorporates the full impact of such devaluation. This has generated a significant distortion in the reported volumes for growth and income generation at most of Credicorp’s Nuevos Soles denominated businesses which currently contribute over 87% of the corporation’s income and has also generated translation losses as well as a valuation loss on structural forward contracts both of which arise from efforts to protect the capitalization ratios of the organization through the construction of the Nuevos Soles denominated equity portion on in our books.

Therefore the discussion of our second quarter results addresses such impact in most of its analysis and focuses for the first time on the evolution of the core businesses in the currency in which it is contracted, in order to be able to evaluate real business trends and results. All-in-all we feel we feel it was a very good quarter in terms of business trends, evolution and achievements. However our earnings results as reported in U.S. dollars distort these concussions and we will try to help you see beyond the reported numbers.

Let’s move to page three please. Reported IFRS U.S. dollar results show a strong negative impact of the currency fluctuation. Total loans dropped 1.6% in the quarter. Net interest income, 2.2% drop. Global net interest margin dropped six basis points, operating income is down 26% and net income dropped 70% resulting in a 5.4% return on equity.

In addition the delinquencies ratio deteriorates 14 basis points. However, a more detailed look at the performance of the business, denotes a truly – business evolution with stronger income generation and margins when evaluating the performance in the currency in which the businesses are conducted. In fact a closer look at the top line of net interest income of Credicorp reveals, for example that net interest income in Nuevos Soles which make up of 87% of total net interest income expanded 7.9% quarter-over-quarter and 21.6% year-over-year if we exclude the impact of other income and expenses which incorporate the losses that arise from our solid equity position held in part through structural forward contracts.

This reveals a dynamic banking business that posted strong loan book growth of 5.7% quarter-over-quarter for the Nuevos Soles portfolio which is almost half of our loan book. However, the FX movement hit both this stronger income generation and the loan book expansion and led to report a 0.4% quarter-over-quarter and 16.8% year-over-year net interest income growth, and a solid portfolio contraction when expressing both in U.S. dollars.

In addition when including the structural open forward position, the distortion in net interest income reported increases as we will see further on. These distortions are also reflected in the NIM which dropped to 4.81%. Therefore what we see in an analysis by currency is strong loan portfolio growth, strong income generation higher delinquencies in line with the retail expansion and a necessary learning curve, excellent fee income generation and good profitability.

In summary and as we would see along this presentation, distortions are found both when expressing Nuevos Soles results of Credicorp’s domestic businesses in U.S. dollars for reporting purposes as we just show, but also when incorporating the accounting impact of the volatility in the exchange range rate on the open currency position that arises from holding our equity in both currencies.

We will see all this better explained in the following chart, next page. When looking at BCP only, loan portfolio growth is well within expectation. Measuring growth in average the balances the Nuevos Soles portfolio which is mainly dominated approximately 80% by the retail business, expanded a robust 5.7% in the quarter, while the U.S. dollar portfolio reflected the contraction in the corporate business following several international initial stock and bonds offerings by major Peruvians corporations and a slight slow-down in business expansion and contracted 2.8% quarter-over-quarter.

Furthermore in year-over-year terms the solid portfolio expanded 23.4% and the U.S. dollar portfolio 10.4%, which are both very strong numbers. However the effect of the devaluation in the consolidated U.S. dollar reporting of the portfolio evolution hit this strong performance and led us to report near 0.4% growth in the retail business and a contraction of 3.8% in the hotel business. This in turn led to a negative consolidated growth of total average daily benefits in U.S. dollar of 1.4% in the quarter, a complete distortion of real performance.

Next page please. With regards to credit quality we feel we are showing an evolution in line with retail expansion and an expected learning curve and feel fairly confident. In fact similar to the evolution of the credit card business which is currently performing well within expectations in all new vintages after adjustments we have introduced, the low segments of SMEs has experienced deviations that have led to an increase in delinquencies to 7.6% of this portfolio.

This cost the overall PDL ratio to increase 12 basis points and situate at 2.16% in the second quarter for all delinquencies. But only increased 10 basis point up to a still very low 1.45% that’s the loan ratio for over 90 day delinquencies. This deviation prompted us to make significant adjustments in our models and conduct a thorough revision of the business model we use to evaluate low income SMEs.

Furthermore our conditions for portfolio quality required us to set aside additional provisions as we continue the process to adjust the models we use to penetrate such low income sectors. Although this segment currently requires additional provisions these needs should subside over time as the adjustments may begin to have an effect. In this context provisions increased 21.8% for the quarter. However this situation was attenuated by devaluation given that more than 90% of provisions are booked in local currency.

This leaves BCP and therefore Credicorp with a healthy portfolio 52% of which is in the retail business, lower delinquencies and still relatively low cost of risk, that is around 2.2% of loans and a good coverage ratio of a 167%.

