Earnings Call Transcript - AVAL Q3 2022

Operator, Operator

Welcome to the Third Quarter 2022 Consolidated Results under IFRS Conference Call. My name is Richard and I will be your operator for today's call. Grupo Aval Acciones y Valores S.A., Grupo Aval is an issuer of securities in Colombia and in the United States SEC. As such, it is subject to compliance with securities regulation in Colombia and applicable US Securities Regulation. Grupo Aval is also subject to the inspection and supervision of the superintendency of finance at holding company of the Aval Financial conglomerate. The Consolidated Financial information included in this document is presented in accordance with IFRS is currently issued by the IASB. Details of the calculations of non-IFRS measures, such as ROAA and ROAE among others are explained when required in this report. Banco de Bogotá executed a spin-off over 75% equity stake in BAC Holding International Corp. BHI to its shareholders, and Grupo Aval subsequently spun-off its equity interest to its shareholders on March 29, 2022. Prior to the spin-off, Banco de Bogotá was the direct parent of BHI. Grupo Aval has retained an indirect stake of approximately 17.2% in BHI, representing our proportional interests in the 25% equity stake in BHI retained by Banco de Bogotá. This interest in BHI is reported as discontinued operations for reporting periods prior to the spin-off and will be reported under the share of profit of equity accounted investees net of tax, equity method line item for subsequent periods. As a result, for comparability purposes, we have prepared and presented supplemental unaudited pro forma financial information for the nine months ended September 30, 2021, assuming the spin-off was completed on January 1, 2021. The supplemental unaudited pro forma financial information does not purport to be indicative of our results of operations or financial position at the relevant transactions occurred on the dates assumed and does not project our results of operations or financial position for any future period or date. The pro forma financial information is unaudited and the completion of the external audit for the year-ended December 31, 2022 may result in adjustments to the unaudited pro forma financial information presented herein, and any such adjustments may be material. This report includes forward-looking statements. In some cases, you can identify these forward-looking statements by words such as may, will, should, expects, plans, anticipates, believes, estimates, predicts potential or continue, or the negative of these and other comparable words. Actual results and events may differ materially from those anticipated herein as a consequence of changes in general, economic and business conditions, changes in interest in currency rates, and other risks described from time to time in our filings with the Registro Nacional de Valores y Emisores and the SEC. Recipients of this document are responsible for the assessment and the use of the information provided here in. Matters described in this presentation and our knowledge of them may change extensively and materially over time, but we expressly disclaim any obligation to review, update or correct the information provided in this report, including any forward-looking statements. And we do not intend to provide any update for such material developments prior to our next earnings report. The content of this document and the figures included herein are intended to provide a summary of the subjects discussed rather than a comprehensive description. When applicable in this document, we refer to billions as 1,000s of millions. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I will now turn the call over to Mr. Luis Carlos Sarmiento Gutierrez, Chief Executive Officer. Mr. Luis Carlos Sarmiento Gutierrez, you may begin.

