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Banco de Chile (NYSE:BCH)

Q2 2013 Earnings Call

August 8, 2013 12:00 PM ET

Executives

Pablo Mejia – Head, IR

Pedro Samhan – CFO

Analysts

Tito Labarta – Deutsche Bank

Thiago Batista – Itaú BBA

Jose Barria – Bank of America

Saul Martinez – JP Morgan

Boris Molina – Santander

Operator

Good morning. And welcome to Banco de Chile’s Second Quarter 2013 Results Conference Call. If you need a copy of the press release issued yesterday, it is available on the company’s website at www.bancochile.com today with us we have Mr. Pedro Samhan, Chief Financial Officer and Mr. Pablo Mejia, Investor Relations Manager. Before we begin, I would like to remind you that this call is being recorded and information discussed today may include forward-looking statements regarding the company’s financial and operating performance. All projections are subject to risks and uncertainties and actual results may differ materially. Please refer to the detailed notes in the company’s press release regarding the forward-looking statements.

I will now turn the call over to Mr. Pablo Mejia. Please go ahead, sir.

Pablo Mejia

Good afternoon. It’s a pleasure for me to share with you our comments on Banco de Chile’s second quarter 2013 financial results. Again as a reminder, our link to the slide presentation is available on the website, at www.bancochile.com under Investor Relations.

To begin, please turn to Slide number 2. During this conference discuss the environment, the results of the banking industry, Banco de Chile’s results during the quarter and we’ll end the call with the peer comparison.

Please turn to Slide number 3, which contains an overview of the recent developments in the macroeconomic environment. After three years of strong growth of around 6% per year, the Chilean economy has showed signs of deceleration in the activity during the first semester of this year posting a GDP of about 4% year-on-year. This downward trend has been widely expected by the market due to a slowdown that has been seen in the emerging economies a weak recovery in developed nations and local aggregate finance that has level off to a more sustainable long-term rate. This decrease in economic activity as in mainly due to our contraction that is referenced boosted among other practice by a drop in corporate confidence due to lower commodity prices, higher operational costs and more cautious outlook regarding the social and political scenario.

Private consumption has also decelerated but more gradually in line with persistent positive fundamentals for the Chilean pesos. As a result, the outlook for GDP growth for 2013 decreased from 5% in March and 4.4% according to the lend estimate. Despite the reduction, this figure implies an improvement in GDP during the coming quarters. The more optimistic view for the rest of the year is based on the persistent lower employment rate which maintains a positive consumer confidence relatively stretchable industries in the banking sector, and the products – from our more optimistic outlook in developed economy.

Regarding inflation, at the end of the quarter CPI we gained an upward trend posted a 12-month increase of 1.9% in June 2013 approaching the Central Bank target range and more in line with historical range. In fact, the most recent forecast adjusted CPI variation make out 2.4% at the end of the year according to the last expectations serving the Central Bank.

As for the monetary policy, the Central Bank has kept the policy rate at 5% since January 2012 due to a solid performance in the economy and that anchored inflation in the expectation. However, we mentioned to you that the current deceleration in the activity has increased the probability for a downward adjustments in the policy rate. In the coming months an option that was confirmed by the Central Bank in its last monetary policy meeting where they pointed out the further deterioration in the GDP growth will require more expansionary monetary policy.

Please turn to Slide number 4, to review the Chilean banking industry’s main figures. In terms of total loans volatility continues. After a moderate increase of 1.5% in the first quarter of 2013, total loans grew 3.2% during the second quarter despite a less semester economic scenario. However, on a yearly basis total loans continued to slowdown from previous quarters, but still with double-digit growth rate in all major product lines reflecting the resilience of credit demand of corporations and individuals. In terms of results, net income during the second quarter recorded an increase of 6% compared to the same quarter last year mainly due to increase in operational income that more than offset the lower inflation figure, higher loan loss provisions, operational expenses and the rights of the corporate tax rate.