Page six. Although reported net interest income dropped 1.6% for the quarter it is precisely here where the strongest distortions are observed. In fact the table at the bottom shows that local currency net interest income which makes up for 89% of total net interest income at BCP expanded 4.7% quarter-over-quarter and 20.4% year-over-year when expressed in Nuevos Soles and excluding the impact of derivatives which include the structural forward contract that make up of our Nuevos Soles denominated portion we referred to before.

This expansion reveals a dynamic banking business that posted strong increases in market share in the retail products. When expressing these figures in U.S. dollars growth, growth comes down to minus 1.6% quarter-over-quarter and 15.6% year-over-year. As per the foreign currency business net interest income contracted 8.7% this last quarter but showed a positive though an impressive 2.7% growth year-over-year.

This was primarily due to aforementioned contraction in the corporate business following several international initial stock bond offerings and a slight slowdown in business expansion. As a result total net interest income excluding the impact of structural forwards contracted 0.9% this quarter and expanded 16.7% year-over-year. Including such derivatives BCP experienced a 1.6% drop in net interest income quarter-over-quarter and reduced the year-over-year growth to only 14.1%.

This distortion is also reflected in the NIM which dropped to 4.92%. However the NIM on loans which is much less distorted thus reflects the better performance we are indicating as it increases nine basis points to 8.19% for the second quarter.

Next page. The reported non-financial income at BCP also shows a negative evolution and dropped 8.8% for the quarter. Nevertheless this includes fee income which is 72% Nuevos Soles nominated and which grew 7.4% for the quarter despite the negative effect of the devaluation of the local currency. This indicates that expansion which was driven by significant better banking fees was quite noteworthy.

Net gains on foreign exchange transactions which are positively affected by foreign exchange volatility in the market also expanded significantly to post 12% growth quarter-over-quarter. However the securities in our portfolio this suffered in interest rate increases for the U.S. dollar which generated significant mark-downs in the value of long term notes and led to a $28 million loss in sales of securities impacting negatively the overall non-financial income line.

Operating expenses were up 7% in the quarter reflecting increases in fees paid to third parties, rent payments, expenses in other subsidiaries consulting fees related to strategic support and systems and marketing. While these additional costs were attenuated by a slight quarter-over-quarter decline in salary and employee benefits this expense is mainly incurred in Nuevos Soles and to a lesser extent by a reduction in additional employee profit sharing.

It is important to note that at the end of June 2013 approximately 70% of all operating expenses were denominated in Nuevos Soles. As such the devaluation of Nuevos Soles against the U.S. dollars had a positive impact on this item as these expressed in U.S. dollars dropped point 0.7% quarter-over-quarter. On the other hand other expenses were inflated by a non-recurrent loss associated with the sales of Correval to Credicorp Capital which is neutral when consolidated at levels of Credicorp.

Next page. BCP Bolivia reported net income of $4 million, down 13% quarter-over-quarter. This resulted from a lower non-financial income after an extraordinary high result in line in the previous quarter and higher provisions related to portfolio expansion. BCP Bolivia also reported a $0.6 million translation loss as it had some investments in the Peruvian capital markets which led to its return on equity to drop to 12%.

Edyficar posted excellent performance and business evolution in its natural currency. Here again we see the sizable impact of FX conversions in the reported results. In fact Edyficar is a local currency business and its portfolio grew 6.5% quarter-over-quarter and 44% year-over-year. This quarter net interest income was 9% up Nuevos Soles while net income improved 28%.

However, after converting to U.S. dollars for reporting purposes we find that the devaluation effect has significantly distorted its performance. After this conversion we see that its contribution drops 32% from $7.9 million to $5.4 million this quarter, which was the result of both, the unfavorable conversion exchange rate and a large $11.4 million translation loss.

Return on equity calculated including the goodwill also suffered and dropped to 14.3% for the quarter revealing a total distortion of a truly solid business.

Next page please. Pacifico Grupo Asegurador reported a 52% decline in its contribution to Credicorp which totaled $5.5 million after deducting the $6.4 million translation loss recorded for the second quarter. Reported net premium growth was 3% for the quarter. This growth however, was understated given that 48% of the premiums are calculated in Nuevos Soles. Higher claims led to a decrease in the underwriting results. This was offset by the fact that the company’s investments performed well which led to subsequent increase in financial income. Life business was again the top performer in the Pacifico Group and contributed to $13.8 million to PGA. The Property and Casualty Business however was a loss generator and is concentrated most of the translation loss.

The PPS business, medical insurance reported a 49% drop in its contribution, which totaled $1.2 million. The medical segment, the Clinics is still in the development phase and incurred extraordinary expenses to launch its new Medical Services Brand, Sanna, and reported a loss of $2.2 million for the second quarter. Return on equity therefore dropped to 2.7% for the whole group.

