Banco de Chile (NYSE:BCH)
Q2 2014 Earnings Conference Call
July 31, 2014 11:30 a.m. ET
Victoria Gabens – Investor Relations
Pablo Mejia – Head of Investor Relations
Chris Delgado – JP Morgan
Jose Barria – Bank of America/Merrill Lynch
Thiago Batista – Itau BBA
Good morning everyone and welcome to the Banco de Chile’s second quarter 2014 results conference call. If you need a copy of the press release issued last Wednesday, it is available on the company’s website at www.bancochile.cl. Today with us we have Mr. Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations, Mr. Pablo Mejia, Head of Investor Relations, and Daniel Galarce, Head of Research, and also Victoria Gabens, 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 Ms. Victoria Gabens. Please go ahead, ma’am.
Good morning. It's a pleasure for me to share with you our comments on Banco de Chile's second quarter 2014 financial results.
Please turn to Slide number 2. To begin, we will discuss the developments in the economic environment, and the results of the banking industry followed by a review of Banco de Chile's results.
Please turn to Slide number 3 which contains the economic highlights. Looking back at the first quarter, Chile posted a weak 2.6% annual GDP expansion after recording a 2.7% growth in the previous quarter. As a result, the activity has been at a slower pace since the fourth quarter of 2013.
Following the trends seen in previous quarters, the slowdown was led mainly by the 5% annual construction and gross fixed investment that followed the 12.3% construction in the previous quarter. This is a consequence of the very weak growth in machinery and equipment investment.
On the other hand, private consumption posted a healthy 3.7% growth, due partly to tight labor conditions given that the unemployment rate was 6.4% in the moving quarter ending in May.
The good news, however, is the reduction in the current account deficits, as a consequence of both lower investment and import growth. Particularly the deficit decreased to 1.2% of GDP in the first quarter of 2014, reducing the 12 months rolling deficit to 3.1% from 3.4% in 2013.
Total recent figures suggest that this below trend growth will remain until the third quarter of 2014 as some leading indicators such as consumer and business confidence have continued to be subdued. However we expect the recent weakness in the exchange rate and the late effects of the expansionary monetary policy to lead a recovery as of the fourth quarter of 2014. In this context, we expect economic growth to increase from 2.6% this year to a range between 3.5% and 4% in 2015.
It is worth mentioning that the GDP breakdown is changing, particularly the recovery of key tradable sectors such as mining and manufacturing suggests that the local economic growth is being led by the improvement in net export. Partially offsetting the slowdown in sectors closely related to private demand such as construction.
Private investment remains weak, although the recovery in margin of capital goods imports that suggests that the growth improvement won’t be following further. On the other hand, lower real wage bill growth and the slowdown in waged employment indicate that a moderate deceleration in private consumption is likely. As demonstrated on the following slide – slide 4.
In terms of inflation, there was a sharp increase in the annual rate from 3% in January to 4.3% in June. This is highly attributable to the sharp depreciation of the Chilean peso observed exchange rate, which has decreased from 7.2% this year and 11.8% since October of last year. However we anticipate that inflation will converge to the 3.8% target in the first half of 2015. Since the full core inflation measures and expectations have remained passive and the economy has grown below its long term expected growth.
In this context, the central bank resumed the easing cycle in July by reducing the interest rate 25 basis points to 3.75%, which proceeded consecutive cuts that totaled 100 basis points between October and March. This can be seen in the upper left graph. We believe that further rate cuts are likely since the central bank maintained the easing bias in the press release which was published after the meeting.
Regarding fiscal policy, the National Budget Office updated its macro-economic scenario for this year. In particular, it is important to mention that the government reduced the GDP growth estimates for this year to 3.2% which is substantially below the 4.9% expansion considered in the original budget. This results in an upward revision of the expected fiscal deficit for this year to 2.0% of GDP in the previous 1.3% estimate.
