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Credicorp Ltd. (NYSE:BAP)

Q3 2013 Earnings Conference Call

November 8, 2013

Executives

Walter Bayly - COO

Analysts

Thiago Batista - Itau BBA

Carolina Yoshimoto - Goldman Sachs

Jose Barria - Bank of America

Saúl Martinez - JP Morgan

Amit Mehta - PIMCO

Jorge Chirino - Morgan Stanley

Boris Molina - Santander

Michael Hong - CQS

Operator

Welcome to the Second Quarter 2013 Credicorp Earnings Conference Call. My name is Lorraine, 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. Walter Bayly, Chief Operating Officer from Credicorp. Mr. Bayly, you may begin.

Walter Bayly

Thank you, Lorraine. Good morning and welcome to Credicorp's third quarter earnings results conference call for 2013. After the volatility experienced in the Sol-Dollar exchange rate in the first half of the year, this third quarter the exchange rate remains very stable, and allowed us to focus on our business, without having the significant distortions in the reporting of our US dollar denominated results.

Numbers this time, though still incorporating some FX distortions, reflect a more accurate picture of our performance, which has maintained it's dynamism, and promises to continue the good growth story, though at a more cautious pace.

As you will see along this (inaudible) we need to continue to improving the risk profile of our SME portfolio, before becoming more aggressive, and we still need to operate and deal with a dual currency system, and the implications of having a balance sheet and income generation split in both currencies.

In the effort to get this message across, we are trying to show the business growth by currency, isolating it to a reasonable extent from the performance of the currency. A difficult and not perfectly accurate task, but helpful when comparing our results in time.

However, given the minimal FX change in the third quarter, the discussion of our third quarter results is much simpler, when comparing results with the previous quarter, but still incorporate some distortions in the year-over-year comparison, which is why we continue trying to isolate the business performance from the currency performance.

All in all, we feel this was a good quarter in terms of business strengths, evolution and achievement, and our reported numbers as opposed to last quarter, help us show this. Next page please.

Reported IFRS US dollar results showed net income back in track with $183.5 million for the third quarter and $179.4 million net income attributable to Credicorp after minority interest. Both net interest income and operating income, reflect the real expansion versus the quarter, with net interest income expanding 4.1% and operating income showing a stronger improvement, an expansion of 28%, as the latter includes lower operating cost and no significant losses on market valuation of the investment portfolio as seen in the previous quarter.

Furthermore, total loans are up 5% quarter-over-quarter. Global NIM is up 32 basis points, and in the absence of volatility and resulting translation effect, net income reflects the true performance, and more than three-folds to reach the reported $183.5 million for the quarter, resulting in an 18% return on average equity, which is still not within our target range, but a significant recovery from the previous quarter.

The return on average equity did remain below the 20% threshold, since it does incorporate the high cost of risk incurred this year, reflected in the expected further deterioration of the existing delinquent portfolio, which is up another 7 basis points, resulting in a level of net provisions of 2.2% of total loans.

Cost of credit risk has marginally improved quarter-over-quarter from 2.23 to 2.19, but still remains at historically high levels. On year-over-year comparison, some distortions are still incorporated in the numbers since the third quarter 2012 income numbers, which were over 70% Soles denominated, were all calculated with significantly cheaper exchange rate, 2.59 versus 2.78 Soles per dollar. Thus, if we recalculate all at a flat exchange rate to measure real business performance, this will be stronger, reflecting the robust evolution of the business FX impact.

In fact, in an approximate calculation, loan growth year-over-year would reach 13.6%. Net interest income will show an expansion of 16.4%, revealing the better gross margins today, and operating income growth will turn positive. Net income however still shows a drop of 8.4% when including translation results.

Making a rough approximation of net income, excluding translation results, the year-over-year evolution would also show a significant [difference] performance with net income expansion of more than 12%. The importance of this approximate recalculations is only to call to your attention, once more that the business continues solid and growing strongly, and that the performance of the currency incorporated into our reported results, distorts this positive business evolution, and can be misleading.

Next page please; when looking at BCP only, loan portfolio growth is well within expectations, measuring growth in average daily balances the Soles portfolio, approximately 80% which comes from the retail business, expanded at a robust 9.1% quarter-over-quarter. While the US dollar portfolio expanded at a more moderate rate of 2.1% for the quarter. A particularity this quarter is however, a very expansion of our wholesale portfolio, more importantly our corporate portfolio, which shows a significant growth of 24.3% in local currency denominated borrowings, while US denominated lending was less strong, with an expansion of only 2.4% for the quarter.

This is the result of a shift in corporate borrowings from offshore US dollars to Soles denominated local borrowings, plus some accumulated investment activity after previous months of holding back such investments. This does show a definitely stronger preference of local currency denominated borrowings, after the volatility in the currency of the previous quarters, and the measures of the central bank to deincentivate dollar borrowings.

