Aug 6, 2015
Executives
Eduardo Vassimon - EVP, CFO & CRO Marcelo Kopel - IRO
Analysts
Philip Finch - UBS Marcelo Cintra - Goldman Sachs Mario Pierry - Bank of America Merrill Lynch. Jorge Kuri - Morgan Stanley Saul Martinez - JPMorgan Tito Labarta - Deutsche Bank Victor Galliano - Barclays Boris Molina - Santander Marcelo Telles - Credit Suisse
Operator
Welcome to Itau Unibanco Holding Conference Call to discuss 2015 Second Quarter Results. [Operator Instructions].
Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Actual performance could differ materially from that anticipated in any forward-looking comments as a result of macroeconomic conditions, market risk and other factors.
With us today in this conference call in Sao Paulo are Mr. Eduardo Vassimon, Executive Vice President, CFO and CRO; and Marcelo Kopel, Investor Relations Officer.
First, Mr. Eduardo Vassimon will comment on 2015 second quarter results.
Afterwards, management will be available for a question and answer session. It is now my pleasure to turn the call over to Mr.Eduardo Vassimon.
Eduardo Vassimon
Good morning, good afternoon. A pleasure to be here with you again to talk today about second quarter results, for those that are following us in the Internet, we will start with slide number two, we have the BRL6.1 billion recurring net income, what we consider to be a positive result considering the more difficult economic environment we're facing.
I'd like to highlight the 17% financial margin with clients' growth in 12 months comparing the first half of this year with the first half of 2014. Financial margin with market, although 17% below first quarter results gives you a very robust BRL1.6 billion result.
Loan loss provision expense basically flat in relation to the previous quarter. We're going to talk a lot about credit quality, understand that this is a point of particular interest of the market.
Moving to slide 3, we have the 24.8% recurring return on average equity, when we see the 12-month figures, we have seven quarters in a row of increasing this metric. The recurring return on average assets is stable at 1.9% in the past few quarters, when we take into consideration the risk element, we see a nice trend of increase of recurring return on average assets reaching a robust 3.2% this quarter, what I believe to show that we're pricing well the risk in the present environment.
Page 4 and again here a good increase in financial margin with clients, 4% in this quarter, 17% in 12 months. Result from loan and lease losses in net terms is around 2% and I'd like to call also attention here to the increase in non-interest expenses in 12 months, 6.7%, well below the inflation in the same period that's around 9%.
Moving to page 5, we have the loan portfolio where we can see in 12 months, 9.3% gross, so basically around inflation. When we exclude the effects of foreign exchange variation, we see a much smaller figure below 3%, 2.6% here, reflecting a low-growth economic environment.
The two main products in terms of growth in the past 12 months continue to be payroll loans 52.3%. This is partially affected by acquisitions of a portfolio that we made in the past month, this basically a process that has ended in the first quarter of this year and also mortgage loans with a robust 21% growth in 12 months.
Moving to slide 6 and we have been showing this breakdown since the end of last year. We basically divided the P&L in two main categories here, Insurance and Services on one side and Credit and Trading on the other side.
Insurance and Services are revenues or business lines that are less related to the economic cycle and in this particular quarter, we had a positive growth of around 10% moving from BRL3 billion in the first quarter to BRL3.3 billion in this quarter. In the Credit and Trading, that is a little bit more related to the economic cycle, we also some increase and here we basically can see that for Credit and Trading, we're showing returns that are similar to our cost of capital, while in the Insurance and Services, we show a robust 49% return.
Moving to page 7, we have the breakdown of our loan portfolio, I'd like to call your attention on upper side of this page to the fact that the mortgage loans and payrolls together represent around 20% of our portfolio today, that's basically double what they represented two years ago, so in line with our strategy of moving from a more risky to less risky product and a business that has been growing in terms of participation is Latin America business, here again aligned with our strategy of regional expansion. This is also positively affected by the FX rate.
On the lower part of this slide, we can see the evolution of our financial margins with clients. The main factor was the mix of product clients and spreads and here spreads played a particular positive role, were also helped it by a higher number of calendar days, despite a lower loan balance.
Moving to page 8, we can see here the net interest margin going up from 11.1% to 11.3% in this quarter, when we exclude the provisions we see an increase from 6.9% to 7.2%, although below the historical levels. Net interest margin with clients is stable at 9.6% and when risk adjusted is slightly better than the previous quarter.
Moving to slide 9, talking about financial margins, with the markets, here again we had a very positive quarter, BRL1.6 billion, although below the previous quarter, is a very strong figure. We cannot consider this as a recurrent level of market results although historically we have been able to generate good results in more volatile environment like the one we're living today.
Moving to page 10 and starting to talk about the credit quality, we saw in the 15 to 90-day NPL ratio as anticipated, a small increase here from 2.9% to 3%, both in the same level of increasing individuals and companies. In the lower part of slide 10, the 90-day NPL ratio, here we see a higher increase from 3% to 3.3%.
