Banco de Chile's Management Discusses Q3 2013 Results - Earnings Call Transcript

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Banco de Chile SA (NYSE:BCH)

Q3 2013 Earnings Conference Call

November 11, 2013 8:00 AM ET


Pablo Mejia – Head of Investor Relations

Pedro Samhan Escandar – Chief Financial Officer


Jose Barria – Bank of America

Chris A. Delgado – JPMorgan Securities LLC


Good morning everyone and welcome to Banco de Chile’s Third 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 Today with us we have Mr. Pedro Samhan, Chief Financial Officer and Mr. Pablo Mejia, Head of Investor Relations.

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

Thank you. Good afternoon. It’s a pleasure for me to share with you our comments on Banco de Chile’s third quarter 2013 financial results. As a reminder, the presentation is available – the link for the presentation is available on our website, within the Investor Relations page.

To begin, please turn to Slide number 2. Today, we’ll discuss the economic 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 the recent developments in the macroeconomic environment. During the third quarter, GDP grew similar to the average of the past two quarters expanding 4.4%, mainly boosted by positive quarter for mining production and solid trends in retail sales. On an annual basis, GDP accumulated an expansion of 4.4%, the lowest figure within the last three years. Accordingly and given the last part of the best scenario for emerging markets, expectations for 2014 GDP growth have been repeatedly revised downwards to 4.4% end of October.

In terms of internal demand, private consumption continues to grow strongly inline with a surprisingly low unemployment rate and positive but downwards evolution in real wages. However for the coming quarters, we expect a slowdown in private consumption due to a decrease in consumer confident and lower job creation. On the other hand, investor has shown a sharper deceleration due to a drop in business confidence and to postpone mining and energy projects.

In response to the down trend in economic activity, and its possible effect upon inflation and expectation, the Central Bank recently reduced the Monetary Policy Rate by 25 basis points, 4.75% after 20 months without changes. The decision surprised analysts and the market who’d expected cuts in December or even in the first quarter of 2014. For the coming quarters, we expect at least one more reductions in the Monetary Policy Rates without ruling out a broader adjustment into economic environment requirement.

Finally, as for inflation, CPI has continued to grow modestly, evolving the lowest historical patterns with some volatility posting the variation of 1.9% as of September and 2% year-on-year, adding an additional support to the Monetary Policy Rate cut. Recently, lower prices of oil has constrained in term line inflation, despite the rise of food and service prices. By the end of the year, we expect inflation to be slightly above 2%.

Please turn to Slide 4 for a review on the main figures of a Chilean banking system. Total loans for the industry grew 2.1% quarter-on-quarter, maintaining the average pace observed in previous quarters inline with a stable credit demand from companies and individuals. On a yearly basis, total loans grew 11% year-on-year aligned with a slight slowdown of the economic activity and the historical elasticity of two times the GDP growth. By product, commercial and consumer loans have gradually slowed growth to grow at low double-digit rate, while mortgage loan growth has remained stable.

We expect that the banking industry’s total loans to continue reducing its expansion in line with a less positive economic environment, growing around 9% and 7% in real terms by the end of 2013 and 2014 respectively.

As for results, the banking system’s net income totaled Ch$487 billion during the third quarter of 2013, an expansion of 16% quarter-on-quarter. The improvement in net income was largely experienced by solid performance in operating revenues associated with the larger benefits from the systems UF position as a consequence of a higher inflation recorded during the quarter and the solid trend in loan and deposit volumes. Year-to-date, net income rose 13%, entirely caused by higher operating income, more than offset large operating expenses, provisions for loan losses and income taxes.

On the next Slide number 5, is a snapshot of Banco de Chile’s main income statement figures. To begin, operating revenues increased significantly by 10% quarter-on-quarter and 26% year-on-year, both an attractive result of Ch$380 billion.

On the following Slide number 6 is a breakdown of operating revenues. As you can see on the chart, however the strong year-on-year growth of 26% was achieved by a sustainable and consistent positive trend in customer revenues due to a proactive management of lending spreads, focused growth in loans and higher non-interest bearing liabilities with average balances expanding 8.4% and 11.8% respectively. Nevertheless, non-customer income contributed to the increase in operating revenue. In fact, an important part of this quarter’s increase in operating revenues was associated with higher inflation that resulted in greater revenues from our UF net asset position due to a 1% rise in inflation during the quarter as compared to a deflation of a 0.2% in the third quarter of 2012.

To a lesser extent, operating revenues also benefited from a positive exchange rate effect on both derivative positions that hedge our exposure to allowances for loan losses denominated in U.S. dollar and expenses related to our customer loyalty programs provided through credit cards. A positive impact in operating revenues has a similar negative impact in fees and loan loss provisions.