Next page. Atlantic Security Bank reported net income of $13.4 million in the second quarter, which represented a drop of 13% with regard to the first quarter of 2013. This drop was due to the lower interest rate income following a contraction at the portfolio level, fewer earnings on investments and losses on foreign exchange transactions, due to the devaluation of the Nuevos Soles. Despite this evolution Atlantic Security Bank’s return equity remain strong and reach 30.3%.

Next page. Prima’s contribution to Credicorp reached $14.4 million, up 24% from the previous quarter. It is important to emphasize that income from commissions this quarter was affected by the following factors: first, an increase of 6.1% was recorded in income in Nuevos Soles with regard to the first quarter in local accounting. This same growth calculated in US dollars, was equivalent to 3.1% due to local currency devaluation.

And second, the application of International Accounting Standard 18, which led to deferred income for $1.4 million. In IFRS these effects translated into a 1% drop in fee income and slightly lower operating income. Despite this evolution lower tax provisions and a translation gain of $1.6 million this is the only entity in the group with a positive translation result resulted in the increase reported in its net income. Consequently return on equity reached an extraordinary 38.8% for the quarter.

Furthermore funds under management totaled $10.7 billion at the end of the second quarter, obviously a lower number, when expressed in U.S. dollars after the 7.5 devaluation of the quarter and represented 31.1% of the total funds under management in the private pension fund system.

Next page. Although this summary chart of contributions to Credicorp’s bottom line shows the negative evolution of net result with almost all subsidiaries contributing significantly less to Credicorp. It is important to highlight that operating and business trends have been very good for the group.

So please move to the following page when we try to summarize and quantify some of the impact of the current fluctuation which affects our U.S. dollar results. On page 13 as mentioned before, the impact of the devaluation is strong on Credicorp because of two factors. First, the fact that given that we operating a dual currency system and have an asset structure today fairly evenly distributed between U.S. dollars and Nuevos Soles we maintain the policy of protecting our capital against currency fluctuation by holding it in both currency, in line with our asset structure, a fact that generates an open position in our equity structure and exposes our P&L to translation gains and losses from the volatility in the foreign exchange market.

And second the fact that we report in dollars which in this case meant a distortion when expressed in business trend, income generation and results in such currency. Given that a significant portion in income and assets are denominated in local currency.

In the chart above, the box at the left hand side we quantify the impact of the first point, that is of holding a portion of our equity exposed to currency fluctuation. This explains a differential of $126.5 million in less income from our expected results as a consequence of the currency fluctuations and its impact on our equity position constructed through holding Soles in cash and through forward contracts plus the additional taxes has paid based on the opposite results in local accounting.

However the negative impact of the second factor, that is expressed in 88% of our Soles income and Soles expenses in U.S. dollar is not quantified here but what we have shown in the evolution by currency in these reports can give you a sense of how our local business has really performed.

Finally, on the right hand side of the table we present the magnitude of the operational and market negatives natural to the business which this second quarter impacted Credicorp’s results in $31.8 million. We appreciate the difficulty of seeing beyond the reported numbers and hope to have given you a better feel of the real evolution of our business.

Page 14 please, with these projections on a few microeconomic figures, I’ll now pass it to Walter Bayly for some remarks before opening the call to Q&A. Walter?

Walter Bayly

Okay, thank you Alvaro. Good morning to all of you. Before we go in to the Q&A we thought it was worthwhile that I take a couple of minutes and try to give you a better sense on how we see the future long term.

Clearly this first six months have been highly impacted by evolutions in the world economy. The world that we saw at the end of last year clearly is not the same one that we see today. Our base case scenario going forward continues to be that Peru will probably grow at a 5% give plus or minus 5% around in GDP growth. But how does this translate into growth in the financial sector. Traditionally this meant that the financial sector would grow between 2.5 and three times GDP growth.

We think that is no longer the case. Not only has Peru reached a higher level of penetration of the banking industry but furthermore regulators are very much concerned to continue to see very important growth rates in the loan portfolio of the banks. Even with this 5% Peruvian GDP growth our base case is that the financial system as a whole will probably grow between 10, 12 maximum 15% growth. Both numbers continue to be very good, particularly when compared with the rest of the world. But that is basically the scenario that we see. Now having said that our base case scenario – now having said that there is another scenario which is that China does not do what everybody expects and that a slowdown in the Chinese economy is a lot stronger than what is in our base case and China grows at a 4% rate give or take.

Those numbers would have severe impact in the growth of the Peruvian economy because they impact of revenues of the central government via lower income taxes, lower royalties et cetera. So that scenario is one which is not our base scenario but it’s not a zero percent probability. It is obviously impossible to pin point the number of anywhere between 20% or 35% probability is what where think that scenario could play. And more importantly probably the percentages, of probabilities of those scenarios are growing.

So even though our base case scenario continues to be one of growth of between 10% and 15% in terms of loan portfolio we cannot take our eyes off this other scenario. So we are being a little bit conservative in trying to assess what’s going to happen in the future.

