Good morning. My name is David, and I will be your conference operator today. At this time, I would like to welcome everyone to the Davivienda second quarter 2018 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. I will now turn the conference over to Rafael Borja of i-advize Corporate Communications. Mr. Borja, please go ahead.
Thank you. Good morning, everyone. Welcome to Davivienda's second quarter 2018 earnings conference call. Today's call is for investors and analysts only. Therefore, questions from the media will not be taken. Joining us today from Bogotá, Colombia, are Mr. Efraín Forero Fonseca, Chief Executive Officer, and Mr. Ricardo León Otero, Chief Risk Officer. They will be discussing the results that were previously distributed on Friday, August 17th. If you have not yet received a copy of the earnings report, please visit www.davivienda.com on the investor relations section, where there is also a webcast presentation to accompany discussion during this call. If you need any assistance, please contact i-advize in New York at 212-406-3693. I would like to remind you that any forward-looking statements made today by Davivienda's management are subject to various conditions and may differ materially.
These conditions are outlined on the last page of the company's press release in the disclaimer. We ask that you refer to it for guidance. It is now my pleasure to turn the call over to Mr. Efraín Forero, Chief Executive Officer of Davivienda, who will begin the presentation. Mr. Forero, please go ahead.
Thank you, Rafael. It is a pleasure to greet you all in our meeting to share the results of Banco Davivienda at the close of June 2018. I would like to start by talking about the macroeconomic aspects, where economic activity continues to show a recovery. Colombia recorded a GDP growth of 2.8% in the second quarter of the year, compared to 2.2% in the same period of 2017. Professional activities and agriculture contributed to this result with a growth of 6.6% and 5.9%. Davivienda's PMI indicators suggest that manufacturing activity continued its recovery into the second half of the year, showing improvements in the different components of this metric. The average exchange rate for the quarter was 2,838 pesos per dollar. This represents an appreciation of 2.7% compared to the same period of 2017.
At the close of June, oil brand price reached a maximum of COP 79.8 per barrel, recording an increase of 13% compared to March 2018, and 65.8% compared to the same period last year. By the end of the year, the average market forecast is around COP 73 per barrel. At the beginning of this month, the new government took office for the next four years, along with the new Congress possession at the end of July. This change, combined with the stable low reference rate and inflation under control, reduced political and economic uncertainty. All the above allow us to expect an improvement of the economy in the following months. Please continue to slide four, where we can see the most relevant aspect of the macroeconomic situation in Central America.
In El Salvador, GDP growth as of March 2018 was 3.4%, recording an acceleration driven mainly by the greater dynamics of the manufacturing and trade sectors. In Honduras, GDP grew at a lower rate compared to the previous quarter due to the lower dynamics in the manufacturing and agricultural sector. As for inflation, some volatility has been recorded during the first half of the year, mainly explained by the volatility in the oil price. However, it remains within the target range of 3%-5%. In Costa Rica, GDP grew 3% as of March 2018, a lower rate compared to the same period last year. This is explained by a lower dynamic of the financial and insurance activity, as well as the construction sector. During the first semester, inflation was pressured by volatility in international fuel prices but remaining within the target range of 2%-4%.
During the first quarter of 2018, Panama GDP grew at a lower rate compared to the last quarter due to lower income growth from the canal, lower retail and wholesale trade, and a slowdown in the construction sector. I would like to invite you to go to slide five, where we will highlight the bank's main results for the second quarter of 2018. Accumulated net income reached COP 735 billion, 13.1% higher than the one registered for the same period last year. Regarding the consolidated gross loan portfolio, we recorded an annual growth of 6.7%. This growth was mainly due to the behavior of the portfolio in Colombia, which grew 8.5% in the last 12 months. The non-performing loans ratio closed at 3.85%, showing a deterioration of 116 basis points compared to the same period last year. This increase was mainly explained by the commercial and mortgage portfolio.
In the last 12 months, we have expanded our net interest margin indicator by 41 basis points, closing at 6.55%. Consolidated efficiency as of June of 46.6%, showing an improvement of 53 basis points compared to the previous year. In addition, we closed with a total solvency ratio of 12.68% and a Tier 1 of 8.52%. Regarding other relevant events, last month, we securitized COP 91 billion of mortgage portfolio. At the beginning of this month, we received the disbursement of a credit by the Overseas Private Investment Corporation worth $243 million. These resources can be used to finance operation in COP and allow us to participate in long-term operation in USD at very competitive prices. Moving to slide six, I would like to share with you the advance in our digital transformation process.