And you can see in this chart that is basically concentrated in the company's portfolio, shows a slight increase and here to be transparent we calculated what would have been this metric if we had not made this transfer of financial assets to have reached 3.5%. This was a transfer of a one single client relevant amount, around BRL1 billion, of an asset, a particular asset that has a very low probability of recovery that was already 100% provisions.
So there was no effect on the bottom-line but because it was booked in an offshore vehicle, it was showing some volatility among different lines of the P&L, although again in the bottom line, the effect was zero. Moving to page 11, we see here the coverage ratio again here as expected we have a decrease in the coverage ratio from 200% to 187%.
We can see that although there was this reduction, the level of complementary allowance for loan losses was kept at the same level, BRL6.3 billion. That's the amount we have in excess of the regulatory requirements by Brazilian authorities and in the lower part of this page, we have broken down this coverage ratio by segment.
And we can clearly see that the retail banking segment shows stability in this figure. So in the past 12 months or more, ranging from 131% to 135%, so basically stable.
And all the difference of this metric was due to change in the Wholesale Banking because we had started already at the end of last year, trying to remove imputing out of provisions have increased substantially the coverage ratio for the wholesale banking operations and at that time we expected some transactions to become overdue, this actually happened and then because of those transactions we saw these reductions in the coverage ratio. Moving to page 12, here we made an exercise to give additional transparency and excluded the fully provisioned credit in the company's portfolio, 90-day NPL ratio.
So the 2.2% figure goes down to 0.6% when we excludes those fully provisioned credit and this 0.6% historically is quite stable, so most of the increase was due to our rent provision. On the lower part of this slide, we provide additional breakdown in the company's 90-day NPL portfolio.
We have divided between very small, small and middle market companies on one side and corporate companies on the other side. And for us middle market goes until BRL300 of annual revenues and this shows that the increase was clearly concentrated in large companies.
The SMEs portfolio is doing quite well; actually it was a small reduction in this quarter compared to March 2015. So all those elements give us a good level of confidence in relation to the level of provisions.
The increase in NPLs was to a large extent due to company's portfolio. Within the company's portfolio, this was related basically to large companies and in the company's portfolio when we exclude the fully provisioned credits we see a stability in the 90-day NPL ratio.
Moving to slide 13 and talking about credit quality for individuals. Here again, on the left side on the top, we see the movement that we mentioned briefly before moving an increasing lines of business that has higher level of currencies.
So mortgage and payroll together increased from 19% three years ago to 41% today. On the right side, we can see that within payroll loans, the public sector that's more stable unless related to economic cycle in terms of employment represents the vast majority of our portfolio.
So only 11% is private sector payroll loans and even this part in selected companies that we operate with. On the lower side, on the left, just to update you with the recent vintage in terms of vehicles and mortgage financing.
So we're generating originating new loans with loan to values likely below our historical patterns. And in the middle and the right side below, we talk a little bit about credit cards.
What we have done here, we took public information from the Brazilian Central Bank about non-performing loans of the system. We excluded Itau Unibanco figures and then we compared this system without Itau Unibanco with our own figures.
And in 100 bases, we can see that the quality in terms of non-performing loans of our credit card portfolio is substantially better than the average of the system. Three years ago, we were 20% below the average today, we're even better 32% below the level.
So in relative terms, we're doing quite well and this is related to the figures on the right side that is the breakdown of our portfolio. We spoke about it in the first quarter call.
We have basically three quarters of our credit card portfolio as transactors. So this includes site payments and installments without interest, so with a lower level of risk, while in the market, this portion represents 70% roughly speaking.
The more risky part of our portfolio that's the revolving credit in our case represents 15% compared with 24% in the market. So here again, we show a good relative position to the market in terms of risk for credit card portfolio.
Moving to page 14, loan loss provision expenses, as I mentioned, basically flat in this quarter when compared to the previous one giving stability to the ratio at 4.8%, Then net one was a little bit below previous quarter bringing 3.9% down to 3.8%. In the lower part, we have NPL creation and write-off and I think it's interesting to make the relation between the two charts here, we can see very clearly that starting in the last quarter of last year, we started to make provisions in a level that was substantially above the NPL creations, anticipating a possible overdue for some specific clients, what happened in this second quarter that explains that in this particular quarter the level of provisions was very close to the level of NPL creation.
Moving to slide 15, we show the similar chart in the previous quarter. And as anticipated, we saw some increase in the retail banking portfolio in terms of provision expenses and some decrease in the wholesale banking portfolio.
Looking forward, we expect to see this movement to continue, so in this environment, we believe it's reasonable to expect slight increases in retail banking provision expenses and some reduction in the wholesale banking portfolio. Moving to page 16 very briefly, we had a 10.5% increase in commission fees from insurance; in relative terms, was a little bit below the level of previous quarter because the margin has increased substantially.
Moving to page 17 again quickly here, just to make sure that we had a good two digit growth in our revenues for core insurance activities, when comparing 12 months. Claims ratio and combined ratio at good levels, reasonably stable compared to the previous quarters and a robust market share for insurance, pension fund and premium bonds.