Given this scenario the base case scenario and this other alterative scenario where we cannot take our eyes off we see that we have two very important levers that we can use to extract value at the Credicorp level. Number one is clearly risk management. As we have mentioned to all of you in the past starting the half of last year, June-July we have gone through very detailed reviews of our risk management process on the retail side. And we have found that we have room to improve. Our practices are not [along] best practices worldwide.

Basically three topics which we can address. One is the governance of our risk management. And again I am exclusively referring to the retail side. We do not have a very long history of working extensively with statistical models. And the governments around have those models operate is something which we have to severely improve.

The second is the quality of the tools themselves. In this reviews that we have done internally and with the help of outside consultants we have found room to improve the quality of the tools.

And the third is the staffing of our retail risk management teams which we’re in the process of seriously upgrading.

So lever number one we think we can extract a lot of value is risk management on the retail side. We have initiated all the processes that will lead us to take us to best practices. Clearly there are quick hits and things we are doing initially. But this is a two, three year process but we are very focused on taking our risk management practices to worldwide best practices.

The second lever that we are very focused on is efficiencies. For the past four, five years or even more the big driver for us has been to capture the growth and we have done so. We have positioned ourselves as number one in the two key markets which were micro finance and consumer finance. We have grown our branch network et cetera.

We think that there are lot of opportunities to capture additional operating efficiencies. We are initiating a transformation process within our organization that we think again will take two- three years but that I think will be a key driver for increased profitability going forward.

The third initiative that we are very much focused on is on the SMEs. Even though delinquencies have increased in our SMEs we think that, that segment is poised to grow, to have growth rates, higher growth rates than the rest of our portfolio. So we’re initiating very thorough review, both of our commercial practices and risk management practices obviously. Because we think that, that segment merits a special attention.

So those are the three if you will new initiatives which we have embarked upon in the last couple of months. But further more just from a record standpoint we still have a couple of open issues. We have done relatively large investments in our investment banking operations acquiring Correval and IMTrust both are performing well. But we have not, we are yet to extract the synergies of that business.

We have paid multiples of their book value and clearly including the goodwill the returns are not yet where we expect them to be. I am very satisfied with the work that is currently being done. We are setting the foundations for a very good business. We’re reviewing our processes working on the culture, integrating the three companies.

So it has proven to be a little bit more difficult than we had originally estimated. But again I am feeling very comfortable that we are doing the right thing and we’re setting the basis for a business that will probably be an important contributor to Credicorp.

And then in Pacifico we have two transformation processes going on. On the property casualty business we’re in the focus of shifting our portfolio more to the retail side more in to direct sales that involves investments and changing the culture and the process et cetera. That has yet to produce the expected results.

And on the health services we have embarked upon the investments on the health services side, which again has yet to produce the expected results. Clearly the demand is there. We see it all our facilities are absolutely working at very close to capacity. But we have to do the expansions and we have to price our products property et cetera.

So again taking a step back, the three levers at Credicorp will be focused on, there new levers which is risk management efficiency and the SMEs and we have this open projects that we think that we have to take, to really extract the value. These are open issues that we’re very focused on.

So going forward I have absolutely no doubt that Credicorp will be a growth company. I have no doubt that the 20 plus return on equity is an extremely achievable target and we expect that the second half of this year will be clearly substantially better than the first half for all the factors that Alvaro has already explained.

I just wanted to take a couple of minutes before the Q&A to again give you a long-term vision of where we expect and we see our company going forward. And with this I conclude my remarks and again we’re open to have, to hear all your questions and try to address them. Thank you very much.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). And our first question comes from Thiago Batista from Itaú. Please go ahead.

Thiago Batista – Itaú BBA

Hi guys. Thiago Batista from Itaú BBA. I have two questions. The first one regarding the asset quality in the SME segment. After all the adjustments you did in the credit policy of the segment in September last year have you already starting to see some improvement in asset quality in the new vintages and do you believe the peak of the loan of this portfolio will be achieved?

And my second question is regarding to the impact of the Soles depreciation. Are you taking any measure to reduce the exposure of the bank to the currency at least in short-term?

Walter Bayly

Sure. Thank you very much for the questions. I will take one the first one and I will leave the second one for Alvaro. On the SME portfolio we have seen continued deterioration. Clearly we have made I think it was 60 days ago our first set said of initial changes in our underwriting policies and adjustments in our credit standards.

I would expect results to start showing in the last quarter of this year. We have within our portfolio certain loans that will continue to deteriorate so provisions and passive loans will probably even slightly increase the next three months. And we could expect first stabilization or even improvement in the last quarter of this year.

With regards to the exposure and when we have now we are not far away from the neutral; let’s say neutral position in the mix of dollars and Soles coverage of equity. What we have done in the last quarter is probably we are a little bit into the Soles larger Soles position because we are preparing the equity for factor growth in Soles. So we are taking a step forward but basically what we have done in the last two months is putting ourselves in a more neutral position in terms of protecting equity. This does not mean this is a neutral position in terms of P&L, that is we will continue to bring volatility if there are major changes in the FX.

