Bancolombia (CIB) Q2 2014 Results Earnings Call Transcript

Aug. 6.14 | About: Bancolombia S.A. (CIB)

Bancolombia SA (NYSE:CIB)

Q2 2014 Earnings Conference Call

August 6, 2014 9:00 AM ET

Executives

José Humberto Acosta Martin – CFO

Juan Carlos Mora Uribe – COO

Analysts

Carlos Macedo – Goldman Sachs

Frederic de Mariz – UBS

Tito Labarta – Deutsche Bank

Saúl Martínez – JP Morgan

Jose Barria – Bank of America Merrill Lynch

José Restrepo – Serfinco

Thiago Batista – Banco Itaú BBA International

Marcelo Telles – Credit Suisse

Boris Molina – Santander Investment Securities

Cristian Hernández – Ultrabursatiles

Alonso Aramburú – BTG Pactual

María Alejandra [ph] – Asesores en Valores

Philip Finch – UBS

Operator

Good day, ladies and gentlemen, and welcome to Bancolombia’s Second Quarter 2014 Earnings Conference Call. My name is Hilden. I will be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. (Operator Instructions)

Please note that this conference call will include forward-looking statements, including statements related to our future performance, capital position, credit-related expenses and credit losses. All forward-looking statements, whether made in this conference call and future filings and press releases or verbally, address matters that involve risk and uncertainty.

Consequently, there are factors that could cause actual results to differ materially from those indicated in such statements, including changes in general, economic and business conditions, changes in currency exchange rates and interest rates, introduction of the competing products by other companies, lack of acceptance of new products or services by our targeted clients, changes in business strategy and various other factors that we describe in our reports filed with SEC.

With us today is Mr. Jaime Velasquez, Chief of Strategy and Financial Officer; Mr. José Humberto Acosta, Chief Financial Officer; Mr. Juan Carlos Mora, Chief Operating Officer; Rodrigo Prieto, Chief Risk Officer and Alejandro Mejia, Investor Relations Manager.

I would now like to turn the presentation over to Mr. Acosta, Chief Financial Officer of Bancolombia. Please proceed sir.

José Humberto Acosta Martin

Thank you very much. Good morning, and welcome to our second quarter 2014 results conference call.

It is a pleasure to be with you, who follow so closely our operations and results. Let us start with a brief description of the main topics that impacted our business in this period. You can follow the slide presentation available at our Investor Relations website.

First of all, I want to open this conference call, elaborate the most important topics that drove the bank. During the second, the loan portfolio grew 2.5%, in line with our expectations, as we were expecting a moderation in the pace of growth. The expansion was mainly driven by commercial loans and financial leasing, whereas consumer loans grew at a slower pace.

These trends in consumer loans growth, was due to our tight underwriting standards, which aim to maintain a high credit quality. When analyzing the loan growth, it is necessary to consider the 4.5% appreciation of the Columbian peso again the U.S. dollar during the quarter. This appreciation cost at a dollar-denominated loan portfolio, which grew 2.6% during the quarter, represented fewer pesos when converted.

Coupled with the growth of the loan portfolio, we experienced a positive trend in quality. The past due loan ratio improved during the quarter and the formation of past due loans was also lower than the 4Q last year and the 1Q this year. As a result of the recoveries, and better performance of vintages [ph] in line with these trends, the cost of credit remains below 1.5% and the coverage ratio increased to 148%.

It is remarkable that a significant contribution to the credit quality improvement was explained mainly by Banistmo. Over the last six months, our efforts in Banistmo permitted to reduce the stock of 90-day past due loans from 1.94% to 1.38% of gross loans, which in nominal terms represents a recovery of $120 million.

In the funding front, we continued our efforts to reduce the cost of deposits. The overall funding cost was 10 basis points lower than the first quarter and 67 basis points lower than one of the year ago. With greater liquidity in the Columbia economy and moderate growth in the loan portfolio, we have focused our efforts in reducing the volume of the most expensive funding sources.

In this front, Bancolombia presents one of its main competitive advantage, the ability to grab its strict and diversified deposit at the lowest rate in Columbia. As a result of the reduction in the cost of liabilities, the net interest margin expanded 10 basis points during the quarter, mainly driven by the performance of the loans, net of the loans.

Now, in the capital front we ended June with a Tier 1 of 9%, which is at the high-end of the range defined to operate the bank in an optimal level. During the quarter, we continued allocating a greater proportion of assets in our core business, which is lending. As a result, we reduced the size and duration of the securities portfolio, and therefore the market value at-risk, which contributed to increased Tier 1 ratio.

Last but not least, I would like to present the results for the second quarter 2014. During the quarter, Bancolombia generated COP 467 billion, which represents an annualized return on equity of 12.3%. The performance of the bank was in line with our expectations and lead us to reaffirm our goals for this year. We will elaborate more on each afterwards.

Having said this, we would like to continue with a brief discussion about the economic environment. Let me turn the presentation to Juan Carlos Mora, who will share our views on this matter. After all, we will elaborate more on the bank’s results. Juan Carlos?

Juan Carlos Mora Uribe

Thank you, José Humberto. Good morning to everybody. For those of you following the slide presentation, please go to Slide #3. After growing 4.7% in 2013, the Columbian GDP expanded to 6.4% during the first quarter of 2014, compared with the same quarter of the previous year. This figure was above the market expectation and our own forecast.

