Hello, everyone, and welcome to the Banco de Chile's Second Quarter 2018 Financial Results Conference Call. If you need a copy of the press release, it is available on the company's website. Today with us, we have Mr. Rodrigo Arena, Chief Economist and Senior Vice President of Institutional Relations Mr. Pablo Mija, Head of Investor Relations Mr.
Daniel D'Arcy, Head of Financial Control and Mr. Cecil Diaz, Investor Relations Specialist. Before we begin, I'd like to remind everyone that the call is being recorded, and the information discussed today may include forward looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward looking statements.
I will now turn the call over to Mr. Rodrigo Ravenna. You may proceed.
Good afternoon. Thank you for joining us on our Q2 conference call. It's a pleasure for me to share with you our comments on the Chilean economy and the banking system during the quarter. After that, Paolo Mejia, our Head of Investor Relations will review the financial results. Please move to Slide number 3.
The Chilean economy continues posting a strong sign of recovery After growing a disappointing 1.6% during the last 4 years, GBP posted an average rate of 4.7% in the first half of the year, which is the strongest growth since 2012. The pace of this recovery can be seen on the top left chart. Chile has been growing faster than its potential rate in spite of some recent opposite forces such as the decline in corporate prices and more uncertainty in the global economy. In this context, GDP grew 5.2% year on year in the Q2 following a strong 4.2% year on year expansion in the Q1. Although the higher annual GDP rate was explained in part from a weak comparison base that PDP has improved in the margin.
On a sequential basis, GDP was also strong, revealing that the economy has a real recovery beyond the statistical effect. As we also highlighted in our previous conference call, the economy is showing a synchronized improvement across different sectors, While mining GBP expanded 5.1% in the 2nd quarter, the rest of the economy, which represents nearly 85% of the total GDP, increased 5.3%. The breakdown suggests that there was an important recovery in private investments, while private consumption remains strong. The strengthening of the local demand is reflected in the impressive peak cost of Chilean import and confidence levels as shown in both charts on the slide. Chilean CPI remains low, although it has been increasing slightly towards the Central Bank target of 3%.
In the 2nd quarter, it was up by 0.7% quarter on quarter, rising the annual rate to 2.2%. The core CPI, which is the measure that excludes food and energy prices, posted a 1.7% annual rate in the same period. Both trends can be seen in the CPI chart on this slide. Now I would like to talk about our macroeconomic scenario for this year. Please move to Slide number 4.
In general, we expect a similar scenario in comparison to that we outlined in the previous conference call. Better growth, high inflation and stable rates, at least in the short term. We also expect these positive conditions will prevail for most of the next year. We are forecasting an economic growth of 4% this and the next year, led by an improvement in gross investment as seen on the top right chart. The recent evolution of several indicators set up capital with imports, business confidence and some construction related figures are supporting the positive view on this component of domestic demand.
In relation to inflation, the depreciation of the Chilean peso and the stronger activity will likely generate a normalization in the next quarter. This leave us to expect inflation to be close to 3% this and the next year after posting a 2.3% increase in 2017. Given these market scenarios, for 2019, we expect a level of around 3.25% for the monetarist policy rate. Now I would like to present the main trends observed in the Chilean banking system. Please move to Slide number 6.
During the Q2, the banking industry was able to post solid results characterized by robust growth, low risk and strong levels of profitability. In general, this trend has been explained by the better economic environment that has translated into a strengthening demand for loans from personal banking and companies this quarter. Specifically, the industry recorded net income of ARS649 1,000,000,000 in the 2nd quarter, which was 6% higher when compared to the figure observed 1 year ago. As seen on the chart, this result was largely explained by higher operating income. As a result, the system posted an average return on average equity of 14%, slightly above the same period last year.
As you can see in the graph below, there is a strong relationship between GDP growth and the loan cycle. In this context, it's expected that the acceleration of GDP will be reflected in greater growth in the industry, mainly in commercial loans, which have been in negative territory in recent years. Considering that the economy would grow around 4% this in the next year and that historical elasticity of loans to GDP is close to 2 times, it would not be surprising that the real loan growth will reach around 7% to 8% real in the coming quarters. Please turn to Slide number 7. This recovery is clearly seen on these two charts.
