Nov 13, 2015
Executives
José Humberto Acosta - Chief Financial Officer Alejandro Mejia - Investor Relations Manager Juan Pablo Espinosa - Chief Economist
Analysts
Carlos Macedo - Goldman Sachs Tito Labarta - Deutsche Bank Saúl Martínez - JP Morgan Jorge Kuri - Morgan Stanley Philip Finch - UBS Carlos Gomez - HSBC Mauricio Restrepo - BTG Pactual Natalia Casas - Ultraserfinco
Operator
Good morning, ladies and gentlemen. And welcome to Bancolombia’s Third Quarter 2015 Earnings Conference Call.
My name is Volga, and I will be your coordinator for today. At this time, all participants are in a listen-only mode.
Following the prepared remarks, there will be a question-and-answer session. [Operator Instructions] Please note that this conference call will include forward-looking statements, including statements related to our future performance, capital position, credit-related expenses and credit losses.
All forward-looking statements, whether made in this conference call and future filings and press releases or verbally, address matters that involve risks and uncertainties. Consequently, these are factors that could cause actual results to differ materially from those indicated in such statements, including changes in general economic and business conditions, changes in currency exchanges rates and interest rates, introduction of competing products by other companies, lack of acceptance of new products or services by our targeted clients, changes in business strategy and various other factors that we describe in our reports filed with the SEC.
With us today is Mr. Jaime Velásquez, Chief Strategy and Finance Officer; Mr.
José Humberto Acosta, Chief Financial Officer; Mr. Jorge Humberto Hernández, Chief Accounting Officer; Mr.
Alejandro Mejia, Investor Relations Manager; and Mr. Juan Pablo Espinosa, Chief Economist.
I’d now like to turn the presentation over to Mr. Acosta, Chief Financial Officer of Bancolombia.
Please proceed, sir.
José Humberto Acosta
Thank you very much. Good morning.
And welcome to our third quarter conference results. It is a pleasure to be with you today.
Let’s just start with a brief discussion of the main topics that impacted our business in this period. You can follow the slide presentation available at our Investor Relations website.
We want to start this conference call by sharing with you some facts that drove the business during the quarter. During this period, we saw a significant depreciation of the Colombian peso against the U.S.
dollar, which caused Bancolombia balance sheet to grow faster when presented in pesos. Let’s remember that the depreciation on an annual basis, it is 53%; and in a quarterly basis, it is 19%.
This trend has also impacted although to a lesser extent. The income statement and some lines grew faster because of this.
The outcome of the mentioned effect [ph] in the FX is that the Tier 1 ratio of the bank diminishes, as a result of the growth in risk weighted assets faster than the Tier 1 itself. Nevertheless, despite every expression of assets and abilities into Colombian pesos, the impact in shareholders’ tangible equity is very small.
This is due to the fact that all of our operations in Central America are dollarized and the assets that we have in U.S. dollars in Colombia are funded with liabilities in U.S.
dollars as well. All-in-all, we rely [ph] on dollars in the portion of retained earnings in Central America, as we prefer to keep those earnings at the subsidiary level rather than bring them to Colombia.
Regarding the loan growth, we saw a 31% year-on-year growth when expressed in pesos and the FX movement explains about 16% of this. As we have predicted a few months ago, we are seeing a moderation in peso growth of the loan portfolio and should end up this year at around 12% and probably next year would be at around 8%.
Another relevant event that impacted our results during the quarter was the issue with one of our clients, Conalvias. This is a construction company that got in trouble due to cost overruns in some projects and led to several lawsuits by deposit sponsors, which were recently ruled against the company.
As a result, the payment capacity of Conalvias was severely affected and now creditors including other Colombian banks are working on that restructuring agreement in order to get repaid as much as possible and save the company. We have a gross exposure of COP 290 billion of which we have provisioned at around COP 80 billion as of September.
In the fourth quarter, we should expect to have at around another COP 80 billion in addition our positions regarding Conalvias. A third topic that drove, and is driving the business environment today is of the monetary policy in Colombia.
The Central Bank increased rates by 75 basis points over the last couple of months, which currently proceeds at a level of 5.25%. These increase coupled with our lower growth in deposits in the Colombian system and the higher stock of long-term debt caused the cost of funds to increase during the third quarter.
As a result, we experienced a compression in the net interest margin during the quarter. As the stock of existing loans re-prices and new interest rates are originated at the higher rates, lending needs should stabilize and eventually go back to the levels of 6% where we were accustomed to see in June.
The main goal on this front has been together reports [ph] at a faster pace without the cost of funds impacting the cost of funds in a significant way and to protecting the margin. In the coming months, we will attempt to maintain a flexible funding structure under Bancolombia usual standards.