As of June of this year, we reached 1.2 million digital customers in our retail banking in Colombia, which means a growth of 27% in the last year. During June, we incorporated 31,000 new digital clients, the historical maximum in one month for the bank. Monetary transactions carried out by our customers through digital channels grew 21% during the last year. This year, 26% of the monetary transactions have been made through our digital channels. DaviPlata continues to be the main platform for financial inclusion, reaching 4.4 million clients, which means a growth of 28% compared to the same period last year. 24% of those customers have already downloaded the DaviPlata app, allowing them to use an evolved version of our services. Last month, we launched new functionalities for our Little Red House Key.
To transfer funds, our clients can now collect money from their contacts, program withdrawal from a third party, split the check, and top up mobile phones. We continue to be the only Colombian bank offering this variety of banking activities directly from any social media or messaging application. We improve our interconnectivity with the financial system even further by including the functionality to transfer money to other banks in Colombia at no cost and without having to pre-register the third-party bank account. We want to share with you the main figures of our mobile saving accounts, which have increased almost 20 times during the last year, reaching more than 57,000 accounts by the end of July. The balance of these accounts added up to COP 27 billion.
To open one of these accounts, our customers are not required to go to any branch, and their identity is validated through a biometric process using their ID information, generating a frictionless and paperless experience. Our first fully digital, unsecure personal loans, our clients can obtain a credit of up to COP 10 million, more or less $3,500, in less than five minutes. It includes a life insurance which covers the value of the loan. Since its launch at the end of May, we have disbursed more than 23,000 credits for more than COP 160 billion. This represents over 23 times the monthly average disbursed through traditional channels. We continue working to offer new functionality, service, and product to our customers to achieve the goal of transforming Davivienda into a fully digital bank.
Let me turn the presentation to Mr. Ricardo León, our Executive Vice President of Risk, who will comment further on the bank's financial results.
Thank you for the introduction, Mr. Forero. Good morning. It's a pleasure to share with you the results of Banco Davivienda for the second quarter of 2018. Please move on to slide number eight. Assets closed at COP 101.9 trillion as of June 2018. This represents a growth of 2.3% for the last 12 months, mainly explained by the gross loan portfolio, which increased 6.7%. Loan loss reserve reached COP 3.4 trillion, 63% more than the previous year due to the higher risk levels and the reallocation of reserve due to IFRS 9 implementation at the beginning of the year. As we can see in the lower part of this slide, analyzing the performance by region, Colombia's assets grew 3.7% in annual terms, while on the Central American operation, assets had an annual growth close to 2% in USD. Let us continue to slide number nine, please.
Here you can see the behavior of our gross loan portfolio and its different segments. The consolidated gross loan portfolio increased 6.7% in annual terms and 4.2% over the quarter. In Colombia, the loan portfolio increased 8.5%, while our international operation grew 3.6% in USD, with El Salvador and Costa Rica leading the growth. The most relevant increase in the loan portfolio comes from the mortgage book, which had a growth of 15% in the last 12 months. The main contribution comes from the positive performance of leasing and middle-income housing in emerging cities in Colombia. The commercial book grew by 4.4% as a consequence of better business confidence. We are expecting the second part of the year to have a better performance in general terms due to an improvement in business conditions in Colombia, as we observed in our most recent PMI Davivienda report.
We expect a growth of around 9%-10% for the year, with the mortgage portfolio growing around 12% and around 7%-8% in our commercial and consumer portfolios. Moving on to slide 10, you can see the performance of the loans in terms of risk. As you know, we are still going through a challenging credit cycle, where we have experienced an additional deterioration of our portfolio. 90-day NPL ratio closed at 3.85% for the total loan portfolio. The higher risk level presented during the first half of the year is mainly explained by the slowdown in Colombia's economy. This situation impacted the entire financial system. Commercial NPL ratio reached 4.5%, mainly due to additional deterioration of the sectors we have discussed in previous calls and some other customers in other sectors of the economy.
Turning to the consumer portfolio, we observe a reduction of 16 basis points compared to the last quarter, mainly due to changes in origination policies and collection strategies. Finally, the 120-day mortgage NPL ratio reached 2.9%, explained by the unemployment and economic situation in different regions of the country. 90-day mortgage NPL ratio reached 3.81%. Given this environment, our estimate for the total NPL ratio for this year is around 3.5%, with the commercial segment closing between 4%-4.2%, mortgage portfolio around 3.5%, and consumer portfolio around 2.6%. Total reserve coverage ratio reached a level close to 128%, mainly explained by the increase of the NPL ratio, as we discussed before. The coverage for the consumer portfolio remained stable. Coverage for commercial and mortgage portfolios had a higher impact due to changes in NPLs. I would like to move to slide number 11, please.
