Credicorp Ltd Q3 FY2022 Earnings Call

Good morning, everyone. I would like to welcome all of you to the Credicorp Ltd. Third Quarter 2022 Conference Call. A slide presentation will accompany today's webcast, which is available in the Investor section of Credicorp's website. Today's conference call is being recorded. Now it is my pleasure to turn the conference over to Credicorp's IRO, Milagros Ciguenas, you may begin.

Thank you, and good morning, everyone. Speaking on today's call will be Gianfranco Ferrari, our Chief Executive Officer; Francesca Raffo, Chief Innovation Officer; and Cesar Rios, our Chief Financial Officer. Participating in the Q&A session will also be Reynaldo Llosa, Chief Risk Officer; Diego Cavero, Head of Universal Banking; and Cesar Rivera, Head of Insurance and Pensions. Before we proceed, I would like to make the following safe harbor statement. Today's call will contain forward-looking statements, which are based on management's current expectations and beliefs and are subject to a number of risks and uncertainties. I refer you to the forward-looking statements section of our earnings release and recent filings with the SEC. We assume no obligation to update or revise any forward-looking statements to reflect new or changed events or circumstances. Gianfranco Ferrari will start the call discussing our strategic initiatives; followed by Francesca Raffo; and finally, Cesar Rios will comment on the macro environment in which we work, our financial performance, and provide an update on our outlook for 2022. Gianfranco, please go ahead.

Thank you, Milagros. Good morning, everyone. Thank you for joining us. We reported another solid quarter while executing on our strategic priorities. In terms of financial results, we continue to benefit from loan growth with disciplined pass-through of interest rate hikes, a differentiated funding structure in which transactional deposits represent 56% of total funding, and high transactional levels. As a result, we saw strong growth again in core income, which includes net interest income, fees, and gains on FX transactions. With improving results across all four of our business lines, we registered an ROE of 19.6% this quarter on the strength of a solid balance sheet and prudent risk management. While there is still downside risk to overall growth in the region, the fundamentals of Peru remain strong, and our estimate of GDP growth is now 2.8% for this year. Unfortunately, the continued political noise is having a clear negative impact on Peru's growth opportunity and deterring public and private investment. This is also detracting from what we should be focusing on with respect to financial inclusion and poverty reduction. Despite the environment in which we work, Credicorp remains committed to being an agent of change in our communities, and our digital transformation plays a fundamental role in aligning with our sustainability-based responsibilities of financial inclusion, financial education and developing the workforce of the future, among others. Our strategic initiatives are driving greater engagement and efficiencies throughout the organization to deliver sustainable growth and value creation. We are advancing on our goal of driving growth in digital clients. At BCP alone, digital customers represented 63% of total customers while over 250,000 individuals were financially included through Yape and Mibanco. Today, we'd like to highlight the progress we are achieving in the transformation at BCP. For this purpose, we have invited Francesca Raffo, Deputy CEO at BCP and Chief Innovation Officer at Credicorp, who has been leading this effort since the very beginning to provide an update on progress today. Francesca?