Thiago Batista – Itaú BBA

Okay.

Operator

Thank you. And our next question comes from Carlos Macedo from Goldman Sachs. Please go ahead.

Carlos Macedo – Goldman Sachs

Good morning gentlemen. I have actually couple of questions. The first one is more related to what Walter just announced in terms of the growth in loans and also the growth or the efficiency program. If I remember maybe not last year but the previous quarter you were talking about doubling the size of the bank and how that would have a negative impact and would allow the efficiency ratio to improve for two or three years. What does this – given the new outlook for loan growth and given the new outlook for this efficiency program what does that mean with respect to your efficiency ratio and to your branch network?

Do you still look towards an aggressive expansion of branches or is that going to be on the backburner for now while you carry out this efficiency program?

And the second question is a little bit more related to FX exposures. While they are not specifically the exposure, with the current keeping I think you mentioned in the last conference call that you expect the government to allow the currency to fluctuate with the little bit more volatility going forward.

And with over 87% of your net income coming in Soles I understand that your functional currency is the dollar but is there any way that you can start reporting in Soles in order to basically offset part of the translation confusion. Thank you.

Walter Bayly

Okay, thank you Carlos for two questions. I will start with the first one and Alvaro will take the second one. In terms of branches inefficiency what we are seeing is that yes, we will continue to grow our transaction and assets anywhere between 10% and 15% let’s stay 12%. That will require growth in our branch network absolutely yes.

The number that is floating around and we are still in the process of making detailed projections. So this is still preliminary. But the number that we seem to fluctuate around is about 50-60 branches per year going forward. So yes it is a lot less than we had originally mentioned. We are always talking about a number 80 to 100 and we are not talking 50-60. But again preliminary numbers but just to give you a sense of what we are seeing going forward.

In terms of the efficiency I will probably need a little bit more time to give you more detailed numbers. We are in the middle of process of working, we are having a series workshops working internally. We have visited banks that have been very successful doing this and I think it will be a bit preliminarily on my side to give you targets. And we will give you, those obviously to the market as soon as we have them, which will probably be for the next quarter. But clearly we are going to be very ambitious.

We have been fluctuating, again big numbers. We have been fluctuating around the 50%-52% and clearly we would love to reach closer to the 42%. But again these are preliminary numbers was just to give you a sense of our ambitions and the overall sense of where we are going.

Alvaro Correa

With regards to reporting to change the functional currency that’s definitely a very reasonable question. We are in the process of doing that assessment. It makes sense to start thinking about that once we have reached this turning point of 50% Soles dollar mix in the asset side and even more so when we talk about income and expenses so it’s in progress but no decision so far.

Carlos Macedo – Goldman Sachs

Okay, thank you for the answers both of you, very interesting and we hope to hear from you in both developments. Thanks.

Walter Bayly

All right, thank you Carlos.

Operator

Thank you. And our next question comes from Tito Labarta from Deutsche Bank. Please go ahead.

Tito Labarta – Deutsche Bank

Hi, Alvaro and Walter good morning. Thanks for the call. Couple of questions also. Just given also the outlook you just presented with a – in a slower growth environment, how do you think that we could end up in terms of profitability? In the past you have mentioned you target ROE 20% plus, I mean do you think that’s still the case or does this kind of slower growth environment means that you think profitability will also come down from the guidance you have given in the past?

And then a follow-up question in terms of your asset quality and provisions. You mentioned you may have some additional provisions in the third quarter related to SMEs. Now is that on top of like the $20 million that we saw this quarter or should we think more the additional provisions would be above like 1.8% excluding that? So just if you could give some more color on the provisioning levels for the rest of the year. Thank you.

Walter Bayly

Sure, Tito. Thank you. In terms of our profitability I want to be very clear. I have absolutely no doubt that the 20 plus return equity is achievable, sustainable over time. We have been affected. This is the first quarter I can think of or the first half of the year that I can think of since I have been in this bank where we have not achieved a 20 plus return equity. It is exclusively or attributable to the fluctuations in the currency, even leaving all the other things on the side. So the 20 plus return equity is very much our target and I have very little doubt that, that is an achievable number.

In terms of provisioning, just a few comments and maybe Alvaro you want to add something afterwards. I was referring that the SME portfolio we continue to see – we have not fully digested the loans that we have in our book and as they continue to deteriorate we will have to increase our provisions, that’s exclusively on the SME.

Clearly all the other pieces of our portfolio continue to be very stable. You have seen them in the chart. We have seen a spike in provisions but related to growth which is fine. So asset quality is really not a concern. Our consumer portfolio continues to boom. The new vintage that we sell are very good. So increase in provisions will only be on the SME and hopefully offset by improvements in the other pieces of the portfolio.