On the retail front, a more cautious expansion is also evident, with the Soles book growing 4.9% and the dollar staying totally flat. This expansion was led by mortgages, micro-lending and business loans, followed by consumer loans, (inaudible), and lastly, credit cards, being these last two segments, but ones that have slowed down the most, following corrections in our scoring models. Furthermore, in year-over-year terms, the Soles portfolio expanded 28% and the US dollar portfolio 6.6%, both which continue to be strong numbers.

Next page please; with regard to credit quality, we continue showing an evolution in line with an expected slight deterioration, resulted from a learning curve, and feel fairly confident about the correction introduced in the new adjusted scoring models. In fact, as explained last quarter, and similar to the evolution of the credit card business, which is currently performing well within expectations in all new vintages after adjustments were introduced.

The low segments of SME experienced deviations, that have led to delinquencies in the previous and last quarters, and as anticipated, to a further increase in delinquencies to 8.03 for this portfolio in the third quarter. This is in line with expectations, and has caused the overall past due loans ratio to increase 9 basis points, and situate at 2.25% this third quarter for all delinquencies, but only increased 7 basis points, to a very still low 1.52% past due loans for over 90 day delinquencies.

Nevertheless, it is encouraging that the SME segment has stabilized in provision requirements and would expect this needs to drop down the first quarter of the next year. As the adjustments made are showing improved performance in the new post adjustment vintages. In this context, and as mentioned before, provisions were flat for the quarter, and cost of risk has marginally improved from 2.23% to 2.19% of total notes.

Page six please; given the sound growth in volumes of loans outstanding throughout the quarter, net interest income expanded also 4.9%. This number results from good expansion of interest on loans, helped by lower interest expense, and a shift towards solid denominated lending, released US dollar liquidity, to reduce more expenses, US dollar funding, expensive when calculated including strict reserve requirements.

In fact, net interest margins for loans improved 16 basis points to 8.35%, as a result of good expansion in outstanding balances and important price corrections introduced this last quarter. Furthermore, a significant 35 basis points increase in global NIM was reported for the quarter, as a result of redirecting funds from investments and securities available for sale to the loan book, as the latter grew 5% quarter-over-quarter, while total interest earning assets grew only 1% for the same period, leading to average interest earning assets to drop 2.2% quarter-over-quarter. This led the NIM on total average interest earning assets to increase to 5.27% in the third quarter this year.

Non-financial income expanded again almost 10%, despite flat fee income and slightly lower gains in FX transactions, mainly due to the absence of losses in the securities portfolio, included in the other non-financial income bucket. However, also the absence of gains in the security portfolio in that same bucket explains the year-over-year 5% drop.

Operating expenses dropped 8% in the quarter. In the absence of one-off expenses related to the investments in Correval Colombia recorded in the second quarter, and also as a result of some immediate costs, controls from administrative expense and lower personnel costs, as we took advantage of the normal rotation of personnel to reduce headcount. This increased cost control, it's also evident in the very modest year-over-year growth of 2.6%. Furthermore, the reported growth in expense is also intensified by the solid depreciation from the previous quarter.

Page 7 please; in this third quarter, Bolivia reported net income of $4 million, which represents a 3.2% decline quarter-over-quarter. This was attributable to, one, growth in net provisions for loan losses, which doubled due to the expansion of loan portfolio which hit the $1 billion at the end of September, this is a record high; and two, an increase in operating expenses, which was due to the fact, that extraordinary provisions were set aside for tax contingencies.

The aforementioned increases were accelerated by growth in non-financial income, as investments in Peruvian mutual funds recovered. This results led to a return on equity of 12.4%. Edyficar on the other hand reported net income of $12.5 million, more than double the second quarter income. This significant increase is associated to a large extent, with a decrease in the translation loss, which was only $0.7 million this quarter, versus a $11.4 million in the previous quarter.

Nevertheless, operating income fell 15.4% this third quarter, due to a 7.9% drop in net interest income, which was in turn attributable to the strong competition in the microfinance sector. In annual terms, operating income grew 77% due to strong net interest income expansion associated resulting from increase in portfolio volume of 30%. This annual expansion was accompanied by good risk management, we have maintained a stable calculation at 4.03. These results led to a return on equity of 30% in the third quarter 2013.

Next page please; the Pacifico Insurance Group posted a significant recovery in net income, reaching $18.2 million in the third quarter. This result was primarily due to one, an improvement in the underwriting results of the property and casualty, and health businesses, due to an increase in the premium turnover, and a decrease in gains, has led to total underwriting results 22% higher for the quarter; and higher financial income at Pacifico, due to better performing investments, but mainly, to important gains of about $7 million on real estate sales.

In addition, the company's translation results was significantly smaller this third quarter, at $235,000, which contrasts favorably with the loss of $6.4 million posted in the second quarter of 2013. These results allow Pacifico to contribute $18.5 million to Credicorp this quarter.

An analysis of the results of each of the businesses reveal some improvements. Pacífico-Peruano Suiza earnings totaled $7.6 million, mainly due to an increase in financial income, plus improvement in underwriting results, and a positive translation. Pacifico Vida reported $13.8 million in earnings, very little variation, to an increase in premium income and a positive translation result; and the health business shows a slight improvement in it's underwriting results, which added to better technical results in the medical services, led to consolidated earnings of $0.4 million. Medical services showed this quarter high occupancy rates at the network clinics, and an increase in the average billing per patient to more complex medical services.