This good result was driven mainly by construction, on both, residential and infrastructure projects. The Central Bank revised upwards its GDP growth projection for 2014 to 5%. We share that view as the second half of this year should be more dynamic, because the level of spending of the government pick-ups, as well as the households demands more goods.

Unemployment rate continue dropping and ended May at 8.8%, down from 9.4% one year ago. This is good news, because of the high correlation between low unemployment and credit quality.

Inflation for the 12 months ended in June 2014 was 2.8% and has been increasing towards 3%, which is the point target set by the Colombian Central Bank. These trends in inflation, plus stronger economic activity, let the Central Bank to increase the repo rate in the last four meetings ending in July at 4.25%.

Although the hiking processes started earlier than expected, we see this action with good eyes, and could allow us to originate loans at the higher yield and eventually expand our NIM. Our expectation is that the repo rate will end 2014 at 4.5%.

Regarding the FX, the Colombian peso experienced an appreciation of 4.5% during the second quarter of 2014, and 2.5% over the last year. This appreciation trend occurred in part because of capital inflows, resulting from a higher weight of Colombian sovereign papers in the JPMorgan Global Bond Indexes.

In the micro front, we see that the indebtedness level of households remains stable and the debt sovereigns borrowed in [ph] as the proportion of disposable income remains at 16%. We have not seen any abnormal performance of bid purchase and the credit quality of closer financial system remains healthy. That trend reduces the risk of higher loan deterioration and provision charges.

In summary, Colombian’s economy is in good shape, and these will allow our business to continue expanding, while keeping risk under control.

After this quick review of the economic environment, let me turn the presentation again to José Humberto, who will discuss the bank results in detail. José Humberto?

José Humberto Acosta Martin

Thank you, Juan Carlos. On the Slide 4, we see the evolution of assets at its composition. During the quarter, the proportion of loans as a percentage of the total assets increased to 69%, as we deployed more resource to our core business, which is lending. The securities proportion decreased to 9%.

In nominal terms, the size of the securities portfolios is 16% lower than one year ago, and the duration remains at a low level at approximately 17 months.

During the quarter, we continued using cash on proceeds from securities to reduce the most expensive funding source, and to grow our loan portfolio. The goal is to move – this move was to reduce the funding cost and expand the net interest margin, as we will see in the next coming slides. This is one of the most and relevant point to highlight during this conference call.

In this quarter, the credit demand reacted positively, after the election process of the first months of this year concluded. Nevertheless, the growth was partially offset by the appreciation of the Columbian peso versus U.S. dollar. During the quarter, we continue originated loans with strict underwriting standards in order to maintain the high credit quality of the loan portfolio, especially in the consumer segment.

The loan growth in Colombian pesos reached 4.6% during the quarter, driven by corporate, which demanded working capital loans, trade finance facilities and loans for CapEx purposes. Consumer loans in Colombian peso also grew during the quarter, but at a slower pace, 3.1%, in line with seasonal factors.

On the other hand, US dollar-denominated loans grew 2.6% during the quarter, driven by financial leases and mortgages in Panama. The 4.5% appreciation of the Colombian peso versus the U.S. dollar during the quarter caused that the growth of U.S. dollar be lower when measured in pesos.

Today, loans denominated in dollars represents 30% of the total loan book. During the last year, the loan portfolio, excluding Banistmo, decreased by 3.1%, but when we include Banistmo, it grew 62.1%. At the right hand side column, we show the contribution of Banistmo to the overall growth of the loan portfolio in dollars over the last 12 months.

When we analyze the year-over-year overall growth of the gross loan portfolio, the 23.5% growth is partially explained by the incorporation of Banistmo assets, which contributed with 14.9% and today accounts for 12% of the total loan portfolio. At the right hand side of the table, you can see the year-on-year contribution of Banistmo to growth.

Finally, we reaffirm our growth target for this year that could be 10% to 15%, and that will be in the middle part of that range. That would be 13% expecting for this year for the whole Group.

Slide #5 shows the evolution of provision charges, which was COP 235 billion during the quarter. It was 1.45% of the average gross loans when analyzed, which is a very low ratio. For the six months of this year, the cost of credit was 1.4%. In the shaded row of the table at the bottom, represent the amount of loans that became 30-day past due during the quarter. The COP 173 billion reflects an improvement in the trend. After the seasonal effect, and of course at the beginning of each year in Colombia and Panama, when individuals tend to belating their payments.

In the quarter, we experienced recoveries of loans deteriorated in the first quarter of this year. The most important thing regarding loan quality is that interest rates originated over the last six months present today a very good performance, as a result of a strict credit underwriting standards, and they should not present abnormal deteriorations in rest of the 2014. We feel comfortable with evolution of the loan portfolio and forecast to have provision charges of around 1.5% of gross loans during this year.

Now on Slide #6, we present a snapshot of the credit quality at the end of the quarter. The 30-day past due loans to total loans ended the quarter at 3.1%, below the 3.2% at March. As we just explained in the previous slide, this decrease was originated by lower past due loans formation in Colombia and Panama. The 30-day coverage ratio ended at 148%, increasing against the 142% at March, due to higher provision charges and lower past due loans formation.

In general terms, we see the portfolio with a healthy quality, well covered by allowances and with past due loans under control.

We forecast to have our 30-day coverage ratio of around 150% in the median term. We believe that it’s more than enough to absorb potential credit losses that the bank would eventually have. Similarly, past due loans should represent between 2.5% and 3% of gross loans at the end of this year.