Consequently, the Chilean banking industry posted the current average equity of 13.9% in the second quarter 2013 which translates into 121 basis points reduction compared to 2000, the same period in 2012 due mainly the stronger capital base in the system. It’s also worth mentioning, that we’re expecting upward trend in inflation for the remainder of the year and consequently an improvement in net income for the industry.

On the next Slide number 5, is a snapshot of Banco de Chile’s main income statement figures. That can be said, operating revenues increased 8% over the same period last year and 2% over the prior quarter. On the following Slide, number 6, is a breakdown of operating revenues. Customer revenues which comprised of net interest income for loan, deposit and net fee income grew 9% over the same period last year at 3% over the first quarter. This trend continued to be driven by a corrective management of lending spreads, growth in loans especially retail loans growth in non-interest-bearing deposit and to the lesser extent higher fee-based income. All these factors has been obtained to a sound commercial strategy that has focused efforts and strengthening areas which are more profitable while maintain an adequate risk-return relationship in our growth as well.

On the other hand, non-customer revenues which are mainly composed of income from contribution we generate for managing the bank term and currency mismatches relative for the trading activities remained relatively flat over the same period last year and the prior quarter. As a result, the lower contribution from our net asset position indexed to the UF has the currency climate variation of minus 0.07% as compared to the positive variations recorded in the other periods.

Additionally, during the quarter we recorded an initial charge of Ch$8 billion related to the adoption of Counterparty Value Adjustment for our positions in derivatives. On the contrary, this charge of more than offset by the positive effect of the hedge we manage in U.S. dollars index loan loss provisions amounting to roughly Ch$5 billion, the positive one-time effect of the sale of the Master Card shares were approximately Ch$4.8 billion and other trading gains of above Ch$5 billion.

Moving on to Slide number 7, is a review of our loan portfolio by segment and the evolution of our market share. During the quarter, we continue to expand our retail book in line with our long-term business strategy, which focuses on profitable growth. in terms of our total loan book, it expanded 6% year-on-year while our retail book where we have focused our efforts, the growth expanded 12% during the same period with a focus in SMEs, mortgage and middle income consumer loans.

This focus has resulted in a gradual change in mix of our loan portfolio as our total loans granted SMEs grew well above the average of the total loan book where it created an annual expansion of 14%, reflective that makes the consistent focus on the segments. The strong growth has been achieved through a solid commercial platform, consisting of around 150 nationwide branches with specialized SME account managers, improved loyalty program and enhancement and strengthened structures in order to better align the branch managers’ target with the corporate strategy.

Also we have been very proactive in taking out the efforts of government tax guarantees for SMEs which were lower risk and representing the important portion of the show up of new loans into the bank as well as the volume we manage.

In terms of consumer loans individuals, these represent roughly 15% of the total loan portfolio and have grown at a pace of 10% year-on-year reaching the market share of 21.7%. If we break this figure down further, one can see the credit Chile which is our area for lower loans to lower income individuals has grown at a slower pace of 3% year-over-year. The lower growth in this product is mainly due to our more prudent risk measures which are in line with the less economic environment and view to the wave of regulations which were passed in the last couple of years and some are still being discussed today.

As for our traditional banking area, this area grew 12% over last year, focus in gaining customers in the middle income segment. One of our strategies has been to get customer to use our products more frequently to improve services and benefit on tax. The effect of this is that customers began to use assets at primary banking. This in turn moved to Banco de Chile’s more strategic positions and target higher quality and less risk customers through pre-approved bonus which is an important percentage of loan growth in the segment.

In terms of product mix, we have significantly increased credit card loans by 17% year-over-year and to a lesser degree a solid consumer loans by 12% year-over-year. In terms of mortgage loans we continue to show attractive growth rate of 13% year-on-year reaching our market share of 17.4%. In recent months, this product continues to grow strongly but at a slower pace strictly because we are reaching a level that is more in line with our overall market share. In addition, we’ve also adjusted pricing in order to attract a new market realities and have increased the customer requirements in terms of loan to value. Nevertheless, we plan to continue grow in mortgage loans and this is important, and this is a great product in retaining customers and providing opportunities for cross-selling.