Next page, in slide 18 we mentioned already we had 6.7% growth in 12 months of our expenses and if we do exclude offshore operations, operations abroad, that are affected of course by a tax effect, it would have been 4.5% so this shows our commitment to keep making stronger efforts to keep costs below inflation level and this is reflected in the bottom of this page in what we consider to be a very good efficiency ratio 42.9% in this quarter, the best figure in this period and when adjusted to risk 61.8%, that's a very good rate in our opinion showing that we're pricing well risks. Moving to slide 19 and talking about capital, we had some special increase in our common equity Tier 1 from 11.6% in March to 13.2% now in June.
This is basically related to three factors. First one is the result of the period itself, the second one is new consolidations that reduced the risk-weighted assets.
And third factor was the effect of the FX appreciation of the real in the quarter that decreased tax loss carryforwards and so improving this ratio. Fully loaded and Common Equity Tier 1, we now have a level of 11.3%, if we consider investment optimization and full use of tax loss carryforwards would reach 12.7% and again this was positively affected by FX, if we take the prevailing FX rate today or yesterday, the present market, this 11.3% would be around 10.5%, so it's an index that sensitive to the FX rate.
In any case, it's a very comfortable level of capitalization, what has encourage us to renew our buyback program and we will be following closely the market to possibly take advantage of prices that we deem to be attractive. Moving to page 20, we see a low level historically, a low historic level of price to earnings at 7.7 and in terms of net dividend yield, when we take the Bloomberg consensus and keeping the same dividend policy and starting using the price at the end of last month, July, we reached 4.1% dividend yield, that's high compared to historical standards.
Liquidity has been divided basically 50:50 between domestic markets and New York markets. On next page 21, we're keeping our outlook for 2015, this outlook as you know was reviewed last quarter, despite the more taxing economically environment, we're keeping this outlook for all the lines we have here.
Finally slide 22, just to reinforce the fact that shareholders for Corpbanca and Itau Chile have approved the merger; this was an important step in our Latin America expansion strategy and now we're waiting for the authorization of the Chilean regulator, want to expect to between in this third quarter of 2015. And finally to invite you all to be present in APIMEC meeting that will take place in Sao Paulo in about two weeks.
With this, I end this part of our presentation. Thank you for your time and Marcelo Kopel and myself will be available for possible questions that you may have.
Thank you.
Operator
[Operator Instructions]. Our first question comes from Philip Finch, UBS.
Philip Finch
I have got a couple of questions, please, first is regarding loan loss provisions. On the first quarter earnings call, I recall that you said that the Q1 level should be the peak level and obviously we've had Q2 at similar levels, maybe just slightly higher.
Going forward, I mean, are we going to see this provisioning trend continue upwards or can we safely say provisions have peaked for the rest of this year? Secondly, it's regarding your repricing of the loan book, given you are clearly in a more challenging lending environment, asset quality environment, are you re-pricing risk in your loan book given the higher credit risk out there and if so can you just share with us how much was the magnitude of this and that what could the implications for margins over the next 12 to 18 months.
Thank you.
Eduardo Vassimon
Talking about loan loss provisions. As I mentioned, we keep our outlook between BRL16 billion and BRL18 billion of net provisions for this year.
Given the more challenging environment, it is reasonable to assume that would be in the higher part of this interval, so between the midpoint and the ceiling. This means that in terms of the amount of expenses, we expect this to be in the next two quarters slightly below the level we had in terms of net provisions.
In terms of CPLs, we're probably going to see a continuous increase, slight increase in the portfolio. In terms of repricing and we have done a rather substantial movement in terms of re-pricing as you can see in our margins, this is of course a dynamic process as we move, we also change our price policies.
So we have done this based in the short-term portfolio that has matured. We will keep doing this as risk moves and we will start to do this in the longer part of the portfolio, it's difficult to quantify this but the trend should follow the risk environment.
Philip Finch
Can I just follow up on that? So in terms of net interest margins, should we assume that margins next year should be higher than this year, given that the repricing of the back book takes maybe 12, 18 months--?
Eduardo Vassimon
It's difficult to talk about 2016 in an environment that's full of uncertainty, but for 2015, we will be probably close to the upper part of our expectations in terms of financial margin growth.
Operator
Our next question comes from Marcelo Cintra, Goldman Sachs
Marcelo Cintra
My first question will be basically a follow up on the previous one regarding in 2016, I understand that it's a little bit too soon to talk about next year, but maybe I'd just like to hear from you, your expectation given that the Bank recently revised the GDP for next year for minus 0.2% and maybe just hear a little bit your expectation for asset quality for 2016. I understand that you mentioned that for the following quarters maybe a gradual increase in NPL ratios, but how should we see the mid-term?
Thank you. And then I will follow up with my second question.
Eduardo Vassimon
Again, we're not in a position yet to make projections about 2016, what we can say is that would be still quite a challenging environment. We don't see growth next year, most probably the economy will continue to contract a little bit.
So in this environments, it is reasonable to assume that risk will be still very present, but we're not making any specific projection yet.
Marcelo Cintra
And my second question is related to the evolution of the non-interest expenses. So basically growth seems to be very under control and running at the low end of the guidance for this year.