Last but not the least, we must highlight the fact that the line dividends and equity investments which are not at the core of Bancolombia business have a significant decline as compared to the previous quarters, and in the second quarter of this year. During the third quarter, we sold a opportunity of stake that we had in a publicly listed company in Colombia called Odinsa [ph] which had generated significant gains in the first half of this year but did not contribute anymore in the third quarter of this year.
Also we sold Seguros Banistmo [ph] posting a total loss of COP 14 billion. These are not operated business, are not recurring at all.
But at the end of the day, we’re talking about at around COP 90 billion less in this quarter. Despite these unfavorable facts, we remain positive regarding the progression of the business plan.
The Colombian economy is experiencing a transition including low oil prices and high FX environment, but we’re reading the signals carefully and continue operating with a primary goal of maintaining a strong balance sheet with an adequate level of provisions. Slide number 3 summarizes the performance of the Bank.
Income before taxes for the first nine months of this year grew 12.8% and net income grew 3.8%. The gap between both figures is caused by the higher tax provision [ph] in the Bancolombia subject this year.
Let’s remember that the first quarter of this year we paid a wealth tax which was at around COP 162 billion, which we did not have in the second and third quarter of this year. All-in-all, we are comfortable with the performance of the Bank through the first nine months of the year, bearing in mind a tougher economic environment with higher taxation, the net income is growing and the balance sheet remains solid.
We remain cautious with the economic outlook and we are constantly making decisions to prevent any risks from materializing while focusing on efficiency, capital adequacy and profitability. Now, we would like to continue with a brief description about the economic climate.
For this purpose, we have Juan Pablo Espinosa, Bancolombia’s Chief Economist who will elaborate more on these models. Juan Pablo?
Juan Pablo Espinosa
Thank you, José Humberto. Now, I will ask you go to Slide number 4 in the presentation.
Let me start by saying that the recent performance of the Colombian economy has been driven by the fall in [ph] the terms of trade due to lower commodity prices. Moreover, the continued adjustment of the economy to this shock will shape its evolution during the foreseeable future.
In terms of economic activity, leading indicators suggest that GDP growth will accelerate from 2.9% in the first half of the year to 3.3% during the second semester. Accordingly, our growth forecast for the whole year is 3.1%, slightly higher than consensus estimate to 2.9%.
However, we expect that growth will moderate next year to 2.8% due to a combination of factors that included reduction of public spending, higher interest rates, higher unemployment, and an increase the debt burden of private agents. With tepid internal demand and weaker currency, in 2016, the external imbalance will have a marginal adjustment.
Trade deficit will narrow from $13.5 billion to $8.8 billion. This means that the current account deficit will be above 5% of GDP in 2016.
With these levels, Colombia will remain highly dependent on the international capital inflows. Meanwhile, we think that next year public revenues will be lower than official estimates.
So, in order to meet the deficit target of 3.6% of GDP, the central government will probably need to implement further austerity measures. We also anticipate that prices will continue to accelerate in the short-term.
We have revised upwards, our inflation forecast for the end of this year from 5.7% to 6.5%, well above the same [ph] of the target range. Inflation should reset [ph] in the second half of 2016 due to a correction of food prices, lower pressure stemming from weaker aggregate demand and base effect.
However, we’ll have to wait until the end of next year to see inflation ratings coming close to 4%. Again this backdrop, we expect that the Central Bank will extend the recent tightening cycle during the coming monetary policy meetings.
We then foresee that repo rate will remain at 6% during most of 2016. Regarding the exchange rate, the challenging global context is in a way the external deficit will translate into further peso weakness.
Having said that we believe that the peso depreciation will be less pronounced, in the future, than the one experienced in the past 12 months. Hence, after closing this year at 29.60, our USD forecast for the end of next year is 31.30.
In conclusion, Colombia will continue to face significant economic challenges. Even though the readings of several macro indicators will be a less constructive than in previous years, we think that the country will be able to adjust in a way that will lead to a more balanced macro context by the end of next year.
After this overview of the economic environment, let me turn the presentation back to José Humberto Acosta who will discuss the Bank’s results. José Humberto?
José Humberto Acosta
Thank you, Juan Pablo. On Slide 5, we see the evolution of assets and their composition.
We want to highlight the fact that during the year we have increased the proportion of the loan portfolio to 74% of total assets. This means that we are allocating more capital to our core business which is as lending.
[Ph] At the time, we have been reducing the proportion of the securities portfolio to only 7% today. The duration of the securities portfolio remains low at a level of 19.2 months, which minimize risks in a very volatile environment.
We continue originated loans with the strict underwriting standards in order to maintain the high credit quality of the loan portfolio, especially in the consumer segment. The loan growth in Colombian pesos reached 10% during the quarter, driven by commercial loans.
