Aug 2, 2015
Executives
Rodrigo Aravena - Senior Vice President of Institutional Relations Pablo Mejia - Head of Investor Relations Victoria Gabens - Investor Relations Officer Daniel Galarce - Head of Research
Analysts
Guilherme Costa - Itaú BBA Catalina Araya - JP Morgan Victor Galliano - Barclays
Operator
Good morning, everyone, and welcome to Banco de Chile's Second Quarter 2015 Results Conference Call. If you need a copy of the press release issued on Thursday, it is available on the company's website.
Today with us we have Mr. Rodrigo Aravena, Chief Economist and Senior VP of Institutional Relations; Mr.
Pablo Mejia, Head of Investor Relations; Ms. Victoria Gabens, Investor Relations Officer; and Mr.
Daniel Galarce, Head of Research. Before we begin, I’d like to remind you that this call is being recorded and that the information discussed today may include forward-looking statements regarding the company's financial and operating performance.
All projections are subject to risks and uncertainties and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements.
I’ll now turn the call over to Ms. Victoria Gabens.
Please go ahead.
Victoria Gabens
Good afternoon. It's a pleasure for me to share with you our comments on Banco de Chile's Second Quarter 2015 Financial Results.
Please turn to Slide #2. We will briefly discuss the macro environment and the banking industry results for this quarter.
This will be followed by an announcement of Banco de Chile's strategy and second quarter results. Please turn to Slide #3, which contains the economic highlights.
After a slow 1.9% growth rate in 2014, the Chilean economy showed promising signs of a modest recovery during the first quarter of this year but soon began to falter. This seasonally adjusted monthly index of economic activity or also known as, IMACEC, has been flat for the last few months.
As you can see in the top left chart, the year-on-year three months average growth shows a downward path of the favorable record over last December to January. According to the economic expectation survey conducted by the Central Bank, analysts now expect the ET to pose a 2.3% in 2015 and 3% in 2016.
The main drivers of this modest growth include a mix of international and domestic factors. First, a larger amount of trading partners and also loan commodity prices are hitting investment in the domestic mining sector, where the comps are roughly 35% of total investments.
On the other hand, as the top right chart shows, domestic, consumer and business confidence are unique and therefore are delaying the recovery in domestic demand. As the bottom right chart shows, in line of the developments in international commodity markets and stronger pace for the dollar, local currency has depreciated strongly at about 7% since last December, which has positively changed by increasing the contribution from net exports to economic growth.
Please continue to Slide #4. Despite the cool down of local activities, labor hadn't shown signs of deterioration until recent months.
As the top left chart shows, since the end of 2014, nominal wages have been growing at roughly 7% year-on-year and unemployment rates have remained on levels at around 6%. However, the latest figures show the effect of slower activity on labor market there, presenting unemployment rate of 6.6% and nominal wages mark a remarkable job [ph].
One of the most noticeable aspects of the Chilean economy since May 2014 has been the increase in inflation. As the top right chart shows, until May of this year, both the headline and core measures seem to decrease, a recent data recorded an additional take-off in the inflation targets seen up 4%.
Indeed, headline inflation grew 4.4% year-on-year. The core inflation showed a 4.7% increase.
Both the depreciation of the local currency and particular food and energy items are the main driving forces behind this last figures. Even though current inflation is above the policy terms, Central Bank reinforces the mutual bias in the last monetary policy meet.
In the context where most of the economists in the market expect the Central Bank to maintain monetary policy rates at least to the end of this year. This scenario is sustained by a well anchored inflation expectation over a two-year horizon at the 2% targets, in addition to slow growth observed or projected for this year.
As the bottom left chart shows, both nominal and real long rates have shown slight decreases in minority development in international financial markets. Although public finances remain strong, the finance industry adjusted its fiscal deficit estimate to 3% of GDP for this year from 1.9% of GDP in the original budgets which was higher-than-expected expenditures and lower growth of revenues, as a consequence of the domestic slowdowns.