As we have graded company of our loan portfolio outside Columbia, the 90-day threshold for measuring past due loans gains more relevance. That’s why in the next slide, we will analyze the 90-day past due loans.

In Slide #7, we compare the evolution of 30-day past due loans, which is in the Colombian standard and the 90-day past due loans, which is a better indicator of credit quality, as we have a greater portion of our assets in countries that use that standard. 90-day past due loans have been very stable over the last two years. As a result of our growth credit origination processes, it presented a slight increase in June, as a result of interest rates [ph] that deteriorated in the first quarter and reached the 90-day threshold.

We start to see a positive performance of the credit quality of Banistmo, product of our more proactive and disciplinary maintenance and collection process, which we put in place in the first months of the acquisition. At the beginning of this year, Banistmo 90-day past due loans represented 1.94% of total gross loans. But today, they represent only 1.38%.

This means that today Banistmo has the lowest 90-day past due loan ratio among all the operations of Bancolombia. We estimate that a sustainable level of past due loans in Banistmo could be at around 1.4%.

Overall, the 90-day coverage ratio is 284%, which we believe is more than enough to absorb credit losses.

Moving on Slide #8, we see the evolution of net interest income and funding cost and composition. Net interest income for the second quarter of this year was COP 1.48 trillion, 2% above the previous quarter, and 43% above the same quarter of the previous year.

This growth is explained by two main factors. The first one is higher volumes of loans during this year; and the second reason is the expansion of the NIM caused mainly by the reduction of funding costs that we explained in the previous slide.

The key element of the net interest income increase in the quarter is that, it grew based in the lending business, and the contribution of the investment securities was just marginal COP 8 billion, as we reduced the size of the securities portfolio and keep the duration in low records. The duration of the securities portfolio ended at 17.3 months and the yield to maturity ended at 4.3%.

The reduction of the funding cost, 10 basis points during the quarter and 67 basis points during the year is the result of a strategy that aims to decrease the most expensive funding sources. With more liquidity in the market and moderate pace of growth of loans, we were able to maintain a stable stock of deposits and therefore reduced the cost of funding of the bank. The proceeds of the stock issuance and cash that we had at the beginning of this year contributed to this effort. Our goal is to keep funding cost as low as possible in an effort to maintain or expand the net interest, NIM.

We’re happy in our favorable asset sensitive condition of our balance sheet, which is positive for NIMs and in hawkish environment.

And Slide # 9 which shows the evolution of the net interest margin. The net interest margin from loans ended at 6.3% in the second quarter of this year, above the 6.1% in the first quarter. This increase is mainly explained by the reduction in the funding cost that we explained in the previous slide. We forecast the lending NIM to be between 6.2% to 6.5% at the end of 2014. The securities NIM was 0.2%, down from 1.8% in the previous quarter. Remember, that in February and March, securities gained margins due to appreciation of the Colombian government bonds after the increase of their weight in the JP Morgan Bond Indexes.

In this second quarter, we did not have such gains and the securities NIM was more in line with the spread between Tier-2 maturity and the cost of funding of the bank.

As we mentioned at the beginning of this presentation, the Colombian Central Bank increased the repo rate, a 100 bps more to 4.25 % in the meetings held this year. We can foresee a positive contribution in our NIM due to a small increase in our reference rate which is DTS, as our balance sheet is asset sensitive.

Fees are represented in Slide #10. This line remained stabled during the quarter at COP 542 billion. We continue to experience more credit and debit card transactions during this quarter. As a result, our effort to promote the use of plastic to paying to stores and increase the number credit cards in new segments.

Additionally, we saw a sustained level of insurance distribution fees, which generate about COP 75 billion during the quarter. We also have to take in consideration, fees from Banistmo operation this year.

Finally, we saw a good performance of our asset management business, product of greater volumes of assets under management. Since we have a very good performance of fees during the first half of this year, and we believe they should remain stable or even increasing a little bit in the next coming quarters, we raise our forecast for fee growth in 2014 to 12% for the whole year. Originally, we were expecting to grow only 8%.

In Slide 11, we present the evolution of expenses, which increased 7% during the quarter. This quarterly growth is totally explained by the 15% increase in administrative expenses, which reflected higher charges as we moved early in the year. On the other hand, labor expenses declined 0.9%. A key point when analyzing OpEx and I want to make a special emphasis on this, I think that we are starting to move towards IFRS regarding the treatment of expenses. Under this standard, we effect the income statement only where we actually incur expenses, whereas on the former Columbian GAAP standard, we projected total expenses for this year and we impacted the income statement on accurate monthly basis.

That’s why in the coming quarters, we might see some expenses that were not incurred at the first two quarters of 2014, the expenses reflected in 2014 including calculation cost of Banistmo.

Our guidance for this year is an increase of expenses of around 13% to 15% taking in consideration that we are having 12 months of Banistmo expenses. Excluding the Banistmo expenses, the Bancolombia Group will increase at around 8.5% year-by-year total expenses.

The cost-to-income ratio using the same methodology that we have used over the recent years was 57% during the quarter. This metric is calculated dividing the operating expenses plus goodwill amortization into operating income before provision charges. Now, if we exclude items that not exactly administrative expenses, like; first, goodwill amortization; second, deposit insurance costs; and third, depreciations from the calculation, the cost-to-income will be 47%.