We focus our growth in the less risky products, as we want to maintain our healthy balance sheet. Regarding currency composition today, loans denominated in U.S.
dollars represent 38% of the total loan book. These U.S.
dollar denominated loans fell 0.6% during the quarter. The general increase in assets in the quarter and year is explained by organic growth as well as the significant depreciation of the Colombian pesos versus U.S.
dollar. Out of the 31% reported year-over-year growth loan, 16% again is explained by depreciation.
Also let’s keep in mind that the Colombia’s balance sheet is full matched in terms of currency, which reduces impacts of FX valuations on the shareholders’ equity. We would like to emphasize the fact that the net interest income after provision expenses grew 19% when compared with the 3Q last year, which is the result of the growth of the loan portfolio coupled with a stable NIM.
Finally, maintain our loan growth target rate for this year at around 8%. Now on Slide 6, we present a snapshot of the credit quality at the end of the quarter.
In general, we saw stability in the quality of the loan portfolio, allowances and past due loans. The 30-day past due loans to total loans, stand at the level of 3.1%, stable compared to the year [ph] ratio and to the 30-day coverage ratio also remains at a level of 119%.
As we mentioned at the beginning of this presentation, Conalvias, a client from the construction sector, filed for bankruptcy, similar to our Chapter 11 during the third quarter. Nevertheless, as at the end of September, it had not stopped servicing annual fees obligations with us, and therefore it is not classified as a past due loan and it really remains at a level of end.
[Ph] Since, we forecast the client [indiscernible] its loans, we started making provision during this quarter. As of September we have charged COP 86 billion that run through our P&L.
We forecast to have a 30-day coverage ratio, ranging from 110% to 120% in the medium-term, which we believe is more than enough to absorb potential credit losses. Similarly, 30-day past due loans should represent between 3% to 3.5% of gross loans.
This forecast includes the default of Conalvias. At the bottom of the table, we compare 30-day past due loans which is the Colombian standard and 90-day past due loans which is a better indicator of credit quality as we have a significant portion for our assets in countries that use that standard.
90-day past due loans have been very stable over the last two years, as a result of our good credit origination process. They represent 1.8% of gross loans as of September of this year with an excellent coverage ratio of 211%.
Slide number 7 shows the provision charges which were COP 491 billion during the quarter. They represented 1.5% of average gross loans when annualized and included COP 86 billion attributable to Conalvias.
In the shaded row of the table at the bottom, we present the amount of loans that became 30-day past due during the quarter. The COP 581 billion new past due loans represent an increase as compared to those in the previous quarter and are mainly represented by retail loans and SMEs.
Let’s remember that the numbers presented in this slide do not include the Tuya operations. One of our outcomes of not consolidating Tuya is a lower NPL formation and higher credit quality.
Besides the issue with Conalvias, we feel comfortable with evolution of the loan portfolio and forecast provision charges to be around 1.6 to 1.8 of closed loans during this year. As we have shared with you in recent months, it is important to keep in mind the context in which we are operating.
The Colombian economy is growing at a slower pace, the Colombian Central Bank is tightening the interest rates, and we should see the impact of these facts in the coming quarters. By that we mean that the pace of loan growth will be lower and we can see an increase in the number of delinquencies.
As of today, we have only seen a mild evidence of these trends. But we are taking the measures to prevent any negative impact in the next coming quarters.
Today, we’ll rather to grow less in an attempt to prevent a possible deterioration of the loan portfolio and higher provision charges. Moving on Slide number 8, we see the evolution of the net interest income NII and funding cost along with funding composition.
NII for this quarter was COP 1.75 trillion, 31% greater than the same quarter of the previous year, driven by higher loan volumes and the depreciation of the Colombian pesos versus U.S. dollar.
Bancolombia’ funding cost was pressured upwards, mainly by higher cost on long-term debt and in a lesser extent by central bank interest rate hikes and lower liquidity which fueled competition among banks for deposits. The total funding cost increased by 19 basis points while the central bank revenue rate increased to 4.75% by the end of the quarter.
During this year, we have focused our efforts, not only in keeping the funding cost as low as possible but also increasing the average time to maturity of the stock of liabilities, in particular, time deposits and long-term debt. Nevertheless, during the third quarter, most of the pressure was on time deposits as we have to recognize at a higher interest on new series.
[Ph] Our goal is to keep funding cost as low as possible while maintaining a conservative approach to liquidity risk management, in an effort to defend or expand the NIM and grow NII. We have in our favor, the asset sensitive condition of our balance sheet which is beneficial for NIM.
Turning the page to Slide number 9, during the third quarter we saw a 5 basis points compression in the reported net interest margin, mainly in the loans NIM. The NIM from securities was minus 1.3% due to the depreciation of the Colombian government securities.
We had to lead the NIM compression to the significant depreciation of the Colombian pesos against the U.S. dollar in the last days of the quarter.
