Credicorp Ltd Q1 FY2021 Earnings Call

This is recording of the Credicorp’s First Quarter 2021 Conference Call on Friday, May 7, 2021 at 9:30 AM Central Time. Ladies and gentlemen, good morning everyone. I would like to welcome all of you to Credicorp Limited First Quarter 2021 Conference Call. We now have all of our speakers in conference. Please be aware that each of your lines is in a listen-only mode. At the conclusion of today's presentation, we will open the floor for questions. At that time instructions will be given as to the procedure to follow if you would like to ask a question. With us today is Mr. Walter Bayly, Chief Executive Officer; Mr. Alvaro Correa, Deputy Chief Executive Officer; Mr. Gianfranco Ferrari, Deputy Chief Executive Officer; Mr. Reynaldo Llosa, Chief Risk Officer; Mr. Cesar Rios, Chief Financial Officer; and Ms. Milagros Cigüeñas, Investor Relations Officer. And now it is my pleasure to turn the conference over to Credicorp's Chief Financial Officer, Mr. Cesar Rios. Mr. Rios, you may begin sir.

Thank you. Good morning and welcome to Credicorp's conference call on our earnings results for the first quarter of 2021. I hope you and your families are healthy. As you know the current sanitary situation in Peru as well as the political landscape are key factors of uncertainty. The sanitary situation in Peru and metropolitan Lima has not improved in recent months, as is reflected in data on excess mortality. Peru's vaccination rollout, which began in February has progressed at a slower pace than other countries in the region. Nonetheless, the government has announced there will be an acceleration in the organization process in the coming months. In this challenging context, we continue to put the well-being of Credicorp's employees first, as we focus on ensuring operating continuity and offering financial solutions to clients and employees alike. Our ultimate goal is to serve society as we continue to create value. On the political scene, candidates Pedro Castillo and Keiko Fujimori will face off in the second round of Presidential elections on June 6. The latest polls show candidate Pedro Castillo in the lead. Mr. Castillo from the political party Peru Libre has proposed a number of measures. According to the party's government plan it intends to shift away from the current market-oriented economic model to one that prioritizes a so-called popular economy with markets. Under this model, the state will play a much more active role in businesses. Peru Libre's plan also includes holding a constitutional assembly to write a new constitution and nationalizing so-called strategic cycles. Mrs. Fujimori, in contrast, favors maintaining an economic model that supports national and foreign investments and advocates a restricted and secondary role for the state in the economy. Mrs. Fujimori also believes that the current constitution should remain in effect. It is still early to predict the outcome of this election. Polls can shift considerably in the Peruvian context, which is marked by high levels of voter indecision. In any scenario, the new executive branch will need to generate consensus to be able to implement changes. The recently elected congress is highly fragmented and composed of 10 political parties. Other relevant elements of Credicorp's operating context in Colombia, the executive branch recently withdrew the bill for tax reform that was submitted to congress, which represents the 15th of its kind since 1991. A new bill will be formulated. In Chile, elections will be held on May 15 and 16 primarily to determine the members of the constitutional assembly. Regarding Peruvian economic activity, recovery continued in the first quarter of 2021 despite localized lockdowns. Our estimate suggests that GDP grew around 4% year-over-year in the first quarter of 2021. This is the first positive register in five quarters. In addition, in seasonally adjusted terms, GDP in the first quarter of 2021 stands very close to the pre-pandemic levels. Electricity demand also continued to recover in the first quarter of 2021 and surpassed our data slightly pre-pandemic levels. Due to political uncertainty, the sovereign Peru interest rate has increased primarily for medium and long-term maturities. The Peruvian Sol has also depreciated to hit a record low. The global economy continues to improve, but interest rates and FX levels remain volatile. Commodity prices continue to be robust and the price of copper, which is relevant for Peru reached a peak of $4.43 almost a 10-year peak. We expect Peru's GDP to rebound to 9% in 2021 underpinned by high copper prices as well as extensive monetary and fiscal policies. Now, I will comment on the evolution of the financial system and the regulatory environment. According to data from the Central Bank, loan growth in March stood at 9.4% year-over-year at a constant exchange rate driven by the influx of Reactiva loans. If we exclude the effect of Reactiva loans, total loans declined 7% year-over-year. Regarding economic policy and the regulatory environment, I would like to highlight the following: first the congress approved a new private pension fund withdrawal. Under this plan, both current contributors and new contributors will be able to withdraw up to PEN17,600. It is important to note that the Ministry of Finance has announced it will propose taking the law to the constitutional court. Regarding new regulations, Congress also approved the withdrawal of 100% of CTS accounts until December 2021. As of February, CTS deposits totaled PEN21.8 billion system-wide. Moreover, the government approved rescheduling of Reactiva loans for a total of PEN19.5 billion along with the five loans for PEN2.1 billion both until July 15. The rescheduling process includes a new grace period of up to 12 months. Lastly, the executive branch has announced it will bring the law of interest rate caps and fee restrictions before the constitutional court. Several private institutions have presented legal actions that may also need to be taken before the constitutional court. Key restrictions have already been implemented while recent guidance from the Central Bank has set an interest rate cap of 83.4% for small consumer and microbusiness loans from May to October 2021. We will continue to closely monitor these developments to evaluate their impact on Credicorp's operations. Now I will comment on Credicorp's performance in the first quarter of 2021. Credicorp's net income totaled PEN 651 million this quarter, which represents an increase of 215.8% year-over-year and reflects the fact that in 2020 we set aside significant provisions to mitigate the impact of the pandemic. Despite an adverse environment due to COVID-19, we continued to recover and posted a return on equity of 10.6% this quarter. The upward trend in earnings in recent quarters has been driven mainly by a decrease in provisions and reflects the favorable evolution of asset quality and an uptick in fee income. This was offset by a decrease in the net interest margin and an increase in life insurance claims. Regarding our quarter-over-quarter evolution, I would like to highlight the loan portfolio remained flat in terms of quarter-end balances as growth posted in consumer loans, mortgages, and Mibanco was offset by contractions in corporate banking and credit costs. Net interest income grew by 2.6%. This result includes PEN 88 million in expenses related to a liability management operation at BCP Stand-Alone, which will generate savings going forward in a context of lower-cost funding. With these results, the NIM remains flat at 3.73%. Provision expenses fell due to the ongoing improvement in client payment behavior, which led to a cost of risk of 1.63% and a structural cost of risk of 1.92% this quarter. Within non-financial income, fee income contracted by 4.9%, which was mainly attributable to a decrease in transactions due to seasonality and localized lockdowns. The net gain on securities also posted a decrease; fixed-income securities from ASB's proprietary portfolio registered a drop in value in a context of higher interest rates. Insurance underwriting results were severely impacted by a considerable increase in COVID-19-related claims and incurred, but not reported provisions in the life business. Expenses remain under control. Finally, our balance sheet remains strong with ample liquidity and adequate capital ratios. In terms of the performance of our lines of business, each of our subsidiaries is in a different stage of recovery. In terms of subsidiaries, I would like to highlight BCP's Stand-Alone drop recovery with an earnings contribution of PEN 725 million, which represented an 18.4% return on equity. Mibanco's recovery is sluggish with an earnings contribution of PEN 14 million and a 2.7% return on equity. Pacifico's business was the most impacted by the pandemic this quarter and registered PEN 96 million in losses. Investment banking and wealth management in turn reported an earnings contribution of PEN 37 million, which was close to pre-pandemic levels. I will now explain the key dynamics in each of our lines of business this quarter, which led to mixed results. After that we will review in detail our consolidated performance line by line. Going into Universal Banking, this line of business drives the recovery this quarter. After registering the most difficult quarter in history in the second quarter of 2020, BCP's Stand-Alone remained on track to earnings recovery, posting an earnings contribution to Credicorp of PEN 725 million and a return on equity of 18.4% this quarter. Net interest income decreased by 10.4% year-over-year, which was driven by a decreasing market interest rate, a contraction in structural loans, and the presence of government loans. These impacts were partially offset by growth in low-cost deposit actions to take advantage of lower rates through liability management strategies and the increase of the investment portfolio. Provision expenses decreased by 65.5% year-over-year, after the majority of grace periods expired