This is a new element on the graph that we have been decided to show you just to reflect the real efficiency level of the bank, adjusting those three elements that we are removing from the cost of the bank.

On the bottom right hand side, we see how OpEx to total assets increased during the quarter as a result of higher expenses. Our efforts right now are focused on improving the efficiency of the bank. Revenue should grow faster than expenses. And the main drivers that cause growth, headcount and branch network expansion are very stable. Our goal is to perform a greater number of transactions through electronic and low-cost channels, such as mobile and agents.

Moving to Slide 11, we see the evolution of the net loans to deposit ratio, which increased to 101% during the quarter, as a result of the loan growth. During the quarter, we used the liquidity and cash from sale of securities in the portfolio to reduce the most expensive deposit and bank borrowings. During this year these loan-to-deposit ratio should be around 100%.

Regarding capital, on the bottom right hand side, we present the capital adequacy ratio at the end of the quarter. The Tier-1 ended at the level of 9%, higher than the 8.9% at the end of March. The increase was the result of the reduction of the market risk of assets. The 9% is well above the minimum required to operate in Colombia, which is 4.5%, and puts us in a comfortable situation of equilibrium between strength of balance sheet and the return for shareholders.

Slide #13 shows the return on assets and return on equities of the bank. Return on assets ended the quarter at 1.4% and return on equity declined to 12.3%, product of a lower leverage of the balance sheet due to the capital increase in March. Considering the capital raise and our net income forecast for 2014, we are expecting a return on equity of 13.5% to 14% for this year.

After presenting these slides with the first quarter numbers to you, I would like just to highlight where we stand today and our plans for the near future. In our balance sheet, we have been able to focus on lending business, reaching a high level of 69% of total assets. We have been able to maintain the loan-to-deposit ratio at around 100%. We maintain a high-level of quality of loan portfolio, maintain a stable level of past due loans. And we have been able also to maintain an optimal level of liquidity.

In terms of results, we want to highlight the improvement in the loan portfolio of NIM, that basically this first half of the year, we’re focused on reduced the funding cost. And the second half of the year, we’ll be focused on the appreciation of the assets because of the asset sensitivity.

Also we have better-than-expected fee income due to high level of transactions that we expect to sustain during the second half of this year. Also we have been – we want to maintain an optimal funding cost during the second half of this year. And we will be able to maintain provisions under control.

Having said this, we are happy to take any questions that you may or might have. Thank you.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Carlos Macedo from Goldman Sachs.

Carlos Macedo – Goldman Sachs

Good morning gentlemen. Congratulations on the strong operating results. I had one question and what wasn’t really operational, and hurt a little bit your top line which was investment, the margin on investments. Here, looking at the slide that you very graciously provided, number – if you could just get to Slide #9, you can see that for a very long time there was at least some consistency on the net investment margin, and then starting 2013, it was very volatile because of the volatility on the underlying securities. You mentioned that with the higher rates, we should expect this to improve a little bit going forward. What would be a typical run rate for this now that you have reduced your securities portfolio, and that you’re taking a little bit more conservative stance? What should we expect, assumingly it’s not going to be the 4% in the past, but is it going to be closer to 0%, 1%, 2% or where should we – at what level should we think about this going forward?

José Humberto Acosta Martin

Yes, thank you. We expect regarding the interest rates are coming in the country for the next coming quarters, probably a NIM of security portfolio between 0% to 1.5%, 2%. We are not expecting a huge net interest margin in the securities portfolio. The third and fourth quarter could be around 1%.

Obviously, we will see impacted mostly on the loan portfolio, because the appreciation of our assets, because we are asset sensitive. So, we are expecting an increase of the NIM of the loan portfolio maybe an extra 20 bps during the second quarter – the second half of this year.

Carlos Macedo – Goldman Sachs

Okay.

José Humberto Acosta Martin

But again on securities portfolio, we are expecting 1% for the second half of this year.

Carlos Macedo – Goldman Sachs

Perfect. Looking further out, we shouldn’t expect a return to the levels of 4% in the past. It should be more between that 1% and 2% that you mentioned before. Correct?

José Humberto Acosta Martin

Yes, correct.

Carlos Macedo – Goldman Sachs

Okay, perfect. Second question on loan growth. We did see a lot of loan growth from you on the corporate side, but still very limited growth or weaker growth, to put it that way, on consumer lending sequentially and still year-over-year only about 8% in Columbia. What is the backdrop for lending on the consumer side? Should we expect – now that asset quality has improved, should we expect with growth coming that you will be more aggressive in consumer lending going forward?

José Humberto Acosta Martin

Yes, we are expecting a loan growth in consumer loans at around 10%, which is in line with the financial sector and in line with the whole economy. Of course, in consumer we are at the end of the cycle, so we are not expecting a huge increase in consumer loans in Columbia. So our guidance for consumer, that would be an increase of 10% during this year.

Carlos Macedo – Goldman Sachs

But it would be reasonable to say that then in 2015, there should be a pick up there as well, right?

José Humberto Acosta Martin

Probably, it depends on the interest rate and inflation, but it’s fair to say that this year could be around 10%, and next year, we are expecting 10% to 12% to 13%.

Carlos Macedo – Goldman Sachs

Okay, perfect. Thank you so much.

José Humberto Acosta Martin

Thank you, Carlos.

Operator

The next question comes from Frederic Mariz from UBS.