For the fourth quarter, we expect inflation measured as the variation is in UF will be in a range close to 0.7% which is consistent with the Central Bank’s 12 months target of 3%. It is important to note that our mid-term strategic plan has allowed us to consolidate our business level based on a decent segmentation, enhanced value offerings and improved customer service quality in all of our targeted segments. This has resulted in a superior capacity to generate customer income represents more than 80% of total operating revenues and undoubtedly contributing preserve our leading position in this matter.

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, our loan book grew 11% year-on-year and 5% quarter-on-quarter. Our growth over the past 12 months has been led by the retail banking area, which is consistent with our focus and increase in the penetration in the segment through tailor-made business solutions. As a result, our retail book expanded 12% year-on-year with commercial loans and SMEs both with an increase of 14.4% year-on-year, followed by mortgage loan and traditional consumer loans growing at 13.5% and 11.1% year-on-year, lagging behind for consumer loans and through lower income individuals rising only 3% during the same period.

The lower growth in the segment has been mainly due to a more credit risk approach that we have adopted since 2012. This is in line with the less dynamic, local economy and recently adopted regulations. All of which has reduced the attractiveness of this risk return relationship for some segments of this market. This strategy has resulted in a gradual change in the mix of our loan portfolio, where today we are much more focused on the retail segments than five years ago.

The keys for reaching this goal have been related to expanding our customer base selectively, taking measures in order to increase loyalty amongst our customers and improving value offerings to maintain a sustained upward trend in capturing new customers. This together with the development of new service vendors and long-term commercial relationships, have allowed us to reduce attrition and post a 5% year-on-year increase in our customer base.

In terms of our wholesale segments, loans picked up this quarter growing 10% year-on-year and 7% quarter-on-quarter. This sharp increase quarter-on-quarter is largely explained by the acquisition of roughly Ch$430 billion in healthy corporate commercial loans from the local financial institution. Excluding this purchase, loans granted by our wholesale banking segment would have grown by 5% year-on-year and 2% quarter-on-quarter.

This moderate organic increase in commercial loans is a result of our efforts to focus on more profitable customers, which provides higher margins and cross-selling opportunities. As such loans to large companies with sales between $3 million and $140 million expanded 14% year-on-year while our corporate banking book which services customers with sales less than $140 million increased by 3% year-on-year. Nevertheless, we increased our operating margin in the corporate book by almost 20 basis points when comparing 2013 year-to-date for the same period last year, in line with our aim of growing profitably rather than gaining market share at any cost.

All-in-all, our strong growth during the quarter managed to place us first in terms of total loans for the Chilean financial industry with a market share of 19.3%, excluding foreign subsidiaries. As you can infer, the most important gains in this market share came from commercial loans, which posted an increase of almost 80 basis points quarter-on-quarter, followed by mortgage loans with an increase of 4 basis points within the same period. This rise was partially offset by a slight drop in consumer loan market share of 17 basis points quarter-on-quarter mainly due to a more stringent acceptance criteria for the retail segment, particularly to lower middle income segment.

On Slide number 8, we show a breakdown of our balance sheet structure. As most of the listeners of this call know the main assets on the Chilean bank’s balance sheet are loans. For Banco de Chile, loans represent 84% of assets while investments represent 9% of assets, as you can see on the chart on the left. This is very important because we think– because we are a bank, that is more focused on traditional banking and not trading. In terms of liability, non-interest bearing deposits continue to be on the strategic priority for us.

We ended this quarter with an exceptionally strong increase of 19% year-on-year, represents a 23% of our total liabilities in equity. If we break this figures down between individuals and companies, current account balances for individual increased 22% year-on-year reaching the market share of 32.5%, while companies have increased their balances by 17% year-on-year, obtaining a participation of 21.3%.

Accordingly, our leadership in DDA together with excellent credit ratings gives us a competitive edge against our competitors in terms of funding. As you can see on the bottom left chart, we focus on average cost of funding of 3.3% as of September 2013 substantially below our peers. It’s also worth mentioning as detailed on the table on the right that we have continued our strategy of diversifying our funding rates and improving liquidity ratios by issuing Ch$754 million in bonds in foreign markets and almost Ch$1 billion locally at very attractive rates.

In terms of our foreign bond issuances, these are generally priced in foreign currency and swapped-back to U.S. under hedge accounting. This allows us to fund our local currency portfolio without taking on any currency or interest rate risk on our balance sheet. Lastly, in terms of capital, we continue to have solid capital adequacy indicators by holding total capital to risk weighted assets of 13.2% and a Tier 1 capital over risk-weighted assets of 9.9%. It’s important to note that Tier 1 in Chile is basically tangible equity, so we don’t have any hybrid instruments in this figure.