Alvaro you want to add something?

Alvaro Correa

No, just to stress on the point that you made before that we started with the adjustments in the SME policies just two-three months ago and we are yet to see the results of that in the second quarter. So – sorry in the fourth quarter of the year. So I would say that we might expect additional provisions in that business alone going forward for a short period of time.

Tito Labarta – Deutsche Bank

Thank you. It was very helpful. Just a follow-up on the provisioning then. So the way we saw about $20 million in addition provision this quarter it could be some additional provisions like that just related to SME but do you think the level will come down from this $20 million or is that kind of a level to expect do you think that it should trend down a bit?

Walter Bayly

Just to be conservative I will keep it stable marginal increase but nothing, I think that the level that we have right now is what I could say is relatively high. We don’t expect dramatic improvements nor dramatic deteriorations from this level.

Tito Labarta – Deutsche Bank

All right, thank you very much.

Walter Bayly

You are welcome.

Operator

Thank you. And our next question comes from Jose Barria from Bank of America. Please go ahead.

Jose Barria – Bank of America Merrill Lynch

Hi, good morning, Walter and Alvaro. Thank you for taking my question. Just on loan growth, we did see some pretty different trends on local denominated portfolio and the U.S. denominated portfolio. Looking specifically at the U.S. denominated portfolio most of that concentration is obviously in commercial loans. What exactly is happening, we understand that the economic environment is decelerating but looking at the quarterly evolution it was a decline in portfolio.

Is this related to specific clients that maybe did not renew in the [inaudible] capital markets or is this more of a trend in the system that you are expecting much less demand in commercial loans going forward.

Walter Bayly

Okay, it’s both. Actually there were a very few number of specific customers that did bonds issues in international capital market, dollar bond issues and obviously with those bonds they repaid the loan facility that had a lot of them which were with BCP. So yes that was that particular specific effect.

Second, we expect less dollar demand clearly corporate have been also very affected by the valuation coming from a very stable currency exchange rate it had become quite common to see large corporate borrowing dollars because of the lower coupon. They have been affected, the result have been affected by translation losses this quarter. Clearly they have been a lot more conservative in matching their flows. So that we do not expect growth in our dollar portfolio.

We expect on the other hand more, and we are seeing more local currency demand. So overall commercial loans will continue to grow but of course tied to a lower growth rate of the economy. If you see the addition of both currencies. In dollars we expect a lot less demand. I don’t know if I explain myself.

Jose Barria – Bank of America Merrill Lynch

Yeah, no that was very clear, thank you. And then when we think about margins going forward, Central Bank is easing maybe on reserve requirements, you have got higher growth in retail, lower in commercial. How should we think about margins going forward? I mean it seems to me like those movements should imply that we should see some stability already increasing, barring any future impacts on the currency which could add some distortion to the evolution?

Walter Bayly

I think the trend that we expect to see going forward has not changed. What we have been thinking in the past which is there are two process that playing against each other. One is the fact that this is a very competitive market and competition is clearly driving margins downwards. But on the other hand we do have a portfolio mix which is growing more on the retail side which has higher margins. So I think it would be conservative to expect overall margins to stay flat even marginally increase but I think it’s a fair assumption that they would stay flat going forward.

Jose Barria – Bank of America Merrill Lynch

Perfect, thank you very much.

Operator

Thank you. And our next question comes from Philip Finch from UBS. Please go ahead.

Philip Finch – UBS

Good morning everyone, thank you for the presentation and taking our questions. I just have one question. In the second quarter you introduced a new scoring model for SMEs which lead to the additional $20 million of provisions that is non-recurring. Can you tell us what other possible loan book have yet to come under this new scoring system and whether this means we could see additional provisioning adjustments in future quarters? Thank you.

Walter Bayly

Okay, we are continuously upgrading risk management tools of the SMEs. We have introduced a new scoring model but the scoring model what it does, it allows the entry or non-entry of new loans. The provisions that we have done are related to the portfolio that is already on our books which will continue to deteriorate.

So the fact that we continue to change the model and we have done that in the past and changing even the parameters the approval rate and that is a continuous effort. So the fact that we have made additional provisions is not directly related to the fact that we introduced a new model but again what the new model does it allows us to have better predictability on the loans that we accept. The provisions are for the loans that we have already in our books.

Philip Finch – UBS

Great, thank you very much.

Walter Bayly

Welcome.

Operator

Thank you. And our next question comes from Mariel Santiago from HSBC. Please go ahead.

Mariel Santiago – HSBC

Hi, thank you for taking my question. My questions have been answered but if I can just do a follow-up on your – you mentioned that you are very, you show that you can achieve the 20% ROE for this year. If you can just explain a little bit more, what are going to be the main drivers to achieve these ROE levels this year?