Frederic de Mariz – UBS

Hi, good morning everyone. Thank you for the opportunity. A couple of questions on my side. A follow-up first on the loan growth. In the quarter, excluding Banistmo, you had a growth of 8.6%. I understand that the FX impact that you mentioned in your presentation, but you also mentioned again plus 10% to 15%. So apologies to insist, but where should we see the acceleration in the second half of this year. Is it mostly corporate? Does it related to the infrastructure stream in Columbia? Just getting a bit of color on this one. And then my second question is on the NPLs. We saw a very small increase in the NPLs for consumer and also for corporate. Just want to get a bit of color. I know it’s a small – it’s a low ratio and one of the strong ones in LatAm, but just wanted to get a bit of color on the trends, if there is any segment that you’re particularly concerned with? Thank you.

José Humberto Acosta Martin

Yes. As you said, Frederic, thank you. Loan growth, we are expecting obviously in the second half of the year, which is mostly focused on corporate. We expect again, and we reaffirm the fact that we expect to close this year 13% of loan growth.

And in terms of NPLs, we don’t expect that a specific deterioration, maybe in consumer loans, and that’s the result why we tight our credit standards, but we don’t foresee at least for the next two or three quarters any specific deterioration in any specific segment. And again, the second half of the year usually the loan growth is explained mainly by corporates in state of consumer loans.

Frederic de Mariz – UBS

That’s great. Thank you.

José Humberto Acosta Martin

I appreciate it, Frederic.

Operator

The next question comes from Tito Labarta from Deutsche Bank.

Tito Labarta – Deutsche Bank

Hi, good morning. Thanks for the call. A question, just trying to understand your, kind of, long-term outlook for profitability. I know you gave some guidance for this year of 13.5% to 14%. But if you think little bit longer term, you’ve mentioned in the past getting back to 17% ROE. So I’m just troubling to see how to get to those numbers given your loan growth guidance around 10% to 15% seems a little low, given the economy in Columbia is doing really well and asset qualities under control, with particularly not growing much on the consumer side, maybe difficult to see some margin expansion, even though you do benefit from higher rates because you’re asset sensitive. So just want to – should we expect this 14% ROE in the longer term, or if you do expect it to get back to 17% which you mentioned in the past, how do you think you can get there? Is it going to come from stronger loan growth, more margin expansion which seems difficult to be not growing much in the consumer? So just want to get a better sense of your long-term outlook for profitability? Thank you.

José Humberto Acosta Martin

Thank you, Tito. Yes, our guidance for medium term in terms of return on equities to go back to the level of 16%. And the main drivers to get that level for the next two or three years will be; first, try to maintain the cost under control and to get our efficiency level at around 15%. That will be the key element to go back to the level of 16%.

Second, the Banistmo operation will begin to give us more level of profits in the next coming years that will support a better return on equity. So those are the two main elements. It is hard to say that we will increase the net interest margin, because the competition landscape is very tough. We did our best, this half of this year, reducing funding cost, but the challenge right now is to maintain this funding costs and strength to take us on [indiscernible] more volumes in the loan portfolio and better interest rates because of the appreciation of the DTS, but Tito, mainly it’s for the efficiency side, and Banistmo operation.

Tito Labarta – Deutsche Bank

Great, thank you, José. Maybe just a quick follow-up on that, because you did just increased your guidance for expenses this year, I guess approximately related to Banistmo, but do you have some color just the total impact from Banistmo maybe in the quarter or what’s the ROE at Banistmo today, and how much you could expect that to improve?

José Humberto Acosta Martin

Remember that our expenses, which will grow 15% this year, 14% to 15%; 8% of that are explained mostly by Banistmo, because this year we will have 12 months of Banistmo and last year we only had two months. So the key measure here is the banking is growing 8% in terms of expenses, which is a very positive in average to compare the growth in the loan with the 10% to 15%, and that explains that.

Tito Labarta – Deutsche Bank

Right, but I guess, do you expect that then to improve. This is a one-time, given corporate money [ph] for this year and then kind of slows down in the future years?

José Humberto Acosta Martin

Yes, of course. We are expecting to grow the expenses for Banistmo in coming two, three years in line with 6% to 8%, because we are serially internally into the bank taking the right measures to maintain the cost and their control. You see for example, a very specific item which is the labor cost that remains very under control, the number is almost flat. And behind that, there is another expenses that we are seeing a very good performance.

Tito Labarta – Deutsche Bank

Great. Thank you very much. It’s very helpful.

Operator

The next question comes from Saúl Martínez from JP Morgan.

Saúl Martínez – JP Morgan

Hi guys. I have one question, and it’s regarding your ROE guidance of 13.5% to 14%. Correct me if I am wrong, but that implies earnings of roughly COP 2 trillion in 2014. And given that in the first half, you’re a little bit below a COP 1 trillion, you really have to be doing about COP 500 trillion per quarter. I am struggling with how to get there to be frank, given your guidance for expenses, which implies a very big sequential acceleration in cost growth, 13% to 15%. I understand the full-year looks fine. I understand the accounting changes and the move to IFRS creates greater seasonality, but just mathematically that implies high single-digit Q-on-Q growth in third quarter and fourth quarter. Your fees, you mentioned are flat to slightly up. And your NIMs are not really moving up much according to your guidance. So can you help me understand how you’re going to be doing – how your earnings are going to improve meaningfully off from the 2Q base given the very fast sequential acceleration in cost growth that you see, how do you get to COP 2 trillion of earnings? How do you get to COP 500 billon-plus in the third and fourth quarter to get to your guidance?

