Banco Comercial Portugues S.A. (OTC:BCPTF) Q2 2016 Earnings Conference Call August 1, 2016 4:00 AM ET
Rui da Conceicao Coimbra Fernandes - IR
Nuno Manuel da Silva Amado - CEO
Miguel Braganca - CFO
Izabel Cameron - Goldman Sachs
Hari Sivakumaran - KBW Capital Partners
Good day and welcome to the Millennium BCP first half 2016 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Mr. Nuno Amado, Vice Chairman and CEO. Please go ahead.
Nuno Manuel da Silva Amado
Okay. Good morning everybody. We are starting the holiday season in August 1, and some of us still are working [Indiscernible]. So I will be beginning with a preliminary comment if you don't mind and then I will go through the first two pages of the presentation. My preliminary comments are basically what I feel. I feel that BCP has done an enormous effort to implement the [strategic] plan as we are now under a very difficult scenario, not only European [macro] interest rate scenario, but also not an easy Portuguese scenario, also a difficult Portuguese scenario.
My second comment is that we really believe that we have some improvements, namely we have implemented, as I mentioned, [Indiscernible] stress tests. The result of the stress tests confirm it, and I will say that more than the result that is positive I think that our action is an important one, it is the right one, and I am confident that in that respect we will – each year we will improve.
Third comment is that we all know and we are aware of that right now on the agenda [Indiscernible] financial sector NPEs coverage risk is one of the hot topics, and is one of the topics that is under discussion, or topic under discussion and I will say that together with business model. So with business model [Indiscernible] of the position and the risk factors.
In the business model I think we will see in our core income, our cost to core income, our efficiency is improving, and that is clear and on that respect we are comfortable that we are doing what we should, and we are doing it on a very disciplined and correct way. But not forgetting the context plus the environment. The environment, let me tell you, we took the decision because we could reinforce the risk coverage, which implies as you already know in abnormal quarterly increase of the impairment, which has a impact in the quarterly results.
This increase gave us the confidence to set – or to confirm the objective to decrease the NPEs to at least 2 billion vis-à-vis the actual level until the end of 2017. So in 1.5 years is an objective for obvious reasons, and we believe that we maintain for the time what we consider adequate level of regulatory capital as you know. And in our opinion, it also will improve or allow us to improve the perspectives for the future for 2017 onwards.
A last word before I start the presentation, for the [proposal], as you know, [Indiscernible] since Saturday night, [soon] immediately after presentation of the results and the knowledge on the stress tests, sent us a proposal that is an offer to buy a stake in BCP under certain conditions. Initially it is around 16%, but with [Indiscernible] to increase it to 20% to 30%. In our opinion it reflects the confidence in our work [Indiscernible] that we are doing. It is not easy, but it is clearly a confirmation in our opinion that we are in the right direction and in the right track.
What will we do now? Now we will analyze [strategically] as we mentioned in the proposal and we will present the recommendation to the board of directors, our board of directors. In principal in our view we see it very positively. We see this initiative [Indiscernible] on the contrary, but now it is time to analyze it and to make a recommendation to the board and it is the board of directors that have capacity or the power to negotiate the same and make the final decision.
So, I think we are doing [Indiscernible] on the impairment side, improving the impairments that had reflect on the results, but also reflects on our perspectives for the future, and that simultaneously or almost simultaneously [Indiscernible] made an offer. I think that clearly [Indiscernible]. So having done this introduction let me go to the page 4 and 5 and then pass the floor to Miguel Braganca.
So the highlights, as I mentioned, stress tests, the results of the stress tests were positive and more than the level, the direction I think is very good and direction continues. There is no reason why we will not continue our journey. We got phased-in CET I in excess of 7%, and [Indiscernible] we received the result was below 3%.
So that is positive, and we got that obviously still with a large [Indiscernible] in terms of capital. Our CET 1 ratio is 12.3%, and this stood at 9.6% under a fully implemented basis. And in terms of asset quality we increased the coverage, our NPEs coverage, including the collateral and expected loss strengthened to 97%, almost 100%. And this will support, as I mentioned before, to fix the objective of bringing down the NPEs by more than 2 billion until December 2017.
The nonperforming loan ratio, the NPL ratio, was down to 11.5%, and it was not a very good quarter as you will see that we have strengthened the coverage and we believe that our objectives for the next 1.5 years are clearly achievable, and possibly we will overtake those objectives.
In terms of profitability and efficiency, we booked a net result of 197 million euros of loss in the first half because of the quarter results, and excluding the abnormal items, we got recurrent normal profit of 56 million, which is a clear improvement since last year, and there is no reason why we don't maintain this quarter-to-quarter improvement on the core.
And core net income, this is what is really recurrent, before impairment and before extraordinary gains and losses, it is margin plus commissions total operating costs had an important [jump]. We got an important [jump] on it. It increased 10% to 437 million and that result in the cost to core income that improved 4 percentage points to 52.5% compared with last year, which I think is a very, very good level, very efficient level. And with total cost to income of 45.7%, so 46%, what I think is also a very important result if you take into consideration the result three or four years ago was around 90% cost to income.
In terms of business, I think that it was [Indiscernible], the commercial gap improved further as it is mentioned, and now the ratio of net loans, as a percentage of on-balance sheet customer funds stands at 97%, what I think is a very balanced balance sheet, much more balanced, much more independent, autonomous vis-à-vis [Indiscernible].
The customer deposits totaled almost 50 billion euros, 48.8 billion, with deposits from individuals in Portugal up by 3.7%, and we got more than 5 million customers, almost 6% higher than in the first half of 2016. So now I will pass the floor to Miguel Braganca [Indiscernible] continue our presentation.
Thank you very much ladies and gentlemen. Going now to page 6, basically this is graphical illustration of what our CEO just commented, with the core net income going up by 40 million euros, with the net income presenting a negative value of around slightly below 200 million negative, but with the net income excluding, so it is more one-off items, more unusual items actually showing a positive strength.
The loan to deposit ratio improved further and I would like to highlight that the result including on-balance sheet customer funds, i.e., also retail bonds, we are already below 100%. The phased-in ratio at 12.3%, the fully loaded at 9.6%, even after this very strong adjustment, and it is exactly this model dynamics that improved the stress test and that allowed us still to present this fully loaded ratio that allowed us to do this adjustment in terms of coverage that we deem now relevant for the present focus of the market and regulators.
