Bancolombia S.A. (NYSE:CIB)
Q3 2016 Earnings Conference Call
November 22, 2016 8:00 AM ET
Juan Carlos Mora – Chief Executive Officer
Jaime Velasquez – Chief Strategy and Finance Officer
Jose Humberto Acosta – Chief Financial Officer
Rodrigo Prieto – Chief Risk Officer
Juan Pablo Espinosa – Chief Economist
Jason Mollin – Scotia Bank
Nicolas Riva – Citi
Thiago Batista – Itau BBA
Tito Labarta – Deutsche Bank
Ernesto Gabilondo – Bank of America
Catalina Araya – JPMorgan
Sebastian Gallego – Credicorp
Natalia Casas – Ultraserfinco
Andres Duarte – Corficolombiana
Maria Barriga – Davivienda Corredores
Good morning, ladies and gentlemen, and welcome to Bancolombia's Third Quarter 2016 Earnings Conference Call. My name is Hilda and 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, in future filings, in press releases or verbally address matters that involve risk and uncertainty. Consequently, they 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 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 the SEC.
With us today is Mr. Juan Carlos Mora, Chief Executive Officer; Mr. Jaime Velasquez, Chief Strategy and Finance Officer; Mr. Jose Humberto Acosta, Chief Financial Officer; Mr. Rodrigo Prieto, Chief Risk Officer; Mr. Humberto Hernandez, Chief Accounting Officer; Mr. Alejandro Mejia, Investor Relations Manager; and Mr. Juan Pablo Espinosa, Chief Economist.
I would now like to turn the presentation over to Mr. Mora, Chief Executive Officer of Bancolombia. Please proceed, sir.
Juan Carlos Mora
Good morning, everyone. It's a pleasure to be here with you today to share Bancolombia's results during the third quarter. During the quarter, we generated COP 604 billion in net income, which represents an annualized ROE of 12.4%. The evolution of the business during this quarter was positive and in line with our expectations.
The figures for the quarter confirm our forecast and the trends observed in previous quarters. Operational metrics such as loan growth, net interest margin and income, fee, revenue and efficiency continue evolving very well. Despite an increase in provision charges due to individuals and SMEs, the net interest income after provisions grows in a very positive way compared to one year ago. As a matter of fact, if we analyze our revenues, net of provisions, that is net interest income plus fee income minus provision charges, you can see a 29% year-on-year growth as compared to the third quarter of 2015.
For the first nine months of 2016 the figure is 25%, higher than one year ago. This shows the excellent performance of our operations and shows the Bank's competitive advantages. Our operation in Central America continues evolving according to our plan. Today, they represent a challenge due to the complex political and economic situation, in particular, in El Salvador.
Nevertheless, we see opportunities for increasing the profitability and efficiency and as a result, a bigger contribution to Bancolombia's consolidated returns. In particular, we are focused in improving the process in Banistmo, in Panama, integrating the operations in Banco Agromercantil de Guatemala and maintaining the profitability in Banco Agricola in El Salvador. On the other hand, Bancolombia Colombia is making extraordinary progress in achieving efficiency levels not seen in the last five years. As we have seen during the first half of the year, a moderation in the pace of economic activity continues.
Nevertheless, we have also seen dynamism in certain sectors, such as construction, manufacturing and services, which continue to improve as the domestic economy remains resilient and benefits from a weaker currency. The peso and the exchange rate have presented a relative stability, although after the elections in the U.S., we have seen increased volatility. Our results for the quarter put us in our way of achieving superior ROEs and I will reiterate the Bank's focus and commitment to generate desirable and sustainable levels of profitability.
We like also to emphasize that increasing profitability in all geographies added to boosting efficiency will be the two fundamental drivers going forward to reach our performance objectives in the stipulated time periods. In addition to the financial performance, we also want to emphasize four aspects of our strategy: first, more relevance of our retail business in the compositions of our revenues, especially in the net interest income; this is an effort to improve profitability by better selecting our risks and allocating capital to assets that generates higher risk-adjusted returns; second, focus on efficiency; by optimizing our processes and systems and implementing very strict cost control strategies; innovation as the avenue for engaging more customer's in Bancolombia's network in an efficient and profitable way; and finally, increasing the profitability of our international operations. We already have to set-up the market, now we are working on improving the processes and improving the profitability of each of the operations. Additionally, I would like to mention that today Bancolombia has the largest distribution network in Colombia, El Salvador and Guatemala.
In particular, in Colombia, where the population is spread across the country and our large network of branches and ATMs permits to target all type of clients. The main advantage of this coverage is that it permits to have the lowest funding cost and the most stable funding structure in the whole system. Nevertheless, we acknowledge that having such a massive infrastructure is expensive. The balance of both advantages and expenses is positive for our Universal Banking strategy. With this in mind, we are gradually shifting our construction from the classical branch towards other channels with a little or no marginal costs such as mobile or Internet.