Thank you, Gianfranco. Good morning. I am pleased to share the progress we have made on the transformation journey at BCP, the subsidiary that began this process first and is most mature. As mentioned during the Digital Day, our customers are more demanding, want greater speed and simplicity, and want to be delighted. We are accelerating our investment to become the most efficient bank in the region while maximizing the customer experience. These investments are heavily skewed towards our core enablers: data analytics, IT, and cybersecurity, which in turn are driven by the best digital talent. Today, around 50% of our staff functions already have a digital profile. Now on the next slide, let me share more of our progress around our key enablers. We are a customer-centric, data-driven organization that is creating solutions through capturing data, the application of analytics, and the development of technology within a cybersecurity framework. Starting with IT, our investments in technology have enabled us to increase uptime to world-class standards. We strive to maintain this level, improving our capability to bring value to the market by increasing the amount, quality, and speed of integrity. Over the last four years, we have gone from 4,500 to 28,000 releases yearly and increased the average speed from 28 to 6 days. The flexible and efficient infrastructure we are developing through APIs positions us well to continue advancing on our journey towards becoming a more digital and open bank. We leverage our data analytic capabilities to increase revenue, reduce risk and improve operational efficiency. Our data lake has more than 28,000 variables, which are organized, structured, and can be safely deployed to build analytical and risk models or to develop customized products or service offerings. Our predictive models have enabled projects within the organization to realize more than PLN 400 million in additional gross margin in the last four years. With our APIs and data, we have deployed price discrimination strategies and have generated more than PLN 500 million of preapproved loans for SMEs. Finally, we are moving to empower our business units through a much more decentralized model. Improvements are required for the cybersecurity space through people, processes, and technology. We are combining cyber risk management with a strong focus on customer experience, leveraging customer-friendly and robust security capabilities through multifactor authentication for digital channels. Moreover, we continuously use advertising to educate and raise customers' awareness of risk and constantly invest in people through employee training. Finally, we have deployed technology for in-depth protection against phishing, malware, data lakes, and distributed denial of service, among others. We are attracting, upskilling, and retaining diverse tech talent. We recruit throughout Latin America and hold a talent hub in Spain, where we are hiring specialized data analytics and IT professionals. In this tech-mindful arena, we practice what we preach and offer our tech talent the opportunity to develop leading-edge capabilities in an environment fully committed to leading in technology. Please move to Slide 6. We are constantly setting new targets for ourselves based on insights to achieve our strategy of being the principal bank for our customers. This slide shows how we increase engagement with consumer clients. With our digital applications, we collect and analyze data, including client profile, product and channel usage, and preferences. With a deep understanding of our customer behavior within and outside the bank, we adapt our digital strategy and develop a specific value proposition by type and level of engagement for each segment. Our goal is to broaden and strengthen our current relationship with each customer, becoming their principal bank. We have been obsessed with the digital sales and transactions models, and now we'll offer a more comprehensive value proposition, integrating safe service and advisory. On the next slide, we share the progress we are achieving with growing our customer base for individuals. Our disruptive mindset and execution capabilities have contributed to increase our digital customer base for individuals. BCP individual customers reached approximately 6 million, accounting for 63% of the total individual customers. The relationship with this group is more active in terms of number of digital transactions and digital product purchases. Growth in digital customers is enabling us to improve our cost to serve to income ratio for these customers. This quarter, we are introducing a more demanding methodology to calculate digital customers, which going forward, will refer to customers making at least 70% of their transactions through digital channels on a rolling six-month basis. On the top right, you can see how the cost to serve to income ratio for digital clients under the new methodology stands at 23%, better than the prior methodology and significantly better than the 36% of nondigital customers. Reaching 70% of digital customers under this methodology would mean a huge stride towards our overarching north star cost to income. Now to Slide 8. We are deploying a similar approach to the SME segment and are seeing good traction. The primary focus has been on digital sales, bringing those capital capabilities to market and analyzing customer insight. The next step is to continue digital servicing while deepening our relationship. With our core analytics capabilities in risk management, we are expanding our SME client base and penetrating deeper into the segment. This is particularly the case for SMEs with no to very low indebtedness in the financial system and little to no credit history, which limits access to financing. Around half of the new clients financed in this segment are new to the financial system. This is a more digitally oriented and sophisticated SME customer base with a different value proposition from that of our clients at Mibanco, and it is a strong complement. We offer the small SME personalized products distributed through digital channels and have seen an increase of around 50 percentage points in the percentage of digital sales of working capital loans since 2019. Now please turn to Slide 9 for an update on Yape, our most mature disruptive initiative within BCP. Today, almost 1 in 3 Peruvians over 18 years of age are active Yape users. At 6.7 million, we are on track to reach our target of 10 million active users by 2026. Our initial strategy was to gain a large customer base, then to increase engagement on monthly transactions, and now we are focused on generating income. We are seeing sustained positive trends across most of our metrics, including the volume transacted, which grew more than 30x since 2019 to more than PLN 40 billion year-to-date. We are now tracking to our initial 2026 goal of reaching PLN 150 billion in transactions by 2024. The number of active users and activity per user continues to grow, while 30% are generating revenue. As one of Peru's most important distribution channels, Yape is creating new sources of income for Credicorp through a marketplace strategy while also allowing us to distribute financial services products and drive fee growth. Last August, we launched Yape Promo with 22 sellers, and 10% of users already visited the site in the first month. We also launched the micro loans offering, which is showing promising results. We see significant opportunity to increase stickiness in the microentrepreneur segment. For example, a taxi driver transacts through Yape on average once every two days, while the top 5% heavy users transact almost five times a day. In summary, we are a more digitally and tech-minded organization. We are attracting and retaining the best talent while investing in the key enablers. Every day, we are developing deeper relationships with our customers and becoming a more relevant part of their daily lives and their primary banking relationships. Yet, we are still at the initial stages of this digital journey. I look forward to providing additional updates on our progress across our different businesses in upcoming calls. Now let me turn the call over to Cesar.