Page 9 please; Atlantic Security Bank reported net income of $9.8 million in this third quarter, which represent a decline of 27% quarter-over-quarter from $13.4 million the previous quarter. This is also reflected in a drop in return on average equity from 30% to 22% this last quarter. This drop is mainly a result of lower gains on of securities, since the previous quarter, significant gains in the liquidation of a fund were realized, and resulted in a $4.1 million higher gains on securities. Nevertheless, the uncertain market conditions was reflected in a pretty flat level of assets under management of $5.1 billion.

Despite this juncture, Atlantic's contribution to Credicorp in accumulated terms was $38.7 million at the end of September, which tops the figure reported the previous year by 11.6%.

Page 10 please; Prima reported very good performance and a further increase in fee income to $34 million versus $33 million the previous quarter. Nevertheless, net income reached $12.5 million at the end of the third quarter, a figure which is 12% below the second quarter's level. The quarter-over-quarter net income drop is due to the fact that a translation gain of $1.3 million was registered in the second quarter, versus a translation loss of $67,000 at the end of this quarter, and the income tax this quarter was also $0.7 million less than this quarter's figure.

Nevertheless, in cumulative terms, at the end of September, net earnings totaled $38.5 million, which represent a growth of 28%, which (inaudible) of same period but by arrear. Year-over-year it represents a solid 32.7% increase in earnings. This expansion was due primarily to an increase in fee income, which coincides with expansion in the client portfolio, more than 200,000 affiliates during the assignment period.

In this scenario, Prima ASB's portfolio under management total $11.1 billion at the end of September 2013, 3.9% increase over the quarter, which represents 31.5% of the total system's funds under management. These results led to a return on average equity of 31.7% at the end of the third quarter.

Page 11; this chart summarizes the results of the Group, at the sum of different subsidiaries and businesses. It is evident that the performance of (inaudible) is back at more normal levels. However, the year-over-year comparison does incorporate some distortions as mentioned before, so just let me remind you, that if we are able to isolate business, [encouraging] performance, those year-over-year numbers would look much better.

Nevertheless, it is also evident that one, BCP is heavy to digest the higher cost of risk, but has significant potential to improve results, precisely with better risk management and search for efficiencies.

Pacifico still needs to improve it's underwriting business and complete the health service project to reach the committed returns, and thirdly the BCP Capital is still to deliver results, to capture the synergies expected and grow potential in a growing business segment. All in all, we believe potential for growth and better return on equities in the future is significant.

With these comments, I would like to open the call for the Q&A session. 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 Itau BBA. Please go ahead.

Thiago Batista - Itau BBA

Hi guys, thanks for the opportunity. I have basically two questions. The first one, is about the efficiency project. I know that the plan has not completed yet, but could you share with us some of your initial view, the potential of this plan, and also the targets of this plan? And my second question is about asset quality, especially in the SME segment. We saw that the segment, it is still posting (inaudible) duration, but at least at a solid pace than the previous quarters. Is it possible to say that the new vintages of this portfolio have better asset quality, and also when do you believe the (inaudible) portfolio will be?

Walter Bayly

Okay Thiago, thank you very much. Let me attack on the second question first regarding asset quality and the SME portfolio. The answer is clearly yes, we are seeing the new vintages at a much better quality level and delinquencies. Clearly, the new loans that are being generated, are clearly of a much better quality. As to when we think we will finalize digesting this, as I mentioned in the call, well into the first quarter. I clearly expect this last quarter, the digesting process will continue, and it will spill over into the first quarter next year.

Regarding the efficiency, we are still at the very initial stages of doing a very thorough and complex and complete review of all of our different processes, and the projects that involve putting the efficiency target very high up in our agenda. We expect to be launching the project internally, during the month of December. I want to be very cautious in terms of committing to a specific number, so I will just mention may be a very longer term number. The target that we are setting for ourselves is kind of two-fold; one is, that we think we can extract probably $100 million in savings in the year four, and second, we are aiming for a low 40s efficiency ratio, this is a three-four year timeframe. I am reluctant to commit to a shorter term numbers or guidelines at this stage. We are still at -- we have not yet fully launched the project internally.

Thiago Batista - Itau BBA

Okay. That's it for me.

Walter Bayly

Thank you.

Operator

Thank you. And our next question comes from Carolina Yoshimoto from Goldman Sachs. Please go ahead.

Carolina Yoshimoto - Goldman Sachs

Hi. Good morning. Congratulations for the results. My question is, first of all, on the admin expenses, it looks like this quarter was lower and it wasn't related to the efficiency ratio you've put in place. So there was some inflation, and therefore, you had some lower provision for profit sharing. I was wondering if you could explore a little bit of what that means, and if this is going to happen again, it's sustainable or not? And also, I know that the focus on inflation is associated with a lower loan growth going forward, but growth wasn't too strong in the quarter. I was wondering if you could also provide some more color, on how you see that going forward in 2013 and 2014? Thank you.