The graph on the left shows the quarterly loan growth in real terms on a sequential basis. As can be seen, there is a clear recovery of commercial loans since the Q4 2017 and in fact this is driving the Q2 2018 growth. This trend is consistent with the acceleration seen in private investments as I mentioned in the first part of this presentation. On average, total loans accelerated to 2.6% this quarter or 10.4% on an annualized basis. This acceleration can also be seen on the chart on the right, which shows that net loan origination has grown faster this quarter, especially in commercial loans, which is more than doubled the increase posted in previous quarters.
Now I would like to pass the call to Paolo Mejia, Head of Investor Relations, who will review Banco Distillery results for the Q2.
Thank you, Rodrigo. Please switch to Slide number 9. Once again, we obtained solid results this quarter, demonstrating our ability to generate robust figures that are consistent with a successful track record. This is not something that we have achieved this quarter, but it's rather this consistency in our results is a characteristic that has differentiated us in relation to all of our competitors. Our net income for the quarter reached 163,000,000,000 vessels, 1.7% higher than the level recorded the same quarter last year.
And on a sequential basis, our net income grew by 14%, thanks to solid customer income growth from both retail and wholesale segments coupled with excellent risk figure. It's worth mentioning that this result is the 2nd highest in our history. Consequently, we reached a return on average equity of 21%, well above the average of the industry. Beyond our high return on average equity, it's important to highlight our strong leadership when we take into account credit risk. As you can see on the chart on the right, we achieved a high profitability, but with substantially less NPLs than all of our peers.
This has been an effect of our long term strategy based on responsible growth and prudent risk management policies and practices. We are convinced that this strategy is the best source of long term sustainability. How have we accomplished these results? In the next slides, we'll go into further detail. As we've mentioned in previous calls and as Rodrigo presented a few slides ago, the better economic scenario is beginning to be felt in demand for loans from both companies and individuals.
This improving cycle should permit us to begin a period of stronger loan growth in key market segments and improve our bottom line. We plan to leverage this by taking advantage of several commercial initiatives and intensive use of business intelligence tools to increase loan penetration, cross sell and upsell our customer base, which is the main driving force behind organic operating revenue growth. Additionally, we are permanently focused on improving our credit evaluation, monitoring and collection processes, along with achieving more productivity and efficiency in our business support processes. Please turn to Slide 10. The improvement in the economic conditions have permitted us to retake growth with lower levels of risk.
As you can see on the chart on the left, total loans this quarter grew 3.4% year on year, but on a sequential basis, we grew an important level of 2.5% or 10% annualized basis. The year on year figure was led by the Retail segment increasing 7.5%, while Wholesale decreased by 2.4% year on year. The opposite trends in loan expansion are consistent with selective growth in personal and SME Banking segments with attractive risk and return relationship. And on the other hand, on the low levels activity shown by the large company segments. Nevertheless, during the last 3 months, we have seen a strong improvement in lending demand from all segments, especially commercial loans, which grew an impressive level of 3.2%.
This was mainly due to foreign trade loans and commercial loans to larger companies that grew 3.4% quarter on quarter, a significant change when we consider that this segment actually decreased in volumes in the last 12 months by 2.4%. The quarterly growth figure in commercial loans was supported by SMEs, which continued growing at 2.7% in the quarter and 11 percent year on year. We also saw an acceleration during the quarter for middle and upper income personal banking segment. This higher demand translated into an increase of 7.6% year on year and 2% for the quarter for consumer loans for the segment and in residential and nonresidential mortgage loans, which grew at 7.3% year on year and 2.2% quarter on quarter. This greater dynamism in retail lending activity is even clear when we analyze the origination of consumer credit and the acceleration, which took place during the quarters of total debtors, as you can see on the charts on the right.
Consumer loan origination grew 26% this quarter compared to the same quarter last year and total consumer loan customers in the middle and upper income segment grew 1.4% quarter on quarter or 5.6% annualized. This is very important to consider that growth has not only increased in quantity but also in quality. Actually, we're selling consumer loans more efficiently and with less risk than in the past. I mentioned this for two reasons. The first of them is that we have been able to grant more loans through online channels, which benefits clients in terms of products and delivery times and security in addition to greater efficiency for the bank.