Net interest income is recognized in the income statement using the average FX rate of the month while the stocks of loans is presented in balance sheet using the FX at the end of the period. As a result of the difference between the average and the period-end FX, when we calculate a NIM divided by NII, the denominator looks bigger, and as a result the NIM looks lower.
The Central Bank will continue raising rates in the near to medium term since its becoming more likely the fed will hike rates before year-end. The driver of rising rates is a good predictor of the higher NIMs as we move into the end of this year and the beginning of next year.
A breakdown of analysis of fees is presented on Slide number 10. During the second quarter, net fees increased by 4% compared to the last quarter.
We have been experiencing sustaining growth in the credit card and users in Colombia due to rising wage and ample credit availability. We continue to see more credit and debit card transactions during this year, as a result of our commitment to promote the use of cards for transactions.
In addition, we are tapping into new business segments when it comes to promoting and introducing numerous benefits. In addition, we saw a higher level of insurance distribution fees which generated COP 60 billion during the third quarter of this year.
Our non-banking corresponding channel is steadily growing as we find new, cheaper ways to bring back to Colombian markets under penetrating geographies and client segments. We forecast a fee growth of around 8% for this year.
In Slide 11, we present evolution of expenses. Total operating expenses grew 26% year-over-year, partially explained by the depreciation of the Colombian pesos versus the U.S.
dollar which naturally puts pressure on efficiency. The cost to income ratio has been improving over the last 12 months, although it increased sharply in this quarter to 57% due to the acceleration of expenditures and super growth in net interest income.
Our long-term goal is to be around 48% to 50% efficiency ratio. If we take only Colombia’s operation denominated in peso, the efficiency has improved consistently as a result of our selective criteria for undertaking projects, a faster development of local channels such as the mobile banking and ATM [ph] of which we have around 6,000.
Operating expenses consist primarily of personal expenses and administrative expenses which have been kept under control in the respective currencies. Today, Bancolombia’s oriented towers, developing channels with low marginal cost and growing expenses in line with nominal GDP.
Our guidance for this year is an increase of expenses ranging from 8% to 10%. Moving on to Slide 12, we see the evolution of the net loans to deposit ratio which ended the quarter at 112%.
The proportion of loans that we do not fund, we deposited [ph] funded to long-term debt in order to have a similar duration in both sides of the balance sheet. This is strategy reduces the volatility on the net income and shareholders’ equity.
It makes more sense to us; perform long-term loans with long-term liabilities. And that’s why the 112% is a level that gives comfortable liquidity position of the bank.
In the last weeks of the quarter, the liquidity situation tightened in Colombia and we have decided to play safe and take additional time deposits in order to improve the liquidity profile of the Bank. The liquidity and capital levels of Bancolombia present today are optimal for the business plan that we have designed.
Regarding capital, at the bottom right hand side, we show the capital adequacy ratio. The Tier 1 ended at the level of 8% to 150 basis points above the regulatory minimum of 4.5%.
The tangible capital ratio defined as shareholders’ equity minus goodwill and tangible assets divided by tangible assets was 7.9% at the end of this period. As we have said before, this is the level of Tier 1 optimal for the operation of the Bank and we intend to keep it between 8% to 9%.
Let’s also remember that the earnings generated during the first nine months of the year which are already in the shareholders’ equity line are not included in the Tier 1 calculation and as a result in the hypothetical case of a portion of those earnings, the Tier 1 will increase at around 60 basis points to 70 basis points. We would only see the Tier 1 ratio in March 2016 after the Annual Shareholders meeting.
For the Tier 2 ratio, we ended the three quarter of this year with 5.3% for a total BIS ratio of 13.2%. Slide number 13, shows the return on assets and return on equity of the Bank.
Cumulative return on equity as at the third quarter of this year was 13.49% and cumulative return on assets was 1.54%. Return on equity dropped to 11.2% from the quarter due to high provision expenses and lower net interest income growth.
We expect to continue grow net income although at a moderate pace while maintaining solid solvency indicators for the rest of the year. For the first nine months of this year, we can conclude that: First, Bancolombia maintains solid and stable loan interest margin based on the strategy of funding cost and pricing control.
Second, enhance the liquidity position of the Bank while controlling funding cost and pricing loans, approaching to a new interest environment and outlook. Our strategy today is focusing marinating risks under control.
And this implies progress with credit origination and monitoring and moderate pace of loan growth. And finally, we’re doing efforts in making sure that cost grow under control while revenues growth at a fast pace.
We target to have a cost to income ratio at around 50%. Over the previous five years the banking industry were in a middle of positive environment, very low interest rate, very optimal level of commodities but today, we’re at the end of the cycle and we’re facing a different cycle in the next coming quarters, which means that we will be focused basically on providing a very solid structure of funding and the loan growth will be originated basically because of the deposit growth.