Walter Bayly

Sure. Okay. Thank you, Carolina. Regarding the administrative expenses, it is important to note that the currency depreciation had some negative impacts but also had some positive impacts. If you look at BCP by itself, which is clearly the bulk of Credicorp, and you look at general administrative expenses, quarter-over-quarter, are actually flat. If you look at depreciation and amortization, it's about 2% above. So there are some increases, which have been offset by the devaluation. Because yes, we have not had devaluation end of quarter over end of quarter, but the average devaluation has been about 4% for the quarter. So that has helped the administrative expenses.

There is only one important decrease in the other line, which frankly I don't have the answer, I am just looking at it right now, it's really to lower marketing expenses. So it's probably a one-off kind of situation. So yes, in dollar terms, we show lower administrative expenses, that is not the case in local currency. We have not yet initiated our efficiency drive, we are obviously being, as usual, very careful with cost increases, particularly now, but I cannot attribute the dollar decrease in administrative expenses to management, it's more related unfortunately to the FX impact.

Carolina Yoshimoto - Goldman Sachs

Okay. Thank you. And about the loan growth outlook that you are seeing?

Walter Bayly

Sure. There are lot of different and contradicting signals in the market, and actually, the central bank yesterday announced a quite surprising, or it caught all the analysts by surprise, a reduction in our reference rate, and there are two readings we can obtain from that. One is that, we obviously feel comfortable with the inflation, and that is clearly a forward-looking view, because we are, as of today, not yet within the targets set by the Central Bank. So it means that, going forward, the Central Bank expects inflation to rather quickly, forwarding the target, and rather quickly, I would imagine, [SG&A] has to be less than six months, probably around three months.

But the other reading into this, is that they feel that the economy needs some stimulus. So what I am -- going back to answering the question, we have seen a lot of contradicting signals. We see growth in the electricity consumption, very important growth, but again, a slowdown in the sales of [cement] sales. So there are portions in the portfolio that are growing, we have mentioned the corporate portfolio has grown a lot. But again, possibly -- a portion of that can be attributed to a desire of the borrowers to borrow in local currency rather than in dollars, so they have been borrowing local currency through the domestic banks, obviously ourselves, and paying dollar loans with ourselves, and a lot with non-domiciled banks. So we have also seen some growth in medium term lending, related to projects, but also projects that were initiated three, six, or maybe a year ago.

On the retail side, we have seen some dynamics clearly less aggressive than we have seen in the past. But there is also the fact that ourselves, we are being more cautious and we have raised our lending standards. So there are a lot of contradictory readings of what the macroeconomic scenarios is going to be going forward. We are seeing some mixed signals. But if I were to boil them down into numbers, I would say that I expect the portfolio of the banks, of the banking system and ourselves to grow at a rate of about 15% year-over-year, and that will be the average of may be 18%, 19% on the retail side, and 12%, 13% on the corporate side. Clearly a very strong bias of growth to our local currency lending rather than dollars.

Sorry that was a long answer to a short question.

Carolina Yoshimoto - Goldman Sachs

But that was clear. Thank you very much for that.

Walter Bayly

You're welcome.

Operator

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

Jose Barria - Bank of America

Hi Walter, good morning. Thank you for your remarks. Most of my questions have been answered already, just to follow-up on your previous comments. Given what we are seeing in terms of Central Bank movements and reserve requirements, and now lowering rates, what do you think the impact on them will be for 2014?

Walter Bayly

Well, still, our base case scenario continues to be that next year, growth will be any where between 5.4% and 5.8%, very difficult to pinpoint a specific number more than that; and we continue to have the base case scenario, where the growth in the portfolio will be, as we mentioned before. If anything, this adds a little to -- a little bit more growth potential into the economy, but again the flipside of that is, what is the Central Bank seeing that prompted them to make this move. So I still don't have enough elements to change our base scenario, but we will keep you posted.

Jose Barria - Bank of America

Sure. I think my question was more on how you see NIM evolving, given all these changes, and also the fact that the commercial portfolio or the local denominated, currency portfolio is growing at a faster pace. Just what are your thoughts and where do you see NIM evolving too?

Walter Bayly

Sure. Sorry, I didn't understand the part of NIM. Yes on NIM, what we have been doing rather aggressively in the past quarter, is we are doing all our pricing into retail products, mortgages, credit cards, SME lending, etcetera, and we have improved our margins in each and every of those businesses.

A part of that increase in margins was also to compensate some fee reduction. We have gone through a simplification and elimination of our fee structure, this is in coordination with the regulators and with the whole industry. So a portion of that increase in the margin was related to compensate for lower fee income. But we have gone a little bit further than that, just to compensate fee income, but to cover for increased risk costs.

Frankly, I think we might have been a little bit too aggressive. We have seen two specific niches, where we have lost some market share. So we will be very cautious in improving or trying to continuously improve our pricing. I would expect NIM to be flat.