The second is that we have substantially improved the supply of preapproved loans, which in addition to allowing us greater efficiency in the credit granting process has been able to reduce the expected loss of the most recent sales close. Please turn to Slide 11. Simultaneously, with our positive figures in loans, we continued to show a solid track record in the acquisition of new account holders. In effect, we grew at a strong pace and increased 7.2% year on year, as you can see on the chart on the top left. And checking account originations grew 36% over the same period last year.
This has been possible, thanks to 3 main factors. 1st, towards the end of 2016, we internalized and reorganized the external sales force subsidiary. This meant making important changes in incentives, which led to a significant productivity gains as you can see on the chart on the bottom left. 2nd, the implementation of several business intelligence actions that allowed us to attract new customers as well as acting proactively to retain them when we see signs of possible attrition. Finally, we provide attractive value proposal based on better products, benefits and excellent post sale customer service.
Please turn to Slide 12. One of the main competitive advantages of our bank is our robust liability structure. Our strong growth in current account balances, significant increase in checking account originations and excellent attrition levels allowed us to grow demand deposits by 13.1% year on year versus the industry that grew 9.6%. This progress once again permitted us to maintain the highest market share in the industry in this source of funding of 23% and to post the lowest cost of funds of only 2.6% in local currency. Additionally, it's important to mention that we have the strongest franchise and high net worth individuals with a total market share in personal banking, current account deposits of over 30% and an average balance per account of MXN 3,000,000, well above all of our competition.
In terms of capital, the local banking industry continues to use Basel 1. As of June, our capital ratio reached 14.1 percent with a Tier 1 ratio of 11.2%, both of them above most of our peers. We feel comfortable with these levels, especially in view of the imminent approval of Basel III in Chile, which the market expects to occur in the coming quarters. In any case, the current build considers our application of Basel III will be gradually phased in during the 6 year time frame. Please move to Slide number
13.
Banco de Chile continues to have the best service quality, which is an essential part of our long term strategy. On this slide, you can see various charts that confirm this reality. For example, our bank has a net promoter score of 73%, which is only the best in the market, but it's also well above the average of our peers. The difference is even greater in mobile banking, high income segments. It's also worth mentioning that our bank has a very strong brand, which translates into the highest top of mind of the Chilean banking industry.
In previous conference calls, we mentioned that the customer service experience is a core competence in our strategy for which we have implemented various digital solutions, strengthened loyalty programs and improved the series of processes among others. I would like to take this opportunity to highlight the important improvements in this area, such as the significant reduction in numbers of fraud loans received, which in just 2 years has been reduced to almost half as well as the improvement of the attrition rate, which is already located below 6%. We believe that these advances are essential to continuing having the best customer base in the local industry. On the next slide, we begin our discussion on our financial results. Through a successful strategy of attracting new profitable customers and developing strong long lasting relationships, operating revenues driven by retail customer income continued to grow as you can see on the next Slide 14.
Total operating revenues for this quarter came in at $457,000,000,000 up 2% year on year and on a sequential basis, 2.7% or 10.8 percent annualized. As you can see on the chart from the left, this growth was led by customer income from the retail side, which is in line with our strategy and market conditions. Retail customer income expanded at a pace of 3.6% year on year and accelerated to about 2% or 8% annualized when compared to the Q1 of 2018. This is mainly due to a change in loan mix that is geared towards more profitable segments as well as lower cost of funds from our strong growth, as mentioned in the prior slide, and in demand deposits. Wholesale customer income decreased 2.2% year on year but grew over 5% quarter on quarter, completely due to better economic scenario and our ability to take advantage of this growth.
Non customer income as well, thanks to higher contribution of our U. S. Net asset exposure, a positive effect in foreign exchange and instruments that hedge allowances and certain fee expenses denominated in U. S. Dollars, along with higher revenues from trading and available for sale instruments, primarily explained by favorable shifts in interest rates.
Those effects were partially offset by a negative impact of credit value adjustments for derivatives. Our net interest margin is consistently higher than the average of the industry. This quarter, we reached 4.46%, in line with last year and 18 basis points higher than the Q1 of 2018. The quarter on quarter rise was mainly due to higher inflation that we experienced this quarter. In terms of total net fee income, we grew 2% year on year.