Today Bancolombia processes 48% of the total transactions of the Colombian system, more than two times the market share that we have in loans. Additionally, out of the total number of transactions that Bancolombia process, 68% are conducted through internet and mobile devices. This compares to 47% of the whole system. These facts represent a competitive advantage of Bancolombia when conducting transactions through low cost channels and it's a cornerstone of our efficiency strategy.
The bigger the proportion of transactions through electronic channels, the greater the efficiency of the Bank and the bigger the capacity to increase capillarity and monetize the massive amount of relationships that we have with our clients. That is precisely our path for the future, to be able to grow our transactions with clients, increase volumes, and of course, revenue at the lowest possible cost.
The demographics of the geographies where we operate create the perfect condition to take advantage of new technologies in order to attract more individuals to the formal banking sector. The main goal with our digital initiative is to be able to materialize efficiencies in growth in a substantial way. Having said these, I would like to continue with the presentation of Bancolombia's financial results for the third quarter of 2016.
Now I will turn the presentation over to Jose Acosta, who will elaborate on the main topics that impacted our business in this period, Jose?
Jose Humberto Acosta
Thank you, Juan Carlos. Slider number 3 shows the profitability of the Bank. As you can see, the third quarter shows a 66% growth in profit before taxes as compared to the third quarter of last year, which is this positive evolution of the business, which has been possible, thanks to better performance of NII, NIMs, cost control, and fee generation. The quarter saw – shows a reduction in profit before tax and in the bottom line as compared with the previous quarter, caused mainly by higher provision charges that we did during the quarter in order to protect the balance sheet. Operational metrics, in particular, net interest income continued to perform very well as a result of the stability in the lending NIM and higher volumes.
As Juan Carlos mentioned at the beginning of his presentation, the expansion of NII has permitted to offset the higher provision charges and for the first nine months of this year to grow income before taxes by 29%. We want to highlight this number because it reflects the good performance of the Bank. Additionally, net fees continue growing at a very good pace, driven by higher utilization of our products and channels. Regarding taxes, we had an effective tax rate of 38%, in-line with our expectations. We forecast an effective tax rate of approximately 39% for the whole year, assuming at year-end FX rate similar to the current one, COP 3,000 per dollar.
Nevertheless, as we have previously mentioned, the tax rate for the year will be subject to any variation in exchange rate. We will only know the tax payable at the very last date of this year. All included, we are very satisfied with these results because they show the strength of Bancolombia. The ability to fund a bank at the lowest cost in the markets where we operate, the capacity to transfer interest rate to the asset side, and the ability to generate capital in an organic manner. Moreover, we take advantage of our strong distribution network, more than 7 million customers in Colombia and 4 million in Central America, along with our Bank's strong local capital market position. We keep paying special attention to the credit quality in order to prevent further deterioration on higher provision charges. Now we would like to continue with a brief discussion about the economic environment. For this purposes, we have Juan Pablo Espinosa Bancolombia's Chief Economist who will elaborate more on these matters. Go ahead Juan Pablo.
Juan Pablo Espinosa
Thank you, Jose Humberto. Now I'll ask you to go to Slide number 4 in the presentation. During the past year, some of the major Latin American economies have been affected by a combination of the international headwinds and internal difficulties. As a result, the region's GDP is expected to contract by 0.6% this year.
However, we expect economic growth in Latin America to pick up to 1.6% in 2017. Despite these, it is important to bear in mind that risks are biased to the downside. For instance, the results of the US Presidential elections raise doubts about the future path of the American economy and the way in which the new administration will refine its relationship with Latin America. Regarding a specific country, we anticipate that next year Colombia will start a recovery cycle that will gain full traction in 2018. Some drivers for a more dynamic internal demand would include this stabilization of terms of trade, the moderation of inflation, and an acceleration of private investment.
Therefore, in our baseline scenario, growth will accelerate from 2% this year to 2.6% in 2017, and 3.4% in 2018. In terms of prices and interest rates, we foresee that the deceleration in inflation that has taken place during the past few months will persist, thanks to our normalization of goods supply and products in the economy. As a result, we expect that inflation at the end of this year will be 5.9%, and by December 2017, will be around 3.9%. Eventually, this will lead to an easing cycle in the monetary policy. However, the Central Bank's recent communications have been marked by the hawkish tone. This can imply that start of the rate cuts could take longer than initially expected. Based on our growth and inflation expectations, we forecast that growth in Colombia will start to recover by the second half of next year.
In the case of Panama, latest activity indicators conforms our moderation in growth this year to approximately 5%. This reflects the sensitivity of the Panamanian economy to global growth and great conditions. Nevertheless, activity will strengthen in 2017% to a 5.6% EBITDA growth, due to investments in mining, logistic and infrastructure, and an expansionary fiscal policy. In El Salvador, our perspective is going through a steady expansion of economic activity. Private consumption has been performing well, and this will lead to a 2.3% growth this and next year. Finally, in Guatemala, we expect activity to expand in 2016 close to the country's potential rate, which is around 3.5%, and to pick up in 2017 to 3.8%, due to higher investment and a stable interest rate. After this overview of the economic environment, let me turn the presentation back to Jose Humberto Acosta, who will discuss the Bank's results.