Net cash as percent of revenues remains at negative 0.4% with the debt which suggests that Chile still has room to perform countercyclical policies, even though it falls in the 19.9% recorded in 2008. Please turn to Slide #6 for a review of the main figures for the Chilean Banking System.
First, as seen on the chart on the left, loan growth for the industry posted an increase of 5.6% year-on-year in the quarter [ph]. Mortgage loans were the main drivers behind this figure as the year-on-year increase of 11%.
The behavior of market loan growth has surprised us given its current economic cycle. The general view on this is that individuals are anticipating home purchases due to changes into this [indiscernible] 2014 and includes the implementation of VAT on public transactions and may increase prices in 2016.
On the other hand, consumer and commercial loans showed dynamism that is more in line of weaker economies. Low confidence levels and rising unemployment rates and is currently between 3% and 4% year-on-year respectively.
In terms of results, the banking industry posted a strong bottom line of Ch$665 billion. This was 23% increase over the prior quarter, in line with high inflations that reached to almost 1.5% this quarter versus 0% last quarter.
Additionally, it was also accompanied by good asset quality indicators, with a loan loss provisions ratio of over 1.1% compared to the 1.13% in the first quarter of 2015. However, year-to-date net income as of June 2015 has decreased by 9% mainly due to the effects of high inflation presented last year.
Please to turn to Slide #8, where we present our strategic pillars. Banco de Chile has five main strategic objectives, which define our medium and long-term goals.
Each of these pillars serves as the guidelines for new project initiatives in all areas of our bank in order to continue creating value for all of our stakeholders. The bond price [indiscernible] in order to meet some of these objectives.
Please turn to Slide #9. Loan growth picked up growing 8.6% year-on-year and 2.5% over the previous quarter.
The main factors that improved loan growth this quarter was a pick up in the wholesale segment, with grew 5.2% year-on-year versus when we presented last quarter when volumes shrank on year-on-year and quarter-on-quarter basis. The increase was primarily result of commercial decisions implemented to grow selectively markedly and trade finance on short-term working capital loans with very little risk and high cost on customers.
Thus, reinforcing our business leadership. On the retail side, SME strong, increasing 11% year-on-year and 3.5% quarter-on-quarter.
Mortgage loans continued to drive growth with a 13.4% increase year-on-year and 5.1% quarter-on-quarter due to an impact regulations that are customers to anticipate home purchases in order to avoid paying value-added tax. Consumer loans in upper income individuals also carry on showing good growth of 10.9% year-on-year and 1.9% quarter-on-quarter, as opposed to the decreases that are currently in lower income consumer loan portfolio, which is in line with our expectation to this segment.
Finally, SME loans have picked up this quarter, posting a rise of 9.7% year-on-year, up from the rates posted last quarter. This represented our strategy to continue penetrating the segments together with several innovative initiatives to improve loyalty amongst these customers.
The technological improvements we have enabled to create new virtual accounts for our customers to get to know as these are products and services. The progress that has been made on all online platforms undoubtedly allows us to continue strengthening our relationships with customers and providing them with better service.
Thanks to these online and technological initiatives, Banco de Chile was awarded the Best Digital Bank Awards for 2015 by Global Finance magazine. This prestigious magazine recognized Banco de Chile for its digital services, emphasizing especially on the side of mobile apps that were introduced last year.
Please turn to Slide #10. As we announced earlier this month, we have entered into an agreement to acquire a loan portfolio from a local bank for approximately Ch$590 billion, which represents just below 3% of loans outstanding.
Due to our size, we were capable of obtaining funding for the operation without problem closing the year in record time. This portfolio was gradually recognized in the bank’s book between July and September.
Some key facts of this transaction includes: first, over 90% of the total loans are with customers that already have relationship with the bank. Second, over 80% of the portfolio is wholesale and is concentrated in the middle-market segment.
And third, the individual average term of loans outstanding is about two years and the duration is approximately 1.7 years. The benefit of this transaction are even more enhanced due to employment synergies that are stated scale of operations.