and clients registered improvements in payment behavior. In this context, the cost of risk was 1.37% and the structural cost of risk was 1.62%. Fee income increased by 6.2% year-over-year given that the first quarter last year was impacted by fee exceptions. On a quarter-over-quarter basis, however, fee income fell somewhat due to a decrease in transactional activity amid localized lockdowns and the initial impact of government-mandated fee restrictions. Net gains on securities increased PEN 73 million year-over-year after posting losses in the first quarter of 2020 due to a general decline in capital markets in the context of the first wave of COVID-19. On a quarter-over-quarter basis, results were mainly driven by sovereign bond sales in the banking book portfolio. Finally, operating expenses remained under control. This reflects a normalization of the levels of variable compensation and the impact of other cost controls. Regarding Bolivia, the business resumed positive earnings contribution given that the last quarter of 2020 was impacted by new government regulations and reprogrammed loans. In Microfinance, Mibanco's recovery is taking long. After resuming growth in earnings during the second half of last year, the bank registered PEN 14 million in earnings contribution this quarter. Mibanco's clients, primarily macro businesses, felt the impact of lockdown measures more than larger entities at BCP. Nonetheless, Mibanco's progress in implementing a hybrid business model has helped partially offset this effect. As a result, origination decelerated and the loan portfolio grew 0.5% quarter-over-quarter. There were new needs for credit facilities as grace periods expired and delinquency increased. Net interest income contracted year-over-year. This reflected the advent of lower interest rates and the fact that through 2020 we targeted lower-risk clients, saw an increase in the average ticket, and registered a decrease in yields. It also includes the net effect of interest reversals of previously reprogrammed loans and amortization on impairment on zero interest rate loans made last year. Recently, the average ticket trend is moving in the opposite direction as the average ticket decreases and origination leads deals increased. These trends, coupled with a decrease in the cost of funds, led net interest income to grow 4.4% quarter-over-quarter. Provision expenses increased 17.6% quarter-over-quarter, which was driven primarily by the deterioration in portfolio quality and by alignment with growth information as competitors' delinquency increased. Non-financial income contracted 52% quarter-over-quarter given that last quarter, we recognized extraordinary fees for credit life insurance commissions relating to the reprogramming loans for the full year 2020. At the operating expense levels, Mibanco's results reflect the positive impact of the gradual implementation of the hybrid distribution model. In Colombia, Mibanco posted positive results for the first time since the acquisition of Bancompartir in 2019. Loan origination is already at pre-pandemic levels, and commercial productivity has been improving. Regarding insurance and pensions, Pacifico's life business generated stable earnings in the first half of 2020, but began to reflect the weight of the pandemic in the third quarter of last year. In the first quarter of 2021, a second wave of COVID-19 ripped through the country, severely impacting the life business. Consequently, Pacifico posted a negative earnings contribution of PEN 95.5 million this quarter driven by PEN 260 million of claims and IBNR reserves for COVID-19. Year-over-year and quarter-over-quarter, the evolution of earnings was driven by an increase in life claims and IBNR provisions, which was partially offset by a decrease in claims in the property and casualty business due to mobility restrictions and an increase in net income from the medical service business due to higher demand. Regarding the pension business, Prima's assets under management expanded year-over-year, reflecting the recovery of capital markets offset by the fund withdrawals of PEN 7.2 billion in 2020 and PEN 2.5 billion in 2021 due to government-mandated facilities. On a quarter-over-quarter basis, assets under management contracted 3.2%. Fees contracted 5.5% year-over-year due to a decrease in affiliate contributions but show an improvement quarter-over-quarter due to growth in average salaries and in the number of active contributors. Regarding our investment banking and wealth management businesses, assets under management and income grew year-over-year, given that the steepest decline in the capital market was seen in the first quarter of 2020. On a quarter-over-quarter basis, I would like to highlight, total assets under management increased 3.3%, mainly driven by net new money in the asset management business. The effect of new subscriptions was partially offset by the evolution of asset values, which were affected by an increase in interest rates. Regarding recurring income contribution, the contraction was driven by downturns in capital markets and corporate finance. In capital markets, fixed-income securities from the proprietary portfolios registered a drop in value in a context of higher interest rates. In corporate finance, income was affected by seasonality, posting lower levels of corporate transaction execution. These results were partially offset by growth in income in wealth management, which was primarily associated with higher gains from brokerage investment products and Prima AFP. Asset management income growth was driven by traditional and alternative funds, as well as by the distribution of third-party products and growth in the treasury book which was affected by the devaluation of long-held property investments. Now I will discuss Credicorp's consolidated performance. On the asset side, Credicorp's interest-earning assets grew 26.9% year-over-year, driven by government program loans and investments. The structural portfolio dropped after wholesale clients had less need for liquidity, which led to an increase in cancellation of short-term loans. On a quarter-over-quarter basis, I would like to highlight, interest-earning assets decreased 2.9%, driven by the investment portfolio at BCP Stand-alone. This quarter we increased positions in the short-term investment portfolio and managed exposure in the medium-term banking book in a context of rising interest rates. Our loan portfolio contracted 0.3% quarter-over-quarter in average daily balance, which was mainly due to a drop in the wholesale banking and structural portfolio and, to a lesser extent, to prepayments in some Reactiva loans. This was partially offset by the expansion posted in retail banking and at Mibanco Bolivia. The 1.3% quarter-over-quarter expansion in retail banking loan portfolio was driven by mortgage, consumer, and SME dealer segments. This evolution was partially offset by a contraction in the SME business, which had high levels of liquidity, and in credit cards, which registered low balances due to a drop in big-ticket purchases and higher constraints in the risk appetite for the consumer segment. Regarding the funding structure, total deposits grew 24.3% year-over-year. Expansion was driven by an increase in demand and saving deposits due to an injection of liquidity through government program facilities and higher saving rates among individuals. The aforementioned, coupled with lower interest rates and active liability management, led to an improvement in the funding cost. Regarding funding management this quarter, I would like to highlight, total funding increased driven by low-cost deposits in a context of high market liquidity. BCP Stand-alone executed a new liability management to sanction exchange to callable subordinated bonds and a 2026 bond at 6.875% and a 2027 bond at 6.125% for a new subordinated bond of $500 million at 3.25% that matures in 2031. This transaction, which will allow us to capture savings going forward, figures related charges in financial expenses for PEN 88 million in March 2021. The structural funding costs dropped to 1.35% this quarter. If we include funding relative to government programs and charges related to the liability management operation, the total funding cost situates at 1.43% this quarter. The evolution of both payment behavior and portfolio quality improved in retail banking, but the situation of Mibanco was less favorable, as clients in this segment have been more impacted by the second wave of COVID-19. At BCP Stand-alone retail clients sustained strong payment performance. On-time payments on loans was 95% in March, as higher volumes of reprogrammed loans expired. Non-reprogrammed up-to-date loans increased this quarter to represent 76% of structural loans and the high uncertainty portfolio, which is comprised of recurring loans and are within grace periods and those that are reduced to 5% compared to 9% last quarter. At Mibanco, on-time payments on loans due remained at 93% in a context marked by an increasing expiration of grace periods quarter-over-quarter. Analyzing the structural portfolio figures, we note, first, non-recurring up-to-date loans posted a noteworthy growth this quarter to represent 57% of the structural loans compared to 49% at the end of 2020. Second, the overdue portfolio increased this quarter from 6% to 9% of the structural loans as clients' facilities expired and clients were impacted by lockdowns. Finally, the high uncertainty portfolio was reduced to 19% of structural loans compared to 24% last quarter. In this portfolio, 10% of the structural loans were still within grace periods, which will be expired mainly by June 2021. Regarding portfolio quality ratios, the majority of Credicorp's NPL ratios increased this quarter. The retail banking portfolio at BCP’s stand-alone improved its structural NPL ratio this quarter, due to a decrease in overdue loans in the consumer and credit card segments reflecting its positive payment behavior. An increase in write-offs and loan growth also