Luis Carlos Sarmiento Gutierrez, CEO

Good morning and thank you all for joining this quarter's conference call. Before Diego provides a detailed look at our numbers, I will provide an overview of Colombia's macro scenario followed by a quick update of our digital efforts and a few highlights of our financial performance. Let's start with the macroeconomic scenario. To begin with, during the third quarter, the world continued to be characterized by resilient inflation and contracting monetary policies, of which Colombia was no exception. Due to the combination of these macroeconomic circumstances, the effects of the war in Ukraine, the energy market, the constraint of global supply chains and the weaker economic performance of China, the largest economies of the world significantly slowed down during 2022. In contrast, Colombia distinguished itself because of its robust continued GDP growth. Having said that, a significant deceleration seems unavoidable for next year. In fact, the IMF estimates that there is a 25% chance that 2023 global growth will fall below 2%, and even one-third of the world's economies are at risk of slipping into recession. But for the time being, the IMF foresees global GDP growth moderating from 6.1% in 2021 to 3.2% in 2022 and 2.7% in 2023. In contrast, Colombia is expected to grow at over twice the global average during 2022, but slower in 2023. Colombia’s GDP grew 7.1% during the third quarter of 2022 when compared to the same quarter of last year and 1.6% on a quarterly basis. This performance was explained by the strength of private consumption, which grew 7.8% and represented 74% of GDP. From the demand side, the most dynamic relevant sectors were commercial activities that grew 7.9%, manufacturing that grew 7.3%, and to a lesser degree, recreation and entertainment and construction and communications. The IMF now expects that Colombia's growth for 2022 will rise to 7.6%, revised upward from 6.3% in July. It also expects a deceleration to 2.2% in 2023. The Colombian Central Bank adjusted its 2022 projection to 7.9% from 6.9% and reduced the projection for 2023 to 0.5% from 0.7%. We now anticipate GDP growth between 7% and 7.5% in 2022 and between 1.7% and 2% for 2023. The labor market has also continued to improve, and the jobs gap caused by the pandemic has now practically disappeared. In September, the national unemployment rate reached 10.7%, 120 basis points better than September 2021, while the average unemployment rate during the third quarter was 10.8% compared to 11% during the second quarter and 12.6% a year earlier. In this context, we expect the annual unemployment rate to fall to an average of 10.5% to 11%. Colombia, like the rest of the world, has been disrupted by two-digit inflation which has triggered steep interest rate increases by the Central Bank. Furthermore, the recent acceleration in Colombia's inflation has been primarily boosted by higher food prices. In fact, 12-month inflation reached 12.22% in October, the highest it has been in over 20 years. Food inflation is running above 27% on an annual basis, mainly because of the prices of fertilizers, bad weather, and the depreciation of the peso that weighs heavily on the price of imports logically, including agricultural imports. On the other hand, rent prices, which accounted for around 25% of total inflation, have experienced a moderate increase. In this context, we anticipate that 12-month inflation could reach 11.7% by year's end and 6.8% in 2023. As mentioned, the Central Bank has conducted a string of repo rate increases up to 11% in October, a combined total increase of 925 basis points since September 2021. Considering the persistence of inflation, we don't rule out the possibility of one additional hike of 100 basis points in December, which would bring the year-end rate to 12%. Even though interest rates could remain high for some time to re-anchor inflation expectations within targets, the Central Bank should begin to reduce rates during 2023 as inflation begins to recede. Monetary policy adjustments of central banks around the world, the risk of recession in the world's main economies, and the escalation of the geopolitical conflict in Europe have led to a strengthening of the global exchange rate. In Colombia, just recently, the rate peaked at PS 5,100 per dollar, representing a 28% devaluation since the end of 2021. However, it is currently retreated to PS 4,900 per dollar or 23% evaluation for the year. This volatility, no doubt, also reflects specific market concerns regarding the vulnerabilities of the Colombian economy, in particular, its trade balance, its dependence on external financing in the context of higher borrowing costs, as well as uncertainty regarding potential policy shifts promoted by the incoming administration. During August, Colombia's trade balance registered a record high $2.2 billion deficit, despite a 66% recovery in oil export on an annual basis. Market consensus suggests that the country could end the year with a current account deficit wider than 5% of GDP. To attenuate the volatility, in recent days, in a pace above previous statements, the government mentioned the possibility of signing new oil contracts, depending on the country's economic conditions. In addition, the agreement by Congress on the 2022 tax reform soon to become law