Earnings Call Transcript - AVAL Q2 2022

Operator, Operator

Welcome to Grupo Aval Second Quarter 2022 Consolidated Results Conference Call. My name is Hilda 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 U.S. Securities Regulation. Grupo Aval is also subject to the inspection and supervision of the superintendency of finance at the holding company of the Aval Financial conglomerate. The Consolidated Financial information included in this document is presented in accordance with IFRS 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 of 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 pay, 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 six months ended June 30, 2021. That assumes 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 date 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, any such adjustments may be material. This report includes forward-looking statements. In some cases, you can identify these forward-looking statements by the 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 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 herein. 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 contents 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. Sarmiento Gutierrez, you may begin.

Luis Carlos Sarmiento Gutierrez, CEO

Good morning, and thank you all for joining our second quarter 2022 conference call. As always, it is my pleasure to introduce our strong financial results for the quarter that ended on June 30. Of significance because the spin-off of 35% of BHI was completed at the end of this year's first quarter, this quarter's results do not include net income from discontinued operations. As you may recall, during the first quarter of this year, income from discontinued operations totaled Ps. 1.6 trillion or Ps. 1.1 trillion in attributable net income. 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 the status of our clients' pandemic-driven loan reliefs, our digital efforts, and a few highlights of our financial performance. Let's start with a macroeconomic scenario. Undoubtedly, the global economy is facing sustained inflationary pressures, which have led to tighter monetary policies worldwide. A yet to be normalized supply chain, the disruption in the supply of domestic gas to Europe, and fertilizers to the rest of the world because of the Russian invasion of Ukraine, China's COVID policies, and consumer spending pandemic savings have all combined to exacerbate inflation pressures. A generalized increasing interest rates and supply issues have slowed down economies around the world. As a result, the IMF now estimates global GDP growth for 2022 of 3.2%, down from the 3.6% expected in April, mainly driven by the slowdown of growth in the three largest economies, the USA, China, and the Eurozone. In contrast, for now, the Colombian economy continued with its post-pandemic solid rebound. In fact, as you may recall, during the first quarter, the Colombian economy grew 8.5% or 8.2% on a seasonally adjusted basis. Recent data suggests that GDP growth will exceed 11% during the second quarter when compared to the same quarter a year ago. Growth was boosted by private consumption and due to a base effect because the second quarter of 2021 was marked with a negative effect on GDP of social protests throughout the country. Accordingly, we have updated our estimate of Colombia's GDP growth upwards and now expect it to fall between 6.25% and 6.75%, more in line with market consensus. Regarding the labor market, the unemployment rate fell to 11.3% as of June. In fact, all the jobs lost due to the pandemic were recovered at the national level, while 90% of all urban jobs have been recovered. The average unemployment rate during the second quarter was 11% compared to 13.2% during the first quarter, and 15.1% a year earlier, enhanced by jobs in the entertainment, agriculture, transportation, and commerce sectors. We expect additional gains in payroll numbers, and a further decline in the annual unemployment rate to an average in the 10.5% to 11% area down from 15.9% in 2020 and 13.8% in 2021. So certainly inflation, Colombia has not been the exception, pushed by strong domestic demand, 12-month inflation continued to accelerate, reaching 10.2% in July, the highest 12-month figure of the last 22 years. Food inflation, which accounts for approximately 15% of inflation at 24.6%, continues to be one of the main drivers of the increase in consumer prices, rent and home utilities inflation, which accounts for approximately 33% of inflation at 6.1%, is another big influencer in the inflation number. Inflation expectations continue rising with a market consensus forecast of 9.1% for 2022. We anticipate that 12-month inflation could reach 9.5% by year's end. In this context, we believe the Central Bank is close to reaching the end of its tightening cycle in 2022. The repo rate is currently at 9% after a 150 basis points hike during the last meeting in July, and real interest rates are finally positive after a couple of years. If inflation behaves as expected, we don't rule out the possibility of one additional hike of 100 basis points in September, which should bring the year-end rate to 10%. Regarding the exchange rate during the second quarter, the dollar appreciated as much as Ps. 879 or 23% but has recently depreciated to around Ps. 4,310 per dollar which equates to a devaluation of the Peso during 2022 of approximately 8%. In general, we expect the Peso to respond to Colombia's trade