The core net income as you see here almost growing 20%, 18.5%, driven by both sides of the [Indiscernible], the income side growing 6% and the cost side decreasing 3%.
Going now to the highlights in point 9, I won’t get into detail in these highlights. The only issue that I would like to highlight is that in spite of this challenging moments that the Portuguese system is leaving, we are being able still to continue to develop our franchise with customers with customer presence and with increasing customer satisfaction, customer penetration, presenting a very good track record in terms of digitalization. As you see, we were elected by Global Finance the Best Consumer Digital Bank in Portugual et cetera. So we are not losing our sight in terms of what really matters over the long-term that is the customer business and customer franchise.
In page 11, we try to do here an exercise trying to exclude what is more one-off and not so to current what is to say more and more recurrence. What you see here, of course, you have the official P&L statement in annex. What you see here very clearly is that the core net income has increased substantially and the operating net income has also increased in spite of a very strong increase in terms of the mandatory contributions both in Portugal and Poland in terms of special contribution and taxes to the Resolution Fund, the taxes of the banking industry and so on.
As you see here, these have increased more than 40 million and in spite of this 40 million increase that goes to the top line, not to the income tax line, we have been able to grow around 14 million our operating net income even after this impact.
In terms of impairment and provisions, we try to do here an exercise that is what could have been our impairment and provisions had we maintained our coverage ratio, including collaterals. So we do think that collaterals are important in terms of coverage and in Portugal, the collateral valuation process is very robust and independent. So our impairment and provisions, including collaterals, would still have been high. I would like to highlight this. So we are speaking here in terms of consolidated terms of almost 400 million.
But still even after these if you want more to the usual impairment and provisions, we would have had a positive net income and showing a very positive dynamic. What have been the so to say the one-offs, the visa transactions, which for the ones of you that follow the banking industry is nothing new, but most of the banks have shown this. The lack of capital gains on Portuguese debt when we compare with last year, the valuation here of corporate restructuring funds, mainly of the construction sector, there was here a one-off adjustment linked to the construction sector of the corporate restructuring fund.
And then of course, we isolate the impact of the increased coverage below. This is a graphical illustration of what I have just commented. So we have here total negative impacts net of the Visa transaction of around 500 million negative in terms of net income to which we had some, so to say, the earnings improvement of around 75 million to get to our present net income that we are showing to you.
Dividing this between Portugal and international operations, we see that in terms of the core net income the Portuguese one has increased 18.5%. This is the margin plus commissions, minus cost, just to remember, 18.5%. And the international operations we felt the FX impact grow 12.8% after the FX impact mainly in Mozambique they are flat, decreasing around 1.6%.
In terms of NII, what you see here is a very robust growth in Portugal, around 9% with the NIM in Portugal reaching already 1.5% in spite of the CoCos cost, and the international operations for several reasons that we can elaborate also growing robustly 16.3%. This allows us to reach a net interest margin already around 1.9%, including CoCos, and excluding the CoCo cost, which is special cost as you know, we are already at 2% NIM.
I would like to highlight that exactly the capacity to generate provisioning profit – to generate earnings that shows the robustness of our business model, and then was also somehow reflected in the stress test. Fees and commissions, you see banking fees and commissions, relatively flat, in Portugal growing around 2%. In international operations, adjusting for the FX impact, they have decreased by 7.6%, a lot of it linked to asset management and insurance and the part of it in Poland linked to regulatory issues in terms of the ability of the banks to sell insurance.
In terms of the other income, as you see here we have here two – it is a story of two tales, if you want, we have here a positive of the Visa transaction, the value is before tax. So that is why it is different, a positive of the Visa transaction, on one hand and on the other hand the absence of gains on Portuguese sovereign debt. So these are the two main impacts that explain the strong decrease in Portugal of the trading gains, if you want.
In the international operations, they continue to grow at a robust level. The cost reduction proceeds in Portugal with our cost to core income already at 52.7%, the cost decreasing around 3.1% and in the international operations they decreased 9%, 5.1% without the FX impact because in Mozambique a part of the costs are dollar linked, so it is very difficult to adjust totally for the FX impact because a part of the costs are not domiciled into domestic currency.
As you see in page 18, a graphic illustration of our cost to core income, when compared to both to our peers in Portugal, and with the Eurozone listed banks, you see here that this very robust cost to core income shows the strength of our business model, is already I would say, quite best in class in Portugal and it is also very relevant when you compare it to the average over the European countries, which is especially relevant when you consider the levels from which BCP has come. This cost to core income of around 52.5 compares with the cost to income already strongly below 50%.
Impairment and provision, this is the issue as you know as our CEO was commenting we have seen that a lot of the focus in the market has shifted towards impairment provisions and the not all the non-performing world. In the past we have here had our matrix of non-performing that basically were focused on loans that were really non-performing. So, every loan that was non-performing after 90 days, we consider they are non-performing. And we registered all the capital associated to these loan, in the context of the new even matrix. On top of these loans we are considering so to say subjective assessments of loans that are I would say not good. So, loans that we would not originated in this conditions, so we consider for instance loans that have impairments about a certain level, even if they are based on qualitative assessment as NPEs.
And is exactly that these that explains the big difference between our domestic number that is objective and the NPE number that considers these and across default, that is no more the focus of the market and regulators. We have seen that these considering the results of the stress test and considering the positive dynamics of our business model, was an important impairment to adjust so to say our coverage, considering collaterals to a level that was more like best in class, reaching numbers or at least good in class that reach numbers around 97% including collaterals. So, and that will enable us also to continue to decrease our stock of NPE's according to the plan that we have presented to you.
You see here, still the NPL which is domestic numbers so without this subjective or qualitative assessment that actually shows a positive trend compared to June of last year. And you see here the coverage by balance sheet impairment and guarantees and collaterals going to 115% based on the domestic number and still the net NPL advantage in Portugal also going down when compared with last year. There is some seasonality in terms of the NPL to be pick early by year-end. The net interest tend to decrease but still what we see here when compared with the number of last year is a positive development.