This reduced level of growth was related to 3 factors. First, we incurred a few one offs in credit and debit card fees due to a change in our loyalty program as well as the negative impact of the depreciation of the peso to U. S. Dollar that affects our U. S.
Dollar fee expense allowance for that same benefit program. 2nd, wholesale related fees were slightly down due to the past economic cycle, which reduced demand for all company banking products. If we exclude wholesale and credit card related fees, net fees would actually grow strongly by 10%, mainly due to higher revenues from our subsidiaries, insurance, mutual funds and stock brokerage and the retail transactional products. In terms of wholesale, we're confident that these fees should begin to show a gradual improvement in the second half of this year following the greater activity as we begin to observe in this segment. Please turn to Slide 15.
Total operating expenses increased 7.2% year on year, which was mainly due to nonrecurring operating expenses related to Tecnologico incident that took place in the quarter. This was partially offset by a reduction in marketing and outsourced services. Excluding this one time charge, operating expenses would have grown by 2.1% year on year, below inflation. This quarter, we completed successfully agreements with all of our trade unions ahead of schedule. This was accomplished thanks to our good relationships we maintained with employees and unions.
Salary expenses remained flat year on year. However, it's important to note that this year, we begin to defer this expense based on a straight line method over the course of the term of the contract, which in this case was 36 months for the agreements reached with the unions. Before moving on, I would like to emphasize that we have been focused on controlling costs and personal expenses by implementing changes improve productivity across the entire organization. On the chart on the right, you can see our productivity levels per employee have continued to improve, up 8.4% year on year. We're also working on improving both origination process and distribution network that is increasingly focused on incorporating digital banking and automating student services and back office tasks.
This has allowed us to maintain good levels of efficiency as you can see on the chart on the bottom right. If we adjust these ratios for these onetime expenses, our efficiency ratio would have actually shown a slight improvement with respect to the same quarter in 2017. We pride ourselves in having a solid track record of management and prudent credit policies. Please turn to Slide 16. This quarter, we once again posted excellent levels of cost of risk, which were below our expectations.
Our loan loss provisions ratio reached only 0.82 percent and the loan loss provisions was merely MXN 53,800,000,000, 13.4% lower than the same period last year. As demonstrated in the chart to the right, this improvement was due to a net quality improvement mainly in the retail segment and to a lesser degree, the release of provisions due to 2 large corporate customers repaying their loans. This was partially offset by a negative effect of the depreciation of the Chilean peso and allowance denominated in U. S. Dollars, although this is hedged and reflected in financial income and growth was primarily in the retail segment.
I think it's important to emphasize, once again, that our track record and that these levels of risk are not like Sam's. At Banco de Chile, we are very meticulous when it comes to risk management. We invest a large amount of resources to ensure we implement and maintain the best standards and risk management throughout the life cycle of our customers. By clearly understanding the economic environment and the industries that we do business in, this assists us greatly to identify risks and to take the necessary actions to limit our exposures if they occur. Please turn to Slide 17 for highlights.
We're happy with our results. Our bottom line this quarter was one of the strongest in our history, and we have generated over MXN 300,000,000,000 as of June. Our return on average equity for the 1st 6 months reached 19.5%, and we're confident that with the improved economy, we should end the second half strongly. The improving economy is becoming apparent in many indicators. Loan growth is increasing 2.5% quarter on quarter or 10% annualized.
Consumer loan origination also continued growing versus the same period last year at 26%. Not only that, we have also continued growing our customer base at important levels. Current account sales increased 36% over last year. Thanks to this base of new customers and taking advantage of cross selling opportunities, we grew retail customer income by 4% year on year and net fees by 2%. But if we exclude the wholesale fees and credit cards, we grew the rest of our fees in double digit levels.
The stronger economy is also showing through in cost of risk, which has helped to report low figures of only 0.8% this quarter. Finally, our Basel ratio remained above 14%, which allowed us to be well prepared for the implementation of Basel III in Chile. Thank you for listening. And if you have any questions, we would be happy to answer them.
Thank you. And today's first question will be from Aaron Gabriondo with Bank of America Merrill Lynch. Please go ahead.
Hi, good afternoon, Rodrigo and Pablo, and thanks for taking my call. My first question is regarding the cybersecurity impact that you experienced during the quarter. So far, is everything solved? Or are you expecting to do some additional investments to strengthen your platform? I don't know if you are considering new programmers or a new IT platform.