First, since most of the customers are already Banco de Chile clients, the additional operational cost inside incorporating a portfolio are minimal. Finally, this transaction entails an important institution loans and market share as you can see on the chart on the right, increasing our market share today by approximately 48 basis points.
As we finance out in the weak economic process with lower loan growth, acquiring this loan portfolio was very attractive given its profitability. Historically we have preferred organic growth over inorganic growth, and even though it continues to be positive leap [ph], we know this particular opportunity undoubtedly creates great value for our shareholders.
Please turn to Slide #11. In terms of funding, we continued to diversify our liability structure while also improving the stability of our liabilities and current liquidities.
Core deposits continued to play a key role in our finding structure, representing 26% of our funding on average. Demand deposits and debt issued in particular have increased significantly year-on-year and decreased their participation from its retail customers, providing more stable sources of funds.
On the left, you can see that current account deposits have increased 18% year-on-year, 49% of which are retail deposits. The remaining current deposits are spread in wholesale and institutional, representing 23% and 8% respectively.
The strong growth in these deposits is due mainly to improvements in retail funding as a result of a strong customer relationship strategy, which is far more stable than institutional funding. This has been achieved through diverse mechanisms, including improved home loan services and fund development and client satisfaction.
On the other hand, time deposits seen on the right have increased 4% year-on-year, in line with expectations. Currently 22% of these deposits are retail.
24% are institutional and 25% are wholesale. Total deposits for institutional only represent around 20% which is significantly lower than industry, especially when comparing to small banks that depend much more on this source of funding.
In terms of debt issued on the bottom left, which has increased 16% year-on-year, in line with our growth in mortgage loans. This is a result of initiatives seeking to open to new international markets and weekly exposure to local institutional.
The various debt issued represents 90% of total funding. This is remarkable increase from the 10% that was in 2010.
As you can see on chart on the bottom right, our strength in funding has translated into an average annual cost of funds for Banco de Chile of over 2.4% as of June 2015, ranking us first among our local peers. This is very impressive especially when you consider that the savings for every 10 basis points of corporate funds represents roughly Ch$35 million in net interest income.
On Slide #12, we present service quality. Our strong focus on the strategic pillar is one of the main reasons we have been able to achieve great accomplishments over the past years.
Today, it is the core of the business strategies. On the left, you can see that our net promoter score have had a positive trend since 2012, moving from 50% to 70% this quarter.
This increase is partly due to important developments in our customer sales programs, which speak to give our customers the high satisfaction on hiring and using our products and services. Another important factor is the rate of online and mobile optimization that has been introduced to facilitate all bank operations for customers.
These initiatives have also continued to empower our brands, as you can see on the right, our current brand name has almost been a competitive advantage, but today it is enhanced by an improving level of customer service, which is facilitating growth and its competitive environment. Please turn to Slide #16.
In terms of operational excellence, we have also made important progress in various projects since this first half of 2015. Amongst these, three initiatives stand out that are focused on modernizing different bank services in order to make operations easier for our customers.
The first of these is a new online platform for retail customers, who will now be able to buy and sell currencies directly from the computers or mobile phone and allow them to collect the cash quickly at any branch. This service will be given to all individuals and SME clients who hold a current account with us.
The second project consists of a new service related to credit card sales, which will now be delivered and activated on the same day, thanks to advanced technology that allows our sales force to collect the necessary documentation and receive approvals faster than the traditional process. This will greatly improve logistics and delivery and activation of this product and should help instant sale.
Finally, we have come together with SERVIPAG to enhance cash withdrawal availability in Chile. SERVIPAG is a company that provides various transaction operations for individuals, such as bill payments and deposits.
This service will allow customers to make withdrawals on deposits at certified branches seven days a week, thus using our 1,500 ATM networks by 350 certified service points. These are just some examples of the projects currently being developed to offer our customers fast and digital solutions to everyday needs, while also identifying operations in areas that need improvement.