Page 21, you see that our structure of our guarantees have not changed materially since last time. And going to liquidity, what we see is that we continue to have here a positive trend. With what really matters that is the deposits of individual that show off our franchise and that has some diversification actually growing 3.7%. We, in order to manage our P&L, we have we are letting some of the large corporate deposits and some of the large deposits from the public sector that our expensive goal is actually to manage better our name and because we don’t need them. So, effect after considering the deposits we are flat but in what really matters that is customers and customer franchise we are growing in a very health way.
In international pricing, we're adjusting for the FX impact in here, the FX impact is relevant, we are going almost 6% which also shows that the positive developments of our franchise. Loans to customers decrease a 5.7% of which 5% in Portugal and 7.9% internationally but of which 1.5% we felt the FX impact. Commercial gap basically closed as we see here and loans to deposits ratio considering the retail bonds already below 100%. Liquidity coverage ratio and net stable funding ratio consolidated terms also very comfortable as you see here. In terms of ECB funding, you see it went down, most of it is the TLTRO right now €3.5 billion, we could even have access to more the TLTRO and have everything in TLTRO. The only reason why we didn’t was to have more flexibility because to be able to decrease as we want because we would be eligible for the full €5 billion if we wanted.
So, as you see here, very strong level of collaterals with eligible excess eligible assets net of haircuts of around €8 billion. So, effectively a very strong liquidity buffer that makes us comfortable from a liquidity standpoint. Capital. As we comment, that we have done this stress test scenario, I would like to remember that last time we have failed these stress test. It was very important for us to deliver on this issue. I would like to highlight here a couple of points, that the way this stress test is done. It's a very close methodology, so very close methodology for instance, there are as some of you that follow us for some time know as in the past we had here some negative commissions or some commissions that we paid to the state to benefit from state guarantee on some loans, just to have an example.
And we for instance we were forced to project, we are not using these commissions anymore and we were forced to project these commissions going forward. And there also whether you should get particularly I would say particularly penalized banks that can was again with a challenging part because the history is very relevant in this stress test. So, when the history is more challenging, of course this influences much more the outcomes of the stress test, then for countries that have had that more beneficial currencies to it. In spite of this, we were able to show a very positive dynamic, effectively clearly being above the 5.5% with the result of 7.2%.
The common equity tier 1 ratio as you see here at 12.3% with the fully low that 9.6% which clearly highlight that we are not still where we wanted to be. As you know we have commented to you that we wanted to reach by 2018, the 11%. So, we are not there yet, so we will not be distributing dividends while we don’t get to this level. But still, I mean, it's a level that is comfortable from an economical capital standpoint. Leverage ratio, I would say a good leverage ratio when you compare it with other Euro-zone listed banks and I would like you to highlight the RWAs density in Portugal, that is very high. It shows that our models I would say are at least indicates that our models and principle are quite conservative.
So, this is something also to give, yet the models have been approved in different by different teams and different point in times and so on, it's not totally clear whether they are totally comparable, nobody knows exactly I think, but I would like to here to highlight at least our capital and our models when you compare. So, top down, the ballpark figure seem to be very conservative when you compare it with the French and the Spanish and the Italian models. Our pension fund present us a negative profitability due to margin to the developments of the mark. Overall, 2.8%. As you know it's managed for the very long term, so our liabilities have an average maturity of around 17 years. So, we have 17% in equities and of course over the short term, I mean, you cannot have a 17% investment horizon and manage it for six months.
I will now pass the floor here to Rui.
Rui da Conceicao Coimbra Fernandes
Now, moving now to Portugal and started by volumes customer funds down by 1% but deposits and as you saw already, they moved up by 1% and driven by the increase on the demand deposits. Loans decreased 5%, driven by the decrease on the company segment, obviously very much influenced as well by the amount of write-offs. And the net income now just for Portugal was -€305 million but very much effective and influenced by three one-offs that we present €280 million after tax. The first one already refer the €300 million before tax or 211 after tax increase on the coverage of the E&Ps. The second element, €126 million or €89 million after tax, due to the devaluation of the corporate restructuring funds, especially on the construction sector as reports already refer.
And the third element, the positive from Visa of €20 million after tax. This just for Portugal. Without these three effects, the result would have been -€25 million as it is there on page 34. When we compare with the previous year, we need to consider as well the last year gains on Portuguese sovereign debt of €388 million or €274 and after tax, and this explains completely the movement from one year to the other. Moving to next page on the core net income, improved €43 million from both sides, €33 million on the income especially from net interest income. We'll see this in more detail, and €10 million less costs.
So, on the net interest income. So, year-on-year, we see an increase of €29 million, driven by an improvement on the commercial margin mainly, where €92 million positive from the decrease of time deposits rates. So, we are paying now in terms of rates 66 basis points versus 143 one year ago. So, it is an improvement of 77 basis points. The second important element is -€31 million effect of lower volume, so this is more or less on average €2 billion less loans that create this negative effect. The third is the well-known decrease of the average Euribor rates. So, it is 24 basis points less on average, this first half versus the last year. And this generate less net interest income of €48 million versus the previous year. And then of course, Euribor plays a role in not just these on decreasing the funding cost that in general generate €10 million more on the NII and I mean funding costs on the more on the wholesale side.
On the other hand, the decrease contribution from the securities portfolio after the sales and that we have done last year on the sovereign portfolio, so the contribution is less but it was compensated by the improved contribution from the NPL. So, last year the negative effect of these movements of accruals to non-accrual status of some of loans was a negative impact of €31 million and this as actually we had forecasted at the beginning of the year and we discuss this separate time. This year this effect is zero now. So, the difference of 31 is exactly the -31 of last year then the zero this year. Quarter-on-quarter NII increased €15 million and this was mainly due to the decrease of the cost of funding, both retail and wholesale, higher than the negative effect of lower volumes and Euribor rates during the quarter.
And looking to spreads now. The second quarter was another quarter of decreasing the back book rates on time deposits of 15 basis points and this between 10 basis points to 15 basis points is the guidance that we are giving. And so, it was another quarter of 15 basis points. Although, given the decrease of 7 basis points of Euribor, the spread only improved 8 basis points. And it is now at -84. So, this exactly -84 exactly 84 basis points. Front book rate is now at 33 basis points, so there is really space to continue this movement at least up to the end of the year. Regarding loans, the average spread remain stable at 2.9. And so, the combination of the improvement spread on the deposit side and as stable on the loan side and generate this improvement on the net interest margin that is now at 1.6 for the second quarter.