should contribute to reducing the fiscal deficit. The reform is now expected to increase tax billings by 15 trillion pesos to 20 trillion pesos, down from the original expectation of 25 trillion pesos. It includes a surcharge for the oil and coal sector, which accounts for nearly half of the expected revenue, a surcharge for the hydroelectric sector and an increase of two additional percentage points on the surcharge for the financial sector, which will now be 5%. On the fiscal front, the government now expects a deficit of 5.6% of GDP in 2022, an improvement versus a 7.1% recorded in 2021, and the 6.5% initially forecasted, reflecting the strong economic rebound and the positive effect of higher oil prices and tax collections. In fact, tax revenue grew 29.2% as of September 2022, when compared to September 2021. This improved physical scenario could contribute to a lower ratio of net public debt to GDP, up 56.5% by year-end, down from 61% at the end of 2021. Moving on, these are some numbers regarding our digital strategy. At the end of September, digital customers of Aval banks totaled slightly less than 5 million, while new accounts of our digital wallet Dale have started to ramp up and are now at approximately 600,000. Dale has also successfully closed several banking-as-a-service agreements, including the LifeMiles pay wallet, Vita wallet from Chile, the fintech Alo, which specializes in collections and payments, and another fintech that will provide working capital micro credit. Our banks sold over 1.7 million digital products in the first nine months of the year, an increase of 52% versus the first nine months of 2021. Our total digital share continues around 60%. PDL ratios of our digital loan portfolio are approximately 60% better than PDL ratios of our traditional portfolio. Digital transactions represented almost 70% of total transactions and increased by 50% over the year. In the same period, transactions conducted in our branches decreased 12.5%. Since we launched our first mobility ecosystem initiative, Caroya, memberships have increased by 17x, qualified credit leads increased by 1.9x, and the leads-to-disbursement conversion rate for – in September, we launched our housing digital ecosystem, Metrocuadrado, which is currently the second largest real estate portal of Colombia with more than 1,200 affiliated real estate agencies and construction companies and around 250,000 houses listed for sale and rent. The use of advanced analytic platforms applied to our client management activity has improved marketing spending effectiveness and increased client lifetime value. Mathilde for example has reduced our customer acquisition cost of retail customers below traditional acquisition channels, such as Facebook and Google, materially increasing marketing spending effectiveness. Campaigns like Ram and our other platform, AUGUSTA, our data-lead platform, achieved a 24% increase in the use of credit cards in clients with high attrition risk. AUGUSTA has yielded improvement of approximately 10% in recovery of written-off loans. Finally, in a minute, Diego will refer in detail to our financial performance during the third quarter of 2022 and provide guidance for 2023. But before that, I would highlight the following. This third quarter was characterized by satisfactory growth of our loan portfolio and by improving loan quality. However, we did run into some headwinds. First, while the current contraction of monetary policy serves to quickly re-price the loan portfolios of our mostly commercial lending banks over faster than the rise in the cost of funds, the same effect squeezes interest rate margins in our two mostly retail lending banks, AV Villas and Popular. It obviously takes longer for the consumer loan portfolios of these banks to reprice. And in the meantime, the cost of funds of the deposit basis, mostly savings accounts and time deposits increased faster than the rate of its loan portfolios. Secondly, fixed rate investments not classified as held to maturity also suffer the consequences of rising yield curves via P&L or OCI accounts. Thirdly, although Corficolombiana's infrastructure projects contributed handsomely to the non-financial sector results, and in fact grew by almost 75% versus a year ago, its contribution was almost Ps.275 billion less when compared to the second quarter of this year, principally due to inflation accounting. Fourthly, personnel expenses were affected by the implementation of salary adjustments derived from negotiations with banking unions and from the accrual and payment of employee bonuses across the group, as a result of last year's excellent financial results. Finally, the effective income tax rate during the quarter was almost 30% higher than last quarter's income tax rate, mainly because of the sources of pre-tax income. However, we will continue to navigate through this challenging environment, deploying cost control initiatives, designing new investment portfolio strategies, maintaining loan pricing discipline, looking for mitigation in the cost of deposits, and continuing to invest in advanced analytics, payment strategies, and digital transformation, improving our customers' experiences and the effectiveness of our sales and marketing efforts. With that, I thank you for your attention, and I pass on the presentation to Diego.