Thanks, Francesca, and good morning, everyone. As Gianfranco mentioned, we delivered solid operating and financial results. I want to start by highlighting some key quarter-over-quarter dynamics. Structural loans grew 5.2%, measured in average daily balances, driven primarily by wholesale banking, consumer, and SME business segments within BCP. Deposits resumed growth, particularly in time deposits as clients sought to take advantage of high rates. Low-cost deposits, which have decreased in recent quarters, still represent a significant proportion of our funding base, weighing in at a 55.9% share at quarter end. In terms of asset quality, the structural NPL ratio dropped to 4.9% as newly formed NPLs were offset by write-offs. The structural cost of risk rose to 1.44%, reflecting our decision to grow in higher yield yet riskier SME-Pyme segments. From a year-over-year perspective, structural loans grew 10.8%, outpacing 2% growth in transactional deposits. In this scenario, core income, which includes net interest income, fees, and gains on FX transactions, registered a strong growth of 22.5%, 6.6%, and 6.3%, respectively. Provision expenses increased materially, given that levels were atypically low last year. Asset quality remains adequate, and we continue to maintain a strong allowance for loan losses, which are equivalent to 5.6% of the structural loans. Our coverage level for structural and nonperforming loans remained substantial at 113.3%, which includes pre-pandemic levels. In the insurance business, the loss ratio fell quarter-over-quarter to 63.6%, similar to pre-pandemic levels. In summary, Credicorp obtained a high ROE of 19.6% while maintaining a sound capital base on the back of gains in profitability across businesses. Next slide, please. GDP growth projections for 2022 situate Peru at 2.8%, Chile at 2.4%, and Colombia, which is expected to be the fastest-growing economy in the region this year, at 7.8%. The Central Bank in Peru, like so many other central banks around the world, has been decisive in controlling inflation expectations. We believe that interest rate increases are coming to a close. These and other policy measures have had a significant impact on liquidity, notably excess liquidity held by local banks, which grew sharply during the pandemic to more than PLN 37 billion in January 2021 but fell to an average of PLN 5.1 billion in October, still slightly above pre-pandemic levels. In October 20, Fitch ratings revisited Peru's outlook to negative from stable and affirmed that the rating is BBB. Just 5 days later, on October 25, Standard & Poor's affirmed Peru's BBB rating with a stable outlook. Peru's economic fundamentals remain strong. Public debt is one of the lowest in the region and stood at 34% of GDP at the end of the second quarter of 2022 while the 12-month rolling trade balance surplus stood at 5.4% of GDP in August. The fiscal deficit was just 1% of GDP as of September, while net international reserves stood close to 30% of GDP, which was the highest print in the region. Next slide, please. The nation's general prosecutor filed a constitutional complaint against President Pedro Castillo before the Congress of the Republic for alleged crimes of criminal organization, influence peddling, and collusion. The government has involved the organization of American states to activate the Inter-American charter in defense of democracy. The organization will send a mission to analyze the situation. On the regulatory front in Peru, to increase the efficiency of the digital payments market, the Peruvian Central Bank mandated that payment service networks in Peru must be interoperable. In response, the market's primary digital payment platforms, Yape and PLIN, are expected to be interoperable by March 21, 2023. Additionally, the constitutional court of Peru declared that the suit challenging the constitutionality of withdrawal from private pension accounts was unfounded. In Colombia, the new government's policy proposals are driving the Colombian peso's exchange rate and sovereign bond rates to historical highs. The tax reform on the table proposed an increase in the income tax rate for financial institutions from 38% to 40% until 2027, and the withholding tax on dividends for nonresidents will rise from 10% to 20%. In Chile, 62% of voters in the referendum held in September rejected the new constitution, and it is not yet clear how and when the government will propose a new constitutional process. The executive submitted a pension reform proposal to Congress in the coming weeks, and a tax reform is still being discussed. Next slide, please. BCP continues to register strong profitability. Regarding key quarter-over-quarter dynamics, net interest income growth was driven by an uptick in structural loans, which was mainly attributable to Wholesale Banking and to consumer and SME business segments within retail banking. Our disciplined approach to pass-throughs in the context of rising interest rates and leveraging a transactional funding base has mitigated the impact of an increase in funding cost. Provision expenses grew 65.4% over a very low base, reflecting an uptick in loan origination in higher yield segments, particularly in SME-Pyme. On a year-over-year basis, growth in net income was skewed by a 31.6% increase in net interest income, which was bolstered by rising interest rates and a 10.6% increase in structural loans measured in average daily balances. Expansion was driven primarily by retail banking, which registered growth of 14.2% year-over-year led by consumer and SME-Pyme, where we were penetrating new lower ticket subsegments by leveraging data analytics and digital channels, and secondarily by Wholesale Banking, which reported growth of 7.4%. Additionally, fee income increased 13.8% fueled by an uptick in transactional levels, particularly through digital channels, POS, and by a 