And also we will be focused on maintaining the NIM under control. After presenting these slides, discussion of the third quarter results, I would like to invite our audience to ask any question you may have.
And we’ll be ready to take it from there. Thank you.
Operator
[Operator Instructions] We have a question from Carlos Macedo from Goldman Sachs.
Carlos Macedo
A couple of questions, first on the margins, as you said liquidity tightened and funding costs went up; that’s what did in the third quarter, rates went up again in Colombia last month. Just wondering to see if there is any impact on this for the fourth quarter and how quickly do you think you can convert the higher rates into your loan spreads, as you mentioned going back up to 6%, whether you see that happening already in the fourth quarter; whether it’s going to be something that phases in the first half of next year?
Second question partially related to that that with 8% loan growth next year, down from say around 13% to 14% this year, where do you expect the greatest deceleration; is it going to be in the corporate side; is it consumer side going to slow; mortgages, where should we expect loans to slow the most to get to that 8% level? Thanks.
José Humberto Acosta
Regarding your first question, yes, we will probably face an increase of funding cost in the next coming quarters. And on the asset side, we are seeing some particular things.
First, the DTF [ph] at the end of the day will increase because they are right now showing a little bit -- the real cost of money for 90 days. So, we will probably see an increase of the DTF [ph] but the most relevant point is the second point is now the banks we are lending in a different deals.
We are increasing our spreads. And you see that pricing of a loan portfolio is increasing, not only in corporate loans, also in mortgage.
So, you will see something of that. Third, banks, in our case are at around 25% of our total loan portfolio is short-term loans.
So, the opportunity to re-pricing will appear in the next coming quarters. So, we will take the advantage to re-price part of our loan portfolio.
Fourth, within the last months, we’ve seen long-term loans, big corporations are demanding for loans for three to five years. As you probably know, those loans, they have better, better deals and better spreads.
So because of that, we are able to say that the -- at least for the first quarter of next year, we’ll see an increase on the size of NII on the asset side. Regarding your second question, yes, we see a deceleration.
And probably the main driver of this deceleration with the consumer, now we are seeing a loan growth of consumer at around 10%, next year will be around 8% and also we see kind of deceleration of mortgage interest rate. Mortgages used to grow at a faster space at more than 30% in the last five years, today, we’re seeing at around 15% to 20%.
So, we perceive that the number will be ranged 10% to 15% regarding mortgages.
Carlos Macedo
Just going back to the first question, I mean, we’re looking at the DTF, it’s still well behind the benchmark at 4.61 versus 5.25 and the last cycle of rate increases have lagged the benchmark by wide margin, never quite got to the premium there was in the past. Is that something that you expect to happen again in the cycle; is that -- would that have a negative impact overall on your ability to generate net interest margins?
José Humberto Acosta
Yes. That’s true that the DTF -- there are a lot of discussions here in Colombia about how -- what’s the reality about the DTF events that we have got in short term?
You know what? It’s happening exactly as same that’s happening in other countries that you compensate that with better spreads.
So, banking industry are compensated, the lack of the DTF with better spreads.
Operator
We have a question from Tito Labarta from Deutsche Bank.
Tito Labarta
A couple of questions. First, in terms of asset quality, just what was the total exposure you said you have to Conalvias?
And once that becomes non-performing or how much your past due may show increase? And then do you think there could be any other corporate where you could be impacted because of this?
And then my second question in terms of profitability, you mentioned last quarter, you aimed to do about 15%, maybe 15.5% ROE this year. Given the ROE we saw this quarter, do you think that’s still possible?
If so, how would you get there, so you can give a little bit more color into the area of profitability, and I guess not just with next quarter but also for next year? Thank you.
José Humberto Acosta
Thank you, Tito. Yes, the case of Conalvias is a unique case.
We are not seeing a deterioration of this sector in terms of construction. This is very particular and it’s originator for a very particular situation and the numbers are -- the total exposure that we have these COP 290 billion, we expect to have a provision at the end of this year in total at around COP 160 to COP 180 billion; and today for third quarter, we have COP 86 billion.
What we expect the fourth quarter in terms of provisions regarding Conalvias, another COP 86 to COP 90 billion in order to cover the loan portfolio. Regarding your second question, our guidance for growth up to the level of 15% will be for 2016 and then will be mainly driven by the efficiency level.
As you see that our numbers in the last three, four years, we have been able to maintain cost under control and we are probably, our guidance for cost increase next year will be at around 5% in order to provide the 15%. As regarding your question this year, we expect to close this year of return on equity at around 13.5%.
[Ph]
Operator
We have a question from Thiago Batista [Ph] from ITAÚ BBA.
Unidentified Analyst
Hi, good morning guys. And thank you for the opportunity.
I have two questions; my first question is about the asset quality evolution. Could you comment on your expectation for 2016, if you expect past due loans to increase?