On the political front, there have been important steps taken in the tax reform discussion. Representatives from both the government coalition and opposition signed a preliminary agreement with several modifications to the original proposal. Today the proposal has two alternative systems for companies to choose from. The first is the original proposal which considered an increase of the corporate tax to 25% and preserve the accrual system. Whereas the second mechanism removes the accrual basis but considers a higher corporate tax hike to 27%. It is important to highlight that in both cases the government removed the 10% additional withholding tax. Further details will be discussed in the senate and will probably be focused on measures oriented to mitigate negative impacts over small and medium companies.
Additionally, the official deadline for the approval of the bill in congress is before the end of September, which is when the fiscal budget must be submitted. It is worth remembering that the tax reform aims to increase fiscal revenues by 3% of GDP in the long term in order to finance the educational reform and other social plans.
Other potential policies to be discussed in the short term include the changes to consumer protection agency, new liquidity regulations for banks, changes to the constitution among others.
Please turn to Slide number 5 for a review of the main figures for the Chilean banking system. In light with the recent economic figures, the Chilean banking system in terms of loan growth has begun to show signs of deceleration, due to more moderate demand coupled with stricter acceptance criteria from banks.
During the 12 months period, ending May 31 2014, total loans grew 5.2% in real terms and when compared to the prior quarter, loans grew less than 1%. This was mainly due to weaker growth in commercial and consumer loans. Mortgage growth, however, remained strong increasing over 9% year on year.
In terms of earnings, the banking industry posted excellent results thanks to the high inflation experienced during the first five months of the year. Benefits from funding repricing and d term gapping and also loan growth expansion. As a result, net income grew 61% over the last year and return on average equity reached 19.3%.
Now I will pass the call on to Pablo who will speak to you about this quarter’s results.
Thanks, Victoria. Please turn to the next Slide number 6. Here you can see a snapshot of Banco de Chile’s main income statement figure. To begin, operating income increased in the second quarter 2014 by 20% when compared to the same period last year. This strong year-on-year increase was due to a variety of factors which will be explained on the following slide.
Please turn to Slide number 7. On this slide, we present the breakdown of operating revenues which is composed of interest income from loans and deposits, fees from non-customer income which is mainly related to income from activity such as funding and gapping, trading and available for sale securities.
Similar to what occurred in the first quarter of 2014, part of this increase in operating income is – in the second quarter of 2014, distributable to non-customer income in particular to the management of our UF structural gap as inflation was up 1.8% this quarter versus deflation of 0.1% recorded a year earlier.
Also, but to a less degree, the increase in net interest income was due to the average volume growth of our loan portfolio which grew 8% year on year with stable lending spread and our ability to maintain the contributions coming from DDAs almost flat despite the strong increase in overnight rate by successfully growing average volumes of DDAs by 14% year on year. .
Additionally, income was further enhanced by expected treasury activities, which improved funding as a result of re-pricing of short term liabilities in line with the decrease of the overnight rates and the more steeply sloped yield curve which allowed us to benefit from term gapping. The positive effect allowed us to deal with the negative exchange rate effect on operating revenues of roughly Ch$5 billion pesos given by a high basis for comparison in 2013 – in the second quarter of 2013.
In addition to this, fees continued to be under pressure this quarter. The main elements that explain this year-on-year decrease are first, the recent regulation that obligates the refund of insurance premium in the case of early termination of insurance policies which began in December 2013, and second, lower business activities that translate into lower credit card and stock brokerage fees. Net, net, this has resulted in an improved operating margin this quarter reaching 7% or 76 basis points above the same period last year.
Moving on to Slide number 8, is a review of our loan portfolio by segment. Even though loans have grown 7% over the past 12 months, they have begun to show clear signs of deceleration. When we look at 2014, loan volumes have remained relatively flat this semester, consistent with less dynamic Chilean economy as illustrated by the recent results of the monthly business confidence indicator IMCE, which as of June reached levels that placed overall business expectations at pessimistic levels. This negative outlook led to decreases in demand from both individuals and companies and has taken us to implement stricter credit acceptance criteria.
In terms of year-on-year figures, the retail segment continues to drive loan growth with an increase of 12%, essentially above the 3% rise in the wholesale portfolio. This growth was primarily from mortgage loans and consumer loans in the middle and upper segment which continued the strong growth trends, posting an increase of 15% and 12% respectively.