But if yes, how do you see your expense line in the next quarters? And then my second question is on the investigation regarding the fraud to the LUXIC fund. Can you elaborate on what could be the potential implications for Banco de Chile like new requirements to improve the internal controls of the bank? And finally, the cost of risk, I think, was particularly low during the quarter due to the improvement of the retail portfolio. But do you think this is sustainable?
Or do you expect a gradual deterioration in the next quarters? Thank you.
Just one second, please. Hi. Thank you for the question. So first of all, in terms of cybersecurity, I would like to highlight some important things for us. First of all, I would like to highlight that security is a priority for us.
So in this context, I would like to highlight that a new cybersecurity division has been created in the bank, independent from the operations and technology divisions in order to carry out a short, medium and long term plan. So it's important to mention that. In terms of investment, we will invest everything that is necessary. It's important to mention that, for example, last year, we invested $16,000,000 in cybersecurity. So despite the fact that we don't have a specific number, of course, we are working on that.
It is very important for us. It can imply that we are having regularities in order to have the best investment plan. We don't have a specific number, but it has been and it is still, of course, an important priority for us. In terms of your 3rd question regarding cost of risk, Carlos?
In terms of the 3rd question in cost of risk, it was cutting out a little bit, but I understood that it was regarding the growth in the retail segment, how we saw that would follow through and cost of risk. The growth that we've been having in the retail segment is to the middle upper income segments. It's at very reasonable levels. We're very cautious in growing responsibly. And especially with the improved economy, better employment figures, we shouldn't expect a significant change there.
We're not expecting a significant change in the retail segment, and we're not expecting we don't have in reality any particular industry that we're worried about at this time. So it's reasonable to expect a cost of risk for the full year at between 1% and 1.1%.
And sorry, in relation to the second question, we don't have information that it affects Banco Estillos. So we don't have any different thing to mention. If you're asking about material.
Thank you very much. And then just a follow-up on the expenses or investment line. So just want to know, you have already said that you don't have a number in terms of investments for this year. But how do you how should we expect the expenses line growth for this year?
For expense line growth, what you should expect is because of this new accounting standard that we're implementing because of a comparison basis. Salary expenses should be a little bit above inflation, so around 5%, we're expecting, while admin expenses should be slightly below that, around 4% due to growth. So for this year, you should expect something around the 4% level between 4% and 5%.
Okay, perfect. Thank you very much.
And it depends on growth. If we continue seeing stronger growth, obviously, those numbers could increase, but it would be offset by higher top line.
All right. Today's next question will come from Jason Mollin with Scotiabank. Please go
ahead. Yes. Hi. Thank you for the opportunity to ask the question. My question is looking at the trading income line, we have traditionally added the foreign exchange, what you call foreign exchange with the net financial operating income and it was $50,000,000,000 excuse me, positive in the net financial operating income and negative $18,000,000 in the foreign exchange for a net in the $34,000,000,000 range.
And that's a lot higher than the run rate we've been seeing. It's up 20% year on year and 15% quarter on quarter. Clearly, we had volatility in the FX with the 8% move. But if you can tell us what drove that large change and
if this was specific decision taking
and what we should think about this line going forward and how we should think about kind of a core ROE
if this is somewhat sustainable or not? Thank you.
Hi, this is Daniel Del Arce.
Well, of course, it depends on the volatility of exchange rate. During this quarter, we had a huge depreciation of the Chilean peso. And of course, we have more volatility on those line items. As long as the exchange rate behaves more or less on the average, we shouldn't have volatility on those lines.
Nevertheless,
we have also had some results from derivatives and also credit value adjustment for derivatives that was a little bit important during this quarter. Net net over the next quarters, as long as the exchange rate moves along with the or quite close to the long term average, we shouldn't have surprises on those lines.
Thank you very much.
The next question comes from Thiago Batista with Itau BBA. Please go
ahead. Yes. Hi, guys. Good morning. I have two questions.
The first one is about the change in the provisions of the technology in Chile that if not wrong, we'll implement it next year. Bancroft Chile has traditionally a much higher level of provisions than the peers. So it's fair to say that the impact of this new methodology should be smaller for Mercurio Chile than the average of Australian banks? And if you have any estimation on how much this methodology should impact? And the second question is about the tax rate, only to confirm if we will see the end of the tax yield now in the second half.