Diego Fernando Solano Saravia, CFO

Thank you, Luis Carlos. Beginning on page 7. On a comparable basis, assets grew 3.5% during the quarter and 14.6% year-on-year. Over the quarter, loans gained share in the mix given the strong growth experienced, while cash lost share in the mix due to the payment of our $1 billion bond last September. Moving to page 8, we present the evolution of our loans on a comparable basis. Gross loans grew 5.1% for the quarter and 16.5% over the year, the highest figure since we adopted IFRS in 2015, and the second-highest quarterly growth slightly below the 5.8% registered during the COVID-19 pandemic hit in the first quarter of 2020. Commercial loans growth reached up 4.5% over the quarter and accelerated to 15.4% year-on-year. Consumer loans grew 5.8% over the quarter and 17.3% year-on-year. Personal loans had the stronger dynamism, growing at 10.9% during the quarter and 29.2% year-on-year, recovering from the room lost during the two years of the pandemic. This increase in risk appetite followed the end of relief, positive trends in credit quality, and a strong macro environment over the past few quarters. Automobile loans, credit cards, and payroll loans grew 7%, 5.9%, and 3.8% over the quarter, taking annual growth to 18.3%, 16.4%, and 13.6%, respectively. Payroll loans still constitute most of the consumer loan portfolio with 57.7% of the total, followed by personal loans and credit cards with 21.5% and 11.5%, respectively. Auto loans represent 8.9% of our consumer book. Finally, mortgages expanded 6.8% over the quarter and 21.4% year-on-year. We expect loan growth to moderate in 2023, driven by lower inflation and GDP growth, higher average interest rates, and a softer economic outlook both locally and globally. On pages nine and 10, we present several loan portfolio quality ratios on a comparable basis. As we had anticipated, the quality of our loan portfolios continued improving measured both by stages and by PDLs, resulting in a stable cost of risk over the quarter. Stage 1 loans now represent 86.3% of our gross loans, improving from 81.7% and 84.3% 12 and three months earlier. The portion of Stage 2 and Stage 3 loans continued improving over the quarter in all of our loan portfolios as relieves continued expiring; credit risk or lays were progressively removed and charge-offs procured. Regarding delinquencies, 90-day PDLs fell to 3.23%, a 57-basis point improvement over 12 months and a 10-basis point improvement over three months. 30-day PDLs fell to 4.33%, a 64-basis point improvement over 12 months and five basis points over three months. Cost of risk net of recoveries was relatively stable over the year and the quarter at 1.36%. Finally, the ratio of charge-offs to average 90-day PDLs was 0.63 times. On page 11, we present funding and deposit evolution on a comparable basis. Funding growth during the quarter was close to that of our loans, maintaining a stable deposit to net loans ratio of 99%. Deposits, which account for 70% of our funding, increased 4.1% during the quarter and 14.4% year-on-year, driven by growth in time deposits that favors the stability of funding. On page 12, we present the evolution of our total and attributable equity and the capital adequacy ratio of our banks as reported. Our total equity grew 3.3% over the quarter, while our attributable equity increased 2.1%, driven by the contribution of net income. Annual decreases of our equity reflect the spin-off of 75% of PHI in March 2022. Solvency ratios slightly fell in some of our banks due to the increase in risk-weighted assets resulting from strong loan growth and the lower valuations of our investment portfolios to OCI derived from the acute increase in interest rates described by Luis Carlos. On page 13, we present our yield on loans, cost of funds, spreads, and NIM on a comparable basis. Our overall NIM fell 12 basis points to 3.52% during the quarter, driven by a compression of our NIM on loans and a negative NIM on investments. During the quarter, Colombia's Central Bank increased its reference rate by 250 basis points from 7.5% to 10% in an effort to anchor expectations amidst inflationary pressures. In addition, the speed at which monetary policy is transmitted to the cost of funds has been substantially faster during this cycle relative to the past rate increase cycles due to recently increased requirements of long-term funding to comply with the net stability funding ratio introduced by the migration of Colombia to Basel III. The magnitude and speed of the current interest rate cycle have compressed the NIM of retained loans given some of the higher credit quality loans such as payroll loans are priced at fixed rates. We expect this measure to improve during the second half of 2023 as funding prices fall driven by the reduction in the Central Bank intervention rate and as fixed-rate loans continue repricing up. Meanwhile, we expect the