Jose Humberto Acosta
Thank you, Juan Pablo. On slide five, we see the evolution of assets and their composition, some important facts about Bancolombia's assets and loan portfolio. Today, peso-denominated loans represent 63% of the total loan portfolio of Bancolombia, while dollar denominated represents 37%. Also the Colombian peso appreciated 1.3% against the US dollar during the second quarter and 7% over the last 12 months. Loans, outside Colombia, represents 28% of the total loan book. Our loan portfolio in US dollars expressed in dollars decreased 15% over the last year due to a lower demand of US dollar financing in Colombia.
And finally, all the products are growing in line with our expectations and forecasts. Total assets grew 9.3% year-over-year, in line with our organic target of 10% growth for this year. Loan portfolio growth is primarily driven by consumer and commercial loans, which continue to exhibit the sustained growth at around 10% for this year. Nevertheless, we start to see the positive impact of seasonal effects on consumer credit demand and towards the end of September.
We experienced acceleration in this product with 13% year-over-year growth. This is basically because we are using new tools of analytics and we are able to increase the level of pre-approvals from retail clients and we are able, right now, to increase the loan portfolio at around 13%. In consumer loans, we focus our strategy in targeting high-income individuals and segments with low indebtedness levels as a way to grow with lower risk in these clients. The main input for our scoring models is a track record of the client along with the payment capacity.
The average yield-to-maturity for the investment portfolio is 6.7% and we continue to maintain a structural debt portfolio primarily for liquidity management. Also, the duration of the securities portfolio continues to remain low at a level of 17.8 months which minimizes the risk in a very volatile environment. We continue originating loans with a strict underwriting standard in order to maintain a good credit quality of the loan portfolio, especially in the consumer and SME segments.
The loan portfolio in US dollars decreased during the last 12 months affected by FX rate, we just mentioned, and by moderation in credit demand. The loan portfolio is growing less than what we saw in 2015, which is in line with our risk and credit standards, since the Colombian economy will be growing around 2% this year and that will be 2.6% next year. We see some opportunities in sectors such as manufacturing, touring, and infrastructure. Many of these sectors have been positively impacted by the weak peso. That is why we maintain our growth forecast for 2016 to 10%. We are going to still focus our growth in the less risky products as we want to maintain a very healthy balance sheet.
Last but not least, we want to highlight a fact that is very important to understand our view on capital. That is the high regulatory capital consumption of all our assets. The proportion of risk weighted assets plus market risk to total assets is 87%; a ratio that is very high and also give us comfort because the risk weightings are very conservative in the Colombian regulatory framework. The guidance of loan growth for 2017 will be at around 10%. Now on Slide number 6, we present the snapshot of credit quality at the end of the quarter.
We saw a deterioration in the quality of the loan portfolio and the coverage ratio of C, D and E loans, the SMEs and the consumer group in particular, credit cards and car loans were the main contributors to the past due loan formation. As a result of the deterioration, 30-day past due loans to total loans ended at a level of 3.4% and the coverage ratio declined to 116% coming to a 120% that we had in the previous quarter. We forecast to have a 30-day coverage ratio ranking from 110% to 120% in the medium term, which we believe is more than enough to absorb potential credit losses. Similarly, 30-day past due loan should represent between 3.2% and 3.5% of gross loans.
At the bottom of the table, we compared 30-day past due loans which is the Colombian standard and 90-day past due loans which is a better indicator of credit quality, as we have significant portion of our assets in countries that use that standard. The run-offs on past due loans that were past due 30 days, three months ago caused us the 90-day ratio to increase to 2.2%. Slide number 7 shows the provision charges, which were COP 791 billion during the quarter. For the first nine months, the annualized cost of risk has been 1.8%.
In the shaded row of the table at the bottom represents the amount of loans that became 30-day past due during the quarter. The COP 892 billion new past due loans is a significant increase as compared to the previous quarter and a reason to be careful with the portfolio. Most of the new past due loans came from the consumer segments, in particular credit cards and car loans. In the corporate side, we have not had any particular problem with the sector or client. Regarding the issue with Grupo Wisa and Waked, we are glad to say that despite the problems that the clients face in Panama, all the banks, the Panamanian government and US treasury worked out on a solution to create a special purpose vehicle that is collecting the payments and serving the banking obligation.
As a result, we do not estimate to have any loss related to these loans, which are financing basically commercial real estate assets. As we have talked about in the recent months, the Central Bank hiked rates at the beginning of this year and we are now stable at an all-time high. These trends translated positively into the better margins, but this have a negative effect over growth of the broader economy.