Overall, during the last 12 months we have increased the retail segment mix from 48% to 51% of our total loan portfolio and we will continue growing in the future given the positive outlook and consumption’s fundamental and private and public policies orientated to strengthen entrepreneurship for the creation of new SMEs.

In terms of our wholesale segments, loans have grown only 1% year-on-year, this lower pace in growth is a result of our strategy to focus our efforts on a more profitable customers which provide operating margins and higher cross-sell opportunities in our wholesale segment. As such, loans to large companies with sales between Ch$3 million and Ch$140 million have grown 13% year-on-year, while our corporate banking book which services customers of sales above Ch$140 million of sales previous decreased by 10% year-on-year.

Nevertheless, we have increased our operating margin in the corporate book almost 10 basis points when comparing the first semester of 2013 with the same period last year. Clearly demonstrating our strategy to improve profitability and avoid growing for the sake of gaining market share.

On Slide number 8, we show a breakdown of our funding structure. Similar to previous quarters, we’ve continued to increase non-interest-bearing deposits in the bank from both individuals and companies. Individual current account balances have increased 9% year-on-year while companies have increased 4%. These increases have been the driver force as in mix permitted to improve funding from non-interest-bearing deposit representing 24.2% of total funding at the end of the quarter, 22 basis points higher than the same period last year. It’s also worth mentioning, that we continued our strategy of diversifying our funding base this quarter by issuing Ch$635 million in bonds in the Swiss markets that’s historically low stress for our non-government foreign corporation.

This focus of diversification and the largest increase the proportion of funding from bonds were around 230 basis points over the last year representing about 15.9% to total funding today. As you can see, on the bottom right, we continue to lead the internship with a lowest cost for funding of only 2.9% due to a strong reputation first rate credit ratings and leading market position increase the term deposits where total market share of 24% and more importantly above 30% for individuals.

Please turn to Slide number 9. As you can see, provision expenses have grown to 8% quarter-on-quarter and 7% year-on-year. On the other hand, operating expenses have grown more moderately posted an increase of less than 1% when compared to both periods.

On the next Slide number 10, is a breakdown of loan loss provisions by segments. As can be observed on the chart on the left, retail loan loss provisions have remained relatively stable, decreasing Ch$4 billion quarter-on-quarter and increase in Ch$3 billion year-on-year. On a year-on-year growth in retail provisions is simply due to our double-digit growth rate in these loans. It’s also important to mention, that this modest increase is the result of a solid risk management practices together with credit acceptance criteria which have made us to grow at these levels while maintaining stable credit risk figures.

On the other hand, wholesale loan loss provisions to be Ch$6 billion this quarter which demonstrates our external asset quality in this portfolio. Moreover, the charge and provisions is mostly due to tax depreciation of the Chilean pesos on our provision denominated in U.S. dollars which are related to foreign currency loss. As a result, we recorded a charge of Ch$5 billion due to this effect and as mentioned earlier, the results associated with the hedge are reflected by an equal obtained amount in operating income.

As for overall credit risk indicators as shown on the table on the right, we have continued to record strong asset quality during this quarter, our reinsured loan loss provisions to average loans remained flat year-on-year despite the effective exchange rates on provisions. As stable behavior was also same on our past due loans ratio, our loans for loan losses and our coverage ratio.

Please turn to Slide number 11, for an overview of our operating expenses. As demonstrated on the chart on the right, our operating expenses have trended flat over the last five quarters, including expenses of above Ch$150 billion per quarter. This was accomplished by controlling personnel expenses closely with a strict policy as well as moderate growth in business activity which have maintained administrative expenses growth flow.