Please turn to Slide number 9. On the next two slides we’ll review risk followed by a discussion on evolution of operating expenses. Please turn to Slide 10, a strong deeply risk culture is a core aspect of our efforts to manage risk at Banco de Chile. Accordingly, we maintain solid and prudent policy and continuously monitor risk factors that can impair our loan portfolio. The strict policies also ensure that our credit exposure are within levels consistent with credit standards and internal limits.

In terms of our concentration levels, our loan portfolio as you can see on the chart left is quite diversified. Our most important factors in the corporate book are commerce and financial services. Additionally, we also hold a low concentration risk in terms of customers with the top 10 customer groups represent less than 12% of total loans and related party loans represent less than 2% of total loans. Additionally, our basic principal of our risk – credit risk management is our constant and deep presence to help the entire credit risk cycle, including approval, strategy, monitoring and collections.

For example, since the first semester of 2012, we anticipated a higher risk from the expected slowdown of the economy and distributing negative effects of the implementation of new regulations. Accordingly, we adjusted our acceptance criteria for the lower income segments and put into practice different initiatives and tended to enhance the collection process. This strategy was successful in lessening the effects of the change behavior from retail customers. The effectiveness of this credit risk management is clearly demonstrated on our NPLs to loans and coverage ratios as you can see on the chart on the right. At the end of the third quarter, non-performing loans as a percentage of loans remained at 1.1% significantly below our peers in the banking system. Also, our coverage ratio measured as allowances to total past due loans remains healthy at two times well above our peers and the industry.

On the next Slide number 11 has some more information on provisions. As demonstrated on the chart in the left, loan loss provisions have increased from Ch$40 billion in the third quarter of 2012 to Ch$70 billion in the third quarter of 2013. However, it’s important to note that more than 50% of this increase is attributable to factors other than loan deterioration. The chart on the right shows the main effects of this increase between the third quarter’s of 2013 and 2012. First in line with our business strategy, loan growth has been concentrated in retail loans where the balance is growing 12% year-on-year versus wholesale loans expanding 10% within the same period.

As a result, the effect of the greater loan volumes and loan loss provision was equivalent to above Ch$6 billion pesos when compared to the same period in 2012. Second, under our prudent criteria, we charged $7 billion in counter-cyclical provisions in view of the actual loan growth, the slowdown shown in the local economy and their expectations of higher volatility over the next years. It’s important to note that this provision does not relate to any specific customers or industry sector, but instead to an overall outlook on that evolution of the economy.

Third, a net effect of Ch$4 billion due to exchange rate shifts affecting our U.S. denominated allowances for loan losses. This was the result of a 5.3% decrease in the Chilean peso U.S. rate in the third quarter of 2012 in comparison to a 0.7% drop in the present quarter. Lastly an important part of the change in loan loss provisions year-on-year is due to changes in credit risk classifications or specific wholesale customers in the third quarter of 2012 and in the third quarter of 2013.

On the one hand, the improved risk profile of the specific customer resulted in the release of above Ch$8 billion in provisions during the third quarter of 2012. And on the other hand, in the third quarter of 2013, we incurred Ch$4 billion in provisions due to one corporate customer which we downgraded based on their financial conditions. Net-net changes in the risk profile of two corporate customers expanded Ch$12 billion of the Ch$13 billion increase in loan loss provisions during the quarter, while the retail segment only represented about Ch$1 billion of its total impact.

Please turn to Slide 12 for an overview of operating expenses. As demonstrated on the chart in the right, our operating expenses have trended flat over the past five years, this has created expenses between Ch$150 billion pesos and Ch$160 billion per quarter. This has been accomplished by closely monitor – controlling our headcount together with the strict cost control policy, lower amounts of IT projects put in place during this year and as well as a more moderate business growth.

Once again, I should mention that we are continuing to see the fruits of our investments in terms of the economies of scale and scope that have arisen from our growth in the retail business segments. This has been permitted us to become more productive by taking further advantage of available capacity in our branch network, back-office procedures and sales productivity gains based on the consolidated CRM system. As a result, we have posted an outstanding efficiency ratio of only 40.6% during the quarter and 42.7% year-to-date. However, it’s important to note that the higher inflation recorded this quarter positively impacted operating income contributed to a relevant improvement in the cost to income ratio for this quarter.