Jose Barria - Bank of America

Thank you very much.

Walter Bayly

You're welcome.

Operator

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

Saúl Martinez - JP Morgan

Hi. Good morning everybody. I have a couple of questions. First, I'd like to understand the fee evolution a little bit better Walter. You've mentioned that you simplified some pricing and maybe, that had a little bit of an impact on your fees. But it seems like there were a lot of moving parts in the numbers, especially at the consolidated level, they fell sequentially. The question is more on the sequential evolution, it fell sequentially, but in local currency terms, you actually have nice growth in BCP alone, if I were to look at local currency numbers, it was good growth.

Can you just tell, how much of the impact this quarter was from the exchange rate, a lower average exchange rate, how much of it was from weak results or slow results at non-banking businesses, Credicorp Capital, you mentioned Pacifico. The underlying just to the question I suppose is, how confident you are that your fee generation capabilities will remain robust, and that you can grow fees on average in the double digit range. So it's a broad question I guess, on -- a multi-question I guess on fees.

Second thing is asset quality, more simply, how confident are you that your cost of risk will stabilize in the coming quarters, and when do you foresee that happening?

Walter Bayly

Thank you, Saúl, good questions. One regarding fee income. Specifically for the quarter, the three elements that you mentioned are accurate; one, is your look at the local currency at the bank level local currency, there is a good growth. That, again translated into dollars, because the average exchange rate for the quarter was not flat, translated into dollars, that is basically a flat result in fee income for the bank.

Second at Pacifico, we had more of an accounting issue, which is that fees paid were recorded as an expense and are now recorded as less fees. So we show kind of a net fee kind of structure. So that's the second impact, which is about $4 million, and the third element is that yes, the investment bank grew particularly in our Chilean operation, fees were quite low. They were $2.7 million lower in the quarter. So specifically, the three impacts that you mentioned are the ones that explain the relatively poor result when expressed in dollar terms.

Now to give you more color on what we see going forward; particularly at the bank level, it is very clear that we will not have any increase in fees other than related to growth in the number of transactions or usage of products. That is our fee structure will basically remain as it is today, we will not be increasing any fees or clearing any fees.

Looking forward, I would say that the growth in fee incomes for the bank as a whole in local currency is in the low teens, that is what we see going forward. 10, 11, 12, somewhere around those numbers.

Saúl Martinez - JP Morgan

It's still true at that consolidated level, which represents maybe a quarter of your fees, is there any difference in terms of what the expectations would be?

Walter Bayly

Sure. What I was mentioning was that, that number in the low teens is what we see at the bank level in local currency. I would expect the investment bank to grow, hopefully a little bit better, they should have some fee growth, though still subdued. So I would say that, at Credicorp level, I will say that the fees will be -- if at the bank level, we would see 12%, 13%, at the consolidated level that's probably 10%.

Saúl Martinez - JP Morgan

Okay. And cost of risk?

Walter Bayly

Cost of risk, yeah sorry. Relating cost of risk, as I mentioned in my comments and in the previous question, we have clearly still not fully digested the deterioration of our SME portfolio. We clearly will see that live with us throughout this last quarter, and well into the first quarter, that's where we expect the full digestion of the SME. Going forward, yes, we will be living with a higher cost of risk because our portfolio is shifting. But we should be focusing our -- [what] percentage of the margin will be dedicated to risk. What we expect going forward, particularly for next year, is that the growth in margin will be higher than the growth in provisions.

Our portfolio [shifts] more into retail, more into SME, more into consumer. Clearly the cost of risk to total assets will increase. So the more relevant measure in my mind, is what percentage of our margin is dedicated to cover risk.

Saúl Martinez - JP Morgan

Okay so another -- go ahead, sorry.

Walter Bayly

Going forward, what we expect next year is net interest income to grow at a much faster pace with the increase in provisions.

Saúl Martinez - JP Morgan

Okay. So you think NII grows faster than your loan, but faster than the 15% loan loss provision, it may grow a little faster than the 15%, but NII still grows faster than loan loss provisions essentially?

Walter Bayly

Yes. I would say that our portfolio growth of 15% next year, the NIM should grow close to 20.

Saúl Martinez - JP Morgan

Okay great. That's very helpful. Thank you.

Walter Bayly

You're welcome.

Operator

Thank you. And our next question comes from Amit Mehta from PIMCO. Please go ahead.

Amit Mehta - PIMCO

Hi. Afternoon guys. I think quite a few of my questions are answered, so I mean, I just wanted to confirm, as you said, the net interest margin should expand, even with the backdrop of this rate cut going forward for next year. And then just to elaborate, in terms of your asset quality trends, we had a second -- I mean, we have had two episodes with the company now, you've expanded into the consumer credit and kind of showed some growing pains there and retracted from some segments, and in SME you kind of went lower down the curve, and have shown some pain there. I am just wondering, where else are you expanding into new territories of your credit book right now, that we could see some growing pains going forward into next year, essentially?