Now I will pass the call over to Pablo Mejia to discuss Banco de Chile’s first quarter results.
Pablo Mejia
Please turn to Slide 15, where we will present the quarterly results for Banco de Chile. This was a record quarter for us with a net income of Ch$168 billion, which represents an increase of 9% year-on-year and 44% quarter-on-quarter.
Thanks to this historically high results have almost completely closed the gap of 2014 accumulated earnings, which was extraordinarily high as a result of inflation. This was achieved by affective and prudent risk management which has permitted us to record lower levels of provision expenses together with successful implementations and execution of a commercial strategy that consistently generates growth and stable core revenue and customer revenues.
In terms of profitability, we posted a 26% return on average equity in this quarter versus the 18% for the first quarter, which consequently results in a 22.3% return on average equity for the first half of this year. Please turn to the next Slide #16.
Operating income for this quarter was Ch$419 billion, a 10% increase quarter-on-quarter, a 1.6% increase when compared to the same quarter last year. The strong quarter-on-quarter rise was mainly driven by non-customer income, which increased from Ch$84 billion in the first quarter to Ch$119 billion this quarter.
This result was mainly due to our U.S. structural gap, thanks to the variation that rose from 0% to 1.5%.
When we compare this quarter to the same quarter last year, the 1.6% growth was driven by customer income, despite the higher inflation posted last year during the same period. The main drivers behind the year-on-year customer income growth were an 8% rise in fees, mainly related to good financial performance from our mutual fund business and debit card administration, in line with customer growth and inflation.
Secondly, a 6.1% year-on-year expense in average loans, which was partially compensation by both a mixed effect residential mortgage loans growing faster than consumer and commercial lending and a slight drop in lending compared with commercial loans. And finally, a positive effect of our FX hedges which are mainly relates to U.S.
dollar-denominated allowances for loan losses amounting to about Ch$2.6 billion due to the depreciation of the Chilean pesos versus the U.S. dollar.
Please turn to Slide 17. Loan loss provisions decreased 18% year-on-year from Ch$72 billion to Ch$59 billion this quarter, due to the effective and prudent risk management, which has greatly improved provision levels in our wholesale and SME segments.
This result is also consequent of higher comparison basis recorded on non-recurring additional provisions in 2014 in the second quarter. The variation on the chart on the right shows these main drivers.
As you can see, the decrease of concentrated and additional and commercial loan provisions, which decreased by Ch$19 billion. This was mainly due to the strong financial position of our larger customers and higher recoveries from government-backed loan to SMEs.
This was partially offset by the negative effect of about Ch$3 billion due to the depreciation of the Chilean peso on dollar-denominated allowances, hedged in operating income as I mentioned earlier and provisions from consumer loans by Ch$7 billion, in line with the weaker economy and the higher unemployment rate as well as growth. Overall, the decrease in provisions together with a loan book expenses resulted in healthier risk indicators.
As a result, our loan loss provision ratios for this quarter is 1.1%, which is significantly lower than the 1.4% reached during the second quarter of 2014. Non-performing loan on the other hand presented a more moderated decrease from 1.31% in the second quarter of 2014 to 1.29% in the second quarter of 2015.
Please turn to Slide #18 on operating expenses. As presented on the slide on the left, expenses quarter-on-quarter decreased by almost 4%, due mainly to extraordinary factors.
On a year-on-year basis, expenses increased marginally by only 1.6% and the main factors excluding this year-on-year increase direct impact of inflation on salaries which grew 8% since these are adjusted by inflation twice a year. The increase is also due to benefits negotiated in the last collective bargaining process with the union.
The effective inflation and the increase on exchange rate on various administrative costs, including higher IT and communication expenses. These expenses grew 8% year-on-year.
These factors were partially offset by last year’s extraordinary payments for a collective bargaining agreement with the union and also establishment of non-credit related contingency provisions established in the second quarter of 2014. As shown on the blue line to the right, represents the efficient ratio this quarter of 41%.