Funding sources grew 3.7% on a yearly basis and 2.4% compared to the previous quarter, closing at COP 86 billion. Gross loans to funding sources ratio reached 94.9%. Decreases in demand deposits compared to 2017 are explained by the adjustment of interest rates consistent with the monetary policy changes. Meanwhile, term deposits increased 11.2% in annual terms. Credits increased 19.5% in the last year, in line with our strategy of reducing the cost of funding, as Mr. Forero mentioned before. Please now go to slide 12. In terms of capital ratios, we closed with a solvency ratio of 12.68%. T1 reached a level of 8.52%, close to 400 basis points above the minimum required. For the end of the year, our guidance is to close with a solvency ratio around to 12% and a T1 around 8.3%.
At the beginning of this month, the regulator issued the new capital requirement framework. There will be a transition period of 18 months, in which the Superintendent of Finance will have nine months to issue the detailed rules for the estimation of solvency ratios. Banks will have nine months to implement the different internal adjustments. Afterwards, entities will have four years to fully comply with the new rules. The new regulation will allow the Colombian financial system to be more comparable to international standards and will reflect, in a better way, the capital adequacy ratios of Colombian banks. Although we will have to wait for the detailed instructions to implement the new standard, our preliminary estimations indicate our solvency ratios would increase around 200 basis points from the current levels. I would like to proceed to slide 13.
Accumulated net financial margin expanded 10% compared to the same period last year. These results were mainly driven by a stable financial income and lower financial expenses presented throughout the year. The 12-month net interest margin ratio showed an expansion closing at 6.56%. For the end of the year, we are expecting a in between 6.5%-6.7%. As we mentioned in our last call, we implemented IFRS 9 since January 1st, 2018. Consequently, the level of provision was increased just for one time by reallocating reserve from the other comprehensive income account in the equity during the first quarter. Given this situation, provision expenses for the first quarter were not as high as they were expected. For the second quarter, we had an increase in provision expenses of around 22% compared to the last quarter and 9% in accumulated terms.
This represent a cost of risk of 2.53% in the last 12 months, in line with our estimates at the beginning of the year. For the close of 2018, we expect a cost of risk between 2.7%-2.8%. For 2019, we expect a better performance in this ratio, considering the expected improvement in the risk of the portfolios. Please continue to slide 14. Accumulated operating expenses showed an increase of 8.2%, explained by the increase in personal expenses. Such increase is explained by a particular payment of COP 30 billion to our collaborators due to the renewal of the employees' collective agreement. Consolidated efficiency ratio closed at 46.6%, showing an improvement compared to the previous year. For this year, we are expecting an increase in operating expenses between 7%-8% and efficiency ratio to be around 46%.
To finish this presentation, I would like to go to slide number 15, where we can analyze the bank's profits. Davivienda's accumulated net profit reached COP 735 billion, 13% higher than the one record during the same period last year. This is explained by the expansion of the net financial margin, a one-digit expenses growth, as well as higher operating income during the past quarters. Our return on average equity for the 12 last months reached 12.9%, while the return on average assets were 1.37%. Our ROE forecast for this year will be around 11%-12%, mainly explained by the higher cost of risk. In general, these are the bank's main results we have prepared for you today. Thank you for your attention. At this time, we can move on to the question-and-answer session.
If you would like to ask a question during today's program, please press the star and one keys on your telephone keypad. Keep in mind that you may remove yourself from the question queue at any time by pressing the pound key. Once again, to ask a question today, please press the star and one keys now. We'll take our first question from Andres Soto with Santander. Please go ahead, your line is open.
Good morning, everyone, thank you for the presentation. I have two questions. The first one related to asset quality. Excluding the effect of write-offs, we saw a significant deterioration in your asset quality indicators, both for your commercial and consumer portfolios, while at the same time your guidance for cost of risk implies that provisioning would remain relatively stable at the level that we saw during 2Q. Will it be fair to conclude that the asset quality deterioration cycle already peaking in 2Q? If this is the case, what will be the main downside risk to this assumption?
Great. Andres, thank you for your question. Related to the NPL, as we mentioned in the previous call, we expect higher levels of NPL in the following quarters, with a slight correction toward the end of the year. In this sense, we had additional deterioration in sectors that we have thoroughly discussed, which represent about 50 basis points of impairment for this quarter. The rest of the deterioration is due to the very sector of the economic and mortgage business, in line with the largest effect of the lower economic performance in Colombia. We expect to close this year with a total NPL of 3.5%. For each of the portfolios, we estimate the following levels: commercial ratio of NPL between 4%-4.2%, consumer close to 2.6%, and mortgage close to 3.5%.