Moving to commissions up by 2%, due to increased commissions on customer accounts and some other more related to investment bank deals. And this compensate the decrease of commissions on loans. On the side of course, operating cost decreased 3% and the cost to core income is now below 53% and the cost to income below 48%. Moving now to credit quality, starting by NPL. So, the NPL decreased from the previous year, more than €600 million. We the net increase +179 but then the effect of the write-offs and sales over around 785 million and this explains the decrease of the NPL. Quarter-on-quarter and the stock increase due to a handful of credit that were already marked as NPE. And this is why we see different trends here during the quarter between the NPL and the NPE.
Coverage by provision improved to a 58% but including collaterals is already above 110% for Portugal, we saw already for the consolidated numbers. Cost of risk increased due to the decision of improving the coverage and so we doubt this one of €300 million we refer before cost of risk for Portugal will have been 140 basis points and 124 for the group, which means inline we've first quarter of the year. And moving to now from NPLs to NPE, the number is and the total amount is decreasing is €1 billion down from June 15, one year ago, and need one more if we go back to December 14, these now at €9.5 billion and the coverage is including collaterals is at 97%.
We have a plan already known by the market to reduce more than €2 billion of the NPEs in the next year and a half, so up to December 17, very much based on accelerating in a way the write-offs and sales but as well less new entry's and even more exits, including loans that are at the quarantine period, as you know is one of the reasons why NPEs above NPL is that there's well we have loans that were NPLs and now they are not, but they stay at the NPE for a period to make sure that loan is cured. So, with this, already 97% coverage and with the forecast reduction on the stock, we in fact are targeting a coverage overrun 100%. And this was already our target for the NPL when the market shift from the NPL to the NPE, we want to have the same type of rational being applied to the NPE now.
Now, just a note, I think, this already but when we discuss credit quality in Portugal, there are three ideas we believe you should always have in your mind. So, the first is that collaterals matter. And so, when we take into consideration, collaterals, Portugal has the highest coverage in the Euro-zone, so it really matters and it matters for us. Real-estate prices in Portugal are stable and in that way they are predictable and so we know the value of the collaterals that we consider when we calculate our coverage. And the third important element is that it really and fortunately takes time to solve a credit giving courts in Portugal. And obviously this is one of the main reasons why the stock is high in Portugal in a particular for and in F.B.C.P.
Moving now to foreclosed and restructuring funds. So, foreclosed assets' at €1.4 billion and regarding sales, we continue to register profits in line with the type of profits of the year before. We present here as well the restructuring, the corporate restructuring funds since it played an important role on the P&L this quarter. So, we split, then the funds we have in to in three groups and both the generic and touristic type of funds are performing relatively well. We had some devaluations on the net asset value that we are providing for. So, one of the things that are every quarter on the other provisions is as you know a part of provisions for banking guarantees and other of dozen sheet. We have as well provisions for closed assets and for the restructuring funds and this typically cover and any type of devaluation here.
The numbers up to now where in relatively small but it was different this quarter. So, the funds linked to construction, have the material devaluation of the net asset value due to the particular conditions of the contrary in which these companies are exposed and it have the consequence over an additional amount of 116 million in provisions this quarter that we consider clearly one-off.
And moving to the international side, on page 45, so net income of the three of the international operations at 161 million, so an increase of 26% in local currency. In Euro, the growth was only 4%, given the depreciation of the three currencies. Adjusting this number four minorities, the contribution is 99 million which is lower than the previous year but in a comparable basis the contribution increased 25% versus previous year. Now, moving to Poland, and starting by the evolution of volumes, customer funds up by 4% and 6% from the deposit in particular an important increase on demand deposits of almost 22%. Loans stable although, with the decrease on CHF mortgage, it's the other portfolios, including consumer and company's loans increase. Then net income increase 31.5% although very much influenced on the positive side by the Visa gain and on the negative side by the new banking bank especially if we take out elements, the result would be completely in line with previous year.
Net interest income up by 8% as the NIM improved from 2.2% to 2.4% and this was the result of improvement on both spread from loans and deposits. Commissions down by 10% due to lower commissions on investments projects and as well from insurance business. And operating cost up by 1%. Credit quality NPL ratio improved to from 3% to 2.6% and the coverage improved to 112%. With lower provisioning efforts, so this year at 45 basis points versus the 56 previous year. Moving now to Mozambique, strong volume growth on both credit and deposits, net income up by 14% with a return on equity at 21. Net income very much affected by the change on the marginal tax rate, we wish were as these in previous quarter already from 16 to 32, so twice the rate we were considering before.
Income grew 25% above the increase in the operating cost and the cost to income improved and this now at 40.8%. And NII up by 40% from both higher volumes and higher net interest margin. So, the NIM is now at 7.6% and material increase of 120 basis points from previous year and due to the fact that credit rates and yields increase more than the deposit rates. And commissions and other income up by 4.5% and the operating cost by 18. Moving now to NPLs. Stable NPL at 5.4% and in-spite of the demanding environment we are having in Mozambique, cost of risk at 196 and this led to -- an increase in the coverage of the NPL that is now at 124%.
Okay, ladies and gentlemen, so going to our concluding page. The main issues in-spite of this one-offs and all these adjustments that we have done in our income statement, we are maintaining our 2018 targets. So, we are maintaining reaching common equity tier 1 ratio of 11% by 2018. And we are maintaining doing this without increasing the tier -- our leverage with so within appropriate loans to deposits and based on the very healthy business model. So, we are continuing to fight and to implement improvements in the cost to core income and in the cost to income. And over the cycle, we have not reasons to review our long term, our longer term so to say cost of risk or below 75 basis points. And our consequence, ROE consistent with this targets of around 11%.
So, what happened here was an adjustment, an adjustment based on another focus on the market on these new concept of NPEs and on the need to cover it through in a different way, so as to enable with reduction. Thanks.
[Operator Instructions] Kahal Carol [ph] of Care Health Capital. Please go ahead.
Good morning, guys. Two questions for me please. The first one is on your 2018 capital targets. My understanding is that course in general is targeting an excess of 12%. I'm just wondering given the cross banking nature of your Portuguese business. The difference in coverage ratio. There's a lot more conservative to target a higher capital ratio?