So it is just for us to assume that it could be maybe a positive surprise, low interest expense growth, maybe below 7% growth and also in this front maybe a quick update on the new data center in Mogi Mirim, the operations are already fully running or you guys still have maybe operations running into different centers and then maybe could be some upside here as well. Thank you.
Eduardo Vassimon
I think from today, we believe that the best expectation we can have in terms of net non-interest expense is the middle of the outlook, particularly because the environment is still uncertain in terms of the level of FX rate and inflation itself and as you know we will have a delayed agreement negotiation in the second half of this year. So seems from today, I think the midpoint is our best expectation for that.
The new data center is going as planned, the integration, it's a very careful process that has been planned in detail, we have basically integrated around 40% of our operations and this will continue until basically the end of next year and then at some point we start reducing the processing of our old data center.
Operator
Our next question comes from Mario Pierry, Bank of America Merrill Lynch.
Mario Pierry
Let me ask two questions as well. Want to look back at your NPL, your corporate NPLs specifically since the merger with Unibanco, we see a peak of 3.7%, your corporate NPL is running at 2.2%.
Do you think that we could see this level given the weak economic conditions in Brazil, given the sharp devaluation of the currency. I think that when we compare the consumer loan book, it's hard to look historically given the changes in your loan mix, but could we use your historical numbers here to try to gauge what is the potential peak that we could see in corporate NPLs?
Marcelo Kopel
The point on the portfolio -- at that point in time, we had much more presence of SMEs than we actually have today which at the end of the day end up pushing up the NPL ratio itself. So even if things stood at the same pace, you would have a lower NPL just by the mix of the profile of the portfolio.
What we mentioned before and we've been talking is that the NPL in the corporate portfolio has grown by specific cases and not that it's a general behavior that we see in the portfolio. So while trying to model that is really a case by case discussion that we've been having internally and I can't really give you a number but one thing I can give you is that if you look at the portfolio mix and even recalculate the numbers based on what you mentioned, you will probably get it to a lower number than it was in the past given the profile.
Mario Pierry
My second question then is related to you're likely to book some gains on your tax credits in the third quarter from increasing the social contribution tax, so I was wondering if you can quantify this amount and the possible use all of the proceeds, if you could be using this to boost your balance sheet, specifically to be boosting your reserve coverage?
Eduardo Vassimon
We're following very closely the process in the Brazilian Congress. As you may know, there are several proposals of changing the original bill that was sent by the Federal Government, so I would say that's still premature to quantify that, but certainly this will be a relevant figure, our policy of provisions is independent of the existence of one-off positive gains, but we could be encouraged in this more challenging environment to revise our provisional criteria.
I'm not talking here necessarily about credit provisions, but in general. But it is still a premature to comment on that.
Mario Pierry
And just to give us an idea of the potential size of this gain?
Eduardo Vassimon
I would prefer not to comment at this point, because again there are several possible alternatives being discussed in Congress.
Marcelo Kopel
Yes, Mario just to add to what Vassimon said, depending on the new ruling is for a certain time period, you have a number, if it's something that is definite it's a different number therefore we would skip on the comment based on that.
Operator
Our next question comes from Jorge Kuri, Morgan Stanley.
Jorge Kuri
I have 2 questions, the first one, can you explain exactly what is this transfer of financial assets? I'm assuming you sold a portfolio of bad debt?
Eduardo Vassimon
Sorry. We didn't hear the beginning.
So if you could please repeat it, sorry.
Jorge Kuri
So two questions, the first one is can you explain the transfer of financial assets? What exactly is that?
I'm assuming you sold a portfolio of bad debt. I guess, as far I conclude from your comments, I understand that it was fully provisioned, but if you're selling something that is fully provisioned, you should get some sort of positive impact as you recognize part of a gain, right.
I mean normally when you sell bad assets if you're already provisioned and write them off, you get some sort of recovery, was that not the case, you can just walk us through exactly what is it that you did and what the different impact is across your balance sheet and income statement? That's my first question.
Second is, in the last quarter conference call, you seemed pretty confident that second quarter was going to be the peak of the NPL problems and we did see sharper delinquency this quarter versus last quarter. And given how delinquency move which is sort of like in waves, it's just hard to see that 2Q will be the peak and so just wanted to get your updated view on what do you think delinquency will look like the rest of the year.
I'm assuming that if someone had asked you at the beginning of the year, that your NPLs would have gone up 50 basis points in six months you would have told them it was almost impossible and they did, same thing with NPL creation if someone had told you, you were going to have the numbers at sort of like a 10-year high, you would have said no. So what gives you the confidence on what you're going to tell me about the next six months and how does that look like?
Thank you.
Eduardo Vassimon
So relates to the first question, the transfer of assets. So we made a sale of assets to an internal company was one single client, one single operation relevant amount BRL1 billion and those are information though the deals are in our MD&A and these were, yes, fully provisioned and was sold by very small amount because the way I see it, the possibility of recovery is very, very limited.
So no impact whatsoever in the bottom line. And even the remaining amount that was small, that was sold to us, again provisions, so there was no effect, zero effect in the bottom line.