I should also mention that we are also seeing the fruits of our investment in terms of the economy to scale the return from our growth in retail, in the retail business. This has permitted us to be more productive by taking further advantage of the available capacity on our branch network, back-office procedures and sales productivity gains based on our consolidated CRM system. As a result, our cost control strategy and economies of scale have premiered us to post the best efficiency ratio among our peers during the quarter of only 43.7% substantially below 2012 figures.

Please turn to Slide number 12. the result of our excellent commercial initiative together with credit risk policies and strict cost control have permitted us to post very positive figures during the quarter despite the negative inflation which impacted figures for all banks in Chile.

The latter is especially noteworthy when we take into consideration that the second quarter of 2013 was almost 50 basis points lower in the inflation and even with that we posted our net income before tax of 18% higher than last year. It’s important to note also, our effective tax was also higher this quarter when compared to last year due to the change in the corporate tax rate were less from 18.5% to 20% and due to lower inflation in the quarter which expects taxable net income. Despite these factors we still had an excellent quarter in terms of net income after taxes which reached Ch$122 billion the quarter slightly higher quarter-on-quarter and 14% higher than the same period last year.

So with that I’ll pass the call over to Pedro Samhan who will go over the next Slide number 13.

Pedro Samhan

Thank you Pablo. The following chart summarizes our successful financial performance and business to the bank, to our team. First of all, as shown by the chart on the upper left, our net operating margin measured as operating income net of credit charge over average interest earning assets reached 5.3% at the end of the quarter well above all of our competition. This figure is even more impressive if we consider that we are the banks that still has room to continue growing in the segment which is significantly more profitable that the wholesale segment. In terms of operating sales we came for the first time in our history in line with the best cost-to-income ratio among our peers posting a figure of 43.9% for the first semester of 2013. As mentioned by Pablo earlier in this presentation the ratio has been achieved through a gradual interaction of cost control culture that aligns incentives with corporate goals as well as diverse projects and initiatives that aim to improve to growth activity in our operation and back office area.

We are very proud that we have been able to post figures that we are confident that in the midterm we continue to improve. After saw our excellent operating margins net upgrades and our total income ratio we have post a very large GAAP in our favor as compared to our competitors in both return on average equity and return on average assets as you can see in both of the chart at the border of this slide.

Taking together this indicator clearly demonstrates our capacity to effectively implement our business strategy by growing our retail portfolio increasing profitability of our wholesale segment controlling operating expense effectively and maintaining a prudent risk approach.

Now if you have any questions we would be happy to answer them.

Question-and-Answer Session

Operator

Thank you. The floor is now open for questions (Operator Instructions) The first question comes from Tito Labarta of Deutsche Bank.

Tito Labarta – Deutsche Bank

Pedro and Pablo thanks for the call. Couple of questions, just looking at your loan growth, you have seen a slowdown in the quarter. Do you expect that trend to continue or do you think loan growth can pick up after kind of the slowdown we saw? And also if you continue plan to grow more in sort of the retail segments? Also, could you give us some expectations on how you think that would impact the asset quality? Thank you.

Pedro Samhan

Thank you Tito. Well first of all we are seeing a slightly downward trend instead of along growing the financial system and our intention is continue growing as a similar part of the system but without sacrificing our risk-return equation that has been one of our clear policy during the last years. Where in some business we prefer not to gain market share because of the risk returns that we are generating we try to gain in this field.

So in conclusion we will see the system this year may be growing a little of 10% knowing our terms more or less with Banco de Chile growing at a similar trend – little slightly maybe below what means to recover some m share participation during the second half. In terms of the asset quality exactly that really in terms of the usual banking business we have not participated for example in the last in line of July there were some complaints in some banks we are in the middle of a complaint now so really we expect to recur some participation there but not sacrificing asset quality in order not to grow so much in the consumer financing industry because of that reason.

Tito Labarta – Deutsche Bank

So you think then asset quality should remain around the levels that we’re seeing today or, just want to get a color in terms of where you see NPLs trending towards?