The green line presented an adjusted efficiency level of 44% under normalized inflation scenario of 3%. However, we believe that a strict cost control policy, together with our productivity improvements, should continue to provide us with first grade efficiency levels that stand out when compared to the banking industry as a whole.
Please turn to Slide #19. As represented by the blue line, Banco de Chile continues to lead profitability with a 26.2% return on average equity, compared to the 18.1% presented in the industry in the second quarter.
On the bottom right, you can see our operating margins, net of risk, where we maintain a significant gap with our peers. This quarter represents a 6.5% net operating margin versus the industry’s 5.7%.
On the left, you can see our performance compared to the industry in terms of efficiency, which has greatly improved over the past years moving from almost 49% in 2009 to 41.3% this quarter, whereas the industry is slowly been increasing the cost to income ratio in the same time period reaching above 45% this quarter. The large gap in all these indicators versus our peers has been made possible due to the quality of our earnings, which is supported by a focused and consistent business strategy together with solid corporate governance practices.
This has allowed us to consistently take greater advantage of new opportunities and once again break records, as both the highest net income figure in our history. For the second half of this year, it’s important to keep in mind that the economy continues to present weak indicators which have gradually decreased growth expectations for 2015 and have kept confidence levels low.
However, we’re confident that these factors can be overcome if we continue to acquire consistent strategy and prudent risk management, in particular, the capacity that has identified business opportunity like our recent loan acquisition. These actions are proof of our unique skills and capacities which will allow us to look at the future with confidence despite a risk.
Operator
Go ahead.
Pablo Mejia
Sorry, I think we got cut out. I think we got left off.
It’s basically we believe that our actions in the last period, for example the purchase of the loan acquisition we had earlier this couple of months provide us with group of a unique skills and capabilities which will allow us to look at the future with confidence despite the weaker economic context. So if you have any questions, we’d be happy to answer them now.
Operator
Thank you. The floor is now open for questions.
[Operator Instructions] Please wait while we poll for questions. Your first question will come from line of Guilherme Costa with Itaú BBA.
Guilherme Costa
Hi. Good morning guys.
This Guilherme Costa from Itaú BBA. So first, congratulation on the results, I have two questions.
First, about loan growth. We saw that you showed an increase in the loan expansion during the second Q.
Do you expect the loan growth should expanded further this year? Do you believe commercial and customer loans could show a higher growth going forward and to possibly offset the expected decelerations in mortgage during 2016, as a consequence of the increase in taxes for housing market?
And then my second question is about asset quality. Could you comment, if you expect a deceleration in your NPL ratio?
And if so, from what second do you think it could rise, and what are expectations for the cost of risk going forward? We saw that the cost of risk achieved 1.1% this quarter, and last year it was 1.4%.
Do you expect this to increase, or you don't?
Pablo Mejia
Thanks. I think it’s important to mention that what we expect for the systems to grow this year.
We believe that the loan growth for the system should be around 8% to 9% nominal, with growth being led by mortgage loans, thanks to customers anticipating a home purchases because of this new tax law that is been implemented beginning 2016, followed by commercial and upper income consumer loans. I think that the loan income will probably loan growth as you see in past regulations on provisions for the maximum interest rates as well for the segment.
For us, we believe we should end this year with a growth in line, with this probably it could be slightly above or in that range, due to the above portfolio repurchase from another bank in Chile, which is equivalent to 3% of our loans outstanding and between 2% and 3%. And your second question on asset quality.
This first quarter - this first half of the year was very good, much better than last year, with better than expected. We think that for the second half of this year, we see economies of Chile isn't growing as far as anticipated and that employment rates is increasing.
So there could be figures more in line with the figure that we had in line with the prior quarter for the full-year of 1.2%. For the second half of the year, so that would mean probably a full-year result somewhere below that 1.2% if everything goes in line with our base economic scenario.
Guilherme Costa
Okay. Perfect.
Thank you.
Operator
Your next question will come from the line of Catalina Araya with JP Morgan.