We believe we have sufficient amount of risk appetite and have not made a change to our initially strategy from the beginning of this year. We will continue monitoring the performance of the loan portfolio and making sure that the new vintages are disbursed under more stringent underwriting standard. Our forecast of cost of risk for 2017 will be 1.8% to 1.9%. Moving on the Slide number 8, we see the evolution of net interest income and funding costs along with the funding composition. As we have seen in the second quarter, this is the most positive trend in our business, because over the last 12 months we have been able to grow NII much faster than the volume of loans and as a result, the operating income of the Bank has grown steadily as well.
This is a combined effort of two fronts. First, optimizing the funding terms and its structure in order to keep cost as low as possible, and second, pricing loans at higher spreads. NII for 3Q of this year was COP 2.5 trillion, 42% greater than the same quarter of the previous year and that was driven mostly by; first, higher loan volumes which grew 11% over the last year; second, higher spread of new originations both in pesos and US dollars; third, an increase of 191 basis points in the DTF, which is the benchmark rate that we use to price a significant portion of our loans in Colombia; and fourth, the evolution of LIBOR as well had a positive impact in the dollar lending NIM.
Bancolombia's funding cost was slightly pressure upwards mainly by higher cost on long-term debt and time deposits. This is the outcome of the Central Bank's interest rate hikes and a relatively tighter liquidity environment that has increased funding competition among banks. The retail deposit base in our foreign operation has also performed in a very positive way, as we keep our asset sensitive condition and the stability of these deposits remains. The total funding cost increased by 34 basis points during the quarter, while the Central Bank reference rate increased 25 basis points and the DTF increased 18 basis points.
During the year, we have focused our efforts not only on keeping the funding cost as low as possible, but also on increasing the average time to maturity of the stock of liabilities, in particular time deposits and long-term debt. The outcome of this strategy has been the stability in the lending NIM that we saw in the third quarter. Our goal is to keep funding cost as low as possible, which we have been able to achieve over the past months, while maintaining a conservative approach to liquidity risk management in an effort to defend or expand the NIM and grow the NII. We have in our favor the before mentioned asset sensitive condition of our balance sheet, which is beneficial for margins. Turning the page to Slide number 9, we show the net interest margin. During the third quarter of this year, we saw a light increase in the reported net interest margin to 6.2%, 10 basis points above the last quarter, explained basically because of the investments in net interest margin.
In particular, regarding the investment in net interest margin, three main factors positively impacted those investments; first, the appreciation of the Colombian treasury and some other securities even though the investment portfolio saw only 7% of our total assets; second, investment flows mainly from international players entering the Colombian fixed income market; and third, more clients demanding in structural products for hedging purposes such as FX, swaps, options.
In the lending business, we saw a stability of the NIM as the interest rate hike cycle seems to have little effect in the repricing of the balance sheet. Due to the asset sensitive condition of Bancolombia's balance sheet, we intend to reduce our sensitivity to potential interest rate cut that we could see in the first months of next year. This is intended to maintain the NIM as high as possible for long as possible.
The Colombia operation showed strongest NIM because of the repeated rate hikes during the quarter, while NIMs in Central America are lower. At the end of the quarter, we had an unconsolidated NIM for Colombia of 7.1% compared with the 3.9% in Banistmo, 6.5% in Banco Agricola, which is a very positive number and 5.5% in Guatemala for Banco Agromercantil operation.
Despite the lower numbers in Panama and Guatemala specifically, we did benefit substantially from the higher NIM environment in Colombia. For next year, we see challenges in the NIM and NII front, as we forecast interest rate cuts in Colombia in the first months of next year. Nevertheless, the NIM from US dollars should benefit from potential hikes from the Fed and you will be reflected that in the LIBOR-base. We are designing our plans for next year, and we are focusing our efforts in keeping the deposits at low cost as possible. In particular, savings accounts as a vehicle for our clients to keep their money in the systems; current accounts, which benefit from our transactional capacity; and CD as a mechanism to provide stability of funds and enhance the maturity profile.
A breakdown analysis of fees is presented on the slide number 10. Fees are another front where we continue making progress, as can been seen in recent results. During the third quarter, net fees increased by 3.4% and they grew 15.2% as compared to the third quarter of last year. Of this annual growth, Banco Agromercantil contributes with 3.2%. The main services and products that lead the fees growth were banking and ATM services as well as debit and credit card fees. We are experiencing sustained growth in cards and usage in Colombia, due to rising income of individuals, and also of the promotion of plastic as a method of payment. We continue to see more credit and debit card transaction, as a result of our commitment to promote the use of electronic methods for in-store transactions. In addition, we are tapping into new business segments when it comes to promoting and introducing numerous benefits and customers rewards initiatives. Today, Bancolombia has 25% market share of the system, billing an 18% of the number of cards outstanding in Colombia. Banking services and asset management were also a major contributor of fee growth during the quarter, as well as asset management.