4.7% increase in net gains in FX transactions in a context of lower volatility and improvements in product and channel offerings. Loan provisions increased almost tenfold over a very low base last year. These levels remain low and are expected to stand at pre-pandemic levels by the end of 2023. Operating expenses grew 7%, driven by higher expenses for personnel, IT, transactional costs, and more investments in disruptive initiatives. In this context, BCP's efficiency ratio stood at 38.8%, and ROE was 24.3% this quarter. Next slide, please. Mibanco's earnings grew 14.9% quarter-over-quarter. After record high disbursements in the second quarter of this year, origination is low this quarter, which reflects a more prudent approach to lending. Mibanco's disciplined pricing approach boosted its net interest income, which grew 2.4%, while provision expenses decreased 19.5%. The low level registered this quarter reflects methodological improvements. This particular set of adjustments will not be replicated next quarter. The structural NPL ratio also dropped due to higher write-offs and stood at 5.6%. Operating expenses were flat this quarter. From a year-over-year perspective, net interest income registered solid growth, driven by growth in structural loans and effective pricing strategies in a scenario of rising market rates. These dynamics were partially offset by an uptick in the cost of funds. Other income grew 38.9% in line with an uptick in total bancassurance fees, which was fueled by strong origination, higher gains in FX transactions, and a better use of third-party channels. Provision expenses fell 30.8% due to the aforementioned quarter-over-quarter dynamic and an environment post-COVID. Operating expenses grew 12% year-over-year, driven mainly by digital expenses. Traditional expenses remained very well controlled. Productivity rose this quarter due to the application of the hybrid model, which allowed us to increase the structural portfolio by 22.6%, improving our loan officer productivity by 12.6% year-over-year. Growth in operating income topped the expansion reported for expenses, which led to efficiency ratio to drop to 49.6%. In this context, Mibanco's return on average equity increased significantly to 22.1%, higher than the expected run rate. At Mibanco Colombia, the positive effect of the increase in origination volumes and effective risk control were offset by a decrease in net interest income, where the cost of funds increased faster than our origination pricing speed, with the latter limited by the regulatory interest rate caps in a context of rising rates. Additionally, the Colombian Central Bank has decreased the rate cap level, which will affect interest income in the coming quarters. Next slide, please. Grupo Pacifico's net income rose 57.7% quarter-over-quarter, driven by the Life business. This increase was associated with an upswing in net earning premiums, primarily through Credit Life, which registered higher sales via BCP and Banco de la Nación. Additionally, net claims in the Life business decreased this quarter due to a drop in COVID-19-related claims from a year-over-year perspective. In the Life business, net earning premiums increased, driven by credit life, which registered growth in sales to the bancassurance channel. Group Life also evolved favorably due to price adjustments and an increase in sales in the complementary insurance for occupational risk product. This positive dynamic was further enhanced by a drop in claims due to a decrease in claims frequency. These dynamics led to total loss ratio standing at 63.6%, which marked a return to pre-pandemic levels. Grupo Pacifico's return on equity stood at 30.1%. It is important to mention that this particularly high annualized figure was the result of a combination of higher net premiums and seasonal effects, a lower loss ratio and reserve and a slight reduction in net equity reflecting unrealized losses in the investment portfolio. Next slide, please. The investment banking and wealth management business registered an uptick in quarterly earnings but continues to be challenged by the current environment, where geopolitical issues and a macroeconomic environment impacted asset prices, market volatility, and investment levels. On a quarter-over-quarter basis, assets under management decreased, despite this effect, earnings from this line of business rose, boosted by earnings in the capital market business where gains were registered in the proprietary fixed income portfolio in Colombia. In the year-over-year analysis, assets under management dropped 18.1%, driven primarily by a decrease in fund volumes in Peru. In this context, income fell 17% due to withdrawals, a decrease in the market value of funds, and a base comparison effect given that in the third quarter of 2021, strong gains were reported for anticipated redemptions and third-party upfront fees through offshore platforms. We are conducting a thorough analysis of our business in a context that points toward a more challenging market. Next slide, please. Now we will talk about Credicorp consolidating dynamics. On a quarter-over-quarter basis, structural loan dynamics remained strong and grew 5.2% driven by wholesale banking and the consumer and SME business segments within retail banking at BCP. The impact of asset repricing continued to outweigh the effect of an increase in funding costs. As a result, the yield of interest-earning assets increased 82 basis points versus an expansion of 48 basis points in the funding cost. On a year-over-year basis, the structural loan portfolio grew 10.3%, driven primarily by consumer, wholesale, and SME-Pyme within the deposit base. Time deposits grew 24.6%, reflecting the migration to higher yield products. At the quarter end, around 56% of our funding base was comprised of transactional deposits. It is important to note that despite this reduction, we