Walter Bayly

Good question. Well I think we made all the mistakes we can. There are no new segments that we can go, and we are all over the place, and yes, clearly, the last two segments in which we had been very focused, inclined to increase market share, were particularly consumer and microfinance. Those were the only two segments of the financial system in this country, in which our market share was below the 30%, which we aim to have in every product segment and those were two segments, which continue to be particularly attractive, not only because we can aspire to increase our market share, but also because they were the higher segment margins, and the segments with high growth potential.

So clearly, we have to focus on those, and yet, there is a learning curve, and yes better cost of going through that learning curve, and fortunately the costs have been relatively manageable, quite manageable I would say, and they have happened after four years of extremely extensive growth. So yes, once can only, always do things better, but putting into perspective into three, four years, very aggressive expansion of almost 25%, 30% per annum growth in this segment, I would say that the pace has been relatively manageable.

So going forward, yes we will continue to be focusing on those segments that have still room to grow. Our overall NIM, I would expect -- as I mentioned before, maybe slightly growing, I want to be conservative and think that they will remain relatively flat; because yes, they are two forces playing at the same time, while there is a portfolio shift which allows for the NIM supposedly to grow, there is also a very intense competition. So I do not eliminate the fact that, I don't want to -- not because of the fact the competition might force us to tighten our margins. So trying to be cautious looking forward, NIM should remain flat, as growth in margins should be healthy.

Amit Mehta - PIMCO

Sorry, last quick question to follow-up, maybe I didn't quite clearly hear your costs target that you elaborated too, but maybe I heard $100 million cost cut on the (inaudible) of the bank, which I think if I am correct, so if you mentioned a 40% target, cost income efficiency ratio, and just so that I understand, is 48% right now. Am I using the right benchmarks which you are targeting?

Walter Bayly

To put it in some perspective, we are talking about year four. We want to go into the low 40s, and that can probably be at least $100 million of savings. But that is going to take us a while and [something] in the process, don't put it into your projection for next year please.

Amit Mehta - PIMCO

No, no sure. But that would represent somewhere around 7%, 8% of the current cost base in that business?

Walter Bayly

Yes. It's an ambitious target.

Amit Mehta - PIMCO

Okay. Thank you very much.

Walter Bayly

Thank you.

Operator

Thank you. And our next question comes from Jorge Chirino from Morgan Stanley. Please go ahead.

Jorge Chirino - Morgan Stanley

All my questions have been answered. Thank you.

Operator

Thank you. And our next question comes from Carlos Gomez Lopez from HSBC. Please go ahead. Carlos Lopez Gomez your line is open. We will go on to the next question from (inaudible) from [Compass]. Please go ahead.

Unidentified Analyst

Yes. Regarding SME segment quality, you mentioned you are going to improve standards of lending and so on, and that's going to improve quality. How much of improvement should we expect, considering that credit in that segment should grow less than one we have seen in the past? I imagine some of the effect on quality, has come from the fact that the loan book is growing less than what we had seen it going before? So in order to get a sense of what's the natural level of quality for this segment, not growing at 20% but growing at 15% or 10%. I imagine, some of the effect comes from the matureness of the portfolio?

Walter Bayly

Yes, you're right. Clearly, some of the deterioration in the ratio comes because the numerator is growing at a lower pace, clearly that's an accurate comment. But let me try to give you a little color what's happening in the market. We have been growing quite aggressively. We have been the financial institution that has been posting aggressively and gaining market share in this segment in the past three years. We have gained about 500 basis points in market share. We have been the institution that has been pushing margins, [because] creating this intense competition. We think that there is still some room for us to continue growing in terms of market share, and we are revisiting both our risk management techniques, upgrading those, and we are also reviewing our commercial processes.

While this adjustment is taking place, clearly the market is growing a little bit slower, the competition is there, and there are certain segments where we can find over-leverage. So we have to be very cautious going forward. The color I can give you is that, we think that there is still room to grow, that we will continue to -- that the new vintages of loans that we are generating are very well within the returns, the modeling, and the expected returns that we would like, and that we have to continue digesting what is already in our books, and that will take us well within the first quarter next year.

Against growth, we will (inaudible) what we had in the past, in the past that segment was growing at rates of 25%, 30%, that growth going forward will probably be closer to the 15%, 18%.

Unidentified Analyst

Thank you. And can I just make another question, regarding deposits of de-dollarization that's ongoing in the country, given that you are also changing the loan mix, do you think that de-dollarization in your loan book would be even more than what we are seeing for the country overall and given that that may be true, do you think that's going to create pressure in funding costs, considering that we will have to have more local currency funding than dollar funding?

Walter Bayly

Great. It's actually the opposite, our portfolio is, even thought it is dedollarizing compared to our other banks domestically, we are the ones with the largest dollar portion, with a high dollarization of our portfolio, and that is because we have a very strong market share in the top corporates, and those are the ones that borrow in dollars.

The mortgages, 80% or 90% of the new mortgages which are disbursed every month are in local currency, all SME lending issue local currency, all consumer finance issue local currency. So we only have dollar borrowings in the corporates and in the middle markets, and that is where our market share is closer to the 45%. Thus our portfolio is more dollarized than that of our competitors.

