Colombia, like its Andean neighbor Peru, is one of Latin America's fastest growing economies and this has seen it become hot spot for foreign investment. This rapid growth in conjunction with the spate of financial crises in the U.S and Europe has also created greater investor interest in Latin American banks, particularly those in the Andean nations of Colombia, Peru and Chile.
The only Colombian bank currently listed on a U.S exchange is Bancolombia (CIB) which, since offering American depositary receipts (ADR) on the New York Stock Exchange in 1995, has performed particularly strongly. Over that period, it has delivered for investors an average annual return of around 67% inclusive of dividends. This stunning performance, along with the bank's quality portfolio of assets and strong risk management, has made it popular amongst investors and my preferred banking sector investment.
However, over recent months its share price has fallen sharply despite the continued growth of the Colombian economy and the expansion of its loan portfolio and revenues. Bancolombia's recent financial results were also disappointing for investors being below estimates. This has seen analysts concerned that the bank's performance is falling on the back of deteriorating asset quality and slower than anticipated growth.
Over two installments, this article will analyze Bancolombia's financial performance, asset quality, risks, future growth prospects and valuation to determine whether the bank is capable of delivering value for investors. This first part will examine Bancolombia's second quarter 2012 financial results, asset quality and liquidity indicators to determine whether it is a well-managed and secure banking investment for investors. Then in the second part, I will examine its growth potential and valuation in an attempt to identify whether there is value for investors.
Latest financial results were disappointing
Bancolombia's second quarter 2012 financial performance was disappointing with the bank missing the forecast consensus earnings-per-share by 13%, reporting EPS of 93 cents. This is despite interest income growing by 29% to $1 billion and can be attributed to net income falling 22% to $199 million. This was also the second consecutive fall in net income since the end of 2011, as the chart illustrates.
*Second quarter 2012 GDP growth rate is an estimate.
For the same period, the bank's balance sheet also weakened, with cash and cash equivalents falling by 7.5% to $4.1 billion, although its degree of leverage fell with long-term debt down by 5.5% to $8.4 billion.
The fall in net income can be attributed to a substantial increase in loan loss provisions, which in comparison to the previous quarter grew by 56% to $174 million. Even more concerning was the 18% growth in the value of non-performing loans to $658.6 million over the same period. However, it is important to note that the significant increase in loan loss provisions was primarily driven by:
- Bancolombia's conservative credit risk management policy; and
- Colombia's central bank applying pressure to domestic banks to over-provision as a means of guarding against future imbalances.
Despite the growing value of loan loss provisions and non-performing loans, along with fears of a Colombian consumer credit bubble, the evidence indicates that Bancolombia's asset quality remains high with credit risk, asset quality and liquidity indicators well within acceptable parameters.
Composition of Bancolombia's loan book
The majority of Bancolombia's loans under management ('LUM') are commercial loans which, as the chart shows, make up 74% of its loan book. This is followed by the consumer loans at 14%, mortgages and finance leases at 5% each and finally by loan loss provisions making up the remaining 2%.
Source data: Bancolombia financial filings Q2 2012
Of these segments, commercial loans have the lowest rate of deterioration and highest quality, with consumer finance, small business loans and mortgages being the lowest quality segments.
Continues to have a high quality, low risk asset portfolio
A key reason why I have historically liked Bancolombia is that like its Peruvian peer Credicorp (BAP) which I recently wrote about, despite experiencing strong lending growth, it has consistently maintained a high-quality loan portfolio. This is illustrated by Bancolombia's low non-performing loan ratio (NPL), a key metric measuring the quality of loan portfolio quality. As the chart below illustrates, the NPL ratio is currently 1.9% and has remained within the 1.5% to 2% range for the last six quarters. This is also lower than the Colombian national average NPL ratio of 2.2%.Source data: Bancolombia financial filings Q1 2011 to Q2 2012
As the chart illustrates, loan loss provisions as a percentage of total loans grew by 20 basis points in the second quarter 2012. This can be attributed to:
- the continued expansion of Bancolombia's LUM, which expanded by 2.3% during the quarter;
- a moderate deterioration of loan quality in the higher risk consumer lending and SME segments; and
- growing pressure from Colombia's central bank for banks to significantly increase provisions.