Please turn to Slide 13. As a result of our excellent commercial initiatives together with prudent risk policies and cost control have permitted us to post excellent figures this quarter. We recorded a pre-tax income of Ch$156 billion, up 11% quarter-on-quarter and 49% year-on-year. In terms of our effective tax rate, its important to note that in the third quarter of 2012, we posted a lower effective income tax rate due to non-recurring tax benefits associated with the effect of our corporate tax rate increase on a deferred tax position. This resulted in an effective tax rate of approximately 5% in the third quarter for 2012. As a result of all these factors, we recorded net income after taxes of Ch$137 billion this quarter, 13% higher quarter-on-quarter and 38% greater than the same period last year.

Now to finish off, I’d like to pass the call over to Pedro Samhan, Chief Financial Officer of Banco de Chile.

Pedro Samhan Escandar

Thank you, Pablo. Please move to Slide number 14. This has been a historical quarter for Banco de Chile, but we have consolidated our leadership position. First of all, as shown by the chart on the upper left, our strong loan growth during the quarter has placed us first in terms of total loans with a market share of 19.3%. It was based on an effective long-term business strategy which focuses on profitable growth and compared us [indiscernible] selected coverage and approach in order to ensure a balanced rate of return relationship in all of our lending activities.

In terms of our revenue generating capacity, we have also ranked first in net operating margins measured as operating revenue net of rate charges to average interest earning assets reaching 5.3% at the end of the period, first of all, all of our main competitions. Nonetheless, it is important to mention that our business strategy strives to continue positioning the Bank a leader in retail banking. Hence we feel that there is still room to continue improving these figures.

In terms of cost to income, we recorded an impressive year-to-date ratio of 42.7% below of our competition. This has been achieved through a strict cost controls as well as through initiatives that tends to increase productivity, improve intra customer service channels, and automate back office activities. However, as mentioned earlier, the figure has also been influenced by certain lower expenses related to IT projects, which would be realized next year along with a possible of loan loss in business activity.

Finally, we can see prior hit from our competition internal return on average equity with our strong double-digit ratio of almost 22%, 4 percentage points above the next leading competitor. The lead indicator has been achieved through solid fundamentals based on a strong customer base, proven risk management and a consistent commercial strategy. Our Banco de Chile continues on consolidating our leadership in every segment we serve and to continue bigger than a bank based on sustainable and profitable business more for our investors. Thank you.

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

Question-and-Answer Session


Thank you. This floor is now open for questions. (Operator Instructions) Your next question comes from Jose Barria from Bank of America.

Jose Barria – Bank of America

Hi, good morning Pedro and Pablo. I have a question with regards to asset quality. So if I look at what you did with regards to these additional provisions basically, you’re saying that you expect a lot of uncertainty in the coming quarters and then that led you do to provision a little extra this quarter. Can you give us a sense of what sort of level of provisions to average loans we should be looking at for you on a recurring basis? And also with regards to asset quality, the corporate clients experienced deterioration over the quarter, where these clients in a specific sector or in different sectors? Thank you.

Pedro Samhan Escandar

Thank you very much. Let me try to answer your first question. Regarding our provision level vis-à-vis average loan, really, we think that instead of what we can see looking forward, there are different force that can affect positively or negatively there. But really in general, with all the measures that we have taken during the last three years in order to have a managed M&A and conservative approach instead of risk management, really we think that we have today in a level of – current level of provision very similar to what we have during this year with the only exception that we got our strategy to be more concentrated in consumer and retail market overly instead of the mix, we would have some impact, but we are not expecting anything rather – or anything more than that. This is in term of your first question.

In terms of your client deterioration really – our [Indiscernible] level has increased a little bit during the last quarters, but basically impacted a number for the retail segment rather was by the wholesale and especially for the SME segment. That is something that we think that today we’re at a level that we can continue having in the next quarters. We don’t see a major raise in order to expect an increasing in this number for the future. We should be in a number around the number that we have today.

Jose Barria – Bank of America

I see. So for provisions to average loans, I mean is it feasible to assume that provisions to average loans will decrease from this 1.4% that you posted in this quarter?

Pedro Samhan Escandar

Yes, by sure. I think during this quarter, as Pablo explained very well, you could see some extraordinary impact that are non-recurring, so really with the level more similar to the average level that we have so far on a year-to-date basis.

Jose Barria – Bank of America

I see. And finally just a follow-up on the corporate wholesale clients where you saw some deterioration, it was risk classification you changed. What sort of exposure do you have in terms of total loans to those clients? And could we see maybe further provisioning or further deterioration there in the coming quarters? What do you think that after the move that you did this quarter that you should be okay?