Rui da Conceicao Coimbra Fernandes
I mean, we don’t, there's a lot of noise about what is catching all targets and what will be catching all capital increase. We think that a situation in which the government clearly capitalizes cash in with excess capital is not something that will probably be approved by the P&L authority. So, we think that the European authorities will limit the capital increases of cashes all deposits to the appropriate capital level. But I don’t want to comment it further because there's only a lot of noise there. And so, we don’t have any reasons to believe that they will have a capital ratio in excess half to half percent. Okay?
Okay, thanks. And just my second question is given the debate that's going on in Italy with respect to the month of the past year on subordinated debts. I'm just wondering can you give current or new shareholders any confidence that there won't be I guess retribution or compensation due to the subordinated debt holders that were converted into equity at a much higher price last year for BCP. Thank you.
Rui da Conceicao Coimbra Fernandes
I mean, as you see we don’t have almost any subordinate there in our case. So, this is not a very relevant issue for our self. So, what I can tell you that we're not analyzing any type of solution that those two are the issue and as you know that the…
--- you see more momentum in the reduction in the cost of funding or not and on the fee side we saw some weakening performance in the quarter. Whether you see any capacity of the bank to recover some of their ground lasting this quarter on the back of that market activity or are there areas of improvements? Thank you very much.
Nuno Manuel da Silva Amado
Okay. So these clean-up exercise why now so to say. So basically there is a tradeoff between the speed at which one has to reduce and then the impacts in P&L at the end of the day. So if one wants to reduce P&L as a negotiation if you want to close a negotiation quickly typically the circumstances and the situation which you close the negotiation are not favorable then if you have time to close the negotiation. What we are seeing now is that the market is putting a premium on the reduction of MP on the fast reduction of MPs and this has an implication in terms of the impacts in P&L so we have anticipated that the impact in these P&L we think that in order to reduce the MPs quickly it's important to have a coverage close to 100% when considered collateral and we have then these strong effort of getting very close to 100% so as to enable us to reduce the MPs quicker because we see that the market is putting, so what are the reasons for this. First, we are seeing that there is a changing perception in the market in terms of that is giving to the MP number basically.
The first issue, second we are now in the position because of our business model that we can do it without worrying the market and without worrying regulators because our business model shows that it's capable of generating pre-provisioning profit that I mean are consistent with these additional efforts. So if we could not do it we could not but right now with the results of the stressness and with the evolution of our core income we can do it without worrying the market and without worrying regulators. So these are the if you want the two main reasons. The repayment of the -- we have asked for the repayment of $225 million, as you know some civil in the meantime there was this turbulence in the market.
We almost had the [indiscernible] in turkey as you know. The markets are very turbulence and basically the regulators told us that we would only take a decision after summer. So after summer, holiday we expected decision in September basically the main issue. In terms of the front book and the back book, the guy had -- looking for solutions that recurred marginal increase around $10 million a quarter which is being more or less verify. We think it makes sense if you do the dynamics in terms of the front book and the back book of the deposit. It's more or less what you get. In terms of also demanding needs to provide more because when you have the evaluation typically there is more volatility in the market and there is more risk in the market. So there is more to provide more. Typically you have less productions. So and the commissions are linked to productions. So it's normal that commissions go slightly down. But what typically compensates and it has been compensating these in our case is the NII because the interest rates goes up because typically these are liability based business models where your business model basically on originating deposits and then investing to a large extent in domestic so to say history securities and when the interest rates go up, I mean you benefit from this. So there are typically some compensations that you see in the type of macroeconomic scenario that you have in Mozambique and typically you have positive news at the NII level that more than compensates less production and slightly more impairments.
In terms of [indiscernible] we had their – the polish business it's somewhat depends on asset management and investments in the market. As you – it has been more difficult to place investments due to the present market evolution. As you know most of you also work in the asset management business and when the markets are not that good and when the employee pull and they are particularly not good. It's more much difficult to place fence. Let's see if the markets recover. I think this is not –this is something that can be recovered but it will depend a lot on market circumstances.
Thank you very much. That was very, very helpful. May I ask you a quick follow-up on your capital plans? So I understand there the target is 11% by 2018 but we have a couple of quarters where we have several one-offs in the capital ratios not only the capital ratio was not only the results but also negative impact in there, pension funds and others. Could you provide us more clarity here on what other impacts you could expect over the next quarter? What would be the capital levels where you would be uncomfortable on a fully loaded basis or not? What are your minimum requirements for the bank?
Nuno Manuel da Silva Amado
I mean we let's say typically the minimum requirement that we have is the last of two numbers, the economic capital that we think we should have to operate well our bank we thought jeopardizing our health and our sovereign if you want and the level that the regulators seeks us. And from an economic perspective and for the business model that we have and considering that we are a pure retail bank, I mean we are very comfortable with – in terms of minimum, with the capital levels that we have and I mean we see no reasons to worry about it. From regulatory standpoints, as you know we are not disclosing our share price, but you can imagine more or less what it is because in other countries the banks have been authorized to disclose it. We are comfortable here about the share prices and the stress that we did I mean it gives us confidence that we will continue to do so because as you know the share price is orders that that's the stress test is an inputs for the yearly succession of the share prices so we are confident that we are where we want to be.
So in terms of minimum level we think there are no worries. And another thing is the optimal level. The optimal level is more or less where we think that we should be so as to optimize so to say our shareholder value and these two to some extent we think that is a lot based on relative terms. So if all the market, if all the shareholders are looking at 11% fully loaded basis, we think it odds to get to these 11% fully loaded base but this is not the minimum level. This is a target. This is so to say an optimal level. So we are in these courses. We want to get there but we want to get there because of the market because of you not because we generally see that we I mean it's the minimum level to operate economically because below these we would be incurring accessories to say. The strategy that we have been mandated by the board up to now to get there was through is through dividend retention. And we think that through dividend retention and based on our business model we are able to get there by 2018. This is the mandate that we have from the board now because as you know there are always two possibilities to get there.