So if it's not clear please tell me, I'm moving now to the second question. In terms of NPLs, in the previous quarter we basically said that we saw the level of expenses to be the peak.
Actually this quarter is basically at the same level in terms of gross provisions and a little bit smaller in terms of net provisions; in terms of NPL, we anticipated some increase and looking forward, we keep seeing slight increases in the portfolio. We expect to have reductions in the expenses, loan loss expenses, in the company's portfolio, because as we explained during the call, this was related to limited number of large clients.
When we see our SME portfolio is doing well. So the larger client segment should show some decrease.
Altogether, we expect some increase in the NPLs that's compatible with this more challenging environment.
Jorge Kuri
And is there a way that you can help us quantify that the extent of how much you think NPLs will increase. Look, the provisions don't really matter much because you can take the provisions out of the P&L or you can take them out of the balance sheet.
You can get to your guidance of provisions through the P&L if you just use your excess provision. So that doesn't really help us much, really thinking more about the delinquency and how bad do you think it is going to get?
So we saw 50 basis points in the first six months of the year. How much do you think we're going to see over the next 6 to 12 months, if you can help us understand better, what you think on a numerical way the NPL cycle is going to look like, I think that will be great.
Thank you.
Eduardo Vassimon
Jorge, it's difficult to quantify it, but we're seeing a slight increase in NPLs. We don't see any strong movements, of course, we're assuming here that we won't have any major problem in large companies.
This is more uncertain but when we talk about the retail portfolio given all the measures you have taken in the past several months and this is a dynamic process, we keep adjusting our credit policy constantly. We don't see any major increase in NPLs for the individual portfolio.
Operator
Our next question comes from Tito Labarta, Deutsche Bank.
Tito Labarta
A couple of questions; first, maybe in terms of your loan growth, just given the weak economy, growth continues to be pretty slow and given now you are expecting a very weak growth also in 2016. Could you maybe give us some color on how you see loan growth to continue to evolve you think you continue to be sort of at the lower end of the range that you provided, maybe even until next year continue growing in the mid-single digit and also continue to grow in that same segments that you've been growing in like payroll loans and mortgages given you've been growing a lot more in those segments.
Do you think that's still sustainable given how weak the economy continues to look? And then a second question, in terms of profitability you've reached very strong levels of profitability even in spite of the weak economy but how long do you think that's also sustainable?
I mean you still benefited a bit this quarter from relatively high trading gains. So when you think of the bottom line with all the moving parts.
What type of ROE should we expect, is this 24% level sustainable, should it go down maybe closer to 20%, if you can maybe just give some color and your first answer to the profitability? Thank you.
Marcelo Kopel
In terms of loan growth, what we provided an outlook for the year is 3% to 7%. If you look into our portfolio, we have something around between 20%, 25% of our client portfolio denominated in non-local currency.
So we think that number the 3% to 7%, obviously the effects can play some role on that, but as of now, we're working from the midpoint to the low end of our outlook for the year and that's just a function of how much we're seeing in terms of the market and then business confidence and consumer confidence. So for this year, that's what we see going on.
In terms of the strategy going forward, we will continue pursuing in less risky assets, we've been doing a lot on – you said are for individuals on payroll and mortgages and for companies we're looking really, especially the lower you go on the portfolio, we're really looking for secured lending, a lot of activity going on with the acquired, the Bank is very present with the acquired, so we continue to foster the prepayment business here. So that's the way we're growing our portfolio without necessarily adding risk one for one into our balance sheet.
In terms of your last point on profitability, let's say, if you consider there are three major avenues here, one is portfolio growth which we already said, [indiscernible] that is going to be a slow growth portfolio, then services and cost efficiency, so we believe we continue to be very keen on penetrating with more services into our client base. Needless to say that in a slow economy, it gets more difficult to have very high growth rates on that, but still by introducing new projects and then different channels, we still have room to grow on that and on the cost discipline, I mean we've been showing a lot of discipline and executing very thoroughly our plans and we will continue to pursue that.
So predicting an ROE going forward is hard, but you should really look at, out of the three elements that we spoke, two of them we're capable to maneuver, one more than the other one being the cost base and that's how much we can talk about the ROE going forward. And then just one comment from Vassimon now.
Eduardo Vassimon
Just to complement, you mentioned trading gains just to point out that part of our margin with markets is related to the banking book, it seems that's a little bit more stable and we have a stronger team for market making and again in more volatile times, we tend to perform well, so it's not that volatile this particular line.
Tito Labarta
So is it safe to say that trading gains while maybe not staying at these levels could stay somewhat high at least in this somewhat volatile environment. And then also following up on the cost discipline, do you think costs can continue to grow below inflation or maybe look at it more from an efficiency point of view, your efficiency has improved quite a bit, is there room for efficiency levels to continue to improve into next year.
Eduardo Vassimon
And this is just a constant effort to improve our efficiency ratio and we're seeing kind of a structural movement in terms of client demand for more digital channels, so this produces lower cost transactions for the bank. So this, I think, encourages us to believe that it's possible to continue to pursue lower levels of efficiency ratios.
In relation to trading again, I think it's reasonable to assume that the volatile environment we would do a little bit better than we're doing in less volatile environment in terms of financial margins.