fueled a drop in the ratio. Deterioration in NPL for wholesale banking was attributable to specific clients in the middle market segment. In Mibanco, the NPL ratio deteriorated this quarter due to higher delinquencies after a large tranche of grace periods expired and client payments began to reflect the effects of the lockdown in February. As a result, Credicorp's structural NPL increased to 6.05%. Finally, the NPL coverage ratio decreased to 142.9% this quarter reflecting also PEN 767 million of write-offs. Now, I will explain cost of risk dynamics. Provision expenses continued to follow a notable downward trend, which was attributable to an improvement in client payment behavior, and an uptick in transactional activity at BCP stand-alone, mainly in retail banking segments. At Mibanco, provisions increased this quarter due to two factors: an upswing in delinquency after grace periods expired and external alignment given that our competitors' delinquency levels rose. As a result, Credicorp's structural allowance for loan losses or the total restructured loan ratio fell this quarter to 8.5%. Regarding the evolution of the structural cost of risk quarter-over-quarter, BCP stand-alone ratio registered a significant contraction of 95 basis points as situated at 1.62% while Mibanco's ratio increased 73 basis points to situate at 5.45%. As a result, Credicorp's structural cost of risk contracted 72 basis points and situated at 1.92%. Finally, Credicorp's total cost of risk contracted 50 basis points quarter-over-quarter, posting a level of 1.63%. At Credicorp, NIM remained flat this quarter at 3.73%. This was attributable to the fact that the increase in net interest income was offset by growth in average interest-earning assets. NIM includes a negative impact of seven basis points from charges related to the liability management transaction at BCP stand-alone. Structurally, NIM dropped 12 basis points this quarter affected by a less favorable mix in interest-earning assets and lower origination rates at BCP stand-alone. Finally, risk-adjusted NIM increased 34 basis points this quarter in line with lower provisions. And BCP stand-alone's NIM contracted 37 basis points quarter-over-quarter following the same dynamics seen at Credicorp level. Mibanco NIM increased 17 basis points quarter-over-quarter given that the structural loan dynamics continue to recover despite the lockdown imposed by the government. And interest rates on new loans increased in line with a drop in the average loan ticket. Non-financial income expanded 24.7% year-over-year driven by 9.3% growth in fee income given that the first quarter of last year was impacted by fee exemptions and growth in the net gain on securities given that the first quarter of last year reported losses in line with the steepest decline in value in the capital markets due to the onset of the pandemic. On a quarter-over-quarter basis, non-financial income contracted 10.2%, which was driven by a decrease in net income securities as significant gains were booked in the last quarter of 2020. This drop was driven by losses registered in fixed income security from ASB's proprietary portfolios due to a drop in value in the context of higher interest rates. These losses were offset by gains on sales of sovereign bonds and BCP stand-alone's banking book portfolio. The decrease in fee income at BCP after extraordinary fees were registered in the fourth quarter of 2020 for recurring loans during the full year 2020. The insurance underwriting result was severely impacted this quarter and posted a loss of PEN 65.2 million. The main driver of this result was the life insurance business. On a year-over-year basis, the increase in the loss ratio in the life business was driven by excess mortality related to COVID-19. This was partially offset by growth in net premiums from Cisco 5 after higher fees were obtained through the new option for ASB mortality risk coverage and price adjustments made in the credit life business. In the case of property and casualty, the loss ratio improved after the claim levels dropped across businesses due to mobility restrictions. The material quarter-over-quarter increase in IBNR provisions from COVID-19 is due to two factors. Mortality was driven by the retired population in the first wave and by members of the economically active population in the second wave. Credit exposure in the second group was consequently higher. Provisioning in the context of the pandemic has been challenging and initially involved our best estimates, given that there is a lag between the moments in which cases occur and when they are reported. Our lending curve has increased significantly since the beginning of the crisis and such as we have adapted our IBNR models to reflect the potential impact of increased mortality. The statistics show that mortality rates are beginning to decrease and IBNR should follow that trend. Credicorp's operating expenses remain under control. The year-over-year deterioration in Credicorp's efficiency ratio, which is situated at 44%, was driven by a decrease in income due to lockdowns and charges for BCP stand-alone's liability management transactions. Excluding these charges, Credicorp's adjusted efficiency ratio was 43.06% which represents a year-over-year improvement of 32 basis points. Expense controls at BCP stand-alone were reflected primarily in a reduction in variable remuneration expenses. Mibanco, in turn, has made significant progress in implementing its hybrid distribution model which is more cost-efficient. In terms of our liquidity, the regulator monitors the 30-day liquidity coverage ratio and BCP stand-alone and Mibanco have maintained levels well above the regulatory minimum both in soles and in dollars. However, the management decision we use a more stringent indicator relying on liquidity coverage ratio of 15, 30, and 60 days whose standards are aligned with Basel III. In this context, we have maintained our high-quality liquid assets at high levels. Regarding capital, each of our subsidiaries maintained adequate capital levels, which ensures solvency. A slight reduction in core equity Tier 1 at BCP stand-alone is related to the reduction of unrealized gains, which in turn is related to increasing long-term interest rates in soles. Mibanco's core equity Tier 1 decreased this quarter given that in local accounting the effect of capital increase of PEN 400 million reported last year was canceled out by the effect of constituting a similar amount of voluntary provisions last quarter. This offset was registered in the first quarter of 2021. We have advanced on our digital journey and are accelerating digital initiatives about the business and Credicorp levels. At BCP stand-alone digital clients have fueled growth. This trend has accelerated over the last year and will continue to be key going forward. Digitalization has grown at Pacifico where almost 64% of its clients are now able to self-serve for different types of transactions. At Mibanco, the hybrid model has boosted the productivity of loan officers and improved efficiency. At Credicorp level, we are in the process of building an ecosystem that focuses on the needs of SME clients. We aim to provide these businesses with a consistent and integrated offer to a platform with unique user experience standards and high connectivity. This will enable us to process data and transactions efficiently. Our goal is to innovate to provide clients with solutions to develop and grow increase customer loyalty and generate new sources of income. In March, Credicorp published its first sustainability report at the holding level with details of its 2020, 2025 sustainability program. As part of the exercise, the company developed a new purpose, vision, and values that are now guiding the implementation of its strategy and decision-making. Additionally, Credicorp has defined three pillars oriented to sustain long-term value creation and alignment with the United Nations Sustainable Development Goals: create a more sustainable and intrusive economy, improve the financial health of citizens, and finally empower our people to act. We invite our investor community to navigate through our sustainability report where you will be able to find details of our ESG business strategy, our analysis of risks and opportunities, our governance structure, and our commitment to the future. Regarding our 2021 guidance, as of today, we maintain our expectation for GDP growth between 8% and 10% for this year. Loan portfolio dynamics have been weak and as such, we expect loan growth to be at the lower end of guidance. Net interest margin was sluggish in the first quarter of 2021. The recovery of this indicator throughout the year will depend on the structural loan dynamics. On the other hand, cost of risk has improved faster than expected and if current conditions hold, we expect this trend to continue. The efficiency ratio posted in the first quarter of 2021 is under control. Our ability to maintain the efficiency ratio within guidance will depend on income dynamics. All in all, we maintain all our return on average equity guidance. There are other factors that may impact our results this year that I would like to mention. First, regarding the new law that sets interest rate caps and restricts some fees, while we estimate that this will have a limited impact on Credicorp's P&L, however, we are concerned about the negative impact of these measures on financial inclusion in Peru. Second, regarding life insurance claims and IBNR provisions, going forward, we have fine-tuned our model to better estimate potential losses. If the mortality curves start to ease in Peru, we expect these IBNR provisions to reach the maximum level in the second quarter this year. Finally, as we communicated to the market previously, we have postponed our decision of dividend payments until certain things on the local scene are clarified. With these comments, I would like to give the floor to Walter Bayly who would like to add some remarks before starting the Q&A session.