In addition we saw a sustained performance of insurance distribution fees, which generates COP 75 billion during the three quarter and grew 26% year-over-year. Fees represented 70% of operating income of this quarter, which is the good share since fees are transactions that do not require a significant amount of capital compared to the lending business. These fee initiatives are not limited to Colombia and we are focusing on steadily growing the credit card segments in El Salvador, Guatemala and Panama. To give you an idea how relevant is the fee business in El Salvador, we implemented a bank assurance business and now this is the first line of fees in the Banco Agricola operation.
As Mr. Mora mentioned at the beginning of the presentation, Bancolombia has an indisputable relevance in transactions in Columbian Banking System. Since 2011, we have been gaining market share of the number of transactions executed in the Colombian banking sector. We went from 37% in 2011 to 48% in 2015. During the same timeframe, our market share of loans has ranged from 21% to 24%.
The actions that permitted these gains are part of our strategy to use electronic channels as the path of interact with more individuals and corporations. We look forward to continue being the leader in the payment systems and to monetize these important competitive advantage. Finally, we forecast a fee growth of around 10% for next year. Now, moving to Slide 12, we present the evolution of expenses. Total operating expenses grew 12% year-over-year or COP 173 billion.
When analyzing this growth in marginal terms, we find that Banco Agromercantil represented 64% of the increase. In other words, excluding Banco Agromercantil, the year-over-year growth would have been 4.2% which is below inflation and it's a very positive number in the Colombian operation. Excluding Banco Agromercantil, the cumulative operating expenses as of September grew 10.3% compared to the first nine months of last year.
The cost-to-income ratio improved significantly quarter-over-quarter because of ongoing cost control initiatives and strong NII growth, this level was 47% for this quarter. Our target is to maintain this number under 50% for the year in the short term. Operating expenses consist primarily of personal expenses and administrative expenses, which are being kept under control in the respective currencies.
As was stated last quarter, Bancolombia is committed to developing lower cost channels based on technological innovation and optimal consumer segmentation, as we strive to grow the expenses in line with nominal GDP. Our guidance for 2017 is an increase of expenses by 8% on organic level, which we believe will be key in obtaining a strong profitability level. Moving on to Slide 13, we see the evolution of the net loans and deposits, which have moderated the pace of growth in recent months. The net loan to deposit ended the quarter at a level of a 115%, slightly below the figure shown in last quarter. This ratio has become relatively stable over the last year and it's a level where we feel comfortable.
The proportion of loans that we do not fund with deposit is funded with long-term debt in order to have a similar duration in both sides of the balance sheet. This strategy reduces the volatility of the net income and shareholder's equity. It makes more sense to us to fund long-term loans with long-term liabilities and that's why the 115% of level. Regarding capital, at the bottom right hand side, we show the capital adequacy ratio. The Tier 1 is at a level of 9.05%, 455 basis points above the regulatory minimum of 4.5%. This is a very good ratio and most importantly, the continuous growths in domestics lead us to reaffirm our estimation that 2016 would be a year of capital accumulation.
If we consider a dividend payout of one-third and appropriate the remaining portion of the earnings, we estimate that in March of 2017 you could see our Tier 1 ranging close to 9.5%. Nevertheless, as we have shared with you in the past calls, the capital levels that Bancolombia present today are optimal for the business plan that we have designed; in particular, we identified four factors to support our thesis. First, the Colombian regulatory is very conservative and the risk-weighting of assets is very high. Nevertheless, Bancolombia is well above the regulatory capital level and that give us comfort. Secondly, the simple leverage of Bancolombia is very low. Third, when we run our model to estimate economic capital required to operate the bank, we find that the requirement is to have a Q1 of 4.4%, which is very similar to regulatory requirement. Four, we have 22% of our equity is in dollars, which mitigates the impact of depreciation of the Colombian peso on risk-weighted assets.
Finally, given the business cycle that we are going through today, we do not see the need to have more capital. The credit growth forecast for this year is very moderate and we will organically generate the capital to achieve that growth. As we have said before, we look to operate the Bank at an optimized Tier 1 ranging from 8% to 9%. For the Tier 2 ratio, we ended this quarter with 4.4% for a total BIS ratio of 13.5%, above the regulatory threshold of 9%. Slide 14, shows the return on assets and return on equity of the bank. The return on equity for the quarter was 12.4% and return on assets 1.3%.
These metrics where impacted by the combined effects of very good revenues, net interest income and fees but also higher provision charges. We expect to continue growing net income, although at a moderate pace, while maintaining a solid solvency indicator for the rest of this year and improving profitability. Our estimated return on equity for 2016 would be 12%, while the medium term target continues to be at around 15% to 16%. As you can see the Bank has achieved most of the plans we have designed in order to increase our profitability. First, our focus on profitability, this will come with a combined effect of moderate growth in our lending business and stability in NIMs. Second, our focus on efficiency, this is a necessary condition to sustainability and profitability, the 47% that we posted this quarter, it's a very good and we expect to operate below 50% in the coming years.