deficit which is very dependent on the price of oil and with the prospects of a tighter monetary policy in the U.S. and an eventual outflow of capital from Colombia towards hard currency economies. However, for now, we expect the stability of the Peso in the Ps. 4,200 per dollar area. On the fiscal front, the government now expects a deficit of 5.6% of GDP in 2022, an improvement versus the 7.1% recorded in 2021 and the 6.5% initially forecasted, reflecting the strong economic rebound, the positive effects of higher oil prices, and very positive tax revenues. In fact, tax revenue in June grew 35.5% compared to June 2021. This improved fiscal scenario could contribute to a low ratio of net public debt to GDP, a 56.5% by year-end down from 61% at the end of 2021. On August 8, Colombia's new government presented a new tax bill to Congress, which we are just starting to analyze, but whose well-known objective is to increase tax revenues by as much as Ps. 55 trillion to expand social programs and reduce public debt. Several other reforms have been announced, including environmental, energy, pension, and health reforms. Moving on. As of June, active debt reliefs in Colombia amounted to approximately 4% of the total consolidated loan portfolio and active debt reliefs in Multibank, Banco de Bogotá's local bank in Panama, amounted to approximately 3% of our consolidated loan portfolio. Our gold loans that have concluded the relief periods are less than 1% past due 90 days or more, and 1.3% past due 30 days or more. I'll move on to digital. These are some noteworthy numbers regarding our strategy. First, a lot of banks' active digital clients remain at approximately $4 million at the end of June. Additionally, clients of our digital wallet have started to grow significantly and totaled approximately half a million by the end of June. Our banks sold over 1 million digital products in the first half of the year, an increase of 59% versus the first half in 2021. Our total digital share continues around 60%. Digital adoption of our mobile banking apps and personal banking platforms reached 59%. We expect to have a 65% digital adoption by year-end. Disbursements through our first mobility ecosystem initiative increased by three times in the quarter. Additionally, the amount of qualified credit leads for our banks increased by 25% during the quarter, and the leads to disbursements conversion rate doubled over the quarter. In June, we launched our insurance digital ecosystem in alliance with global insurance companies and Allianz. Campaigns conducted through material ads, our programmatic ad platform, have improved our banks' client targeting and materially reduced our digital acquisition costs. Finally, we are proud to announce that for a second consecutive year, our digital lab was recognized as the best innovative digital lab by global finance. To finish, in a minute, Diego will refer in detail to our financial performance during the second quarter of 2022. However, I would highlight the following. The second quarter marked the first entire quarter without BHI Back Holding International under our wings. BHI continues to perform very well and I'm sure its new shareholders are thrilled with its performance. In the meantime, our Colombian banks or non-financial sector subsidiaries registered a remarkable quarter when compared to previous quarters adjusted to strip out the contribution from BHI. In fact, on a comparable basis, Aval delivered a quarter 7% higher attributable net income than the first quarter of 2022, with notably better credit quality and cost of risk. Additionally, operating cost control continues to be very high on our priority list, as well as the execution of our digital innovation and payment strategies. As expected, in this rising rate scenario, loans' interest margins continue to expand in our two largest banks, which in turn are those with loan portfolios mostly composed of commercial loans. While loans' interest margins tend to contract in banks with loan portfolios with mostly fixed-rate consumer loans. Obviously, the cost of funds continues to rise both for our banks and for our non-financial subsidiaries. We remain very vigilant of the effect that continued rising interest rates could have on the ability of our customers, especially customers with variable-rate loans, to meet their obligations. For now, we are satisfied with what we're seeing. Finally, our pension fund manager has seen its insurance premium costs rise due to the pandemic increase in mortality, and its fixed-rate portfolios have also suffered volatility derived from higher interest rates. As we highlighted, the economy continues to move in the right direction, but inflation has not started to subside. Therefore, we expect that monetary policy will continue to tighten until it makes a dent on inflation. Importantly, on the foreign front, we have yet to see the final global consequences of the fast-approaching European winter without a solution to the domestic gas crisis and the full restoration of the global supply chain. Locally, we will await and analyze closely all the announced reforms and the consequences for our businesses. I believe that future quarterly calls will contain chapters focusing on quantifying those effects. But ultimately, we continue to strongly believe in this country's resilience. I thank you for your attention. And now I'll pass on the presentation to Diego, who will explain in detail our financial results. Thank you very much.