In this way, as we commented in the last conference, we were expecting a high level of deterioration in this quarter. However, for the second part of the year, we estimate improvement in consumer and in mortgage portfolio, and even to keep a level between 4%-4.2% in commercial portfolio. In general, we have adjusted our policies with the aim of improving our NPL levels. For example, in corporate segment, we increased, given the level, the analysis in some specific business. We have working in the process to increase the quality of the collateral that we request to our customers, as well as checking the risk appetite in some sectors of the economy. In mortgage and consumer portfolios, we have been adjusting the policies of origination. However, in consumer, it's easy to capture very fast the impact.
However, in mortgage, the process is a little bit delayed because maybe the policies take six or nine months to see the effects in the portfolio.
Thank you, Ricardo. My second question is regarding your digital transformation initiatives. I appreciate the details you are providing on the presentation. I would like to understand if you have any specific medium-term targets, either in terms of market share gains or efficiency. More in the short term, if you are anticipating any additional expense growth related to these investments.
Thank you, Andres. This is Efraín Forero. Our digital strategy is a key point in the bank, and we have been working on that for several years. What we point out is to be able to become a complete digital bank by the year 2020. We have been making a lot of different research and innovation in the bank in different areas. We are working, trying to develop the ability to serve our customers, both in Colombia and in Central America, with different channels that allow us to be very much more closer to customers and to have the ability to have more flexibility and proximity to them. For getting that, we have been involved in different type of alliance with different fintechs and different startups and trying to know what the industry sector is doing in several parts of the world.
We have now an investment for this year of about COP 50 million that are related with different areas in which technology and service ability, development of new channels, and different alliance that we are trying to use to make the bank much more efficient and much more close to customers, both in personal banking and in corporate and medium and small businesses. That includes a transformation, and I would say, like a reinvention of our channels, both branches and digital channels. Far, we have been able to do a different type of, let's say, the new releases of DaviPlata and The Key, and now we have this process in which we are doing different things related with the offering in personal banking of our different line of accounts and credit lines.
We expect to be able to have the personal banking completely digital by the second semester of 2019. We are working as well in the corporate bank. What we look for is to get much more efficient and the ability to be in the market in our personal banking, both in the high-level income and in the other levels of our customers in Colombia and to all the customers. On the other hand, we are expecting to be willing to develop new abilities in the medium and small business.
Perfect. Thank you, Mr. Forero.
We'll take our next question from Diego Batista with Itaú BBA. Please go ahead. Your line is open.
Hi, guys. Thanks for the opportunity. I have two questions. The first one about the profitability of Davivienda. The ROE of Davivienda has been very volatile in the last quarters, for instance, 1Q, I think, was 17%, now about 10%. You already mentioned that for the full year, we're expecting something close to 11%-12%. Looking a little bit above 2018, what do you believe is the normalized level of profitability that Davivienda could deliver, let's say, in a couple of years? Second one, about the margins of the bank in the 2Q. The margins, in my view, was a little bit weak in the 2Q. In the press release, you mentioned that consumer and mortgage business. What were the main drivers of these weak margins?
Can you comment a little bit more about the margins of those segments and how are you seeing the competition in consumer and mortgage business?
Diego, thank you for your question. As of June 2018, we presented a return on equity for the last 12 months of 12.9%. Our forecast is to gradually improve the return on equity towards level of 14%-16% in the medium term to recover our level of ROE. In particular, we estimate that in 2018, we should close with our ROE of 11%-12%. Our return on assets on the last 12 months closed at 1.37%. Related with the reduction in the consumer and mortgage business, we will mention that the income of the mortgage portfolio decreased compared to last quarter due to the reduction of interest rate of the portfolio. Since December 2016, reference rate decreased 350 basis points. Asset repression have less effect given change on this rate.
In addition, reduction of inflation during the last month affected the income of loan portfolio linked to this rate. Related to the consumer loans, it has a similar cause. The reason is the income of the consumer portfolio decreased compared to the last quarter, due to the reduction of interest rate of the portfolio.
Yeah, perfect.
We'll take our next question from Gabriel Nobrega with Citibank. Please go ahead. Your line is open.
Hi, everyone. Thank you for the opportunity. Could you just remind us again, what's your provisioning level for each of your specific cases? Then moreover, could you also give a sensibility to us of how much the deterioration in your asset quality, then, sorry, in your cost of risk this quarter was mainly due to these higher provisions? I'll make a second question afterwards. Thank you.