José Humberto Acosta Martin

Good morning, Saúl, and thank you. Yes, let's begin to talk about fees. Again fees, we really believe that we are right now able to get 12%, 13% in increase of fees, because we really are seeing an increasing of volume of transactions. As a result of that, you see debit cards and credit cards and bancassurance growing up. That will help us a lot in the second half of this year.

And going back to the first point, in the next two quarters we will have more loan portfolio and we will have a different interest rate because of the assets sensitivity. If you made the calculations, we clearly we will grow more than 9% our net interest income in the second half of this year, so that we will try to support the increase of expenses that you mentioned at the beginning of your question.

So the answer is mostly that will explain because of the net interest income, because the balance sheet and the loan portfolio will be stronger and with a better interest rates.

Saúl Martínez – JP Morgan

Okay. So just, when you say 9% in the second half of the year NII, what do you mean by that? That NII will be 9% higher in the second half than in the first half? Is that…

José Humberto Acosta Martin

Yes, exactly. That is correct.

Saúl Martínez – JP Morgan

Okay. So you’re seeing a nice pick-up in NII and that’s basically going to offset the higher sequential growth in costs and allow you to get to your number, but am I right, José Humberto, in saying that just to clarify that 13.5% to 14% really is when you back into the numbers close to COP 2 trillion of earnings?

José Humberto Acosta Martin

Yes.

Saúl Martínez – JP Morgan

Okay, great. All right, thank you so much. That’s helpful.

José Humberto Acosta Martin

Thank you, Saúl.

Operator

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

Jose Barria – Bank of America Merrill Lynch

Thank you, José Humberto and team. Just want to go back to asset quality and look at the new PDL formation that you saw in the quarter, which was very good at COP 173 billion. It’s much lower than the first quarter. There seems to be some seasonality in the second quarter. When I look at 2013, there was also a big move down. I just would like to understand is this level of new NPL formation is actually something that we could expect going forward, or if the second quarter was particularly low for – because of some seasonal factor? And then on the back of that, what is your forecast for NPL ratio for this year and next, if you have it? Thank you.

Juan Carlos Mora Uribe

We had during the second quarter, recoveries of the bad loans that we had during the last year. And we have a trend during the last three or four months that in the consumer portfolio that has maintained the level of our quality. So we expect during the next semester, we are going to have the same trend. We don’t know if the recoveries come, because those were specific in some credits, but the trend in consumer portfolio in its quality, we expect the same that we had.

José Humberto Acosta Martin

Remember then, to understand right now we’re happy with past due loans in the balance sheet in Bancolombia, in Panama 90-days considering not past dues. So we have to do a next driver [ph] in terms of provisions that implies that we will have some kind of volatility in terms of provisions for the first 90 days on consolidated basis under Columbian GAAP. So that’s the main issues that the team of risk is doing right now in Panama, trying to reduce that volatility of past dues between zero to 90 days.

Jose Barria – Bank of America Merrill Lynch

I see. So I guess going back to the question, the level of new PDLs that you see here in the quarter, which was COP 173 billion. Is that a normal run rate that you should expect for the second half of the year, or you’re not sure because of the recoveries?

Juan Carlos Mora Uribe

I think that, we are not sure about the recoveries, but we think that we expect that in Banistmo we are going to have better recoveries in the range that José just said to you. So we expect – I don’t know if the recoveries of the bad loans that we had before, but we are sure that we are going to have better recoveries in the range between 30 and 90 days.

Jose Barria – Bank of America Merrill Lynch

Okay, I see. And then I guess, finally the NPL ratio forecast that you’re working in your budget, what is it for this year?

José Humberto Acosta Martin

3%. At around 3% on the coverage, and around 150% Group.

Jose Barria – Bank of America Merrill Lynch

Got it. Thank you.

José Humberto Acosta Martin

Thank you, Jose.

Operator

The next question comes from José Restrepo from Serfinco.

José Restrepo – Serfinco

Good morning, and congratulations on the results. I have one question regarding guidance here, which is the loan growth you are expecting in the coming year and in 2015, and if you can give us like the long-term ROE expectation that you have?

José Humberto Acosta Martin

Thank you, José. As I mentioned previous – in the previous question, for long-term, our return on equity expectation is to go back to the level of 16%, again based on considerations that to improve the efficiency level.

And loan growth, really it’s a factor of the growth of the economy. And you know the financial institutions, we are growing 2x, 2.5x the GDP growth. So we are expecting for next year almost the same level that we are expecting for this year, which is 10% to 15% annual basis.

José Restrepo – Serfinco

Okay. Thank you.

José Humberto Acosta Martin

Thank you, José.

Operator

The next question comes from Thiago Batista from Itaú.

Thiago Batista – Banco Itaú BBA International

Yes, hi guys. I have just one question basically about the infrastructure projects. Could you comment on how much those projects can impact the bank’s operations in terms of loan growth and also on the bank’s margins?

José Humberto Acosta Martin

Thank you, Thiago. Yes, we’ve talked about it in the previous quarter conference call. Obviously the infrastructure projects, we will materialize those projects in our books maybe at the end of next year in 2015 or fully at the beginning of 2016, because that kind of projects will take time. Obviously, our position as a bank is number one in Columbia. We will be ready to participate in those projects, but again, we are still not have clear the tenors, we still not have clear how we will design the lending structure with the government, with the constructors. So again you don’t see these reaction in our books at least this year, or at least the second half of next year.