SME commercial loans have also contributed to growth posting an attractive year-on-year increase of 9%. We’re achieving these figures especially in consumer loans by better using business intelligence tools and improving effectiveness of all sales channels, in particular, online along with other initiatives.
On the other hand, when we look at the lower income segment, this remained flat year on year and the growth in our wholesale portfolio continued to be growing only 2% year on year, in line with the sharp contraction of the investment economic figures.
On the following Slide number 9, we show a breakdown of our funding structure. First, thanks to the important effort realized in increasing and diversifying our funding base, we were recognized in May by MTMI, a database platform that is recognized by market leaders as the most relevant new issue information and longer term trend analysis of the MTM market. This magazine distinguished Banco de Chile as the rising start based on the successful cross-regional funding diversification. This was a result of the relevant rise in international debt placements over the past couple of years which continued in the second quarter of 2014, placing bonds in Japan and Hong Kong for over $120 million with terms of eight and six years respectively.
As you can see on the chart on the left, debt issued has increased by 363 basis points year on year, representing 19% of total liabilities as of June 2014. If we looked back a few years, bonds represented less than 10%, so this change is very impressive.
It’s also worth mentioning that these bonds issuances contribute to increase in the duration of our liabilities which have allowed us to replace less stable time deposits funding from institutional customers, thus improving our liquidity.
This growth in debt at first rate spread together with a leadership position in DDA which represents 24% of liabilities have translated into generating a cost of funds ratio of only 4%, significantly below the average of the system which reached 4.4% as of May.
Also on the chart on the right, we compare the cost of funding and time deposits by currency, which we believe is a good indicator for comparison purposes, due to the fact that they are more similar in terms of duration than any other liabilities. As you can see, we continue to excel our main peers in funding in pesos, US, and foreign currencies. It’s also important to mention that Banco de Chile has one of the lowest concentrations in funding from AFPs and mutual funds representing only around 13% of the source of fund.
Please turn to the next Slide number 10. As shown on the chart on the left, loan loss provisions have grown 34% from Ch$54 billion in the second quarter of 2013 to Ch$72 billion in the second quarter of 2014. However it’s important to mention that part of this increase is due to the facts [ph] which are related to loan deterioration. First, under current risk criteria, we established Ch$10 billion in counter-cyclical provision, increasing the total balance to almost 120 billion or roughly 20% of last year’s net income. It’s also worth mentioning that these allowances don’t relate to any specific customer industry sector but instead are intended to be used during negative economic cycles.
Second, there was an increase in provisions for loan losses due to the expansion of our loan book that was mainly focused in retail loans, growing 12% on average over the same period last year versus our wholesale book that grew only 5% year on year in average balances. This expansion of our loan book explains approximately Ch$6 billion in higher loan provisions.
And finally, as explained earlier, the strong 8% depreciation of the Chilean peso relative to the US dollar in the second quarter of 2013 increased the comparison base by Ch$5 billion because of certain loan loss allowances denominated in US dollars. In the second quarter of 2014, the Chilean peso depreciated only 0.6%.
In terms of credit deterioration, we recorded 7 billion, almost 7 billion in provisions for loan losses that was concentrated in the wholesale banking segment. This was associated with one -- principally with one specific wholesale customer in the period. Unlike previous quarter – unlike the previous quarter, loan loss provisions for retail banking remained stable just under 2% as a percentage of total loans, thanks to measures we took in order to – to control our risk exposure in the segment.
Before moving on, I want to emphasize that we are confident in maintaining our good risk indicators, thanks to the high involvement of the board of directors and upper management in the preservation of strong credit acceptance, collections and monetary practices at Banco de Chile, as well as the important human and financial resources allocated for this purpose. This has, on average over the last 10 years, allowed us to consistently post loan loss provision figures at around 0.3% below the industry average translating into significant benefit for the bank.
Please turn to Slide number 11 for a review of our operating expense. As you can see on the chart on the left, our operating expenses have grown 13% over the last 12 months. The main drivers for this increase are mainly due to the 12% growth in personnel expenses which is mainly explained by three factors. First, adjustment in salaries which are linked to inflation. Second, a slight increment in headcount, and third, higher expenses related to non-recurring bonuses and variable compensation associated with commercial campaign.