Yeah. Thank you for this question. Give me a second, please. Gabriel, our total exposure to particular cases, in particular in energy, transportation, and infrastructure adds up to COP 1.9 trillion. It has a coverage around 35% on the IFRS, which represent COP 665 billion. That is our coverage for this kind of business.
All right. Could you also maybe share with us what is the coverage on each of the specific lines? Because I know that it's in the oil and gas sectors, in the infrastructure, and in the mass transportation as well. Thank you.
Okay. The exposure to infrastructure sector as of June was less than 4% of our total portfolio, with a coverage of 4.8% for the total industry. For 2018, coverage for the infrastructure portfolio could reach around 8% to 10%. Companies with higher risk levels have a coverage above 57% on the IFRS accounting. In this quarter, we made additional provision on some clients, reaching a coverage of 60%. As of June, our exposure to the mass transportation system was around 1.4% of the total loan portfolio, and the coverage is around 32%. The bank has been carefully monitoring the sector. By the end of the year, we're expecting to reach a coverage between 40% and 45%. On the IFRS accounting, the coverage reached 32% at the end of the second quarter of the year, and we're planning to take it to 40% to 45% through 2018.
All right. That's very clear. Thank you. My second question, it's regarding your digital strategy. You have said that you are going to invest $50 million throughout the year, and I just want to understand, what does this mean in terms of efficiency and how much efficiency gains should you have this year? Thank you.
Thank you very much. We expect to improve our efficiency ratio between 100 and 150 basis points in the coming year.
All right. That's very clear.
We expect to have even better results for the coming, let's say, 2020.
All right. That's very clear. Thank you.
As a reminder, if you'd like to ask a question on today's call, please press the star and one keys on your telephone keypad. We'll take our next question from Neha Agarwala with HSBC. Please go ahead. Your line is open.
Thank you for taking my question. I just wanted to touch base on the Basel III implementation. What is the impact that you see on the bank on your capital ratios? Do you have any strategy in place to improve your ratios or anything in that regard? Thank you so much.
Thank you for your question. It's important to understand that the rule is new, not only the authority has to prepare the specific instruction about how to apply the rule. However, our estimations are focused on the next discussion. According to the local new rules, we estimate that our solvency ratio will increase between 200-300 basis points after the implementation of the rules. The main topics that the rule redefined is the level of risk-weighted assets, considering credit ratings associated to the collateral that each customer has to support the obligation. On the other side, the T1 include the current and retained earnings that are implemented in Basel III and in Colombia, we didn't have that possibility so far. To include in the T1, the reserve and other comprehensive income.
Other important aspect is that the new rule include to discount the full goodwill in Colombia and incorporate the systematic and conservation buffer as Basel III defined. In general term, we consider a positive implementation of Basel III in Colombia.
Okay. After 18 months, you expect the 100-200 basis point positive impact on the capital ratio once it's fully implemented?
Yes. Absolutely. We are working with the authorities to establish a schedule to give the possibility to implement it, the new rule, before that 18 months. We are working with them.
Okay. That's great. Thank you so much.
Thank you.
We'll take our next question from Natalia Corfield with J.P. Morgan. Please go ahead. Your line is open.
Thank you very much for taking my question. It's actually a follow-up on margins. I think it's clear the behavior of margins up until now, but could you give us a little bit of more color of what you think next? Do you think your margins are going to be stable? What's your guideline for us on that front?
Okay. Related to margin, we are expecting a NIM around 6.5%-6.7% at the end of the year. To keep the NIM around 6.6% in the next year. Remember that this year we started to implement IFRS 9, and in the first year we have some effect over the NIM.
All right, what's going to drive the improvement in the margin?
We think that this year we have the adjustment that we were expecting for the income and financial cost. We think that for the coming years will be around 6.6% with a stability in the income and in the financial cost.
Okay. Thank you.
Once again, if you would like to ask a question today, please press the star and one keys on your telephone keypad. We will pause a moment to allow further questions to queue. There are no further questions on the line at this time. I'd like to turn the floor back to Mr. Forero for any closing remarks.
Thank you very much to all of you for being with us in this conference call. We see very good opportunities for the economy in Colombia and Central America for the coming months, and we expect a better behavior even for 2019. In this framework, we expect to be willing to continue developing our strategies, mainly related with the digital transformation process in the bank and doing right investments that allow us to be much more efficient. We believe that we are going to be willing to comply with our objectives in the coming months and in the coming year. Thank you very much for your attention.
This does conclude today's program. Thank you for your participation, and you may disconnect at any time.