And what is the level of tax rate that we are expecting after the end of the tax shield? Okay. So well,
the first question on the provision model, that was released by the Sprint agency on July 6, 2018. And basically, the new model affects the group based methodology for commercial loans. So it's part of the Sprint tendency plan to release standard models for each of the segments. This has to be implemented by July 1, 2019, and it affects something around 12% of total loans. But the impact, what we've analyzed up to date is not material for our results.
It will flow through income, but it's similar to other models that have been implemented in Chile. So if you think of the mortgage loan model when we implemented that, the standard model, the impact was very material. It was around between MXN 5,000,000,000 and MXN 10,000,000,000 in total at that point. So it's reasonable to expect what you're indicating in your question. And the second question, tax rate.
And the second question, the tax rate, we should expect an effective tax rate for this year of around 17% sorry, 20%. And the end of the tax yield is July of this year. So beginning August, we should have a similar level of the industry, which is should be around depending on inflation because the tax authorities use inflation accounting to calculate taxable income should be around 23%, 24%. So for the full year, 20%.
Thank you. Thank you, Pablo.
Okay. You're welcome.
Next question comes from Alonso Garcia with Credit Suisse. Please go ahead.
Hello. Thank you for taking my question. My question is regarding the liquidity ratios that were announced by the Central Bank. The LCR was I mean, minimum levels were set for the liquidity coverage ratio as well as the time line for its implementation. So I just want to check if you have any color on the liquidity position of the bank.
If you could share, if possible, where you stand in terms of liquidity coverage ratio and net stable funding ratio? Or what is your view on the level of liquidity of the bank considering these levels and these time lines? Thank you.
Daniel Dell'Arce here. Well, as you probably know, the implementation of the new regulatory limits for LCR and FSCR are going to be facing during approximately 5 years. So we are going to start in 0.6% or 60% for LCR. And considering that, we feel comfortable with the current levels we already have.
In terms
of the final ratio or the final threshold for this ratio, which will be 1% 1 100% or 1%, we believe we are not going to have any troubles in order to comply with that.
Perfect. Thank you.
You're welcome.
Next question comes from Neha Arguara with HSBC. Please go ahead.
Hi, Rodrigo and Pablo. Thank you for taking my question. My question is towards loan growth. We've seen higher demand, but we're also aware that you're very cautious in your underwriting. What kind of loan growth could we expect for you for this year, with the way things are going right now?
And what do you expect in your model for the system as a whole? And my second question is on the profitability for the second half of the year. Now as we understand, as you mentioned about the tax rate, which is going to pick up in the second half, How do you expect to offset that higher tax rate? Is that with higher margins or with at similar levels of provisioning as we saw in the Q2? Thank you so much.
Hi. Well, our intention, as we've mentioned in prior conference calls and based on what we've been seeing, is to grow faster than the market with a key focus in certain segments, which are loans to SMEs, which as you saw in the presentation, we're growing above 10% year on year and consumer loans to the middle and upper income individuals. But what you also saw in the presentation is what's been happening in corporate loans, both from the demand side and what we've been posting is much stronger growth in the last two quarters. And actually, the growth that we had in the last quarter was stronger, was well above what we posted in the last 12 months. So what we're expecting and what the intention is to grow above the average in the market that the market will grow in those key segments.
In terms of your second question for profitability for the second half, it's true that we'll have a slightly higher tax rate. And what we're planning on doing there is to continue growing. We're expecting to have better loan growth in the second half than the first half. As you saw, there's an acceleration in loan growth. And because of a better overall sentiment, business confidence levels, more demand from corporates, more M and A.
We should also see an improvement in the fees from the wholesale segment as well as efficiency. Is something that we're always very cautious and very focused on in controlling. So I would say that those three areas, growth, better fees and continuing to grow with good levels of efficiency, it should help us posting solid results in the second half.
Thank you so much.
This will conclude today's question and answer section. At this time, I'd like to turn the floor back to Banco DeCheri for any closing remarks.
Thank you for joining us on this conference call, and we look forward for the next quarter's results. Thanks.
Thank you. This concludes today's presentation. You may disconnect your line at this time and have a great day.