pressure on NIM on our fixed-rate retail portfolio to persist over the next few quarters. In this context, NIM on loans in our banking segment contracted 30 basis points through the quarter. In addition, the higher funding cost of our non-financial activity resulted in an overall NIM on loans of 4.55%, contracting 36 basis points during the quarter. Bear in mind that the increase in interest expenses associated with the funding of our non-financial activity was offset by a strong performance of the non-financial sector presented on the following page that benefits from inflation. Tailwinds on our commercial lending activity that prices promptly from a hawkish monetary policy led to a 31 basis points quarter-on-quarter increase in NIM and commercial loans, while headwinds on our NIM and retail loans that have longer repricing periods take longer to benefit from this environment contracted 127 basis points quarter-on-quarter. NIM on investments was negative 0.65% during the quarter, impacted by the performance of mark-to-market fixed income in a rising rate environment. NIM on investments includes the performance of our investments held by Porvenir under the mandatory stabilization reserve. On page 14, we present net fees and other income on a comparable basis. Gross fee income increased 1.8% year-on-year and 7% quarter-on-quarter. Net fee income decreased 3.3% year-on-year and increased 7.1% quarter-on-quarter. As mentioned on our last call, pension fund fees decreased due to lower performance-based fees and higher insurance premiums associated with the increasing mortality rates during the pandemic. Income from the non-financial sector remained strong, although, softer than a particularly high second quarter. As mentioned in the past, financial assets from our concession agreements benefit from higher inflation and the depreciation of the Colombian pesos. Other income decreased during the quarter mainly because of the softer results of BHI as the appreciation of the Costa Rican Colón and the increased impairment losses following the end of relapsing panel negatively impacted US denominated results. The depreciation of the average peso rate over the quarter partially offset this performance. On page 15, we present some efficiency ratios on a comparable basis. Cost to assets had a slight increase over the quarter and remained flat versus a year earlier at 2.7%. Cost to income increased to 47.7% driven by softer results from our non-financial sector relative to a particularly strong result during the second quarter and by a compression in our NIM on retail loans. Quarterly expenses increased 14.6% relative to the third quarter of 2021, with personnel expenses increasing 8.8% and administrative expenses increasing 21% pressed increases in operating taxes, particularly the industry and commerce municipal taxes and by a depreciation of 14% of the quarterly average exchange rate that mainly affects IT-related OpEx in Colombia and overall expenses in MFG. Quarterly expenses grew 6.8%, driven by personnel expenses that grew 8% as salary adjustments and annual bonuses were recognized in some of our companies during this quarter. Administrative expenses grew 7.7% over the quarter. Finally, on page 16, we present our net income and profitability ratios as reported Attributable net income for the quarter was Ps. 480 billion or Ps. 17.2 per share. Our return on average assets and our return on average equity for the quarter were 1.3% and 9.8%, respectively. Before we move into questions, I will now summarize our general guidance for 2022 first. We expect 2022 loan growth to be in the 16% area with commercial loans growing at 15% and retail loans at 17%. We expect our cost of risk net of recoveries to be in the 1.45% area. We expect full year NIM to be in the 3.75% area with NIM on loans in the 4.75% area. We expect cost to assets to be in the 2.6% area. We expect our fee income ratio to be in the 18% area. We expect our non-financial sector to be 1.2 times that of 2021. Finally, we expect our full year reported return on average equity to be in the 18% range. Bear in mind that this return includes extraordinary income from the deconsolidation of 75% of BHI. Regarding guidance for 2023, we expect loan growth to be in the 12.5% area, with commercial loans growing in the 12% area and retail loans in the 13% area. We expect our cost of risk net of recoveries to slightly increase to 1.5%. We expect full year NIM to be in the 3.75% to 4% area with NIM on loans in the 4.75% area. Our NIM on investments is expected to recover to positive ground. We expect cost to assets to slightly fall to be in the 2.5% to 2.6% range. We expect our fee income ratio to be in the 20% area. We expect our non-financial sector to contribute 70% of that contributed in 2022. Finally, we expect our full year reported return on average equity to be in the 13% to 14% range. We are now open for questions.