continue to gain market share in this source of funding. In terms of yields, our effective asset repricing strategies led the interest-earning asset yield to increase 180 basis points, which surpassed the increase of 83 basis points in the cost of funds. Next slide, please. Now I will discuss the year-over-year evolution of core income. Core income grew 17.5% year-over-year, driven by an uptick in net interest income and fee income. Net interest income grew 22.5% year-over-year, in line with the evolution of the balance sheet and the yield dynamics explained earlier. Credicorp's net interest margin grew 108 basis points year-over-year to stand at 5.3% this quarter, while structural NIM stood at 5.6% and risk-adjusted NIM grew 56 basis points to stand at 4.5%. Ongoing improvement in NIM was partially offset by an increase in the cost of risk. Fee income increased 6.6%, driven by point of sales and interbank transfers, which grew 46.9% and 53.4%, respectively. Cashless transactions represent 45% of the total transaction amount as of September. The 11.7% increase in parking serving fees was partially offset by a drop in fee income from mutual funds. Net gains on FX transactions increased 6.3% year-over-year in a context marked by a decrease in FX volatility year-over-year, which was offset by broadening product and channel offerings. Next slide, please. I will now move to Credicorp's structural loan quality dynamics. On a quarter-over-quarter basis, our structural NPL volumes decreased slightly, given that the volume of new entrants to the NPL portfolio was offset by an uptick in the volume of write-offs, which was driven primarily by SME-Pyme and individuals. New entrants to the NPL portfolio were concentrated in SME-Pyme clients who took short-term working capital facilities, consumer loans, and wholesale banking related to specific clients in the retail and hotel sector that received refinancing. Note that the asset quality in each segment remains within our expectations and adequately provisioned. Year-over-year, higher NPL volumes were mainly driven by SME-Pyme and wholesale banking at BCP for the same reasons described in the quarter-over-quarter basis. The increase in NPL volumes at BCP was offset by a decrease in volumes at Mibanco due to a base effect in the third quarter of 2021, which was impacted by the expiration of grace periods for reprogrammed loans. NPL ratios dropped across segments with the exception of Wholesale Banking. In this context, Credicorp's structural NPL ratio stood at 4.92%. Next slide, please. Structural loan loss provisions increased materially over an unusually low basis. Provisions are expected to rise next quarter, particularly at Mibanco, following the expected trajectory. On a quarter-over-quarter basis, growth in structural provision was mainly driven by the growth in penetration of higher yield yet riskier SME-Pyme segment and a low base effect, particularly within the SME segment. In a year-over-year basis, structural provision expenses increased 197.5% over an exceptionally low base. In this context, the structural cost of risk stood at 1.44% year-over-year and was 1.04% year-to-date. The structural coverage ratio continues to trend back to pre-pandemic levels and stood at 113.3%. Next slide, please. Operating expenses grew 8.2% year-over-year, which reflected an increase in salaries and employee benefits and in administrative expenses. The salary line was up this quarter due to an increase in variable compensation, which reflects an uptick in earnings and achieving commercial goals. Growth in administrative expenses reflects an increase in transactional costs in line with higher transactional levels, an uptick in IT expenses related to cybersecurity, new functionalities, significantly higher digital transactional volumes and an acceleration in disruptive initiatives. In this context, Credicorp's efficiency ratio improved 68 basis points in the first nine months of the year, driven by higher core income. Thanks to its hybrid model, Mibanco's operating expenses were controlled and up only 9% during the first nine months of the year. Operating income was up 19% over the same period. Mibanco's efficiency ratio improved 450 basis points in the first nine months of the year. If we exclude OpEx from investments in disruptive initiatives such as Yape, the efficiency ratio for the first nine months stands at 41.3%, which represents a difference of 258 basis points from the reported figures. Next slide, please. ROE stood at 19.6% this quarter, driven by increased results across our four business lines. Over the course of the last five quarters, our ROE has consolidated in the high teens. Now I will move on to the outlook. Next slide, please. Despite current political volatility, Peru's macro fundamentals remain solid, and we expect GDP growth to stand at 2.9%, which is above our initial guidance. Loan growth in Mibanco, SME-Pyme, and consumer loans is expected to continue decelerating. As such, we expect structural loans growth to be at the higher end of guidance at year-end. Given that interest rates continue to increase, the net interest margin should situate near the upper range of guidance at the end of 2022. The cost of risk is also expected to close the year in the upper end of guidance. Asset quality is expected to continue to evolve within our expectations. We are carefully monitoring the impact of higher inflation and interest rates on our clients’ payment performance and risk profiles. As transactional levels rise, our IT and digital investment increases. Given that expenses for these components are concentrated in the last quarter of every year, the efficiency ratio will move upward but close to year-end within guidance. Finally, we expect a lower ROE for 2022 to remain around our guidance of approximately 17.5%. With these comments, I would like to start the Q&A session.