You can either frontload and optimal objective and normalize immediately the bank and so to say and to start immediately so to say paying dividends and PC so to say these optimal level. This is one possibility or you can leave below the optimal as long as it's an optimal and not a minimum and being a dividend retention for some time listening to our shareholders and to the share holders to the dependent board members that are represented on the board and so on with the mandate that we have until now because the ones we present the shareholders I think that's what’s protects better the shareholders interest is to get to these levels in an organic fashion through dividend retention and we are maintaining these plan up to now but there are always alternatives, but we are maintaining the finance up to now.
Very clear. Thank you very much.
Izabel Cameron of Goldman Sachs. Please go ahead.
Good morning this is Izabel Cameron from Goldman Sachs. I have two questions please. One is on [indiscernible] and one on the results. In relation to proposal one of the pre-conditions of the offer is the clarification around contributions to deliver solution funds but my understanding is that the bank of Portugal has already given guidance on this issue. So could you explain what further assurances are needed for the proposal to go ahead? And the second question is on your results and specifically the MP coverage. Do you coverage level as sufficient or should we expect any further reinforcement going forward? Thank you.
Nuno Manuel da Silva Amado
On the first point it's same thing that it must be clarified in the next week with the first one because if you – by conditions. So it is a great condition of the proposal from them. So we asked to clarify it with them in some detail then with our authorities. We cannot clarify right now because it's not our pre-condition okay.
Yes. So basically I mean leveraging on what Nuno just said so personally I agree with you. I think that what the bank of Portugal said was enough that there won’t be any extraordinary contribution and that they should be accounted for on an ongoing basis. We have received the letter over the weekend. We have to understand what they need more let's see but personally I agree that what has been said by the bank of Portugal is enough to have confidence that this won't be an extraordinary contribution and by not being an extraordinary contribution according to IFC 21 I mean it should be accounted for on a ongoing basis but let's understand exactly what they need.
In terms of the MP coverage we think that going to 97% of MPE coverage mainly when considering collateral mainly when these MPE already include many loans that they are not in the fault. So many loans that are basically seen as qualitative less goods, but they are not formally out in inner use so to say to be correct. So they are not formally in a use, we think that the 97% is a good ratio and it will allow us to go to the level of MPs that we think we should go by the end of next year i.e., around 7 billion we think at -- having said that as you know we are having excluding these impacts a cost of risk cover around 120 basis points we continue to expect to have this cost of risk without considering this. We are not bear in mind that over the longer term I mean probably we will have much lower cost of risk one thing is a next two or three years the other thing is our long term across the cycle cost of this. But so to say the richness of our provisions is already considered in our projections but overtime.
Okay. Thank you very much.
Nuno Manuel da Silva Amado
[Indiscernible] Research. Please go ahead.
Hi, thank you. Firstly I like to follow-up on the state CoCos. Can you remind us whether the stress test assumed a full repayment of the state CoCos?
The stress test has many impacts and has many assumptions that I just commented, some of them more realistic some of them not so realistic. I was just commenting that for instance assume that we cannot re-pass an increase in defending cost in the same way as we have re-passed in the past. They have assumed for instance when we do an expected loss or when we do a lot of impairments that the otherwise don't go down in stress test which also doesn't make a lot of sense. And they have and these particularly penalizes they have assumed that in these MP scenario in which we have a lot of loans that are not in arrears that we will not recover practically any interest so they have a lot of – it's a very close methodology that clearly penalizes a lot the banks in countries that have had difficult past not least because it indexes also to the writing of the country and to the writing of the rank. So it particularly penalizes because it looks it's somewhat backward looking in terms of the assumptions and not totally independent from the past. So this is something that I would like to comment. Of course there are some positive and some negatives. As far as I understand I think that in terms of the CoCos it assumes maintenance of the CoCos but this is left and compensated by either impact that are even higher than these impact that I am just commenting.
Okay. Okay. So there assumes no repayment. Then can we shall we maybe assume that repayment of the CoCos could then depend on an investment by --?
This is kind of a pre-condition if given that the stress test didn't assume a repayment?
Nuno Manuel da Silva Amado
No because as I am just commenting to you the stress test has also other vary situations and that are not that that will not be verified and some of them will compensate the others and in many case as I am just commenting here the way that the regulator will decide on the stress test and will not decide on the repayment of the CoCos is based on the fading ratio and these fading ratio that it’s not fully loaded, so I think it’s very, very important in this fading ratio is very comfortably above the 5.5% even so and we’ve some capital generation. So the fact that our fading ratio is comfortably above the 5.5% which is one that’s relevant for the repayment of the CoCos. The fact that we will be generating capital until middle of next year, the fact that there are some very I would conservative assumptions in terms of the stress test not the least the fact that when we convert unexpected losses and expected losses there otherwise do not reduce so when we do impairments, when the expected loss goes up, otherwise will not reduce, the commissions that are there, the negative commission that we’re having the stress test are high influenced by negative commissions that we paid in the past and that we will not pay in the future. So, we’re not dependent on it. What I could say is the following. If you were to repay of course the full CoCos tomorrow which is not the strategy that we’ve now of course, if these were strategy which up to now it isn’t, it has not been decided this way, of course we would only be able to do it, with the capital increase, but I would like to remember that this is not our strategy to repay everything tomorrow.
Sure. I get your point on the capital generation and you previously said that you see a consistent increase in your capital ratios probably, I mean, given that your capital ratio’s job in Q2 do you think the regulator may want to see a few quarters of capital to get more comfortable?
Nuno Manuel da Silva Amado
I mean, we’re already comfortably above the minimum ratios of the regulator. Okay, comfortably.
Okay. Okay. My other question is that just on the provisioning outlook. I would, so you are not targeting it. You are too busy on MPE reduction and your MPE coverage in terms of cash coverage is still relative low. So how do you think about your provisioning outlook in the context of this MPE reduction because if I look based for the last 18 months I think you had almost the 2% provisioning even if I exclude the one offs provision and this helps you get down from an 11 so to divest 1.5 billion of MPEs so in the context of this more than 2 billion MPE reduction how will you think about your provisioning outlook?