Operator, Operator

Thank you. We will now start the question-and-answer session. Our first question comes from Mr. Nicolas Riva from Bank of America. Please go ahead.

Nicolas Riva, Analyst

Thank you, Luis Carlos and Diego, for the opportunity to ask questions. I have a couple of inquiries, and I will list them all together in case I get cut off. First, regarding the tax reform, can you confirm that there will be a surcharge of 500 basis points on the income tax rate for banks starting next year? Will this mean that the statutory income tax rate for Aval will be 200 basis points higher due to the current surcharge for banks? My second question concerns the pension reform. I understand it hasn't been presented to Congress yet, but could you share your latest thoughts on its potential impact on Porvenir and Grupo Aval? Third, regarding funding needs for the Holdco, I noticed you included a chart with year-by-year maturities. It appears that there are no large maturities after the payment of the '22 in September. Therefore, I would assume there is no urgent need to enter the global market next year, but I would like your insights on that. Lastly, pertaining to the double leverage for the Holdco, I found it interesting that after you paid the $1 million maturity in September, there was no decline in the double leverage. Could you explain why that is? Thank you.

Diego Fernando Solano Saravia, CFO

Let me take a few of those. Luis Carlos will take pension. Regarding the tax reform, you're right, this is a 5% or five percentage points surcharge of which we already have three percentage points. Therefore, the marginal change will be of two percentage points affecting only the banking business that we have. So, businesses such as what comes from the non-financial sector, what comes from equity method and other pieces will not be affected. Therefore, the full impact will not be an additional 200 basis points on our overall effective tax rate. Regarding funding needs for the Holdco, you're absolutely right. We're already done with that. Our next maturity comes around in 2030. International bonds, local bonds will only come around in almost 24 months from now and their minor additional refinancings of around $50 million when you had them throughout the last months of next year. So, no need for cash at this point with what we've already done during September. Then regarding double leverage, what happened is exactly what should be happening because of the way double leverage is calculated is, you take your investments and you divide them by your equity. Given that what we had was a transaction from cash that took away liabilities, it's not affecting either of those. So, what reduces double leverage is a combination of two things. One is, as time goes by and we retain earnings, that generates a benefit to reduce double leverage. And then one of the pieces that adds to our double leverage is the AT1 bond that we bought from back that was non-profile that has around three years to go or short of three years to go, and that should be a step down in our leverage when and if they exercise that call.

Luis Carlos Sarmiento Gutierrez, CEO

Let me summarize the government's upcoming pension reform, which is expected to be presented to Congress around May 2023. This reform will impact Aval, especially considering Porvenir's revenue sources. Porvenir primarily earns from four areas. First, obligatory pension contributions from employees, which are deducted from their monthly salaries, and employers also contribute. This money goes into employees' accounts at Porvenir, which receives a percentage of these contributions. The commission Porvenir collects is divided, with a portion going to insurance companies that charge premiums for early pensions. Due to rising global insurance premiums, Porvenir has seen its commission decrease significantly, retaining only a small fraction of the total. Additionally, Porvenir generates revenue from managing Cesantias, funds accessed annually on February 14. However, voluntary pension funds are not a major source of income for Porvenir. Most importantly, Porvenir manages its own capital, a substantial part of which is used to meet capital requirements for pension funds. The reform under consideration would require employees earning up to four minimum wages, approximately $800 monthly, to stop contributing to private pension funds and shift to government-owned pension funds. This change could reduce Porvenir's monthly revenue by about 60%. Nonetheless, since Porvenir's overall revenue heavily relies on managing its own capital rather than contributed funds, this decline in commissions may not drastically impact its financial performance. We will have to wait for the reform's presentation to Congress and its final outcome, as legislative changes often alter the original proposals significantly. Ultimately, Porvenir's financial health is now more dependent on how it manages its investment portfolio rather than on the monthly contributions it receives.

Diego Fernando Solano Saravia, CFO

Okay. When it comes to foreign exchange losses, it's important to consider that there are multiple accounts involved in the foreign exchange situation. This includes the net foreign exchange gains, which you can find detailed on page 14 of the report. In the second quarter, we recorded a net income loss of negative 109%, and for the third quarter, it was negative 154%. This indicates that we have offsetting figures, and the costs tied to derivatives have increased significantly, exceeding what is typical. Nonetheless, there hasn't been much change throughout the quarter. As for Banco Occidente's capitalization, the bank has been enhancing its commercial effectiveness over the last few years and has successfully expanded in both the corporate and retail sectors, which is why their capital consumption has been notable. Given the particularly negative other comprehensive income from fixed income over the recent months, you would normally expect equity to grow at the same rate as a thriving loan portfolio in a growing bank like Banco Occidente. However, due to the negative changes in OCI, capital consumption has occurred despite positive commercial performance. Regarding any actions to alter valuation, if that was your inquiry, I regret I may not have fully understood your question. Currently, we have not disclosed any plans for action in that regard. Our focus as management is on increasing net income to generate intrinsic value. If I understood your question correctly.

Luis Carlos Sarmiento Gutierrez, CEO

Okay. Regarding foreign exchange losses, it's important to understand that there are several accounts that reflect what's happening with FX. This includes foreign exchange gains net, and I encourage you to look at page 14 of the report. For the second quarter, we had a net income loss of negative 109%, and for the third quarter, it was negative 154%. What we're seeing is that there are offsetting figures, and the costs of depreciations linked to derivatives have increased beyond normal levels. Despite this, there hasn’t been much change over the quarter. Now, concerning the capitalization of Banco Occidente, the bank has been working on enhancing its commercial effectiveness over the last few years with notable success in expanding both its corporate and retail sectors, which explains the capital consumption. Typically, you would expect equity to grow in line with the loan portfolio of a successful bank like Banco Occidente. However, given the particularly negative OCI from fixed income recently, we have seen a discrepancy where positive commercial performance has resulted in capital consumption due to OCI changes. Regarding any actions to alter valuation, if I understood your question correctly, I apologize if I didn't. Currently, we have not announced any measures in that regard. Instead, our management is focused on increasing net income in a way that allows us to create intrinsic value.