Thiago Batista – Banco Itaú BBA International

Okay, thank you.

José Humberto Acosta Martin

The point is infrastructure was not a key relevant item in our loan portfolio at least the next 12 months.

Thiago Batista – Banco Itaú BBA International

So the guidance of 10% to 15% is not incorporating any big impact of those projects?

José Humberto Acosta Martin

No. Or in the corporate loans, some of it, maybe we are seeing couple of projects and we are analyzing, but that would not be a trend because this kind of projects you know, very well that they will begin to ask for lending only after six or 12 months of being assigned to a different constructor.

Juan Carlos Mora Uribe

We have a delay, if we compare with expectations that we had for this year and the coming years, but we expect some growth in restructure portfolio at the second half of the next year, but we are going to have a little bit in the first half. I think that’s the answer for the question.

Thiago Batista – Banco Itaú BBA International

Okay, thank you.

José Humberto Acosta Martin

Thank you, Thiago.

Operator

The next question comes from Marcelo Telles from Credit Suisse.

Marcelo Telles – Credit Suisse

Hi, good morning, everyone. Thanks for the opportunity. Congrats on the good results. Most of my questions have been answered, but I have just two follow-up questions. Can you just remind me what your expectation for cost of risk is for the year, and where you think you could maintain going forward? And the second question is regarding your NII growth expectations for the second half. If you – there is a very strong growth embedded there, so I believe that the driver from what you talked about will probably be also like a higher margin on the securities portfolio. But my question here is also if you look at your available-for-sale portfolio, there seem to be a sale of the securities, and since you had realized some losses in the P&L right from this available-for-sale. So I was wondering, if that would also help your NII in the second half of the year, because probably now you’re going to be able to reinvest at a higher rate. I know you’re shortened the duration, but you think there is any positive impact arising from that sale, because you’re going to be able to invest at a high interest rate versus what it was originally recorded?

José Humberto Acosta Martin

Thank you, Marcelo. Cost of risk, we are expecting to maintain under control, and the cost of risk at the end of this year will be 1.5%, maintaining almost the same level as we had the previous years that was 1.6%.

In terms of NII, again the NII performance of the second half will be mainly originated because of the loan portfolio. We are not expecting from the securities portfolio, because as you probably remember, the second half of last year we decided to take several measures to reduce the volatility, the duration and the size of the security portfolio. So the first question I remember was, what was the potential NIM of your security portfolio? We are not expecting nothing between 0% to 1%. So we are not aggressive in this business line. We are maintaining the liquidity for the bank and to obtain our clients.

So the NII, the main characteristic would be because of the lending business. We are not expecting a huge support, because of the security portfolio. Again, it could be 0% to 1%.

Marcelo Telles – Credit Suisse

Okay. Yes, I asked that because if you look at the – as you mentioned earlier, the yield to maturity of your securities portfolio, I think you said it was like 4.3%. Correct?

José Humberto Acosta Martin

Yes.

Marcelo Telles – Credit Suisse

In the second quarter, but if you look at where the DTS is today, it seems low compared to the repo rate, right, that is at 4.25%. I know you’ve shortened the duration. So most likely this is also expected to increase, I believe.

José Humberto Acosta Martin

Yes, that would be – that’s true. That probably would increase, but our expectations is regarding DTS, and increasing on DTS. So we don’t want to take in consideration any other particular gains because of the interest rate of the securities portfolio.

Marcelo Telles – Credit Suisse

Okay. Great, thank you very much.

José Humberto Acosta Martin

Thank you, Marcelo.

Operator

The next question comes from Boris Molina from Santander.

Boris Molina – Santander Investment Securities

Yes, thank you. Good morning. We have just one remainder. What is your budget for integration expenses at Banistmo for this and next year, and how much did you spend in the second quarter? I remember there wasn’t much of an impact in the first quarter. So I just wanted to get an idea of how much was the impact this quarter, and what do you expect of the full-year this year and next year?

José Humberto Acosta Martin

Regarding Banistmo operation we are contemplated – I would say the other way around. We are contemplated that the profits for the operation in Banistmo this year could be around $80 million. And that includes the integration of parent that we will expand, there in Panama. So remember that we have a contract during 18 months to implement some of our systems. So this line of expenses that will be reflected also as a major value of pieces of software. So that would be OpEx.

So we don’t expect at least more than $15 million to $20 million in expenses regarding the projects of IT in Panama.

Boris Molina – Santander Investment Securities

And if this figure is expected to come down significantly next year, or this should be a similar number?

José Humberto Acosta Martin

It could be a similar number, because the integration process will take one year and a half. So we do expect these two years to have same level of CapEx.

Boris Molina – Santander Investment Securities

Okay. Wonderful, thank you.

Operator

The next question comes from Cristian Hernández from Ultrabursatiles.

Cristian Hernández – Ultrabursatiles

Hi guys, congratulations on your results. I was wondering – I’ve got two questions. First question is related to the cost of funding. How much do you guys expect it could go down eventually in the mid-term according to your strategy? And the second question is related to the efficiency ratio. What you guys expect would be the efficiency ratio at the end of the year, and how low it could get by the next year? Thanks.