Third, capital generation, we are building equity as we generate profits and better locate our assets, getting a level of 9.05% of Tier 1. Four, focusing in optimization of our international operation through locking better levels of efficiency and increase the profitability of our lending business. And finally, innovation is a key element to increase our market and reduce expenses. After presenting these slides and discussing our third quarter results, I would like to invite our audience to ask any questions you might have and we are gladly to take it from there.
Thank you. [Operating Instructions] We have a question from Thiago Batista from Itau BBA.
Yeah, hi guys, thanks for the opportunity and thanks for a very complete presentation. I have two follow-up questions. The first one about margins, you already mentioned that the interest rate in Colombia will probably decline in 2017. In this scenario and after a very positive performance of margin in 2016, do you believe, it is possible to see margins relatively flattish next year or is more likely to see some decline in the margins?
And the second question is about tax, I know that you already mentioned that the tax probably would be around 39% this year, but do you have any guess for the level of tax in 2017? I know that there is a lot of moving parts but do you have any view on the tax in 2017?
Jose Humberto Acosta
Thank you, Thiago. Regarding your first question, yes we see a challenge for the next year regarding how to sustain the NIM. Our focus right now will be to maintain the funding costs under control. Our sensitivity is, for every 100 basis points that are retained, the interest rate will be reduce or increase our NIM, 9 bps. Based on that assumption and assuming that the interest rate goes down, maybe the compression of the NIM at around 10 basis points. But again, next year also, you'd see a huge potential of maintain the funding cost under control, if you double check and compare us with the other institutions, we today are able to have the lowest level of funding cost. So the answer is, yes, we'll try to maintain at the same level, but we will see a slightest reduction in the second half of 2017 in 10 basis points. Regarding your second question with the taxation and our statutory tax, we are modeling the next year with a tax at around 38% to 40%.
Thank you. Our next question comes from Nicolas Riva from Citi.
Yeah. Thanks Jose Humberto for taking my question. The first one on asset quality, if you can explain what happened really this quarter, because we saw an increase of 20 basis points overall in the NPL ratio for the whole Bank and we saw increases in all three segments; commercial 20 basis points, consumer 30 basis points, mortgages 10 basis points. If you can explain what happened in the third quarter on NPLs? And also, what's the outlook for the NPL ratio fourth quarter and next year?
And the second question on capital, which I believe was one of the main positive highlights on the quarter. The improvement in capital, Tier 1 ratio increased 60 basis points quarter-on-quarter 9.1% now. Now I understand that Colombian banks capitalize return earnings only once a year and that happens in the first quarter, which is going to be first quarter next year. So then, what really explain the improvement in capital, and if it was mainly really just the fact that the risk-weighted assets were about flat quarter-on-quarter? Thanks.
Jose Humberto Acosta
Thank you, Nicolas. Regarding the asset quality, there are several factors that affect the deterioration of the loan portfolio. First, the vintage of the consumer loan book that we generate last year behaving in a different way, and right now, we are adjusting those scoring models, but that was the first reaction. We saw an increase of deterioration, because of that; the vintages of consumer credits originated the last year.
Second, there are some corporate loans that impacted the deterioration of the loan portfolio and the Panamian operation also has an increase in credit cards operation and consumer loans, that was impacted, and that's the reason why you see an increase of deterioration of the loan portfolio. Our guidance in cost of credit, as I mentioned at the beginning is today, we believe that this year-end, we'll close with a cost of credit at 1.8%, and next year we will be at the stabilization of this cost of credit and the range will be 1.7% to 1.9% and this is basically because interest rates will go down, the GDP, as you hear from Juan Pablo will increase to 2.6%. So we see a better environment for loan portfolio next year.
Regarding your second question on quality, we are allocating in a best way our securities portfolio. That's the reason why our solvency ratio is increasing and we are trying to increase the capital level. That's the main reason why it is explaining that increase in the BIS ratio. Yes, in March, there will benefit of the retained earnings and you'll see on the legal reserves and the number again will be at around 9.5% at the end of this year.
Thank you. [Operator Instructions] Our next question comes from Tito Labarta from Deutsche Bank.
Hi, good morning. Thanks for the call. Actually, my question is on the tax rate, again, just more on the fiscal reform that some has been mentioned. Just could you give us the latest update on that? And what would that mean for your corporate tax rate beyond 2017, if that's approved? I think there's a big reduction in the corporate tax rate. Could you give us any update where that stands and how that would impact you? Thank you.