Pedro Samhan

Well it is very similar. We are seeing a very similar trends in the last year or really with that trend that we have found in the last quarter in order to reach a number by the end of the year 1.1%, 1.16% instead of a loan loss provision vis-à-vis the total loss.

Tito Labarta – Deutsche Bank

I see, alright. Thank you very much.

Operator

Our next question comes from Thiago Batista at Itaú BBA.

Thiago Batista – Itaú BBA

Hi guys good morning thanks for the opportunity. I have one question about regulation. Could you give an update to us about the two projects that are in Congress, the first one about the cap interest rate, La tasa máxima? And the second one regarding the consolidation of the credit bureau, do you believe that those projects will be approved this year and how much asset quality of individuals could improve in the medium term with the consolidation of the credit bureau?

Pedro Samhan

Yeah well regarding the máxima interest rate is something that has been discussed in the Congress and we expect that by the end of this year by the last quarter may be the law will be passed. So the impact for this year should be minimal because of that result. In the future as you know in this implementation there is a gradual turn. At the beginning you have a more significant growth but after the value have a gradual trend so really the impact during the year during the next year would be also gradual in this trend. In terms of the other law really is something that I cannot tell you that will be obvious I will be enacted this year we are not sure about that. But probably any debt consolidation is very positive for the banking sector. So really we are looking forward to seeing this law enacted as soon as possible.

Thiago Batista – Itaú BBA

Okay. Thank you.

Pedro Samhan

You are welcome.

Operator

The next question comes from Jose Barria with Bank of America.

Jose Barria – Bank of America

Pedro and Pablo thank you for taking my question. Just a follow-up on regulation; can you just tell us what’s going on the fee income side with regulation as well and are there any other regulatory sort of issues that could be of a concern to you and as we look at the next 12 months? And second, I wanted to understand exactly where you – or what the impact of a potential cut in benchmark rates would be in terms of our NIM? We understand obviously the sensitivity to the US inflation, but there we were to – we were to see a cut in rates later this year how that would affect your NIM? Thank you.

Pedro Samhan

Thank you very much. Hold on please.

Operator

The next question comes from Saul Martinez with JP Morgan.

Saul Martinez – JP Morgan

Hi...

Jose Barria – Bank of America

Yeah, I will hold off on asking my question until you respond to the prior one.

Saul Martinez – JP Morgan

Okay, Thanks.

Pedro Samhan

To the whole instead of fee income obviously we see that the regulatory environment can affect the level of commission of the banks in general Banco de Chile in particular. However in our case because of t diversification in terms of the justification instead of different business that we have with number of legal in order to generate revenue in terms of mutual fund stockbrokerage house, insurance, etcetera. Within that we are prepared in order to try to counterbalance any impact that we will have instead of the commission reaction because of some regulatory changes.

One of them could be yes instead of considering that of the transaction in order that the customer has to say okay when you may change in terms of the commission. We will receive preliminary draft in order to the review and receive any positive that this allows to do something that in terms of closing the account of the customer you will receive an answer timely. So really in this way we think that is in the right track. But nevertheless, going to the NIM and all the impacts the commission numbers will have we will see very significant impact because of that before we have some other source of revenue instead of commission that can increase in the future that are very well we use to raise the growth of the condition of the market for example mutual fund stockbrokerage houses, et cetera in terms of UF and CPI obviously we have a very significant impact not only Banco de Chile but all the banks in the first half we see very positive list during the second half owing the inflation to a normal basis.

You’ll see today that inflation was 30 basis point as you have a UF variation of in both month above 7 or 3 basis points vis-à-vis almost zero that you have during the rest of the year. Your transition to work the average and to project an inflation for this year or a variation of UF about 2% of between 1.5% and 2% mainly the impact in the main for the rest of the year to could be between 20 and 30 basis points easily in our favorable vis-à-vis the first semester.