Catalina Araya
Hi. Thanks for taking my question, and congrats on the great quarter.
My question is related to expenses. We saw a significant improvement quarter-over-quarter and a slow growth year-over-year.
So I just wanted to get your thoughts, how do you see expenses growing through the second half? And then my second question would be I just want to know what’s on - under a normalized inflation environment, what's your ROE expectations?
Thanks.
Pablo Mejia
In terms of expenses I think something that frank to mention is the stability that we’ve had in expenses over the last couple of quarters. The first quarter of this year was still one-time risk which increased expenses, as you can see in the press release I’m sure you’re well aware, but if you look at the year-over-year figures you mentioned, the expenses are growing somewhere around 8% range and that’s what we’re expecting for year-end, taking into considerations or excluding the negotiations with the trade union that took place at December and in June of last year.
So if we take that into consideration which is above Ch$45 billion. You should expect similar levels of operating expense growth for year-end.
And the reason for that increase which is around 8% to 9% is both still growing and there is a higher inflation last year as mentioned earlier in the call that the inflation effect salaries and different expenses as most expenses are indexed to inflations. Also exchange rates affected operating expenses for IT.
And your second question was?
Catalina Araya
ROE under a normalized - yes.
Pablo Mejia
I would say ROE at a normalized range is between 20% to 22%, and then if you think of long-term ROE including the tax reforms and what we know, during discussions being taken right now and based on what we know. And without having the subordinate debt payments of one of our shareholders, it should be around 20% ROE as well in the long-term.
Catalina Araya
Great, thank you.
Operator
[Operator Instructions] Your next question will come from the line of Victor Galliano with Barclays.
Victor Galliano
Hi there. Congratulations on the quarter.
Just really following up on credit quality. There is a lot of talk out there clearly about an economy that's softening.
It looks like the cycle maybe turning here, maybe bottoming out. How do you look at this now, say looking 12 months hence?
You've made your comments about where you think NPL ratio could be. Could you give us a sense here about, Pablo, where we might be in terms of cost of risk on an annualized basis looking by the year end.
Do you expect any sort of significant pick-up in terms of cost of risk, and where do you see the biggest risks on credit quality. Would you say that's in the SME portfolio, in the consumer portfolio?
Thank you.
Pablo Mejia
Well, I think something I’m trying to say is that the copper prices been falling for a while now. So mining companies [indiscernible] costs over the last couple of years, put these investments on hold.
So the cost of risk and credit quality you mentioned this has affected companies providing products and services to the mining industry, but this is already taken place. So really the large effectiveness has already taken place.
It’s difficult to quantify but the buyers with largest amount has already taken place and we don’t expect that this should have significant impact of provisions. Obviously it depends on how long it’s expected that this figure should - these levels of copper prices should be maintained, but if you look at what’s foreseen in the coming years, it’s a recovery in the copper price as seen by many private analysts.
So government spending should be higher, higher government participation should be expected as well as investment in the medium-term should pick-up. So we don’t expect us to have a significant impact in terms of risk.
And for the second half of this year, as I mentioned, we should probably be more in line with the level of 1.2% or a figure as we mentioned earlier for the full-year. Mainly I would say unemployment is probably going to rise and that should - that’s always has an effect or generally has an effect on the operating expenses.
Victor Galliano
Okay.
Pablo Mejia
And third on the risk area, there isn't any particular area where we’re concerned about. So the biggest concern which is just what every analyst would think of Chile is more macro, more what’s happening in China and how that affects Chile.
Victor Galliano
Okay. Thank you.
Pablo Mejia
You’re welcome. Thanks.
Operator
That will conclude the question-and-answer session. At this time, I’ll turn the call back over to Banco de Chile for closing remarks.
Pablo Mejia
Thank you for listening to our call and participating. We look forward to sharing our next quarter results.
Thank you. Bye.
Operator
Thank you. This does conclude today’s presentation.
You may disconnect your line at this time and have a nice day.