Thank you, Cesar. Good morning to all of you. I would like to summarize the key results of this first quarter conference call and make some additional comments before opening up to Q&A portion of the call. ECP delivered a strong quarter with an 18.4% annualized return on equity. We are still not seeing growth in the loan portfolio and loan growth will probably be sluggish throughout the year. These strong results were largely driven by lower cost of risk. Mibanco's structural recovery was negatively impacted by the lockdown measures which curtailed loan origination. The situation did stabilize and I am confident that Mibanco can still deliver high single-digit return on equity this year. Pacifico's results were severely impacted by the second wave of COVID-related deaths. This was exacerbated by changes in the methodology utilized to more accurately calculate incurred, but not reported claims. We should see the tail end of this second wave in the second quarter. The impact should nevertheless be less severe, as the statistics indicate that the second wave is already declining. Changes in regulation allowed us to anticipate IBNR claims. A third wave cannot be ruled out before the year ends, but the severity should be less as the vaccination process is already underway with approximately 5% of the population already vaccinated. The relevant risk factors today are not related to the performance of any of Credicorp's units and are centered around legislation and politics. As Cesar mentioned, Congress recently passed and enacted legislation around interest rates which benefits no one. This legislation has a limited impact on BCP who is traditionally more focused on providing for consumers. This legislation is more relevant to Mibanco who will have to redirect its loan origination salesforce to other segments. This could even be marginally more profitable since entry-level microfinance loans are the most profitable, but are core to our purpose and mission of financial inclusion. This piece of legislation, which is being challenged in congress, will have a very negative impact on financial inclusion. Other legislation worth mentioning is an additional distribution from the private pension system. This will represent approximately PEN 11.4 billion or 24% of assets under management. But of course, the largest risk factor is around the upcoming second round of presidential elections. The outcome is still unclear. With important segments of the population still undecided, they could change the results either way. We will have a clearer picture as the election date comes closer. But it is very worrisome that one of the candidates has made public statements regarding his party's intention to shut down or eliminate institutions such as the central bank, which are pillars of our democratic system. Furthermore, the Peru Libre government program mentions the state taking over oil, gas, mining, and other sectors of the productive economy. Such initiatives have been tested in Peru in the past and in similar countries with very negative results on production levels, employment, investment, and overall economics. Members of Congress have already been elected and we will have a very fragmented Congress. And whoever becomes President will have a hard time enacting new legislation. To the extent that the new administration governs within the boundaries of democracy, the checks and balances of our system should prevail. Having said that, this political and economic volatility is extremely negative and comes at a moment when Peru is struggling to recover from the worst economic and health crisis in its history. Peru's population is greatly impacted by the health and economic crisis, and hopefully, we will continue down the path over the past decades that has proven successful in reducing poverty and improving the quality of life in Peru. With this, I finish my comments and we'll open up the Q&A session.