Yes, all in all, as the portfolios of everybody start growing more aggressively in local currency, there should be some pressure going forward in terms of funding costs. We have not seen it so far, fortunately, if there is pressure on funding costs, that would be a competitive advantage for us, and that our competitive advantage in terms of funding is having this very stable, low cost funding base, which has not been a competitive advantage in the past three-four years, as we have lived with very low interest rates, and excess liquidity. But if there is a shortage, our competitive advantage would start to show.

Unidentified Analyst

Thank you.

Walter Bayly

You're welcome.

Operator

Thank you. Our next question comes from Boris Molina from Santander. Please go ahead.

Boris Molina - Santander

Yes good morning, thanks for taking my questions. I wanted to pick your brains a little bit over how could we think about the three kind of moving parts of your plan in terms of a network of branch expansion and this idea that may be you have to scale down, may be to meet your expansion plans in terms of distribution channels, versus the fact that the economy is still growing, would like to be healthy around 4.5%, 5%, plus the need to invest in IT, and your cost cutting plan, which I would say, requires or has a (inaudible) that you develop new software to support streamlined operations. So maybe if you can talk about these three factors of how this is going to translate into a cost growth, we have seen the growth decelerating in the bank, and we are pretty impressed about it. But we don't know if this is something that is more of a one-off or should we expect cost growth to still grow close to 15%, 20% next year, or is it something that is going to decelerate to lower teens, as your investment -- we have seen already has the increase in expenses, and we don't know if there is more to come?

Walter Bayly

Sure. Thank you, Boris. Not easy questions. Branch expansion, we are probably looking into 50 or less branches for next year, as opposed to the 100 that we were looking at two years ago. This is a consequence of a couple of things, one is, less growth in the economy. Second, we have been quite successful in taking number of transactions out of the teller, the physical teller. The physical teller now only represents about 13% of all the transactions that we do. Actually the Agente, let's say now, more transactions are done via that channel than by the teller at the branch.

So the second element is not only less growth in the economy, but we have been successful in having moved our transactions out of the branch, that we need less branches.

Branches in the future are becoming necessary more as a point of sale, than as a point of transaction. Thus it is slightly a different type of branch, locations of them are slightly different, and we are testing a lot of different models. But I would say, that the two drivers that will allow us to open less branches, are the ones that I have mentioned. Less growth in the economy, and successful transferring of transactions out of the branch.

In terms of systems, our big driver and effort here is through outsourcing. We have been quite successful in the first two steps that we have taken, and the overall concept is that, we want to make sure that one, costs in terms of systems, become valuable costs, and second, try to get some economies of scale. This is not easy, this takes a lot of discipline and a lot of time to actually materialize, but we think we are on the right track. So I would not expect substantial savings in cost of systems, what we can aspire, is that those costs will be comparable, and second over time, the cost of systems overall, as compared to net interest income, hopefully will be able to capture some economies of scale, and thus become a smaller percentage.

In terms of investments, we will continue to invest clearly. We have to do investments to capture the growth. Hopefully, those investments will be less in infrastructure, and more in efficiency of sales, and extensive utilization of data to be more focused on reaching the customers. The efficiency, you can -- even though initially it might sound contradictory, you can grow and capture efficiencies. There are a lot of models that we have visited around the world, and there are some financial institutions that have been successful doing this, this is not a thing you do overnight, this is a process that will take us two or three years to get our processes online, our incentives, and this will be coming at the top of our agenda.

We are confident that once this institution focuses on an objective, figures the right way to go about it, and go about it in a disciplined fashion, aligning all the incentives, we over time are quite disciplined and will get there. So yes, I think we can grow and capture efficiencies and invest and walk into them at the same time. We think we can do it.

Boris Molina - Santander

And in developing a (inaudible) towards loan growth, do you think that it's going to accelerate or sustain around mid-teens or low teens in next year?

Walter Bayly

Low growth, as I mentioned, probably around the (inaudible). Cost growth. I don't have a good number for that. Cost growth for next year, what I would like is that our efficiency ratio comes down by 1%, that's a nice target for next year. So whatever number would close this year's cost to income ratio, lower it by 1%, and that will be our target.

Boris Molina - Santander

Wonderful. Thank you.

Walter Bayly

Welcome.

Operator

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

Jose Barria - Bank of America

Hi Walter. Just one follow-up question, putting all the thoughts together, would you enter to give us your thoughts on when you think the bank or the Group will return to a 20% ROE -- you grow on your way there, and by when do you think that could be achieved? Thank you.

Walter Bayly

With a little luck, by next quarter. With a little luck. With a good end of year quarter -- end of year business activity, we should do it -- we could do it by next quarter, I feel a lot more confident that the first quarter or second quarter next year -- the first half of next year we will be there. But hopefully, end of quarter.

Jose Barria - Bank of America

Okay. Thank you.

Walter Bayly

Welcome.

Operator

Thank you. And our next question comes from Michael Hong from CQS. Please go ahead.