Operator
Our next question comes from Saul Martinez, JPMorgan
Saul Martinez
I'm going to push a little bit more on 2016 and ask maybe a question that you've answered in pieces to the various others, in response to the earlier questions, but when I look at 2016 it seems that there are a host of factors that make the earnings and profitability outlook more challenging.
Eduardo Vassimon
Saul, we missed the beginning of your question, could you please repeat the beginning of your question.
Saul Martinez
Yes, sure. I'm going to pick up the handset.
I am going to be a little bit repetitive and really push you on 2016 again a little further because when I look at the profitability and earnings outlook for next year, it seems like there are a number of factors that are making it more challenging, you have cost pressures associated with the wage hike that you're negotiating in September, especially given inflation tax rate is going to go up probably at least 5 percentage points for financial institutions maybe more the SELIC may come down in the second half of the year as quality issues could persist, loan growth is probably going to continue to be weak, how do you think about all of this and how do you think about your ability to sustain returns on equity in that environment that are comfortably above your cost of equity. That's my first question and then I'll follow up with say an additional question on corporate credit.
Eduardo Vassimon
Okay, let's start with the -- you mentioned cost pressures and it's known for everybody that there is a wage agreement that happens every year and the way we have to deal with this is we have to obtain and be more productive year-after-year. So our work force has a certain turnover number that is a natural turnover of the workforce.
By reviewing our processes and doing further automation and also with the behavior the clients have choosing to use more digital channels, the path we're following is that we have the opportunity to be less labor intensive in certain channels than we actually are and that provides an opportunity not by necessary restructuring the workforce but basically just managing down the workforce by simply managing the turnover. So that's one area that helps us do this.
Tax rates going up is a function of what has been announced and the 5% announcement doesn't hit us in full because the 5% applies only to financial institutions, given our earnings mix coming from different companies, including non-financial companies that number tends to be lower. So there will be an increase because of that but in lower amounts.
SELIC going down, yes, but eventually next year still is going to be higher than this year and the average spread given that we're still re-pricing tends to be higher than this year. And you know you can end up the year with a lower number but the average of the number should be higher.
It's a fair assumption at this point to be a higher number than this year and you mentioned the last factor you mentioned is weak loan growth, it's true. This year we're seeing weak loan growth, next year to the extent we have or the information we have it shouldn't be materially different than that.
So all those things considered just makes us having to work more on the efficiency gains by making the equation between revenues outgrowing expenses, putting more focus on being more and more efficient on the expense side. And that's something that we -- I'm not going use the word control, but we have better conditions to tackle given the weak economic environment that you outlined.
Saul Martinez
Let me ask on corporate credit, can you give us any color on what common threads you saw in terms of the deterioration? It seems it's a very small group of credit leverage that's related in sectors that you can give any color and it seems like your commentary for some NPL pressure here but lower provisions in -- but you're guiding to lower provisions in wholesale.
But do we see a risk of worsening in corporates for which you have not yet provisioned because obviously this quarter you provisioned for those corporates who had fell into NPL status. Why are you comfortable that in the coming quarters you won't see additional worsening that could -- for companies who have not yet provisioned for which you would have even more pressure on your loan losses?
Eduardo Vassimon
In terms of the corporate cases, there is no particular concentration in terms of sector, a little bit related to Lava Jato but no specific concentration. Of course, these is supposed to be tough having a no risk environment but to the best of our knowledge it seems from today we expect this to reduce a little bit because we had some specific cases with relevant amounts that were provisioned in these two first quarters, so no other factor but the mix is confident that will keep within the guidelines, within the expectations we have provided, is a good performance we have seen in the SMEs portfolio.
So in our view, the increase we had in the NPL in the corporate sector is really related to some specific cases that we don't see a repetition of those cases in the near future. Of course, all this is dependent on the evolution of the economic scenario, but I think from today we believe that we will see some reduction in the level of expenses for corporates.
Having said that, altogether NPLs should continue to go up a little bit, we see is slight increase in the next quarters.
Saul Martinez
Okay. So to summarize, you're not seeing any many particular large warning signs in terms of specific economic groups of corporates that you feel are vulnerable to a deterioration?
Eduardo Vassimon
I think that's a fair statement, Saul.
Operator
Our next question comes from Victor Galliano, Barclays.
Victor Galliano
Just a follow-up really from me, my main questions have been answered, but on the transfer of financial assets, again, I'm afraid. This affiliated company, is that a subsidiary of yours and therefore wouldn't that be consolidated within the Group numbers.
I'm just trying to get my head around this or is this a company you have a minority stake in, I just want to understand that a bit better, if I could?
Marcelo Kopel
It's a fully owned subsidiary. So basically, since this is a consolidated entity, any impact – since credit was fully provisioned basically what you did see is a write down of the asset to the value of the transaction but with no impact.
So it's basically a reduction of the asset value in book but P&L wise it was neutral.
Victor Galliano
So it's just freeing up capital effectively.
Marcelo Kopel
Yes, but from a capital perspective, you are basically writing down the asset and you have a full provision to that.