Pedro Samhan Escandar

Well, we discussed already we have an exposure today that we have monitored very closely in order to see what’s happened; really we are trying to have the best pro forma here. However, we can control the possibility to increase our provision during this quarter because of that. And we see any impact or any possibility that the capital could be deteriorated. So really so far we have some provision already reflective, we cannot rollout the possibility to have some increase during this quarter.

Jose Barria – Bank of America

Okay. Any color you can give us in terms of exposure size and reserve size?

Pedro Samhan Escandar

Well, I don’t prefer to give this number publicly because we really – we are talking about the customers.

Jose Barria – Bank of America

Got it.

Pedro Samhan Escandar

So these are the issues that I can tell you that we have an exposure that should have been reduced over the time, and during the last quarter between the last two years, but during the year, we have already reduced a bit more and so really a decline in trend over the time, clearly.

Jose Barria – Bank of America

Okay, fair enough. Thank you very much, Pedro.

Pedro Samhan Escandar

You’re welcome.


(Operator Instructions) Your next question comes from the line of Chris Delgado with JPMorgan.

Chris A. Delgado – JPMorgan Securities LLC

Hi, good morning. Just given recent rate cut, I wanted to get a sense of how you saw net interest income evolving versus loan growth and your NIM for the upcoming year?

Pedro Samhan Escandar

For NIM?

Chris A. Delgado – JPMorgan Securities LLC


Pedro Samhan Escandar

In the NIM or NIM really we expect different forces that can impact and influence this number for both this quarter, the last quarter and looking forward thinking in the 2014.

On the positive side, we have picked a positive inflation, a higher inflation for this year or more of an inflation, a higher U.S. variation that should be something closer to 3%; a lighter year that is closer to 2%. This is one positive impact. The segment is the mix. You know that our strategy and our focus is to grow more in the retail segment. So really, if you have a mix oriented to the retail, you have a better return in these indicators.

First in terms of the [indiscernible], there is a possibility, it’s not something that is sure, but when an economy, the internal rate, the CPM is going down, mainly you have more possibility instead of [indiscernible] depending on the evolution of the long-term or maybe internal rate, they follow the turn of the short-term or really if the gap has been more open and – still in it. So really these are all positive impact.

On the negative side, you have first the internal rate cuts that sure we think it will be in place from the next year, maybe the first quarter, maybe the second quarter, but anyway will be flat in terms of the market internal rates.

The second thing is a negative side, it was having with our Chilean banks because as long as the internal rate builds out, the remuneration of these accounts are lower, but at the same time, you have with a internal rate cut, you have a benefit because of the repricing of the portfolio, because our liability side on in average is shorter than our asset turnoff.

So really you have a positive and negative, so net-net you should think that we will affect or we should expect a lower level of NIM that could be in the range between 15 basis points and 25 basis points in a year. But however, this is instead of the NIM, however, we expect to continue growing in our portfolio that or really is a positive trend that will partially offset, or totally offset or partially offset the lower level of NIM.

Chris A. Delgado – JPMorgan Securities LLC

Okay, and just so I get the number correct, a 15 basis point decline over the course of the next year then, is that from the current level of about 5.3 or the full-year average of about 5?

Pedro Samhan Escandar

It is in terms of our average level…

Chris A. Delgado – JPMorgan Securities LLC


Pedro Samhan Escandar

Average level of this year because you know that this quarter we have an inflation of more than 1% that impacts very positively the number.

Chris A. Delgado – JPMorgan Securities LLC

Okay, great. Thank you.

Pedro Samhan Escandar

You are welcome.


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

Pedro Samhan Escandar

Thank you very much. Well, before ending the call, I would like to close by saying that 2013 has been relatively nice year for Banco de Chile.

Looking forward, it’s important to note that 2014 will be a challenging year for Banco de Chile. From a positive perspective, we’ll think that asset and liability will continue growing at attractive rates and that the higher inflation will also help to increase operational revenue generation for the industry. Nevertheless, [indiscernible] presentation on new regulation for sure that is very important also instead of the asset, instead of the insurance other than the new regulation in – that grows our revenue and some policy is still recognizing upfront, we have a negative impact that was included in the number that I gave you before. On the possible implementation of a bill, which limits internal rate for loan less than 200,000 – I am sorry 200 UF, we’ll have an adverse impact on results.

In the [indiscernible] be temporarily and Q3 influencing the change in as we have mentioned recently. Later, we will force banks to adapt their business model in order to properly absorb these changes. We are confident that institutional like ours have the skill before that and the skill required to them for little bit for us to continue to creating value for our shareholder. Thank you and we look forward to sharing with you our year end results.


Thank you. This does conclude today’s presentation. You may now disconnect your lines. Have a great day.

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