It’s important to also mention that during this quarter we successively renegotiated a collective bargaining agreement with one of our union which represents 7% of the total labor costs. This implied a one-time expense equal to Ch$4.2 billion for end of negotiation bonuses for these workers.
Administration and other expenses recorded a rise of 13% as compared to the same quarter last year which is mainly due to the rise in expense provisions and to a lesser degree a 3% rise in IT and other general administrative expenses related to our branch network.
Overall I would like to say that this has been a positive quarter in terms of efficiency, recording the level of 41.3% this quarter, consistent with our past efficiency level. This compares favourably to the 43.7% recorded a year earlier and the 43.7% posted by our peers in the first two months of this year.
Although the improvements of this quarter is chiefly explained by the excellent results in operating revenues, we believe that a strict cost control policies together with productivity improvements should continue to provide us with first rate efficiency levels that stand out when compared to the banking industry as a whole.
Please turn to Slide 12. Looking back on the first half of this year, it’s important to note that we have achieved excellent overall results despite the slowing economic cycle. For the second quarter in a row, we have surpassed the Ch$150 billion barrier in net income, 26% increase when compared to the same period last year.
I can also highlight that the return average equity is outstanding at 26% for this quarter and our efficiency continues to out-perform our peers. Additionally, selective loan growth and forward looking decisions in assets and liabilities management boosted our operating revenues by 20% year on year which was reinforced by a significant contribution of our US net asset exposure and gains from funding and gapping.
We have combined this achievement with improvements in business intelligence, operational risk management and efficiency. These elements should provide us with long term competitive advantages that are particularly valuable for the challenging business environment ahead, especially for the coming quarters in which we'll face an environment with lower inflation, partially affecting our results.
Now if you have any questions, we would be happy to answer them.
(Operator Instructions) Your first question comes from the line of Chris Delgado with JP Morgan.
Chris Delgado – JP Morgan
I just have a quick question relating to net interest margin. Given that inflation in Chile has started to normalize, how do you guys see your net interest margin and your NII growth evolving over the rest of the year?
Hi Chris, can you repeat the last part, I cannot –
Chris Delgado – JP Morgan
Yeah, no worries. I just wanted to get a sense of how your see your net interest margin and your net interest income growth evolving over the end of the year given normalizing inflation in Chile.
What I can say is that for the net interest margin, there’s factors that are pushing margins up and there’s other factors that are pushing margins down. You can see that – there is higher risk obviously which is associated with the complications or the more difficult economy which is pushing margins up because we always look to maintain an adequate relationship between risk and return. On another hand, what you mentioned – inflation is pushing net interest margins down for the second half of the year because we are expecting obviously a lower inflation rate than we have experienced in the first half of this year. So that together with the lower overnight rate which will reduce the margins we receive from DDAs or currency time [ph] deposits, we’re expecting something for net interest margins above obviously what we thought in 2013 which is 4.7% but obviously below the 5.2% that we posted this first half of the year principally due to the high inflation.
So based on our current base scenario, we should end the year the net interest margin for the 12 months period of around 5%.
Chris Delgado – JP Morgan
And then just one follow-up question on that. As you mentioned, the economy overall in Chile is slowing down, you’ve seen loan growth kind of taper. Could you just remind us what your loan growth is -- expectation is for the full year?
[indiscernible] dynamism in the economy growth has been weaker, if we look at the commercial loan portfolio, the total portfolio grew around 3.9% and if we only look at the wholesale it grew around 3%. The slower growth has been the result of taking more prudent steps in terms of our risk and return policies in order to have criteria which is more adequate with the current economic scenario. So we're always looking at having an adequate risk and return relationship. Also part of this slower loan growth that we saw in the commercial loans, is due to some short term loans that came due during the first half of the year.
But also there is some good news. We’ve been growing strongly in terms of retail loans. If we look at retail loans, including SMEs, the growth has been 12%, so the mix has been changing a little bit. And we think for the remainder of the year we should grow in line or above the market in all products which we are looking at about 8% in nominal terms, 7%, 8%.