Nuno Manuel da Silva Amado
Okay. Just I mean if you have a lot of questions probably then we can sit down later because I think a lot of people still wanting to ask questions. I think this is your last question here in the call. So that we give also the opportunity to others also to make their questions. Okay. Now our as I was just commenting first, we don't think it makes sense to compare insecure MPEs with secured MPEs I think both the analyst, the market, the rating agencies are clever than that. So we do think that what is important and what you see the graph that we have presented here is a graph that was presented by the ECB was not presented by somebody else that more and more people are becoming more sophisticated and look at that coverage with collateral than we thought. Of course in countries that have reverse collateral evaluating processes so we take a look at our collateral evaluation process in Portugal is very robust. It's independent. It's yearly. It's being seen by many people. So we take comfort that the main ratio should be the coverage with collateral. The big difference is that we were looking at the coverage with collateral for the former MPE.
If you want domestic MPLs that didn't consider qualitative MPEs that only considered loans that were effectively 90 days in the years didn't consider and the default and that didn't consider. So to say a loan debt qualitatively we decide to provide and to provision even when the custom is totally up-to-date. So the fact that we are now having a different matrix that also has these qualitative assessments of course makes us also to increase the coverage. We have collateral for these different matrices. In terms of getting there now we think it's an effort to get to the 7 billion that we get there mainly if you will see what we have done in the recent past. In the recent past we already have reduced 1.5 billion in terms of these MPEs so we think that 1.5 billion to reduce the remaining is perfectly consistent with our track record.
In terms of our cost of risk of course cost of risk is like little bit like trading games mainly when you look at larger cases. So it's more – it's easier to make a projection across the cycle and make the projection over the long term than to be right in any specific quarter because I mean there is some risk there. So it's like forecasting exactly where the share price will be. But our projection right now for the – as it was in the beginning for the year end is still the 120 basis points. So we are maintaining this projection. Over the longer term as we have seen, as we have demonstrated here we have and across the cycle impairment cost clearly below the 75 basis points as you see in our targets for 2018. Okay.
Okay. Thanks very much.
Nuno Manuel da Silva Amado
[Indiscernible] Capital. Please go ahead.
Hi, thanks. It's a question on the pension fund. At the moment you have got some differences like less than 200 million Euros. Now the discount rate is 2.5% if I remember correctly and some of all European banks are applying lower rates in the range of 1.7%, 1.8% so my question is what would be the impact on these actual differences if you were to apply this sort of strong rate of 1.7% and what would be the impact of your capital position? Thank you.
Nuno Manuel da Silva Amado
Okay. I don't have the data with me, but what I can tell is the following. Our discount rate is based on methodology and just to remind – and on the specific situation of our pension funds. Somebody has -- that I am listening to the person that could put the mute. So what I can tell you is the following is that our pension fund on average has 17 years cash flows. So the cash flows of our pension funds are quite longer than the average pension funds in Europe not least because a couple of years ago the Portuguese government transferred the pensions that were in payment so to say to the social security. So effectively the pensions that are in the pension funds are basically pensions that are not yet in payments. So our pensions of people for most of it that are still working which is something very different from the normal pension funds in Europe and from the normal pension funds in other countries. So this is something that I would like – so it is an average of 17 years but a very long time if you want. What the ISS say is that discount rate on a pension fund should be the low risk corporate rights for the same maturities so to say without defining exactly what is low risk and typically low risk is considered to be either A plus or A minus more or less.
So my take to you is would you invest in 17 years corporate A plus bonds at 2.5% or not. So it's true that the rate came down but for me in these volatile environments I can tell you I would not invest in the 17 years bonds that do not present so I would demand higher rate. So I do think that 2.5% for the specific situation of our pension funds that is a very low pension fund in terms of assets it is the adequate and we can show this in support of this is the correct discount rate. Okay.
Yes, thank you.
[indiscernible] please go ahead.
Yes hello, good morning. Thanks very much for taking my questions. Regarding the MPE, I want to clarify that you had 2 billion targets for reduction by the end of next year is from the 9.5 billion that you have reported this quarter that's one question. Second one, I don't know if you could tell us how do you expect the reduction to be split between write off organic recoveries and sales of MPEs. Third thing is if you could comment about your experience over the last two, three years in selling MPE portfolios what is the kind of appetite that you see out there and when do you expect to start doing these kind of transaction in the coming months?
And then one thing on the dynamics of MPLs in general we have seen MPLs coming up quarter on quarter. You have mentioned there are some very specific cases also entries in the quarter are up could you comment on the general dynamics of MPLs as you see them right now and what do you think are the main impacts there are, how do you expect that to above of what from year to year end mainly and then next year as well. And the final thing is on for closed assets. What’s the dynamics there because we are also seeing some increase in the total amount? It is not a big amount but it's going up. And what is your target coverage for the close assets because that's also come down quite significantly over the past year from about 20% to 30% so you also want to increase that coverage or not. And that's it. Thanks very much. Sorry for the many questions I am asking. Thank you.
Nuno Manuel da Silva Amado
Okay. Thank you very much. Starting here with the general plans so we have as you see here that MPEs are over 9.5 billion and we wanted to reduce it by 2 billion in the end of the year of next year. And this is basically then through between 0.8 million and 1 billion of course it depends about in terms of delivers so we will get to a higher number to the one that I am saying but between 0.8 million and 1 billion but basically between in terms of prevention and reduction of the period of recovery around 400 million right now in terms of loan saved and between 1 billion and 1.5 billion in terms of basically EPI and writing off but we felt any additional impairments to the one that we are doing right now. In terms of the real estate and foreclosed assets and so on couple of comments, totally to weather countries we have I mean we are not having a problem here in terms of disposal of real estate.
So once we get the access to the real estate fee of -- once the assets come to us it's quite easy to sell it. So and we don't sell it with a loss. So the value that we have in our balance sheet has proven to be the correct value and effectively in the recent past years where we still have gains. So the real estate I mean we don't have any relevant for instances houses to for sell in Lisbon, in Portugal and so on. So we are not having a problem in terms of selling the real estate and reducing the foreclosed assets. Of course, the process of recovery in the short term have an impact in terms of the foreclosed assets because I mean typically people that get into default don't have cash because if they have cash they would not get into default. So what they have typically is asset. So the process the typical process of recovery is I mean execution getting access to the asset and then selling the asset. The critical point here for us in Portugal is not that much selling the assets because we are being able to sell it and sell it to the appropriate price. The typical challenge for us is the period in which having to get the time to get the assets. Okay.