And what is your expectation for the cost of risk of the Bank? And my second question is about the reclassification you did in this quarter for the service fee income.
We saw that you reclassified some operating revenues and expenses into fees. Could you give us more on this?
José Humberto Acosta
Regarding your first question, the asset quality evolution, today, we don’t feel comfortable saying that the vintages are deteriorating. We don’t have enough data to suggest on deterioration.
It’s appearing in our loan portfolio. That’s the reason why we expect to have a cost of credit next year, in between 1.6% to 1.8%, again Conalvias particular case.
But again, we only see a slight deterioration SMEs. And this is because, once you see FX volatility and cost of credit increasing, this kind of companies feel the impact immediately, but again, 1.6% to 1.8% next year, just to give you an idea about the cost of credit regarding the loan portfolio.
And regarding your second question, Alejandro?
Alejandro Mejia
The classification is an outcome of the process of adjustment to IFRS. This year is, remember, a transition year from Colombian GAAP to IFRS.
So, we’re receiving permanently recommendations from our auditors, internal processor reporting to better show the economy reality of the Bank. So, we decided to reclassify some of these fee revenues into other income line that present at the bottom of the P&L.
José Humberto Acosta
Yes, what happened with IFRS is we received at the end of last year, the last [indiscernible] of the government. So, you can understand that reprocessing the previous quarter is very complex process.
So that’s the reason why during this year, we are making some adjustments to make comparable the numbers with the previous year.
Operator
We have a question from Saúl Martínez from JP Morgan.
Saúl Martínez
I’m going play that a little bit and ask how you see, how you can get to a 15% ROE in light of the backdrop in Colombia? Because when you take a step back, it seems very, very challenging to me.
You have an economy that is decelerating; you have still sizable credit count deficit, in spite of severe depreciation in the currency; you have fiscal-end monetary policy tightening; and you have a higher tax rates going forward. It seems like the banks are on the curst of a credit quality cycle, even your guidance of1.6 to 1.8 coming from a low base, and it’s fairly rapid growth in loan loss provisioning.
You have a repo rate that has gone up considerably more than the DTF rate, and I frankly don’t know if the DTF rate and repo rate the relationship is going to hold. And obviously that’s negative for your financial margins and increase faster increasing in the repo rate.
It seems -- so when I take all this together, it’s even with a very moderate increase in cost, even with you guys managing on cost on pricing, it seems very, very difficult to see any type of earnings growth next year. In fact, it looks like you could see this situation where earnings decline and ROEs come down from current levels.
So, can you just give me a little bit more color as to how you actually see ROE expansion from current levels in the current environment?
José Humberto Acosta
Yes, Saúl, you’re right it’s challenging times. But remember that we are not only a Colombian bank; we have 30% of assets outside Colombia.
And if you double check the numbers outside, for example El Salvadorian [ph] operation, the return on equity there is at around 17% and Banistmo also will contribute it because Banistmo is on track; it’s growing at a very good pace which is 12% and they are recovering the lower level of return on equity than they had. So this is the first point.
The international operation will help us, not only on the return on equity side, also will help us in cost of credit and other metrics. Second, as I mentioned at the beginning of the process, I would say the Bancolombia will focus our efforts trying to maintain a very solid deposit base from our clients.
So today, we are doing all the efforts to maintain cost under control. And if you double check, we have the lowest cost of funding coming from clients, because we have a huge network of branches.
So next year, the focus will be the deposit base. And third, it is demonstrated that we will be able to reduce the pace of growth of cost and there is some strategic areas in which they are not growing in terms of cost, they are growing negatively, and it’s a very strong stemming saying that we expect to grow 5% cost next year.
On the side of the income, again, in Colombia happening, the pricing it’s adjusting and banks are adjusting pricing and customers and clients recognize that this is different time, and this is in our favor because of the activity. I agree with you in terms of the DTF that will not help us in terms of NIM, but the deal, the new spread and the longer tenures also will help us.
And remember, fees is because transactional level. We have 45% of the total transactions in Colombia; we are the number one in every single business regarding the retail business and cash management.
So based on those combinations, it’s challenging but this is our challenge to get 15% of return on equity.
Saúl Martínez
That’s helpful. Thank you.
What proportion of your earnings currently comes from Central America?
José Humberto Acosta
At around 20% today, and this is relevant. The numbers come from Banistmo every month and it’s more solid and stable.
So at the beginning, remember, a year ago, the net income from Banistmo were a level of $60 million; today, we are talking at around $100 million that will help us in terms of profitability of the operation. And the profitability of the operation again of El Salvador is very stable.
Saúl Martínez
And final question, on the tax rate and I know we’ve discussed this in the past. I mean you’re having a very low tax rate in spite of the fact that taxes went up in Colombia and as you’ve explained Central America and Banistmo is a contributor to that, but shouldn’t we see thetax rate be moving up in the coming years or is the mix shift going to be so pronounced that it doesn’t allow -- it allows you to keep the stable tax rate?