Jose Humberto Acosta
Thank you, Tito. Yes, we are on every stage regarding the tax reform, but our perception is it is positive regarding – because it's oriented to individuals, including the VAT, increasing the VAT. Our Chief Economist has mentioned previously that probably the best way to put in place that fiscal reform or tax reform will be doing a step-by-step increase in the VAT gradually for the next three years. We see an opportunity reducing the corporate tax, and we, the counterparty of that probably we'll see an increase in the level of investments in Colombia that will help to the economy to increase the activity, to maintain unemployment and rates under control. So again, the perception is positive Tito, but it is still early to give some clear guidance. It depends on the conversations and discussions in the Congress. But again, we see positive, but that this is a mandatory tax reform, not only because of the fiscal deficit or the oil price, it is because the government needs to increase the tax base in individuals and to reduce the tax base for corporates.
Thank you. Our next question comes from Jason Mollin from Scotia Bank. Please go ahead.
Hi, everyone. I have a follow-up on the asset quality evolution. We did see deterioration in the segments that you talked about, but one thing is, when we look at the sector numbers or the banking system numbers in general for Colombia, it appears on certain metrics that Bancolombia's numbers deteriorated more. Are you seeing that? And what do you think drove that, if that is in fact the case? Thank you.
Hi. This is Rodrigo Prieto speaking. Regarding the financial system in Colombia, we have – the last two years, we went through different segments. Those segments are low income segments that I can divide the answer into two. The first one is that, it comes by the margin, because even though the loss is higher than the results in the margin are seeing right now. And there are some that we saw the degradation last year, we thanked credit policies this year expecting now to launch in May and we have others in June, and the last ones we did in September. So, I think that in cost of credit, we are in the peak right now. I don't know exactly how the loss is for the future. I consider that in five or six months we are going to see the decrease in the cost of credit. So, if we compare, it's exactly what you're seeing, but we are in other segments that the comparison with other banks is not appropriate in consumer portfolio because every bank in Colombia is different in the segments that we have, as I mentioned.
Jose Humberto Acosta
The key message here is, this is not taking by surprise for us the provisions that we are having right now. If you remember in our previous conference calls, we announce that in the first quarter, for example, cost of credit were very low and we have the number and we expected to get that number, I mean the 1.8% and the message that we are sending is, this is maybe the peak that we are getting in terms of party loans and the number would be at least flattering for the next coming quarters or even reduce, depends on the behaving of the economy.
Thank you. Our next question comes from Ernesto Gabilondo from Bank of America.
Hi, good morning to everybody, and thanks for taking my call. So only one question, I believe the Colombian banking regulator will follow Basel III. As such, I'd like to know to what extent Bancolombia will be aligned with the new capital standards and if you're considering to incorporate a systemic buffer as other banks or systemic banks should have aligned with Basel III in 2018? Thank you.
Jose Humberto Acosta
Thank you, Ernesto. Yes, we have an internal team here analyzing the implications of the Basel III. We are also in early discussions with the regulator. Yes, we have two or three different fronts. The first one is the buffer for provisions. If you see, we have also 200%, almost 200% of provisions of 90 days past due. That will be a kind of buffer that you're having on the asset side, instead of having on the equity side. So we believe that with the regulators we will have conversation regarding that, how to transfer from the asset side to the equity side regarding issues on both propositions. Regarding the systemic buffer, we know that the numbers could range from 0.5% to 2%, if you compare with the Chilean model.
So we are running some models to realize what will be the number for 2018 regarding Basel III? And no matter what the number we'll get that today meaning levels is 4.5% assuming that they will increase 150 basis points or 200 basis points for systemic buffers, we are still complying with the level of Q1. So we don't have any specific concern, but again, we are also defining how it will be implemented these Basel III term, for sure will be implemented in tranches. So we will have time to maintain and to grab some new capital.
Thank you. Our next question comes from Andres Duarte from Corficolombiana.
My question is about Bancolombia's US dollar proprietary position. So Columbia Central Bank gave us a deadline, July 5 to correct the existing proprietary position corresponding to goodwill and the application of IFRS. This excess is about, or adds up to about a $1.3 billion and the goodwill part is related to the acquisitions made by the major Colombian banks in Central America. So I would like to know what's your opinion on that and what's the portion of these excess, in position that corresponds to Bancolombia and how do you plan to correct it as the deadline is July 5? Thank you very much.
Jose Humberto Acosta
Andres thank you for your question. Yes, this is a very technical question regarding proprietary position. Do you know that the regulation in Colombia is contemplated some adjustments, because the banks in Colombia is acquiring international operations and we are funding them in a different way. So if you want to give you a very detailed answer, we can call you during the morning because, again, this is a very technical, basically it is because of the accounting system which is, which accounts or which lines of the accounting system you have to take into consideration to calculate the property position. But we are, again, working and talking with the regulators and with the Minister of Finance and with the Central Bank regarding how to adapt this number to the new environment and the new structure of the banking industry. We will call you, for sure, during the morning, Andres.
Thank you. Our next question comes from Maria Barriga from Davivienda Corredores.
Hello? Thank you very much for taking my call. I was wondering about your operations in Central America, specifically in El Salvador, where recently a rating agency downgraded its BCA. So I was wondering if you could expect any impairment on these operations. Thank you.