Thank you, sir. Our first question comes from Ernesto Gabilondo with Bank of America.

Hi, good morning Walter and Cesar. Thanks for your presentation. I have a couple of questions, so I will ask the first one. I will let you answer and then I will do my second question. So, the first one is on the political outlook. I just want to know your thoughts on what could be the risk for the financial sector if Castillo is elected president.

It is quite unclear, Ernesto, what an explanation would be regarding the financial sector. There is nothing specific in the economic program, so there’s very little we can comment on.

Okay, perfect. And then my second question is on your cost of risk which came at 1.6%, so below your guidance of 1.8% to 2.3%. Do you think that now the cost of risk would be more in the low end of your guidance?

Hello, Ernesto, this is Reynaldo. Yes, I mean the performance of the portfolio in general has been quite good, better than we expected by the end of last year. So, I mean your forecast is probably correct. We expect that the performance continues in these good trends on the low side of our guidance.

Perfect. Thank you so much.

Thank you. Our next question comes from Brian Flores with Citi.

Hi, good morning. Thank you for the opportunity to ask you a question. Just a quick follow-up on the guidance. You mentioned cost between 1.8% and 2.3%. So, do we expect higher provisions for the coming quarters? And then if you could talk about what we should expect regarding expenses given that in this quarter they served maybe a 6% decrease.

I couldn't hear very clearly.

In terms of customer risk, we haven't changed our guidance. There are still some uncertainties in the future. There is quite an important side of the portfolio which is still on reprogramming facilities without payments, so we haven't changed our guidance at this point. Having said that, as I mentioned before, we are positive on the trend and on the performance of most segments of our market, so we are expecting to be as I mentioned in the lower side of our guidance for the next quarters.