Victor Galliano
Yes. No, I recognize there's no P&L, I just wanted to understand the sort of mechanics and rationale.
Thank you.
Operator
Our next question comes from [indiscernible], Barclays.
Unidentified Analyst
I have two questions, one related to the liquidity and the other one from capital. So the question on liquidity is that, we saw a decrease in all across the board in deposits quarter-over-quarter and if you noted also time deposits continue to drop sharply year-over-year.
Just wanted to better understand the history of the Bank behind the management of deposits and if this is more than just not asset liability management of deposits or you're seeing some sort of light outflows, you saw some outflows from the Bank. That will be the first question.
And I will stop there and then I'll ask the capital question, thanks.
Eduardo Vassimon
The reduction in deposits reflects the decrease in creditor demand, we basically manage our pricing for deposits according to our financial needs and terms of profit, as you know in this weak economic environment, demand for credit has reduced so we have it just accordingly adjusted our price, so the reduction in deposits is basically related to this weak credit demand and there was also some migration to other products of the Bank, basically funds that may offer additional yields for our clients. So it's basically an asset management liability issue here.
Unidentified Analyst
Let me stop there. I understand the less demand for credit, but demand deposits went down 11% quarter-over-quarter and time deposits are down 25% year-over-year.
So I feel like there has to be something more behind that, just like liquidity management at the Bank, it seems like a sharp reduction quarter-over-quarter, even though the credit portfolio slightly increased. I mean it was a raise, but not by that amount?
Eduardo Vassimon
No, that is not really a bit different from what I mentioned, it's really an asset management liability strategy and you can see that most of the reduction in deposits was emigrated to funds and to other products. And also it's normal that in weak economic environments, there is a reduction in deposits from clients and also in higher inflation environment, clients tend to reduce the amount they leave in demand deposits and look for ways of protecting the real value of their savings.
Unidentified Analyst
Okay and it's two, thank you and so finally the question on capital. So we saw a material increase in capital ratio of the Bank and one of the reasons you mentioned for that, it was the BRL appreciation during the quarter, but this quarter, I'd just like to understand what will be the pro forma capital ratios of the second quarter 2015 if we consider the already 10% plus depreciation of BRL?
Eduardo Vassimon
The end of your question?
Unidentified Analyst
So in terms of capital, we saw sharp increasing capital levels during the second quarter relative to the first quarter and one of the reasons that you mentioned for that increase was the, I think in the press release, was the reduction in risk-weighted assets related to credit and had to do somehow with the BRL appreciation during the quarter. So considering the BRL depreciation that we have already seen since June 30 which is 10% plus, plus the future integration of CorpBanca in Chile and also the potential downgrade of the Brazilian sovereign, what is your more or less pro forma capital ratio for the Bank?
Eduardo Vassimon
Okay. In terms of Core equity Tier 1 fully loaded, the figures we show now in the first semester is 11.3% and I briefly mentioned during the call that considering the present FX ratio, these would be around 10.5%.
So the depreciation of the real in this third quarter will reduce this figure. CorpBanca will represent any part of around 8 bps in terms of capital ratio.
So we're still at comfortable levels given particularly the ability that we have shown of producing returns and increasing the capital coming from the property itself. In terms of downgrading, we believe that the government is a looking hard to avoid this possibility.
I think the government is taking measures in the right direction, but of course this is a process that's outside the control of the government and although we do not consider this to be the most probable scenario, we cannot completely discard it. The impact would be in the Bank linkage, markets have to a large extent already priced the deal, when you see, for instance, the price of CDS and in our particular case, I mean, as you may know, the bulk of our funding comes from domestic deposits.
So we would have some increase in the foreign funding, but that's not a relevant part of our business.
Unidentified Analyst
Just to clarify the impact of the CorpBanca would be 8 or 80 basis points?
Eduardo Vassimon
80 basis points.
Operator
Our next question comes from Boris Molina, Santander.
Boris Molina
I have a question regarding your deferred tax assets. We've been noticing how you deferred the taxed for non-performing loan provisions, regulatory and excess, has been increasing at a much faster rate than the increase in provisions to the effect that over the last three years, I used to track the effect of [indiscernible] basically equal to the tax rate applied to your provisions stock, now they are double.
So it seems to be that there is a difficulty in converting deferred tax assets into cash. I would like to understand how this goes forward because this growth is obviously not deducted from your fully loaded Core Tier 1 because there is this current guarantee but we can debate whether this is valid capital or not but it's a little bit of a frustrating situation.
And my second question is regarding the impact of the deconsolidation of credit card from your capital ratio, how big was the impacting the this change in consolidation perimeter and in the quarter?
Eduardo Vassimon
Let me start with the second one and then like I go back to the first one. Credit cards due is being consolidated under our numbers, maybe I didn't get your question, but it's still consolidating to our numbers.
Boris Molina
What happens is that when you look at the Pillar 3 disclosures you find that it's not consolidated for capital calculation, so this reduces risk-weighted assets. So how much of the impact in risk weighted asset reduction was because of the change?