José Humberto Acosta Martin

Okay. Thank you, Cristian. Cost of funding, I would say that we took the advantage in the last 12 months and you saw a huge reduction of almost 70 bps in the funding cost. For the next coming two years, we don’t expect to reduce more of the funding cost. The other way around, we feel pressure to increase the funding cost, because the interest rate is going up, but the counterparty will be the asset side that will help us to offset that increase of the funding cost. So again, cost of funding, the better in terms of reduction happen in the last 18 months.

In terms of efficiency, we will try to get to a level of 53% at the end of this year, and we are trying to realize it in 2016, we get to the level of 50% of efficiency ratio in the next coming two, three years. And the best way to understand that is if you check the number comparing expenses versus growth of assets, right now we are below 4%, which reflects that we have been able to grow faster the assets than expenses.

Cristian Hernández – Ultrabursatiles

Low as you can get, right?

José Humberto Acosta Martin

Right.

Cristian Hernández – Ultrabursatiles

Okay, thank you.

Operator

The next question comes from Alonso Aramburú from BTG Pactual.

Alonso Aramburú – BTG Pactual

Yes, hi. Good morning. Just a follow-up on your investment portfolio. Just wondering if you feel like you have more space to reduce the investment portfolio as a percentage of your asset mix in coming quarters similarly to what you did this quarter? And also on your investment margin. You mentioned comments regarding some of the measures that you took at the end of last year. I believe that includes some hedging on the portfolio. It used to be the case when you had a quarter with normal rates or most of your [ph] rates you had like 1% or 2% interest on spreads, but it seems like these days it’s close to flat. So my question is, is that what we should expect going forward if we have a quarter in which rates don’t move that much, your spreads should be close to zero?

José Humberto Acosta Martin

Thank you, Alonso. Regarding the size of the security portfolio, we don’t expect to reduce that level of security portfolio, because one of the pillars of this bank is liquidity. So we want to maintain the level that we are having right now. So we want to reduce more – the reduction we did where mostly to reallocate to the lending business, which was a very good strategy, because that was reflected in the net interest income.

Regarding the NII for the securities portfolio. Again, we do prefer to not count with value of rates in Columbia, and again we believe that the NII or the NIM from security portfolio, we’ll be looking at 0% to 1%. We are not expecting more than that.

Alonso Aramburú – BTG Pactual

Okay, thank you.

José Humberto Acosta Martin

And going to your first question. That would be the size of the security portfolio that we want to have, mostly because of the liquidity.

Alonso Aramburú – BTG Pactual

Great, thank you.

José Humberto Acosta Martin

Thank you, Alonso.

Operator

The next question comes from María Alejandra [ph] from Asesores en Valores.

María Alejandra [ph] – Asesores en Valores

Well, good morning and thank you for the presentation. I would appreciate if you could please provide some color on target loans to assets, if you would expect to maintain the 69% reach for the second quarter, or if you expect to keep increasing maybe?

José Humberto Acosta Martin

Thank you, Alejandra [ph]. We want to maintain this – the 69% is [indiscernible] sign of the asset side. So we don’t want to increase. We will maintain the 69%, 70% of loan portfolio. And we will maintain 9% or 10% in security portfolio. We won't change that mix. Again, we have to have liquidity, and because the 69% is comfortable [ph]. And the growth that we are expecting which is 10% to 15% we can certainly meet.

María Alejandra [ph] – Asesores en Valores

Okay. Thank you very much.

Operator

The next question comes from Philip Finch from UBS.

Philip Finch – UBS

Thank you very much for the presentation just now. Couple of questions. One is a follow-up really. You were talking about cost growth and NII growth of 9% in the second half. Can you just repeat what is your targeted efficiency ratio, or cost income ratio by the end of this year, and whether you have any, sort of, targets for next year? And my second question is to do with your effective tax rate which fell down 70 basis points. Any reason why it’s a bit lower this quarter? And going forward, what should a sustainable level that we should be working on? Thank you.

José Humberto Acosta Martin

Thank you, Philip. Regarding cost of growth – regarding efficiency ratio, again we are expecting to grow this year at a level of 53%. Remember that two years ago, we were at a level of 59%. So we are doing our job regarding efficiency ratio. And the guidance for the next three years, again, is go to the level of 50%.

Cost growth is – and we tried to explain that. This year we are registering the real expenses that we are doing in the bank, because of the IFRS. In the past, we made our calculation for the projected expenses every month. So that’s a reason why the first quarter you saw a very low level of expenses, because generally you have only two weeks of costs of expenses of different stakeholders that work with us.

So the second half will be important, and the increase of cost for the whole year will be 15%. The first half only is 7%.

And regarding the taxation, we are expecting our taxation rate of 28% during the whole 2014.

Philip Finch – UBS

Okay, that’s very clear. José, can I just go back. So with the adoption – the early adoption of IFRS this year, surely next year the quarterly performance in terms of costs should be a lot more smoother. Is that an assumption we can make?

José Humberto Acosta Martin

Absolutely. That is correct, Philip.

Philip Finch – UBS

Great. Thank you, José.

Operator

With this, we have reached to the conclusion of our Q&A portion. I would like to turn the meeting over to Mr. Acosta for any final remarks.

José Humberto Acosta Martin

Okay. Thank you for participated in our conference call and for your questions. Hope to see you in the next conference call that will take place in November. Thank you very much.

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. We thank you for your participation. You may now disconnect.

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