This indicates that the overall quality of Bancolombia's loan portfolio is high, with the highest portion of non-performing loans (NPL) in those segments which, as the chart shows, make up relatively small portions of the bank's total book.Source data: Bancolombia financial filings Q1 2011 to Q2 2012
Other than consumer finance and finance leases, each of the segments' non-performing loan ratio is trending downwards, indicating that the quality issues are being actively managed by Bancolombia.
The upward trends for consumer finance and finance leases are symptomatic of the bank's aggressive expansion into the credit card and consumer durables leasing lines. It is these product lines that have experienced the greatest consumer demand, with Colombia's strong economic growth fueling the expansion of the country's middle-class and boosting domestic consumption.
The quality of Bancolombia's loan book becomes even clearer when it is compared to its peers, and on many measures it is superior to competitors and regional peers, including Banco Santander Brasil (BSBR), BBVA (BBVA) and Citigroup (C), as the chart shows.
Source data: Bancolombia, Banco Santander Brasil & BBVA financial filings Q1 2011 to Q2 2012
* Citigroup's NPL Coverage Ratio was not available for the period charted.
All of the risk indicators are well within acceptable parameters and illustrate that Bancolombia has a high-quality loan portfolio that is superior in quality to many of its peers.
But I am concerned by the substantial growth in provisions over the first half of 2012, and particularly in the last quarter for two reasons. Firstly, it indicates that there has been a higher than expected deterioration in the quality of Bancolombia's loan portfolio. While this doesn't present any risk to the bank's solvency, it will have an ongoing impact on profitability through the increased administration costs associated with recovery and the lost revenue these funds could have generated.
Secondly, there is a significant economic cost attached to every dollar set aside for lending loss provisions. This arises because Bancolombia is unable to use that capital for revenue generating activities, but still has to carry the cost of raising and administering that capital. All of this will result in margin compression and lead to reduced profitability for Bancolombia.
High liquidity indicators
Bancolombia has a history of prudently managing its capital in a manner that allows it to maintain liquidity within optimal levels that meets regulatory requirements while minimizing economic cost. This also includes having a manageable degree of leverage, and with a debt-to-equity ratio of 168%, which is well below the industry average of 216%, this is clearly the case. All of this helps to reduce the bank's exposure to movements in short-term interest rates and minimize the risks associated with credit in a volatile global economic climate with increasingly risk averse capital markets.
At the end of last quarter, Bancolombia reported a tier one capital ratio of 11.5%, which was an increase of over 1.5% year-on-year and higher than the minimum investors should be seeking of 10%. However, as the chart shows, Bancolombia's tier one capital ratio is lower than some of its peers.
* Banco Santander Brasil includes 'goodwill' in its Tier 1 calculation
I do find it somewhat strange that Banco Santander Brasil is including goodwill in its tier one capital. There is also an economic cost associated with tier one capital and an excessive level does have an impact on profitability. Bancolombia has also continued to maintain an optimal loan-to-deposit ratio which was reported as 103% for the end of the last quarter and, as the chart illustrates, has been within what is considered the optimal range of 95% to 105%.
Source data: Bancolombia financial filings Q1 2011 to Q2 2012
This range is considered the optimal level because it allows a bank to generate the maximum benefit from utilizing its deposit base while ensuring sufficient liquidity to cope with extraordinary or unplanned events. Bancolombia's loan-to-deposit ratio is also superior to many of its peers, as the chart illustrates.
As a whole, Bancolombia has a high quality loan portfolio, a strong deposit base and conservative credit management practices, which have left it with enviable risk and liquidity indicators. These indicators are all well within acceptable parameters and superior to many of its peers.
The verdict so far
From the analysis so far, it is clear that Bancolombia has a high-quality portfolio of loan assets with risk indicators well within acceptable parameters despite some deterioration in quality in the consumer and small business segments. Its NPL ratio is one of the lowest among its peers and is below the Colombian national average for the banking and finance sector. It also has adequate liquidity and a particularly healthy NPL coverage ratio, which is among the best in the industry.
However, there has been a substantial increase in loan loss provisions, despite the high-quality loan portfolio and it is this that is having a direct impact on profitability. Part two will examine Bancolombia's growth potential and valuation in light of its risk and liquidity indicators to determine whether it will be able to build and grow revenues to deliver a value for investors.