Diego Fernando Solano Saravia, CFO

Thank you, Luis Carlos. Before I start, I want to mention that on this call, we are presenting the gains from loss of control of subsidiaries related to the spin-off of 75% of BHI as these are continuing operations improving the comparability of our continuing operations. On our first quarterly call, we have classified them as other income. We are aware that this changes previously reported metrics for efficiency and key income ratios. Beginning on Page 6, on a comparable basis, assets grew 13.9% over the year, and 5.7% during the quarter. Over the quarter, our mix shifted towards cash reflecting the position that we have already prepared to pay the $1 billion bond on September 26 of this year. Over the year, our unconsolidated equity investments increased their share of assets reflecting that after the spin-off, Banco's direct equity interest in BHI is accounted for as an investment in associates. Moving to Page 7, we present the evolution of our loans on a comparable basis. Gross loans grew 12.8% over the year and 5.2% in the quarter. Quality growth rates were strong both in commercial and retail lending. Commercial loans continue to gain traction, reaching 5.4% growth over the quarter and 11% over 12 months. Midsize companies and SMEs explained part of this performance. Demand for consumer loans continued to be high resulting in a growth of 4.8% during the quarter and 14.7% over 12 months. Improvement in GDP growth, employment, and the overall macro environment have allowed us to increase our underwriting of personal loans and credit cards. Federal loans represent most of our consumer loan portfolio at 59%, followed by personal loans and credit cards at 20.5% and 11.5%, respectively. Around 3%, close to 9% of our consumer book consists of Federal loans that continue to drive our growth, increasing 3.8% quarter-on-quarter and 13.6% year-on-year. Personal loans, credit cards, and mortgages grew 7.2%, 5.8%, and 5.1% over the quarter, taking annual growth to 19.8%, 12.9%, and 14.6%, respectively. Finally, mortgages remain dynamic expanding 5.8% of the quarter and 18% year-on-year. Even though headwinds from monetary policy can be expected to reduce the pace of the system, we have a positive view on growth moving forward, as GDP and household and government demand will support this performance. In addition to improvement in employment will further benefit retail lending momentum. On Pages 8 and 9, we represent several loan portfolio quality ratios on a comparable basis. The quality of our loan portfolios continued their improvement trends, both measured as competition by stages and through metrics. Cost of risk will substantially decrease compared to a year and a quarter earlier. Composition of our loan portfolio classified by stages continues improving, as well as the coverage ratios for each stage. Stage 1 loans now represent 84.3% of our gross loans, improving from 80.7% and 82.6% from 12 and three months earlier. Stage 3 loans are back to pre-pandemic levels. The retail portfolio is already slightly below pre-pandemic levels while commercial loans are approaching 2019 levels. The proportion of Stage 2 loans is still affected by the outstanding balances of assets released. The relief put in place during the pandemic should lift the higher level of Stage 2 loans. We expect this portion of our books to continue moving forward from Stage 1 as we advance into the second half of the year and continue reducing the balance of actively used and removing overlays. Regarding delinquencies, 90 day PDLs fell to 3.33%, a 94 basis points improvement over 12 months and a 20 basis points improvement over three months. 30 day PDLs fell to 4.38% with a 115 basis points improvement over 12 months and a 27 basis points improvement over three months. Both metrics stand over 50 basis points below pre-pandemic levels on a comparable basis. The cost of risk net of recoveries was 1.4% including a 57 basis points quarterly improvement in commercial loans to 2.49% and a two basis points increase in retail to 2.6%. Finally, the ratio of charge-offs to average 90 day PDLs was 0.54 times for the quarter, stable relative to a quarter earlier. On Page 10, we present funding and deposits evolution on a comparable basis. Funding growth during the quarter was in line with that of our loans with a stable deposits to net loans ratio at 100%. Deposits, which account for 70% of our funding, increased 4.8% from the quarter and 7.9% year-on-year driven by growth in time deposits favoring the stability of our funding. On Page 11, we present the evolution of our total attributable equity and the capital and