Diego Fernando Solano Saravia, CFO

Yes. If we take any action, we will announce it to the market at that point. We can't announce anything as of today.

Julian Ausique, Analyst

Hi everyone, thank you for taking my questions. I have two inquiries. My first question is about the DHI tender offers. Is there any opinion or analysis from the administration on this? Additionally, has Grupo Aval considered the possibility of selling its remaining shares in DHI? My second question pertains to your expectation of a 13% ROE for the next year. Given the anticipated growth of the loan portfolio, improvements in cost of risk, and enhancement of NIM, what impact will these factors have on ROE for the upcoming year? Thank you.

Diego Fernando Solano Saravia, CFO

Okay. Regarding BHI, Julian, we have to be very careful at this point because that's a decision that Banco de Bogotá Board should be taking and hasn't taken yet, regarding participation in this tender offer. What I can tell you without being this a full analysis of what's going on is what will happen is Banco de Bogotá sales, its investment in BHI. Day one, they will get cash and they will liberate some solvency and improve their SFN as well. So that's the day one. So depending on how they invest that money over time, they will get some sort of return. At this point, that's the only thing I can comment on, if you go out to the market and check what you can get from risk-free in Colombia, it's basically an improvement over the rates that you currently have. Long term, we need to see what Banco de Bogotá suggests, but we are in this process, improving solvency and improving the SFN position that gives them room for mobility. So even though I can't comment and we have to be very careful because this is a decision that needs to be taken by Banco de Bogotá Board, these are some basics, not a full analysis, but some basics of things that need to be taken into account. Then, I have to apologize, but I didn't get your question on the 13% ROE. So if you can try to rephrase it.

Julian Ausique, Analyst

Of course, I would like to understand what you are expecting a reduction in ROE for the next year. If we have this good performance in loan growth and a stable cost of risk and even an improvement on – what are the main reasons that we have this reduction of ROE for the next year? I know we have the effect from the BHI – it's been up, but we know that the ROE will be reduced for the next year?

Diego Fernando Solano Saravia, CFO

Yes. You're right. The main explanation of ROE falls relative to this year is the spin-off of BHI. However, I'm not sure that's your question, but part of what I need to say is a 13% to 14% ROE is not what we expect to be a stable ROE of Grupo while moving forward. And the reason why we are prudent on the ROE that we're guiding into is, at this point, we see pressure on the NIM and the retail lending side. Therefore, we expect that to overflow into next year, negatively affecting the first half of the year. So what we should be seeing next year is a first half that is not representative of what Grupo looks like, and we're going to have an improvement over the rest of the year. So when you average those out, you end up in, let's call it, a conservative ROE for next year.

José Cuenca, Analyst

Hi, everyone. Good morning, and thank you for taking my questions. I have a couple of follow-ups. The first one is with regard to the infrastructure income performance. We've seen a very good performance in the past couple of quarters. But 2023 guidance implies a relatively softer performance, it seems to me, I just want to confirm if this is due to inflation eventually, and I would guess, FX also these two variables eventually stabilizing for next year, and those not being like very important – very strong tailwinds for infrastructure income. That would be my first question. And my second question is with regards to the effective tax rate. I really didn't understand why the effective tax rate was a bit higher, especially when considering that pre-tax profits were a bit softer, both quarter-over-quarter and year-on-year. So if you could clarify a bit why with, let's say, softer earnings, the effective tax rate was higher. And lastly, I'm not sure if you could comment a little bit on what do you think would be a more normalized or sustainable ROE level moving forward? Thank you very much.