Operator Instructions. The first question comes from Jason Mollin with Scotiabank.

Congratulations on BAP's profitability and the improvement in the KPIs within BAP's digital base. My main question is about regulatory changes. You mentioned the cap on interest rates, and I would like to understand how this cap is affecting your business and your expectations for its evolution over time. Additionally, the presentation noted that the Central Bank has mandated interoperability for mobile wallets. How is this going to affect Yape and BAP? Continuing with the regulatory discussion, you mentioned the increase in income taxes for banks and taxes on dividends in Colombia. Do you anticipate higher taxes in Peru? Lastly, regarding regulatory changes, you discussed the pension reform in Chile. What is your perspective on pension reform in Peru?

Jason, there were several questions combined, but we'll address them. Let me answer a few, and then I'll pass the more challenging ones to Cesar. Concerning Yape and interoperability, our vision from the beginning, approximately 4 to 5 years ago, has been that the main competitor for digital wallets is not other banks' wallets, but cash. We believe that the interoperability from the Central Bank is a positive move that will benefit both the country and digital wallets. Yape handles about 70 to 75% of the number of transactions, and while we anticipate that Yape's market share may decline, the market is expected to grow significantly. By "significantly," I mean it could increase twofold or threefold, though the precise factor is uncertain. We are very optimistic about the regulatory environment. Additionally, we are progressing in our strategy, evolving from what began as a peer-to-peer application to becoming Peru's super app. Regarding the pension funds in Peru, as I mentioned in a prior call, we believe the pension system has faced challenges over the last few years. Currently, we are not concerned about the future of PRIMA, our pension fund, but we think the entire pension system needs a redesign and a reform is necessary. Both the executive and legislative branches are reportedly working on this, and we are preparing a proposal to contribute to the overall pension system, not just focused on our business. Cesar, could you handle the remaining questions, please?