Brian, I think you made an additional question but I couldn't hear you clearly.

Yes, sorry. The additional questions are regarding expenses. I saw a decrease of around 6% year-over-year. So, how should we think about this line for this year particularly?

If I hear you and understand well, we think our expenses are under control. And what we saw during the last year was a reduction of variable compensation. Variable compensation now is going to be adjusted more in line with the current results and to normalized levels. At the same time, we are enforcing a number of initiatives to control other expenses and increase efficiency, particularly for example in Mibanco. So, in terms of cost, we think that we are going to be very much in control that the combined ratio, the cost-to-income ratio is going to be more affected by the trends of income that as we stated during the initial remarks are somewhat challenged in terms of margins.

Thank you.

Thank you. Our next question comes from Thiago with UBS.

Yes, hi guys. Thanks for the opportunity. I have one question about Mibanco. Mibanco used to have an ROE of close to 20% or even above 20% before COVID. Do you see this level again considering a more normal Peruvian scenario? Or are there any changes in the markets that should prevent the ROE from returning to this 20% level?

Thank you for your question. I will take it. This is Walter. Yes, we expect that Mibanco will be able to return to the 20% fast return on equity next year. This year our target, as I mentioned in my comments, is to have probably in the high single digits. The size of the portfolio, the profitable portfolio at Mibanco suffered a lot. The duration for the full year is about 13 months. So a couple of months with very sluggish loan origination due to the lockdowns really shrank the profitable portfolio in a substantial way. So, we think we can go back once the situation gets normalized in terms of our sales force being able to move freely and we are also making a lot of efficiencies in the hybrid model which is not exclusively dependent on the salesperson. So in short, yes, we can get to the 20-plus return on equity next year.

Perfect. Very clear.

Thank you. Our next question comes from Jason Mollin with Scotiabank.

Hi everyone. I have a general question about the current uncertainty you mentioned, especially regarding the political situation. Given your experience with political uncertainty in the past, how should we view Credicorp's preparations for this situation? Are there steps being taken to strengthen positions, such as US dollar positions? What actions are you currently implementing to get ready for a potentially less favorable market environment?

Can you tackle this one?

Yes. We are preparing in two different prongs. One in the short term, we are managing the FX position and the sensitivity of our books to the volatility of interest rates. And in parallel, we are analyzing how we can navigate in a different scenario. But I would like to emphasize the experience of the institution and the management team in general dealing with uncertainty and complicated situations throughout the history of the company. We have managed challenging situations before and thrived, increasing the capabilities through these kinds of times. So we are prepared in the short term, a number of measures, and we generally think that we have the capabilities to adapt and manage uncertainty down the road.

Let me add to what Cesar just mentioned. In addition to the clear increase in liquidity and some foreign exchange positioning while managing less exposure to interest rates, we remain focused on the long term. We are an institution that is essentially fully phased, and that is our identity. In that context, we have certain levers we can adjust. More importantly, as Cesar pointed out, we have successfully navigated very challenging political situations in the past, and we believe we can continue to do so. We have taken the necessary steps to increase liquidity and manage foreign exchange positioning within reasonable limits.

Thank you very much. I have seen Credicorp really manage some pretty challenging situations, so I understand that. Is there anything that's different this time than what we've experienced in the past and through in the last 25 years?

No, no. Really when we faced similar situations before, we went through a similar situation. This one is no different.

Thank you very much for the comments. Congratulations on the results in the tough environment.

Thank you, Jason.

Thank you. Our next question comes from Alonso Garcia with Credit Suisse.

Hi, good morning everyone. Thank you for taking my question. I want to discuss the interest rate caps. The Central Bank announced a level of 83.4%, which was significantly higher than we anticipated and also higher than the rate caps in Colombia and Chile. This suggests a more positive outlook for Credicorp due to this rate cap. Could you share your thoughts on the possible impact or the percentage of your portfolio that might be affected if the rate caps are set at 83.4%? Additionally, could you address the expected timing for the implementation of this rate cap? Thank you.

Yes. This is Gianfranco. Let me take this question. Good morning everyone. I tend to disagree with your comment on being a benign rate. You have to consider the level of formality of the economy in Peru. Therefore the cost assessment or the cost of risk plus the distribution costs are very high in our market. The major impact is going to be in terms of financial inclusion. There are some studies that say that over one million people that are currently financially included that have gotten a loan will be excluded in the upcoming months. So that's actually the major impact. Regarding BCP and Mibanco, unfortunately, the small-ticket loans are going to be hurt the most. That's not relevant in terms of the size of the portfolio. However, it's relevant again in our financial inclusion agenda. Regarding your question on timing, actually, I believe, as of Monday, May 11, this cap starts to be in place.

This is very clear. And just as a follow-up, are there any legal challenges to the rate cap in place or will it be indeed put in place next Monday?

Yes. Yes. The answer is yes. Well, first of all, the executive power has mentioned that they will present a proposal to the constitutional review in order to ask for this law to be declared unconstitutional. There's another group, which is a private association that has also experienced the same requirement. And there are some financial institutions that have already presented a different type of legal requirement. So, the answer to your question is yes.

Thank you. Our next question comes from Yuri Fernandes with JPMorgan.

Hi, all. Thanks for the questions. I have a question regarding FX deposits. We saw some increase.

It looks like Mr. Fernandes' line cut out, so we're going to go to our next question. Brian Flores with Citi.

There was a technical difficulty.

I couldn't hear. I'm sorry. I think I understood the question. It was related to dividend payments. At this stage we feel comfortable with the capital gains that we have, and we are working to clear some uncertainties around the health situation and the political situation to be able to analyze paying dividends in the second half. I think that was the question. I'm sorry, the line is not very clear, yes.