Eduardo Vassimon
Boris, sorry we can take it offline, but it does consolidate into our numbers. So let's take it offline, but it certainly does consolidate.
Your first question is regarding the buildup on DTAs, on deferred tax assets related to credit? If I recall, there was an email from yesterday to Marcelo and how we build that, we're going to take it offline, but let me anticipate part of the answer.
The timing of how we take the deductions and the timing where we take the write-offs and we book the assets in the books, the deferred tax assets in the books, it isn't necessarily one is married to the other one, okay, so you can have a lag between one and the other one therefore you can have a distortion when you simply do the math and work backwards, how much you have over DTA and how much you need in terms of your loan book that was written off, but we'll get back to you specifically on that, on your email.
Boris Molina
Yes, because it appears that [indiscernible] question that once you write off the loans, you probably sell the loans off to asset recovery companies and then you're able to clean your tax benefit on those loans but this seems to have been broken down for the last couple of years.
Eduardo Vassimon
No, it's not the case, Boris, but if that was the case, you would see much more often in our disclosure that assets were sold and we do it very -- last year we probably -- if we did it once, it was a small amount and we disclosed that very thoroughly like we did this quarter. So it's not the asset sales to crystallize the -- let's say the tax deductibility that drives that.
Boris Molina
And then maybe if I may just one additional question on capital. The impact of CorpBanca of 80 basis points, let's assume an initial capital injection because when we look at CorpBanca and the dividends that was paid out in the second quarter and the one that is going to be paid at the beginning of the year, on a fully loaded basis this bank is going to be left with around 3% Core Tier 1, that is true also in this capital calculation do you foresee an additional capital injection in Chile?
Eduardo Vassimon
As part of the agreement, there is a $550 million capital injection that we will do prior to the merger, did you factor that $550 million in your calculation.
Boris Molina
No, but the payments are much larger.
Eduardo Vassimon
Higher than $550 million?
Boris Molina
We can take this offline, but the bank is going to require probably a capital increase.
Eduardo Vassimon
The bank will be properly capitalized that's the assumption you can make for us to continue to grow and benefit from the opportunities here, that's as much as I can tell you now, but please do factor in that there is a $550 million capitalization that will happen prior to the merger, okay. And it turns out to be that this will be a very well capitalized entity in Chile.
Operator
Our next question comes from Marcelo Telles, Credit Suisse.
Marcelo Telles
My first question is regarding asset quality, actually I like to ask a more broad question on asset quality, at what point of the asset quality cycle do you think Itau is right now, I mean are we reaching the peak it's not when you think the peak for the delinquency should be reached. And my second question is regarding the increasing spreads that we've seen based on the Central Bank data that all banks have increased spreads quite materially and of course Itau as well particularly on the revolving credit lines.
So one of the doubts I have is, you have increased the social contribution tax. So was the higher social contribution taxes effective from September on, would you intend to increase your spreads further or the increasing spreads we've seen so far they are already in anticipation of the let's say the higher concentration to pollution tax and it's a worst asset quality environment.
Thank you.
Marcelo Kopel
In terms of spread, this is a process that has been going on already, but you know the market is very competitive. So the ability to price it depends on competition but, of course, there will be a net negative impact on the banks in general given this increase in the taxes.
[indiscernible] it's still early to define the level that will be -- these are not gain related to protect gains. Our provision policy is independent of this type of event but we're always revising this in a more challenging environment we could be even more conservative but it's premature to mention that.
Eduardo Vassimon
Sorry, Marcelo, talking about our position this cycle. We expect this deal leads to keep going up slightly NPLs.
We don't see that we reached the peak of this cycle. The peak of the cycle is related of course to the macroeconomic situation and we still see unemployment going up this year and probably going further up next year.
So we'll probably see this going up but we don't see any major movement in this process.
Operator
Our next question comes from Victor Galliano, Barclays.
Victor Galliano
Sorry, I just wanted to clarify, you were saying a sort of like-for-like on the capital side. Like-for-like fully loaded Basel III, would that be 10.5% you were saying factoring in no FX effect, is that correct?
Marcelo Kopel
Yes, Victor, that's 10.5%, that will bring the number to 10.5%.
Victor Galliano
Okay and that has no mitigation in there of any kind?
Marcelo Kopel
No. Had we run our capital position of 11.3% today, it would have been 10.5% for reference on page 19 of the presentation.
It's where we're taking this number from, the 11.3%.
Operator
This concludes today's question and answer session. Mr.
Eduardo Vassimon at this time, you may proceed with your closing statement.
Eduardo Vassimon
Thank you all for the time in our call. We believe as I mentioned in the beginning, that we have delivered good results in the second quarter particularly considering the challenging economic environment.
The increase of loan loss expenses is of course inevitable in this type of environment but on the other hand, we're increasing margin, financial margin for the clients meaning that we believe, we're pricing well this new risky environment. We're keeping costs under control aiming at having them below inflation and taking advantage of a more volatile environment in terms of market results.
So thank you very much again and hope to see you in the next call. Thank you.
Operator
That does conclude our Itau Unibanco Holding earnings conference for today. Thank you very much for your participation, you may now disconnect.