Jose Humberto Acosta
Thank you, Maria. Salvador is one of our most efficient operations. The return on equity there is at around 15%. We are the number one there with 30% of market share. So I would say that, yes, that impacted the price of the bonds that we issued two years ago, but we are not feeling impacted – any particular impact regarding funding cost, regarding cost of funding cost. So we are not seen a deterioration of the banking in the country, because again, the performance there it's very good. We are still growing at a pace of 2% to 3%. We are just still maintaining the market share and if you double check the numbers for the first half of this year, we are almost, close to 60% of the total net income of the financial system. So again, we don't foresee any specific deterioration in our Salvadorian operation. The other way around, as we explain at the beginning of the speech, Banco Agricola is growing. We have replicated the same experience in with products there. We are growing very healthy way in fees, we are growing with new products as leasing operation. We are doing a lot of things in El Salvador and it's working very well.
Thank you .Our next question comes from Catalina Araya from JP Morgan.
Yeah good morning, I was just wondering, I think in terms of expenses, you guys are delivering good growth, only less than 5% by higher inflation in the country. Was the expectations for next year and what's the long-term goal in terms of efficiency? Thank you.
Thank you, Catalina. Yes, as you can see, this is the numbers that we feel proud, because the last five years we are doing our job regarding reduction in expenses in the local operation and international operation. Our guidance and you know that this is very, very key for us, if we want to recover our return on equity, the level of efficiency, it has to be below 50% and we will expect for the next two years to get a level of 48% of efficiency ratio.
How we will do that? If you double check the numbers, in our Colombian operations our efficiency level is at around 44%, 45%. So as Juan Carlos explained at the beginning, that would be key to become more efficient in international operations. We have to do a lot of things there in the three operations, so it will be balancing every stages, we have to implement a lot of systems, we have to implement a lot of procedures but the way to get the 48% the next few years will be doing through our international operation. So we have to do a lot of things there, increasing the income, the fees, increase in the NII but also maintain under control, the expenses.
Thank you. Our next question comes from Sebastian Gallego from Credicorp.
Hi, good morning everyone. Thanks for the call. Just a follow-up on the last question, you mentioned the room for improving efficiency within Central America, but can you expand more on the specific strategy that you want to implement in those countries, particularly in Panama and Guatemala on the expense side? Thank you.
Jose Humberto Acosta
Okay, thank you Sebastian. Efficiency is a combination of the both sides of the equation. What we are planning to do in Panama, for example, we are experiencing a growth of NII, because we are growing our loan portfolio, we are increasing the fees. So that would help the efficiency level of the income side. Also, we would try to replicate the same in Guatemala. On the cost side, remember, that we have spent a lot of money on Banistmo operation the first two years, implementing the software. Right now, we are seeing a kind of plateau in terms of expenses. So we expect to see a reduction of expenses the next two or three years. Same, we are happy with the Banco Agromercantil operation in Guatemala. So we will expect to reduce the level of efficiency from 65% at least to 60% in Bank Agromercantil. But again, the efficiency level in those operations will be focusing the two sides of the story, increasing the income and trying to maintain cost control.
Thank you. Our next question comes from Natalia Casas from Ultraserfinco
Hi, thank you for the call. I am kind of worry about the asset quality of the bank, because this is like the worst number that you have shown under IFRS. And so, I like to know if you have any guidance about the PDL ratio for this and the next year and how are you going to reduce this indicator or the PDL ratio? Thank you.
Jose Humberto Acosta
Thank you, Natalia. Yes, the level, as I mentioned, is quite high this quarter. If you compare for the whole year, the number it's under control which is this 1.8% of cost upgrade. But regarding the guidance, we will expect the level of past due loan will be at around 3.2% to 3.3% this year and we will expect same level for next year, assuming a GDP growth of 2.6% because we don't see clearly, the impact of the tax reform. So that's the reason why our guidance is to maintain the same level of past-due loans of 30 days.
Thank you. That is all the time that we have for questions. I would like to turn the call over to Mr. Mora for final remarks.
Juan Carlos Mora
We would like to thank everybody who are attending this conference call. I'll end with some final remarks. I know that you are concerned about asset quality we are following very closely the development of our loan portfolio. We are assured that our development in the rest of the year is going to improve. During the quarter, there had been some specific issues related basically to the upgrade of our credit card platform that didn't allow us to have enough information to do collections on the right way. That had an impact, that's a situation that is solved already.
So we are expecting that by the end of the year, the asset quality is going to be in line with our expectation. And our second the focus is taxation. We need to work on how to improve the taxation because it's impacting the net income of the Bank because the operational results are very good, taxation is impacting. And also, we expect that the third quarter is going to be positive for the results of the Bank. Again, thank you very much for attending this conference call and we expect you to be with us on the conference call that we will have to present the results of the year 2016. Thank you very much and have a good day.
Thank you. Ladies and gentlemen, this concludes today's conference call. We thank you for participating. You may now disconnect.
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