Michael Hong - CQS

Good morning. More of a macro question from my side. There seems to be more approval of mining projects and infrastructure efforts going on in the improve -- I was just wondering if you are seeing the government being more supportive to the mining community and be more active on the infrastructure side, and is that leading to more activity, maybe on the lending side for you guys? Thank you.

Walter Bayly

Sure, thank you Michael. Yes on both sides. One is that, clearly the government is also worried about the slowdown in the Peruvian economy, due to world and domestic circumstances, and yes, once they realize that the economy has slowed down, they are redoubling their efforts, in trying to promote investment. And as you will know, investment in this country is private sector investment, it's not public sector investment. So yes, they have redoubled their efforts to support all types of private investments.

With regard to infrastructure, a good number of fairly large projects that are going to be implemented -- launched in the next couple of months. But these are long term projects we are talking about, for instance, the airport in Cusco, the new airport. That's a big project. But you know, building an airport is a three-four year project. The subway system in Lima, a lot of infrastructure improvements in the city. So yes the projects, the governments, very aggressively trying to push those projects, but unfortunately those are projects that do not happen overnight.

As regards to the mining, I have a sensation that the tide is turning, that the anti-mining movement, or whatever you want to call it, type of sentiment is clearly losing momentum, and as the economy has slowed and some of the provinces has seen couple of large projects not materializing, this movement has lost sheen, and I would not be surprised if a couple of projects that have been blocked or having problems going forward will materialize or start to get, 'destrozados' in the next couple of months.

So yes, the government is very active, both in the infrastructure segment sector, and while trying to promote those large mining projects that had been blocked in the past.

Michael Hong - CQS

Okay. Thank you.

Walter Bayly

Welcome.

Operator

Thank you. And our next question comes from Chris Delgado from JP Morgan. Please go ahead.

Saúl Martinez - JP Morgan

Hi, this is Saúl again. Just one very quick follow-up on your capital position. You see some slippage in your tier-1, it's greater than 9%. In the past, you've always kind of indicated that you feel capital is kind of burning a hole in your pockets, and just curious as to, how you feel about your capital position, and where do you think it's efficient, in light of your mid-teen type of loan growth outlook?

Walter Bayly

Sure. Currently, we have excess capital, both by two reasons. One is that, while we have been carrying some excess capital, which is invested, we have, as you will know, a relatively interesting and profitable investment in BCI, the Bank in Chile, which consumes a certain amount of capital, has been a profitable investment. But at the end of the day, if we were to have some important capital requirements, (inaudible) that we could dispose off. We have also had investments in EGENOR, the electric utility company. Again, that's a good investment, that's a good place to park some excess capital, but it's not core to our businesses.

So we have excess capital, well deployed within our organization. And second, this year and at the beginning of this year, we anticipated the issuance of tier-2 capital, being the rates where they were, and having current risk at the levels that we had at the beginning of the year. We anticipated a lot of our tier-2 requirements, and thus we overfunded if you will, our tier-2 requirements going forward. And what happened ever since, is that we have grown less than we had anticipated. So not only did we pre-fund it, but the projected growth was less than expected. Thus we are at a very healthy capital level at the bank as well.

So unless we find some interesting investment opportunity, clearly, what we are talking is a continued increase in the business payout.

Saúl Martinez - JP Morgan

Is there a tier-1 at which you feel comfortable? The target tier-1, below which you would be uncomfortable and maybe monetize some of the investments?

Walter Bayly

The tier-1 level that we have established at minimum is, let me recall -- the internal target that we have set minimum for Tier-1 is 8.5, reaching 9% over the next three to four years. And I think right now, we are even slightly above that. If I recall correctly, right now, 9.27. So we are even very close to where we wanted to be in a couple of years.

Saúl Martinez - JP Morgan

Okay. Thank you.

Operator

Thank you. This concludes the question and answer session of today's call. I will now turn the call back over to Walter Bayly, Chief Operating Officer of Credicorp for closing remarks. Sir, please proceed for closing remarks.

Walter Bayly

Well thank you very much for your continued interest in Credicorp, and thank you for this very active and interesting set of questions, it's always a challenge and an opportunity for me to be able to have this exchange of opinions with yourselves. We are fairly confident that after a couple of quarters, with a lot of volatility, we are bringing our results back into track. This is not something that you do in a month's time, but it will take us probably two quarters. We have a lot of open issues that we are aggressively focused on. We want to take the insurance, the property and casualty insurance to a level that we feel comfortable. We have made investments in the health services side, that are still not giving us the returns. We are focused on capturing the synergies of our investments done in our investment bank, and we will be focusing aggressively within the bank, at improving our risk management capabilities and focusing on efficiency.

So we have got a lot of open issues, a lot of work to do, but again, we are seeing a lot of potential of growth in the economy. The economy continues to be very healthy, with very interesting levels of growth, both for the economy and for the financial systems. So we continue to see a very bright future ahead of us. Again, I want to thank you all for your participation and very active Q&A session, and hope to be with you at the end of next quarter. Thank you very much and goodbye.

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