José Humberto Acosta
You’re right, Saúl, the reason why the tax for third quarter is because two reasons: First, the reason you are seeing, which is the international operation, we pay 27% tax instead of 39% that we pay here in Colombia, the offshore operation in Panama pays 0% tax against 39% of Colombia, so that help us a lot. And the second reason is, during the first-half of the year, we had calculations based on the profits of the end of that year, so we made provisions for tax.
This quarter, we see that it’s not necessary to have the same amount of provision. And regarding your question about what we expect for the next coming years in terms of tax, we expect to sustain and maintain the same level of tax because this year we have the huge impact because of wealth tax, we would have the same every -- the next few years and also the increases of the over taxes but we will be able to maintain at the level that we are having today.
Operator
We have a question from Jorge Kuri from Morgan Stanley.
Jorge Kuri
I just wanted to go back to the expenses. So, you’ve talked about bunch of initiatives that are ongoing to try to control expenses.
However, we are not seeing the results of those, and I think you’ve been talking about it for over a year now. So exactly what happened this quarter that expenses went up as much?
And what gives you confidence that over the next 12 months, you’ll be able to cut the pace of growth to basically half what you are doing today? And again in the context of that being something that you have been focusing now for over a year and we really haven’t seen the result, at least not the extent that you portray them.
Any color on that would be greatly appreciated. And just to clarify on the last question, you had a 13% tax rate in the third quarter and you’re saying that taxes are going to stay at the level they are.
Can you just clarify, I mean, I’m sure, you’re not saying 13%, so what is the exact number that you’re thinking about for the effective tax rate in 2015 and 2016?
José Humberto Acosta
Regarding expenses, we have two impacts because again FX. It is very complex for a Colombian bank to explain what happens with expenses when you have 30% -- 32% of expenses are outside in our international operation; and second because internally the expenses in Colombia -- around 50% of those expenses are also linked to the devaluation because we’re paying software license, we’re paying international payments, I mean linked to depreciation of the currency.
So, that affects a lot. And the second reason is EVA.
[ph] We had a provision for bond [ph] plan. At the beginning, we made a huge provision.
That’s the reason provision for a bonification plan looks high; we don’t expect to maintain that the level for the last quarter -- in terms of EVA [ph] qualifications. What we expect for quarter is the seasonal effect and we probably expect an increase of expenses in order to compensate what happened in the first quarter.
If you double check, expenses every single quarter, the first one was almost 60% of the second and the one. So, we expect an increase of 10% to 20% in the expenses for fourth quarter.
At the end of the day, we expect our expenses growth at around 10% for the whole year. Excluding FX, obviously we’re taking not including depreciation.
Regarding your second question, taxation, we expect to close the year at a level of 25% of tax growth.
Jorge Kuri
And for next year, sorry?
José Humberto Acosta
Next year 25%-26%.
Operator
Philip Finch, UBS.
Philip Finch
Thank you for the presentation. Really just one follow-up question on the cost risk, which I think you said in your presentation that you expected to end this year at 1.6% to 1.8%.
Can you clarify, is that the fourth quarter level or for the full year of 2015? Obviously in the previous quarters the rate’s been at a low level.
So, I’m, just trying to ascertain the magnitude of provisions in the fourth quarter? Thank you.
Alejandro Mejia
Sure, Philip. Indeed, the cost of credit has gone up slightly over the last couple of quarters, as a result of the situation that we experienced -- that we explained before.
We decided to take a more prudent approach to provisions, in particular with this client, which has not been classified yet as past due loan, Conalvias. But we made close to 80 billion to 90 billion in provisions already.
So, probably in the fourth and in the first quarter of 2016, we’ll see a cost of credit in the neighborhood of 1.5% to 1.6%. We should experience some mild deterioration in the retail and SME portfolio.
So, we’re contemplated that possibility in our own forecast to be around 1.6%, 1.7% for 2016.
Operator
We have a question from Carlos Gomez from HSBC.
Carlos Gomez
A follow-up on the earnings abroad; can you give us a breakdown of the earnings by geography and also tell us, where your ROE is currently in Panama? And if I may ask, we all understand it is very complex to run a company with different currencies and different geographies, but I think would help everybody understanding, if you were to breakdown the financial information between domestic and international operations, so that we can actually follow the impact.
After all -- and I wonder that is very difficult. Thank you.
José Humberto Acosta
That’s completely true. Our next conference will be with the breakdown of currency adjusted to give you a clear idea in which point we are in terms diversification.
That’s true. Regarding your first question, yes, income statement, 20% comes from international operations and 80% comes from local operations.