Saul Martinez – JP Morgan

Okay. So this is Saul. I guess I will ask my question now. Two questions, one is more macro oriented. And then I think Pablo mentioned the part of what’s dragging down investment is social, political concerns. Can you, and obviously, there is some concern about the election and the implications. Can you talk a little bit broadly about what you – what Bachelet presidency would mean in terms of policy making, the economy and how you think that would impact the banking sector more broadly? And secondly, you had a very healthy ROE of 22% more or less – 22%, 23% in the quarter, with deflation essentially over the course of the quarter. In a normalized inflation environment how do you see your ROE evolving?

Pedro Samhan

Yeah, well, let me go one by one. The first question in terms of the economy, the Chilean the fundamental of the Chilean economy within that we will maintain. You will have some different priorities depending on the new government instead of the fundamental if we market economy and really allowing the bank to do the business as we are doing today we will see a major risk. It will have some different intensity but it doesn’t mean that your business necessarily will, would suffer. However, it is very preliminary to give a final opinion we will see we are not sure today what is going to happen and you can see that in the case of the Bachelet program there have been some changes instead of the graduality and the intensity of the reforms, as you could see before that the primary election and you have seen today where some people from the center, the center political spectrum are being integrated to the team.

So really it is very preliminary but we will see instead of the fundamental of the quarterly we will not see major significant changes. In terms of the UF what happened with the return on equity because of the U.S. order inflation are not carried deposits by the insurance instead of the CPI during the first half within that impact of that easily instead of return on our reduction equity is between 3% and 4% in terms of the return. You go to a more normalized inflation scenario your return on average equity could improve in 300 or within 300 or 400 basis points or the others thinks equal.

Saul Martinez – JP Morgan

So in other words, you think under a normalized inflation environment your ROE could be 25%, 26%?

Pedro Samhan

Yes it’s very similar to within that we have had during the last year.

Saul Martinez – JP Morgan

Okay, great thank you very much.

Pedro Samhan

You’re welcome.

Operator

And the final question comes from Boris Molina with Santander.

Boris Molina – Santander

Yes thank you so much for the opportunity to ask questions. We have a question regarding your exposure to SMU. Could you please give us a detail of how much loans you have lend to this retailer, and if you have lend to FIPs or investment funds that are exposed to the equities of this company?

Pedro Samhan

Yeah well…

Pablo Mejia

One second please.

Pedro Samhan

In terms of SMU I would like not to give you very specific numbers for obvious reasons but in general terms I could say that our participation instead of market share in the country is below the participation that we have instead of the loan market. And really the other thing we are always monitoring the financial inflation of this company as well as we monitor the financial preparation of any other company especially when you have this kind of issues or this kind of problems. But really the bank is taking all the measures that are necessary in order to decide the position and also try to review the situation and finish relatively lower exposure that we have today in order to minimize any impact that we would have on our P&L because of that and we are doing that on the way.

Boris Molina – Santander

Is it possible, well you have lend to the FIPs related to this company or not, even if you don’t have any exposure?

Pedro Samhan

No we don’t have any exposure to FIP this is other a very good point that you are mentioning that I was missing.

Boris Molina – Santander

It’s okay – okay. Wonderful…

Pedro Samhan

Holding on.

Boris Molina – Santander

Excellent, thank you so much.

Pedro Samhan

You’re welcome.

Operator

This concludes the question-and-answer section. At this time I would like to turn the floor back to Banco de Chile for any closing remarks.

Pedro Samhan

Thank you. To close I would like to mention that the first semester despite the weaker economic environment and low inflation was very good for us thanks to our commercial to our commercial efforts to improve this operating margins our proven risk approach and excellent efficiency figures. As for the second semester despite the evolution of a more complex environment for the banking system we expect a stronger performance that we have already seen a pick-up in inflation, maintaining all the other things equal obviously. This together with our focus on improving profitability should allow us to post excellent result during the second half of the year. Thank you very much and we look forward to discussing our third quarter 2013 financial results.

Operator

Thank you. This concludes today’s presentation. You may disconnect your line at this time. And have a nice day.

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