equity ratio of our banks as reported. Our total equity grew 1.9% during the quarter, while our attributable equity increased 1.2%. Lower valuations of fixed-income investments held at fair value through OCI in a rising interest rate environment dampens the contribution of net income. The annual decrease in our equity reflects the spin-off of 35% of BHI in March 2022. The solvency ratios slightly fell in some of our advances despite positive results in net income incorporating the increase in risk-weighted assets resulting from loan growth and the lower valuations of our investment portfolios. On Page 12, we present our yield on loans, cost of funds, spread, and NIM on a comparable basis. Our overall NIM fell 50 basis points to 3.64% during the quarter driven by a negative NIM on investments, a stable NIM on loans in our banking segments, combined with a higher funding cost of our non-financial activity resulted in a NIM on loans of 4.91%, contracting 19 basis points during the quarter. NIM on loans performance incorporates benefits from monetary policy under commercial lending activity that we price strongly. On the other hand, our consumer loans that have long repricing periods take longer to benefit from these environments. The banking book is heavier on commercial lending, which favors the NIM on loans of our combined banking segments, despite differences across banks. In addition, the interest expense associated with funding our non-financial activity impacts our NIM on loans. Worth anticipating is that this increase in cost of funding is compensated by a stronger performance of the non-financial sector presented on the following page, which benefits from inflation. NIM on investments was negative 1.25% 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 investments held by under mandatory stabilization results. On Page 13, we will present net fees and other income on a comparable basis. Gross fee income increased 1.9% year-on-year but fell 8.3% quarter-on-quarter. Net fee income decreased 4.6% year-on-year and 1.8% quarter-on-quarter. Pension fees decreased due to lower performance-based fees and higher insurance premiums associated with increasing mortality rates during the pandemic. Income from the non-financial sector, in particular, infrastructure, was strong given that the financial assets from our concession agreements benefit from higher inflation and depreciation of the Colombian Peso. Regarding other operating income at the bottom of the page, few elements drove the changes relative to previous quarters. Starting this quarter, income from non-consolidated investments through the equity method incorporates the fully paid 25% equity stake in BHI, which contributed Ps. 150 million to these line items. In the first quarter of 2022, seasonal dividends were reported in this line item. Second, derivatives and foreign exchange gains or losses include the performance of FX hedges in the non-financial sector. And finally, the first quarter of 2022 other income from operations included one-time Ps. 137 billion in income from fair value associated with the remaining 25% of BHI. On Page 14, we present some efficiency ratios on a comparable basis. Cost to assets remained flat over the quarter at 2.6% and improved relative to a year earlier. Our cost to income increased to 41.1% driven by the compression of NIM driven by previous prices as well as the seasonality of dividends. Expenses grew 6.9% year-on-year well below inflation metrics driven by personnel expenses that grew 3.8%, while administrative expenses grew 11.9%. Finally, on Page 15, we present our net income and profitability ratios as reported. Attributable net income for the quarter was Ps. 675 billion or Ps. 29.7 per share. Our return on average assets and return on average equity for the quarter were 2.1% and 16.6%, respectively. Before we move into Q&A, I will now summarize our general guidance for 2022. We expect loan growth to be in the 15% to 16% range with commercial loans growing in the 14.5% to 15% range and retail loans in the 15.5% to 16.5% range. We expect our cost of risk net of recoveries to be around 1.5% on average. We expect full-year NIM to be in the 4% area with NIM on loans between 5% and 5.25%. We expect cost to assets to be in the 2.6% range. We expect our fee income ratio to be in the 19% to 20% range. We expect our non-financial sector to be 20% higher than that of 2021. Finally, we expect our full-year reported return on average equity to be in the 19% to 20% range. We're now open to questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. We have a question from an analyst from Scotiabank. Please go ahead.