Diego Fernando Solano Saravia, CFO

Sure. Regarding infrastructure performance, you're correct. To recap our original guidance on Corficolombiana from last year, we expected its contribution to decrease by about 25%. However, as you noted, inflation and foreign exchange rates are beneficial for our concessions, which tend to yield increasing earnings over time as they are reflected in the financial assets from the concession. This year, we experienced unexpected inflation and depreciation, leading to better-than-anticipated performance from the concessions. Moving forward into next year, we anticipate a return to normal levels of inflation and depreciation, as you mentioned. It's also worth noting that Corficolombiana has been actively pursuing opportunities for new projects, including advanced infrastructure initiatives that were awarded recently, along with potential ventures in the energy sector to further support their growth. Regarding the normalized return on equity, a key factor is bringing inflation back to the range of 3% to 4%, which would allow us to make ROE comparisons more meaningful. Under such conditions, we expect our ROE to consistently exceed 15%. You also inquired about the effective tax rate this quarter compared to the last. It's challenging to break down, but as you pointed out, earnings before taxes were softer. However, it's important to consider the sources of those earnings. For instance, income from our Central American operations isn't taxed here because those taxes have already been settled in Central America. As the contribution from those Central American operations to pre-tax income declines, a larger portion of the remaining pre-tax income becomes subject to taxes. Thus, the variance in the sources of pre-tax income between quarters resulted in this quarter's higher effective tax rate.

Daniel Mora, Analyst

Good morning. Thank you for taking my questions. I have a couple of inquiries. The first concerns NIM. I would like to start by asking about the NIM strategy and margin strategy moving forward, considering the current pace of the Central Bank rate and the cost of funding. You mentioned that you expect better numbers in the second half of next year, but I would like to know if you're considering any changes to the loan book or loan mix to enhance margins. Could you also reiterate the NIM guidance for this year, 2022, and 2023? That would be great for my first question. My second question pertains to NPLs. Although we are seeing improvements in asset quality indicators, it is evident that following the spin-off of BHI, Grupo is reporting higher NPLs compared to peers, exceeding the 3% threshold. What is the outlook going forward, especially as we face a period of economic slowdown, rising interest rates, and persistent high inflation? What are your thoughts on this matter? Thank you.

Diego Fernando Solano Saravia, CFO

Okay. So regarding margins, the scenario we're looking into is a scenario where we're very close to the end of the rate increase cycle. We should see it throughout this year and should be stable during the first months of next year. We are not certain at what point should that turn around if it's beginning or end of third quarter, but that's the sort of scenario that we're taking as a base. Regarding strategy for cost of funds, what we have been doing, and it's part of the reason why you see some increase in our cost of funds, as we've already been increasing our position in time deposits and working on bonds. Therefore, we've been preparing for that sort of a scenario in cost of funds trying to get funds in advance to the remainder of the increase in the interest rate cycle. Regarding the loan book, and this ties to your question on NPLs, what we — what prepares us for the cycle is the work we've been doing over many, many years. When you look at our book in Colombia, it is very concentrated in payroll lending that should perform much better over time regarding NPLs than an average book in Colombia. So we already went in that direction. And then when you look at our numbers, our numbers do have higher NPL ratios than pre-spinoff of BHI, because BHI had a much faster cycle to write off their past due loans. So part of what you need to look into is, by stages, how our stages are behaving, our stages continue to improve. When you look only at NPLs and you compare it throughout the system, it is somehow affected by differences in write-off metrics. When you look intrinsically at our portfolio, what you see is an improvement in the Stage 1 loans, Stage 2 loans, and even the composition overall by stages. And then, something to look into is the speed at which NPLs are changing for our — the Aval banks and the speed at which NPLs are increasing for the rest of the system. Basically, at this point, we continue to see a positive behavior at the Aval level. We've been watching our peers and some of our peers have started to show different NPL increase behavior, and that is explained by a higher concentration into higher-risk consumer lending products. In the case of Aval, what we're having is a protection from the structure that we've built over the years. Please let me know if I covered both of your questions; I did it in not a very organized manner, but I want to make sure that I properly answered your questions. Regarding NIM for this year, NIM on loans should be at PS 475 million – when you think of next year, we're looking NIM at a similar level, also PS 475 million with some opportunity for increase there. But at this point, we're taking it as flat. However, NIM on investments that has been running negative, we expect to move to the positive ground. Therefore, when you look at overall NIM, that for this quarter was – or for this year, we guided at PS 375 million. For next year, we're guiding an improvement of around 25 basis points to that. And the explanation is similar NIM on loans, but we're stripping away the negative from NIM on investments.

Luis Carlos Sarmiento Gutierrez, CEO

Well, thank you so much. So as you can see this quarter, we had some headwinds. And – but as Diego was saying, we do expect to be almost at the end of the rising repo rate scenario, that would really work in our favor, and we are implementing all other sorts of corrective actions that I think will, in the next quarter or two get us back on track. With that, I leave you, and I thank you again all for your attention and your great questions, and we'll see you next time.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.