Yes, sorry.

Thank you. Our next question comes from Alonso Aramburu with BTG Pactual.

Hi, good morning. Thank you for the call. I wanted to ask about the impact of income from the interest rate cap. Can you quantify how this law affects income? Also, do you know if the constitutional challenges presented to the tribunal will impact the fee income, or are they only relevant to the interest rate cap?

Alonso, it's for both. It's actually for both. In our case, I'm talking about DCP the impact is much higher on the fee side rather than the interest rates. But I don't have the exact figure.

Yes. The impact in interest rate is actually very modest impacting the number of clients significantly as Gianfranco mentioned before, but the fee income impacts around 4% of the fee based on a yearly basis.

That is 4%.

Yes.

Okay. And do you know if the challenge will also challenge the constitutionality of the fees being imposed or being taken out?

Yes. Yes. No, the challenge is for the whole law Alonso both on the fee side and the rate cap.

Thank you. Our next question comes from Andres Soto with Santander.

Good morning everybody. I would like to hear your thoughts regarding margins. Obviously, Credicorp is facing a low-rate environment, but asset mix has probably been a bigger factor in turning that, and recently given the increased weight of securities versus loans in your asset composition. So can you please comment on your NIM trends? And also, if you can exclude from that the effect of Reactiva on how your current levels compare with those before the pandemic?

Yes. I would say that even if you exclude Reactiva loans, we are now operating under a lower margin. That is the reflection of the low short-term interest loans that affect the investment portfolio, but also the short-term corporate and enterprise loans that are a significant part of the portfolio. So, this is impacted and it's going to be impacted as long as the interest rates are as low as now. In terms of mix, we have, as was explained in the remarks, mainly by two factors in the case of BCP lower demand in corporate loans, the companies are optimizing the balance sheets and are in general change liquid, so lower demand in corporate loans. And in the retail portfolio, we have an impact particularly in credit cards, due to two factors. One is the big-ticket discretionary expenses are at a lower level and this is going to be the case until the lockdown is in place or restricted measures are in place and some restrictions in risk appetite for the consumer segments. The other parts of the portfolio are growing at a healthy pace. And in the case of Mibanco, as Walter mentioned, we have a decrease in volumes that are recovering now. And also, we are transitioning from lower risk, lower margins to higher margins with a little bit more risk down the road. This mix is going to be visible down the road. But until the pandemic is still with us, the mix is going to be affected in the Prima sector and particularly in credit cards.

Maybe just a quick additional comment on what Cesar just mentioned is over the last, I would say, 30 days, also the mortgage performance in terms of new origination has slowed down, which makes total sense with the political uncertainty. The last quarter of last year and maybe the first couple of months of this year were very positive in terms of the mortgage growth. However, as we speak, the state of originations has lowered quite a bit for the last 45 days.

Thank you. My second question is about the measures approved in Congress, particularly the new ASP withdrawals, which are estimated to be nearly $10 billion, and the withdrawals from CTS accounts, both of which affect Credicorp's funding. Beyond these negative impacts, do you see any opportunities arising from the high liquidity levels we expect in Peru due to these measures?

Let me address the question about CTS, and perhaps someone else can respond to the question about pensions. Regarding CTS, we are observing a situation where the smaller financial institutions that rely heavily on CTS are experiencing the most impact. This is not true for either Mibanco or BCP. Therefore, we see an opportunity, particularly in the microfinance sector, as several financial institutions may face challenges with liquidity and funding. Typically, given our market share, especially at BCP, we find that we gain more deposits in terms of sales and current accounts. I'm unsure who will address the question about pension funds. Alvaro, are you available?

Hello, everyone. Good morning. Yes. On pension funds, the challenge today with this new law is to manage investments in order to minimize the impact on values and therefore could not affect as much those customers who stay at the fund and in turn do the required payments without major stress. As you know, there are investments in the local markets, but also in the foreign markets and in order to keep the balance of the portfolios probably both of them will have to be used. But that's the challenge. The opportunity for Credicorp, I would say, has to do with what happens with those withdrawals. People go and deposit that in the financial system and that's typically something that benefits the most solid financial institutions and especially over the last year was beneficial for BCP deposits. So, that's the opportunity that I find in that event.

Perfect. Thank you for the answers and congratulations on the results.

Thank you. Our next question comes from Sergey Dubin with Harding Loevner.

Good morning. Thank you for the presentation. My first question is about your guidance on loan growth. Are you assuming a stable political environment? If Castillo wins the elections, how should we view loan growth moving forward? That's my first question.

Okay. Yes, our guidance assumes, I would say, the continuation of the economic model. I think it's very early to project the impact of a change in the case that Castillo wins and we need to hear the specific measures that they implement or propose as an elected officer and not as a candidate.

There is a strong connection between GDP growth and loan growth, as history indicates. We anticipate that Peru’s economy will grow between 8% to 10%, which should lead to an increase in our portfolio. However, political uncertainty is making some economic participants more cautious, which is why I mentioned that growth may be slow. Currently, the mortgage sector is affected, as corporations are also adopting a conservative approach. Still, with GDP expected to grow significantly this year, loan growth should align with that trend, although the political situation remains uncertain.

Okay. The second question is about elaborating on your previous comments. What specific preparations are you making for potential worst-case scenarios? I understand it’s difficult to provide details since the proposals and rules are still uncertain. However, can you discuss your plans regarding foreign currency exposure and any other steps you may be taking? Additionally, without sharing specific numbers, how should we view the potential impact of these measures?

I take this initially. What we are trying to do in the very short-term, and this is not a strategic response but a tactical one, is to be long in the FX side and manage the exposure to medium-term bonds. But this is a tactical response.