Walter Bayly

Okay Mariel, no I did not imply that for this year we will have a 20% return on equity. Clearly that would be a complicated mathematical exercise given return on equity in the first half. What I implied is our long term return on equity objective continues to be 20% and that clearly, hopefully even it’s only exclude only having the second half of this year we might get closer to the 20% depends on how the currency fluctuate. So no let me make it very clear, for the year 2013 we will not have 20% return on equity but that is our target achievable on the long term basis.

Mariel Santiago – HSBC

What do you think then could be your ROE range for the year?

Walter Bayly

Anywhere between 20 and what we have in the first half. I’m sorry I would try not to give very detail projection going forward as you can imagine.

Mariel Santiago – HSBC

Great, thank you for the answers.

Operator

Thank you. And our next question comes from Saúl Martinez from JPMorgan. Please go ahead.

Saúl Martinez – JPMorgan

Hi, good morning everybody. I’m going to play devil’s advocate a little bit and I apologize if the line of questioning comes across a little bit aggressive but I want to ask, it seems like the message that Alvaro gave was really that this is a very good quarter operationally in terms of operation in profitability trend if you look at the currency depreciation.

And when I look at the numbers my conclusion is that, it was a good quarter from a top line perspective and a growth perspective looking past the currency depreciation but not necessarily from a profitability standpoint. And when I look at for example the BCP numbers in local currency and adjusting for currency gains this quarter obviously in local currency and maybe someone-offs and I know it’s tricky. It seems like the earnings there were not very good in local currency, you had pretty elevated cost growth obviously.

You had as you mentioned very high increases in provisioning and it seems like at least the growth you had is in the short term negatively impacting your core profitability. So I’m wondering how you respond to that and especially in light of the later comment made you really that you are fine tuning the risk management practices, you didn’t have best practices. How do you think about that and is that assessment that, that growth has led to lower profitability more recently this quarter and the first quarter, is that a fair assessment in your view?

Walter Bayly

Sure. You are not absolutely wrong I think you have a good point. It was a good quarter again excluding all the effects, noise it looks a good quarter from a top line and yet can be better on the bottom line. Two things to consider when you are looking exclusively at the BCP local currency numbers.

One is that we continue to have BCP Correval until the end of the second half, which was not there the first quarter last year. So comparing you are not comparing apples-to-apples, there are couple of oranges there. And the other thing again exclude from that a loss which is already reflected in BCP’s books of the sale of Correval to Credicorp Capital which is on the consolidated it’s not a loss obviously.

So even if you think those two out which are clearly make it for more comparable numbers trying to look different your conclusion would be not exactly, what you are saying though at a different level. We have to work better on our bottom line and our bottom line I think where we can extract a lot of value is again on the risk management and on the efficiencies.

Even excluding Correval I think we have work to do and again we talk about the negative effect of translation. But they have had positive effects on the cost of [inaudible]. So yes we do have to work a lot on efficiencies and we can fine tune our risk management. So you are right. Even if you exclude the foreign exchange and the extraordinary items that you have mentioned we do have work to do and that’s what we are very much focused on and your conclusion would not be absolutely wrong but at a different level.

Saúl Martinez – JPMorgan

Okay.

Walter Bayly

We will see good result, good bottom line results but not extraordinary.

Saúl Martinez – JPMorgan

Can you remind me what the loss on Correval was at BCP, do you disclose that or no?

Walter Bayly

Seven? 10, 10 million.

Saúl Martinez – JPMorgan

10 million okay. 10 million Soles?

Walter Bayly

Dollars.

Saúl Martinez – JPMorgan

Dollars, okay. Got it. And then just secondly related, how do you I mean the three levers risk management and efficiency in SMEs but typically when I look at SME, when I look at a segment where a company is tightening risk selection and tightening risk standards they typically don’t grow as quickly as you’re still growing in SME even as you are tightening risk standards. How do you respond to the notion that you shouldn’t be growing 30% in your local currency SME book 6% sequentially, if you really are indeed tightening risk standard and trying to tighten up risk selection there?

Walter Bayly

Okay, let me go deeper into SMEs. Even within the SMEs you do have different types of SMEs. Obviously you’ve got the large SMEs and the very small, if you will, entry level SMEs. The entry level SMEs will be an extremely healthy portfolio, mostly done with through [inaudible] report separate numbers and you can truly evaluate what I’m seeing, you’ll see extremely healthy growth and very consistent delinquencies.

Where we have had a problem is with the high end SMEs, which are mostly done at BCP, in BCP’s books. So at the low end SMEs we have absolutely no concerns. They’re growing quite healthily. What I referred to in terms of focusing on SMEs going forward is what we see a longer trend, which is that the entry level SME are Edyficar type of model. We don’t see that market segment gaining market share, if you will, of our total portfolio.

Where we see the growth coming in the next, five to seven years is at the high end, precisely where we are not very good at. We’re not very good at risk management and we’re not very good, even in our commercial processes. So that is what we are focusing on.