Your next question comes from the line of Jose Barria with Bank of America.
Jose Barria – Bank of America/Merrill Lynch
Very quickly on provisions, just want to address the Ch$10 billion in counter-cyclical provisions that you took this quarter. Was this something that you guys did to take advantage of the high gains coming from the inflation-linked income, or is this something that we might be seeing on a more recurring basis going forward in the second half of the year considering that the economic outlook continues to be relatively weak?
For the counter-cyclical provisions that we took this quarter, normally this is a decision that’s made at the board level. So the board generally reviews this at least annually, and in this case, they decided based on the current economic cycle and maybe what could happen in the future, that was Ch$10 billion – that was in additional provisions. It’s important to mention that these are fairly [ph] segment industry or customer in particular, the more provisions for when the economy is going well, to be used during times that there is a more negative cycle. So it’s not based on what you were mentioning earlier.
Jose Barria – Bank of America/Merrill Lynch
So we shouldn’t just assume that you'll be taking -- you'll be booking more on counter-cyclical provisions going forward necessarily. It's basically based on that case by case review of the situation.
No, it’s based at the board level, and looking more on medium term, not on a medium term – so necessarily – this doesn’t mean necessarily that there is more this year. We can’t rule out anything but it doesn’t necessarily mean there will be more provisions for this year.
Jose Barria – Bank of America/Merrill Lynch
And looking at your coverage ratio, I did notice that it came down. I mean it’s still pretty high at 190 or 191 relative to peers. That's still pretty good. But it did come down from close to 200 in the first quarter. Are you guys working with any target on reserve coverage or any special that you feel comfortable at or is this level still very high and therefore we could see it come down?
The coverage ratio, we don’t have a target for coverage ratio, it’s a product of our provisioning models and how we believe – basically our provisioning models for individuals and for companies. In terms of the reason why the coverage ratio dropped below this quarter, you have to remember that commercial loans don’t necessarily follow the provisions in terms of overdue book. So generally you analyze larger companies as a case by case basis and then this quarter, you saw that maybe in the prior quarters we provisioned these customers but those loans they come overdue and in this quarter the loans came out overdue, and that’s the reason why the coverage risk overdue is below that. And you also have to take into consideration that the coverage ratio doesn’t account for additional provisions that you increase this figure around 0.4 times over past due.
(Operator Instructions) Your next question comes from the line of Thiago Batista with Itau BBA.
Thiago Batista – Itau BBA
Hi Pablo. Thanks for the opportunity. I have basically one question. Actually one question and one follow-up. The question is regarding the NPL ratio. How are you expecting to see the trend of the NPL ratio during the second half And also in '15, I know that you were stating in the press release that you have a positive view on this, but could you comment a little bit more on the NPL ratio evolution? And the follow-up on loan growth, how much do you believe the loan portfolio can grow in '15?
In terms of NPLs, well NPLs have – for this first half of the year, they have increased similarly in both companies and individuals. And they’re both basically very in line with the weaker economy. It’s important to note, like I mentioned earlier, that commercial loans don’t necessarily follow the provision charges for corporate customers. Because we review these customers on a case by case basis.
In terms of the retail loan book, it all really depends on the outlook for the economy and what actually happens. Our base economic scenario is that the economy will grow around 2%, 2.5% for this year and unemployment rate of about 7%. So extreme changes – we are not expecting. For next year, we look at 3.5% GDP growth for the economy which could have maybe a better outlook, once we get closer to the end of the year, when – after certain policies are implemented and we see investment picks up again, which is an important factor for growth. And for loan growth, [actually for] Chile, we will also have something around 2 times GDP growth, so taking that into consideration you should think for 2015 a GDP loan growth in nominal terms around 10%.
This concludes the question and answer session. At this time, I would like to turn the floor back to Banco de Chile for any closing remarks.
Thank you for the questions and thank you for listening and participating in our conference call for the quarter. We look forward to sharing with you our next quarter’s results. Have a good day.
Thank you. This does conclude today’s presentation. You may disconnect your lines at this time. And have a nice day.
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