So does that mean that you want to increase your FX holdings or FX exposure because you believe there is a current risk of currency?

Yes, within the established limits by the regulation. In any case, it will have a moderate impact on total results.

Okay, okay. Thank you.

Thank you. Our next question comes from Yuri Fernandes with JPMorgan.

Thank you again, guys. I hope this time it works well. Congrats on the BCP special results this quarter. I have a first question regarding your liability notably deposits in dollars. We saw some increase this quarter right in term deposits in dollars. How is that tracking lately for you in April and May? And if this trend continues to be slight in dollar relations, how does that impact your margins? So that's my first question.

We have observed that our liquidity and overall level of deposits have remained stable without any negative trends. There has been a shift in the composition of these deposits, with a slight decline in sol deposits and an increase in dollar deposits, which we are managing accordingly. Given the strong liquidity levels and the relatively low interest rates in both dollars and soles, the short-term effects of these changes are minimal. When considering the very short-term Fed funds rate of about nine to ten basis points versus the central bank's 25 basis points, the distinction between the two is real but not significant.

Super clear. And if I may, a second question regarding Bolivia. Can you talk a little bit about the challenges you face in the country, not for COVID but even before COVID? We saw that the Bolivian unit was reaching like 11%, 12% ROE? That is lower than the group. So can you explain a little bit, like historically what were the challenges you saw in Bolivia? What explains this ROE gap? Is it the difference in scale? Is it different on penetration? Is a rate gap issue in Bolivia? Can you talk a little bit about the business in that country?

Sure. It's a combination of factors. Operating in Bolivia, particularly in the banking sector, is quite difficult. There's excessive regulation, including interest caps on both loans and deposits. Additionally, there are requirements to maintain a specific portfolio in certain sectors at subsidized rates. Recently, due to COVID, there have been many restrictions affecting the collection of interest and payments. This makes business operations in Bolivia quite complex. We believe we have a solid presence in Bolivia, especially in the mid-sized and corporate segments. However, the country has significant business potential, but the existing political climate and economic policies create challenges.

Perfect. Thank you very much.

Thank you. Our next question comes from Brian Flores with Citi.

Hi. Just a quick follow-up. You mentioned the liquidity breakups, liquidity of 4%, importantly what item specifically?

Brian, sorry, I couldn't hear clearly.

So, can you hear me better now?

Yes.

Now it's better.

Okay. Perfect. Now just a quick follow-up on your comments on the liquidity backdrop. You mentioned an impact of 4%. My question is concerned to what items specifically?

If I understood correctly, you are looking for more details about the interest rate caps and fee restrictions. The 4% figure I mentioned refers to the impact of fee restrictions on fee income on a normalized basis. The effect of interest rates, as we have discussed before, is moderate.

Let me emphasize my earlier point. This may seem like a short-term perspective. What worries us is the significant growth potential in the lower segments of the population moving forward. The interest rate cap will greatly affect both the financial institutions' business and, more critically, those who are un-banked or under-banked.

That's great. Reynaldo, thank you very much.

Thank you. Our next question comes from Carlos Gomez with HSBC.

Hi, good morning. You may have already answered this, and I apologize, I joined the call late. I would like to know if you could comment on the allowed withdrawal for CTS and insurance employment funds, whether that could affect any of your business or units and whether that can affect the bank system as a whole. Because I understand that's an important part of the funding for some smaller banks?

Yes. The CTS we have system-wide around PEN 21 billion, around PEN 7 billion at BCP. As we mentioned, in a situation like this, we will expect an important withdrawal of these funds. But what usually happens is that the deposits come back in another form, for example, saving deposits or short-term CDs. In previous cases, BCP ended up gaining share in terms of sales and current accounts. But the impact on the system-wide can be significant for the smaller institutions which have a significant part of their funding based on CTS at high-interest rates. For them, it can be a significant pressure in terms of funding.

Do you expect these funds to ever return to the system?

No. If other measures are not taken, the funds are going to rebuild. But it's going to be a lengthy process because what is deposited is one-twelfth of the yearly income, on a yearly basis with two deposits. So, to reach these levels it's going to take probably three or four years in the extreme case that all the deposits are taken out. But that's an extreme case, not the basic scenario.

Okay. That's very clear. And if I can ask another question, is regarding your insurance business. Obviously, you have had an impact in the short-term because of the higher claims, which is completely understandable. I imagine that you would continue to have it this year. I don't know if you have given some guidance. In the long-run, I'm talking three, four, or five years from now, do you see your insurance business changing for the better or for the worse because of the challenges and experience of COVID?

Hi Carlos, this is Walter. We recently had a very interesting conversation at the board at Pacifico. We questioned whether our portfolio mix deserved to be revisited given the changes that have happened with COVID and whatnot. And the conclusion was no, that precisely the portfolio that we have, which is highly skewed towards sales through the banks, the down for the credit and other financial institutions, is a good portfolio. It has been extremely profitable in the past. And we think that once the region normalizes, it will continue to be a profitable portfolio as it had been in the past.

Very good. That’s clear. Thank you so much.

Thank you. At this time, we have no further questions. So, I'll turn it back to Mr. Walter Bayly, Chief Executive Officer for closing remarks.

Okay. Thank you. Thank you all for joining us in this conference call. These are indeed challenging times. We hope that, by the next conference call the mood will be better. And we will be able to continue the path of recovery of our profitability in our finances. This year has been very strange. We are working towards recovering the profitability and concluding with all our expansion programs and digital investments that we've made. Again, thank you all for joining us. And see you all at the next conference call. With this, we conclude the call.

Ladies and gentlemen, that concludes this morning's presentation. Thank you for your participation. You may now disconnect.