So and this is something that is partly linked to the judicial system in Portugal as we just showed. Part of it also has to do in how far we use the judicial system and how far we use agreements with customers. So to make a long story short so the foreclosed assets are not an issue. But they may go slightly up mainly when we pressure – when we improve a lot our recovery performance because the first impact of recovery is to get the assets. So if we -- a lot of recovery process of course in the first moment we receive more foreclosed assets but we are not able to sell it. In terms of the MPLs over the cycle and so on we will be probably we will be seeing them going down but as you see the main difference between the MPEs and the MPLs that I was just commenting is this qualitative adjustment. So it's when we access a loan to be not good so to say but or likely to fail if you want but they – but it has not failed yet so to say. So what we see is that in the quarter the MPEs have performed very well because the ones that are there or likely to fail so the [indiscernible] likely to be -- actually went down of course some of the ones that were likely to becoming to -- became effectively in the arrears so this quarter it is there was an increase but actually I mean it is more to larger cases than something else. And what is becoming more and more important for the market and for the regulators at that point is that MPE number.
Thank you. [Indiscernible].
Hi, hello good morning and thank you for taking my question. First of all I would like you to give us an update on the deductions to your capital ratio, full implemented ratios. If you can give us the numbers with the break down as of June and then a clarification on your last comments and also including investment funds. Should we expect any additional provisions for the second half of the year or more normalized level of provisions for those other provisions. It's just a clarification on your last comment? Thank you.
Nuno Manuel da Silva Amado
So, as usual I will share more detail on this but roughly the numbers are 400 million on minorities, 300 on goodwill, 800 on EPAs, 200 on participation, financial participation. And 300 on expect loss GAAP. Okay so altogether make a number around 2 billion and this is what coming from the initial equity over 4.2 plus minority interest of 900 and the CoCos and then reduction of this 2 billion gives a common equity year of around 3.7 billion that together with [37.9] of assets gives the 9.6 ratio.
Nuno Manuel da Silva Amado
In terms of the investment fund I mean we are not expecting anything abnormal so there we will probably have the normal variations. We think this is the wrong construction sector in Venezuela, in Angola was something very, very special. I mean some of you are following what’s happening in Venezuela and the problems that occurred in terms of hard currency in Angola I mean the construction companies have suffered. We don't expect them to suffer them much more. And the other ones I mean there maybe some gains or some losses but we are not expecting anything out of the ordinary construction business.
Hari Sivakumaran of KBW Capital Partners. Please go ahead.
Hi there. Just on the recovery funds. What fixed rate value of the assets transferred into the funds?
Nuno Manuel da Silva Amado
The value, the gross value I mean when the assets before the assets get transferred into the liquidation funds they are provided so to say there is a mark down of the asset on average of around 20% once they get to the funds. The net value of the funds right now I will just give you the correct value. It is around 1.2 okay.
Okay. So if –
Nuno Manuel da Silva Amado
So just to give you an idea so basically the initial credit was 2 billion. Okay. They had the markdown because they I mean they are managed separately and these funds have different shareholders and have the same structure to perform to buy low and high so to say. It's a negotiation process. So they typically were marked all by 20% so they went down to 1.6 billion now and now they have a provision of around 0.4, 0.5 so that the value right now is around 1.2 billion.
Right. Thank you.
The final question comes from [indiscernible] please go ahead.
Hi, sorry this is just a final question just on the final guidance on impairments. In the last quarter I understood that you were expecting the cost of risk to go down by to around 1% in 2017 and I think now you are now guiding to 120 basis points this year and the line excluding the one offs and I wanted to confirm it if you maintain the 1% credit cost of risk in 2017. And secondly if you could explain one off impact in the capital ratio in the quarter compared with 10.1% in March perform of Angola merger that will be really appreciated but if it's not we can call afterwards. Thank you.
Nuno Manuel da Silva Amado
Okay. I mean for this year what you are saying is that our guidance is around 120 and for 2018 our guidance is around – is below 75 basis points so probably 2017 will be a number between 120 this year and 75 basis points next year. So, in terms of the dynamics of the ratio what – in terms of the fading ratio if you want we had the impact of the fading that was around 60 basis points in the beginning of the year. Then we had the merger of Angola which has given us slightly an excess of 30 basis points. Then we had if you want the impact of the pension funds that has had an impact of around 30 basis points. Then we had the impact of our net income of year-to-date that is almost 50 basis points negative of course and then we had had an impact in terms of the rating of Mozambique that made the balance sheet of Mozambique consumer capital that had an impact of around 20 basis points. So these were the largest impacts that we had in our capital ratio.
Okay we have a question from [indiscernible] from JB Capital Markets. Please go ahead.
Hi there. Just a quick one. I understand that you have just received -- and that you need to go through it. I think we all agree that part of the appraisal of that offer is conditional or what happens to the bank situation. My question is I was just wondering when can we expect response from DCP to the frozen offer and have they put a deadline or timing or validity to this offer? Thank you.
Nuno Manuel da Silva Amado
In terms of formally the frozen offer is not really dependent on the outcome of the bank situation. So what they are asking is a clarification on the treatment of the resolution fund and of the way it impacts our capital base and where it is they have enough assurance that it will only have impact overtime so to say and not immediately. So in terms of the way I mean we are looking at it I mean we will sit down, we can we will sit down and probably -- in the next 15 days we will be digesting these. We will be demanding some clarifications. And the next board meeting with the full board because this is from the governance point something to be much more managed by the non-executives and by the independent directors of the board than by the ex-co it should be this way as we respect very well the good governance procedures but we will issue I mean an analogy for the board them to discuss and we would be expecting these to occur during the month of September that is when we have the full board doing this. So our – we would expect we have more news I would say until the end of September. This is a little bit odd time. Okay.
Fantastic. Thank you very much.
There are no further questions in the queue. I would like to turn the call back to Mr. Miguel Braganca, CFO for any additional or closing remarks.
Thank you very much ladies and gentlemen. So this is special quarter as you have seen. So it is quarter in which we have improved a lot our stress test, in which our business model showed resilience and in which these resilience was used to adjust the coverage to a reasonable coverage for these new concept of MPEs. We’re now facing interesting moments. We have just received an offer as you know which we have to explore to make sure that it delivers well for our shareholders and please count on our commitment in these to continue to perform well both at the operating level and in terms of delivering value to you. Thank you very much.
Thank you. That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen you may now disconnect.
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