Unidentified Analyst, Analyst

Hi, good morning. Thank you for taking my question. I have two questions, one on net interest income expectations. And the second one on the new purchase of net interest income decreasing due to higher interest expenses. So I was wondering, how should we expect this to evolve for the rest of the year and when can we see net interest income increasing again? And the second question related to delinquencies. So we saw an improvement in the NPL ratio this quarter. So I wanted to know, how do you expect this to continue on for the rest of the year? And at what level do you think that the NPL rate is going to settle?

Luis Carlos Sarmiento Gutierrez, CEO

Okay. Regarding NIM expectations, there are several forces at play. To break it down into pieces, if we consider our business lines, the NIM from our banking segments should be stable and probably have an upside, as we're able to reprice our loans. Then, if you look at the non-financial side, the non-financial side of the business only bears the expense side of NIM, therefore, it's not able to translate through the line of NIM but rather benefits through the income from the non-financial sector. So when you bring together those lines, the overall NIM on loans might have a slightly negative bias with the banking segments being neutral or positive, and then a negative effect from the cost of funds of the non-financial sector. The other factor in play that is very market-dependent is what happens to the NIM on investments, which has had the heaviest and most negative effects on NIM over the past few quarters. We expect some improvements there, even though that side is under pressure. Some of that has already been evidenced throughout this quarter. During the couple of months we've been running this quarter, we see Colombian government bonds starting to have some periodic recoveries, which should start to establish a new trend. Overall, for the rest of the year, we should see less pressure from the main investments and similar trends for NIM on loans. Regarding delinquencies, you have to bear in mind that Colombia has had strong GDP growth that has been positively surprising over time. The reason behind our guidance for the year at 1.5% for cost of risk. What that implies is some sort of pressure building during the remainder of the year with the higher rates coming from the Central Bank. However, you should consider that our book is much more protected than some of our peers concerning these changes, given that it concentrates heavily on payroll lending and the consumer side, while the profile of the corporate side is similar to the rest of the system. So you should see an improvement relative to previous years, rounding up at around 1.5% of cost of risk net of recoveries.

Operator, Operator

Thank you. The next question comes from an analyst. Please go ahead.

Unidentified Analyst, Analyst

Hi, everyone, and thank you for having my questions. I would like to ask you, first of all, if you can give us more detail about the decrease in pension fees, what was the reason behind the performance during the quarter? And I would also like to ask you about the net stable funding ratio in all your banks, how is it performing? Is it already above the regulatory levels or do you have any pressures in any of your banks? Regarding this question, I would like to know if the NIM will face some pressure; you already mentioned that you expect it to perform better during the next quarters. But if the net stable funding ratio has some pressure, will you experience pressure in the cost of funding?

Luis Carlos Sarmiento Gutierrez, CEO

Okay, let me start with your two questions regarding the pension situation in Colombia. Perhaps something you need to be aware of is that as recent as August 4, the superintendency came out with changes in regulations that will relieve some of the pressure that we had seen over the past few months. In that sense, we are not expecting pressure to build up from September, but rather a more positive outlook for the next few quarters than what we've indicated in our previous numbers. Therefore, there might be relief throughout the system, as the cost of funds has been pressed not because our banks need some help, but from the overall leading banks requiring additional funding and pressing the cost across the system. We expect to see some relief there, which should favor our numbers. To your question about regulation, yes, absolutely. We're above regulatory levels at this point, and we're not foreseeing pressure on that front. Regarding the decrease in pension fees, as I went through in the presentation, two forces have been affecting us. One piece of our fees is performance-related, which means that if the market is not doing well and the funds we have to invest in are not performing, that suppresses our key component. The other piece is our fees, which are net of insurances. Even though there have been changes in mortality throughout the world during the past couple of years, that has increased some of the premiums that we have to pay.

Operator, Operator

Thank you. At this moment, we have no further questions. Now I give the word back to Mr. Sarmiento for his final remarks.

Luis Carlos Sarmiento Gutierrez, CEO

Thank you so much. Thank you all for attending our second quarter call. These are interesting times, and next time we will probably be talking about all the reforms that are being passed and have been presented to Congress. Congress is starting with a tax reform. But for now, we're just analyzing this and I am sure it will be a subject of future conversations. We expect to continue yielding results in the numbers and we will see you in the next call. Thank you so much.

Operator, Operator

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