And it has a clear explanation, the NIM outside because it’s dollarized economy and it’s U.S. dollar operations, the NIMs are around 12% and the NIMs in Colombia are around 6% to 7%, that’s the reason why the number is 20%, international, 80% local operations.
Regarding breakdown on equity in the different geographies, again 70% in Banco Agricola and today the Banistmo operation will be at around 11% coming from 7% of last two years ago. So, we see a real recovery of the operation in Banistmo because of combination of better loan portfolio, reducing in a very important way the cost of credit, the cost provisions were very low, and increasing a bit the fee income in the business in Banistmo.
So at the end of the day that will converge to support the 15% that we are expecting for the next coming years.
Carlos Gomez
Second follow-up on Banistmo, at the time of acquisition, you mentioned a target, low end target of reaching 18% ROE, you just mentioned 15%; is that an intermediate target or that is your new assessment of what the long-term profitability of this operation is?
Alejandro Mejia
Carlos, in Banistmo in particular, we have been very prudent with the capital position of the bank. You probably recall that we decided to retain all the earnings that the bank generated during 2012 and 2013 in the bank; we did not pay a dividend.
So, the solvency position of the bank has increased over the last 24 months when we had control. So ROEs today are lower than the 18% as we got -- when the company was acquired because of a lower leverage of the operation.
And remember the 18% included operations that did not enter in the deal, loans and operation of cash management outside Panama, which were not part of the acquisition.
José Humberto Acosta
And status of bringing the money back, we do prefer to maintain to allocate capital because the loan growth is happening here, regaining market share in a very different way, so that’s the reason why we do prefer allocate capital there.
Carlos Gomez
All right. So, again, this is a 15% on the account in equity that you have retained in Panama.
Can you give us that number and presumably that’s not included goodwill generated in this acquisition, right?
José Humberto Acosta
No, it’s not including -- it’s not including the goodwill, if I understand your question, Carlos.
Carlos Gomez
No, the question is what is the current capital rates of your bank in Panama, this 11% on what equity rate?
José Humberto Acosta
It is -- we are double checking here the numbers, we have had around $800 million in capital which is set around Tier 1 of around 10%. We’ll give you, we will send you information regarding the capital structure of Banistmo but that will be around 10%, very solid.
Operator
Our next question comes from Mauricio Restrepo from BTG Pactual
Mauricio Restrepo
Two follow-ups, the first one on expenses. You mentioned 6% growth for next year, but I was wondering which will be like drivers, taking into account the depreciation of the currency and also the higher inflation in Colombia in mostly so of the components of the expenses are linked to those key rivals?
In addition, the second follow-up is on the capital that you have in Central America. Maybe you can tell us how much is the excess capital that those subsidiaries have, and if you can be prepared for new acquisitions with this capital?
José Humberto Acosta
Thank you, Mauricio. Regarding your second question, we -- by now, the capital location that we’re having on the international operations basically are mainly focused to sustain the growth.
We are not expecting to shaking new opportunities of business because we are on digestion mode with operations in Banistmo. The management is focusing the efforts trying to put Banistmo on track which is happening at the end of the day with the numbers.
So, the excess of capital again, it is basically allocated, because of loan growth and because of expectations of regain market share in the Panamanian case. Regarding the 6% that we are expecting this year, yes, inflation would be challenging.
But remember that inflation, expectation of inflation will reduce at the second half of this year. So, obviously in labor [ph] cost, we will have less flexibility of increase to maintain or control expenses cost, but the operating costs, we are right now again focusing the efforts trying to some areas to grow zero percent and in other areas to grow minus x percent, so that would be the effort.
We want to compensate a new challenging environment basically on the cost control.
Operator
We have a question from Natalia Casas from Ultraserfinco.
Natalia Casas
I would like to know just more about the efficiency ratio. I understand that this time it was released because of the depreciation but I’d like to know why this is happening, what is the proportion of your administrative costs that are in U.S.
dollars or what’s going on? Thank you.
Alejandro Mejia
We estimate, Natalia, that roughly one-third of our expenses, something like 35% are in dollars that includes the operations in Central America, which are dollarized plus some expenses that we have included on the offshore [ph] in dollars. In addition, remember, there was a significant drop in the dividends and equity contribution of some of the investments.
So, the revenues were affected on a non-recurring basis because of this dropping in revenues. So, the cost to income ratio was slightly higher than the term or the long-term that we forecast for 2016 and ‘17.
As José mentioned at the beginning, we should be ending 2015 in the neighborhood of 50% to 52%, but on a long run basis we should be below 50%.
José Humberto Acosta
I think we close the conference call. Thank you for your questions and hope to you see in the next coming quarterly conference call.
Thank you very much all of you.
Operator
Thank you, ladies and gentlemen. This concludestoday’s conference call.
We thank you for participating. You may now disconnect.