The lower SME is a very healthy business model, which is operating quite perfectly with low delinquencies. On the high end is where we have to focus which is at the bank level.

Saúl Martinez – JPMorgan

Okay, thank you very much. That’s very helpful Walter.

Walter Bayly

You’re welcome.

Operator

Thank you. (Operator Instructions). And our next question comes from Boris Molina from Santander. Please go ahead.

Boris Molina – Santander

Yes, I had a question regarding capital [issues[, I hear that you begin to publish the consolidated group capital ratio requirement for the bank and insurance up gradations, and we really appreciate this it’s a nice big improvement in disclosure. Nonetheless when you look at the Tier 1 ratio that would be derived from this, this would be around 7.8 for the second quarter. But then it’s improved on a year-to-year basis.

We would like to see if you can help us understand how does the local regulator look at this capital ratios? And what are limits they are in and how do you feel about this number, because it’s the discrepancies between what the bank and the group are, could be misleading.

Walter Bayly

Thank you, Boris. The local regulator does not have a minimum of tier 1 capital. What they do have is the total capital and a minimum mix of tier 1 to tier 2, which is 50%. Obviously we don’t want to be at that level. We have our target of tier 1 to tier 2 or tier 2 to total of around 30% roughly, but no specific target for a tier 1 or tier 1 common capital ratio.

We do have an internal minimum set by the board, which is going to go up overtime from 8% to 9%. I think we’re about 8.5% today, for BCP. I am talking about BCP. With regards to your question on Credicorp consolidated capital ratio, the local regulator was defined as the consolidated regulator for Credicorp. And they do have the implemented consolidated capital requirements about three years ago, and we do comply with that, I want to report that as well and that includes all businesses, financial and non-financial businesses that we may have.

Boris Molina – Santander

So they think that it’s the same minimum and limit requirements for the [consolidators] or the bank or is there a different, because there seems to be some too big to fail and market share and all this stuff the additional capital requirements that they put. So we don’t understand if this is same as the bank or the group level and how does that regulator feel about the minimal? Is the minimal for the group is the same as the minimal for the bank?

Alvaro Correa

They are the different metrics. For the bank you have capital requirements for different purposes, as you mentioned for big-too-sale and for concentration and other types of capital requirements and they received a schedule to adopt to that to adjust to that. We have decided internally to adjust it fully by July of last year. So we’re very compliant with that.

And we do not have the same type of metrics for the consolidated Credicorp capital. There, what we have it’s an amount that has to be defined depending on the different, under the different business we are in. So it’s basically first one amount, not a ratio.

Walter Bayly

Boris, this Walter. This is extremely complicated calculation.

Boris Molina – Santander

Yeah, I can see.

Walter Bayly

For the bank it’s relatively simple, standard, worldwide capital ratios and very comparable to what you would see in other places. For the Group through they are very complicated, because they include insurance. We even have non-financial businesses, capital requirements, how do you consolidate them separately.

It’s very complex and what I would do is I would ask our Investor Relations team to give you a call and going to all the detail you want. It will be very difficult…

Boris Molina – Santander

I appreciate that.

Walter Bayly

Try to explain that here.

Boris Molina – Santander

Yeah, one question is, the local regulator has introduced some accounting changes for local listed banks in terms of something IFRS updations. Do you foresee that they would actually to comply to the local regulatory accountings standards as part of this process or review of your portion of currency change? And do you foresee that you might be willing or require to publish audited statements with notes on a quarterly basis?

Walter Bayly

We, as of this year, we had already have to comply with the new IFRS aligned reporting for local purposes; a very, very similar to international standards. So you won’t see, besides if we ever change the currency, the functional currency with beside the translation or, sorry the conversion you should not see major differences in reporting. We are not required to have quarterly audited financial statement.

Boris Molina – Santander

Okay, I guess I was making this question just because I was wondering where are the local accounting treatment of the four-walls that you’re putting your margin would be IFRS compliant on the Peruvian version.

Walter Bayly

Yeah, they’re same accounting books.

Alvaro Correa

The only major difference you see between local accounting IFRS rule and international is probably the provision itself, provisions for portfolio in which provisions under the local books are more in-line with the super-in tendencies, methodologies then with international financial reporting standards.

Boris Molina – Santander

Okay, wonderful. Thank you.

Operator

Thank you. And at this time I’m showing no further questions. This concludes the question-and-answer session of today’s call. I would now turn the call back over to Alvaro Correa, Chief Financial Officer for closing remarks.

Alvaro Correa

Okay, thank you very much everyone. Good questions. I think we have been a resource of the quarter and then we definitely hope to have a net volatile quarter and hope to hear from you soon about our company. Thank you very much.

Operator

Thank you ladies and gentlemen. This concludes today’s teleconference. Thank you for participating. You may now disconnect.

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