Yes. Franco, thank you. First, I will address the interest rate caps. The explicit mention was in Colombia. In Colombia, we have a standard cap that is 1.5x the average rate. Due to the profile of our portfolio in Mibanco Colombia, part of the portfolio is close to this limit. A slight modification in the regulation is going to affect a part of this portfolio. In the case of Peru, our main market, we also have an interest rate cap that is 2x the average rate. Due to the portfolio that we have particularly in BCP, we operate at rates that are substantially below the cap. So in the short term and in the current circumstances, we don't have any particular worries. Beyond that, we explicitly mentioned in the case of Colombia that we also need to consider that the environment of interest rates is more acute than in Peru. The reference rate is 11%, in Peru it is 7%. So it's a different environment. In terms of income taxes, the regulation is specific to Colombia and is part of this broad and ambitious agenda of President Petro, who wants to collect significant taxes targeting particularly the oil, mining, and financial sectors. But I think again, it's a country-specific effect.

So no expectation of changes in the tax system or structure for Peru at this point?

No.

Next question comes from Ernesto Gabilondo with Bank of America.

Congrats on your solid net income and your ROE above 19% in the quarter. My question will be on asset quality. We have seen the cost of risk starting to normalize, and you were mentioning that we should expect the cost of risk in the upper guidance of roughly at 1.1% for this year. However, when looking to next year, how should we think about the cost of risk in the context of still high inflation and likely soft economic growth?

I'll provide a broader answer and then ask Reynaldo to go into the details. As we've mentioned before, our expectations going forward is that the risk-adjusted NIM should go back to pre-pandemic levels. If you were to ask me today, maybe the risk-adjusted NIM next year is going to be slightly higher than that because of the current inter-rate environment. Obviously, inflation may hit somehow the quality of the portfolio, but specifically in Peru, there are no variable rate loans or inflation-adjusted rate loans. So basically, the bulk of our portfolio is at fixed rates. Our clients or our portfolio should not be affected by inflation directly. Obviously, the repayment capacity may get hit because of inflation. Reynaldo, I don't know if you want to complement that.

Yes. I'd like to add two things, Ernesto. First of all, as we have mentioned, we expect in 2023 to get back to normal in terms of cost of risk. We will provide further details in our guidance for 2023. But as a general number, that's our expectations. The other thing regarding the inflationary context we are living — remember that in IFRS 9, we incorporate the macroeconomic outlook. We are starting to see those numbers in our projections and incorporate those into our provision levels as of today. We are very active in following the macro environment and incorporate those in our models for provision estimations as well as for our underwriting policies.

Perfect. Franco and Reynaldo. So to think about cost of risk at pre-pandemic levels, would that number be around 1.5%, 1.6%?

Yes.

Perfect. And then just let me make a second question related to the ROEs at the subsidiaries. We have seen BCP, stand-alone Mibanco, Grupo Pacifico, Asetepima, all of them already with ROEs above 22%. However, when looking to BCP Bolivia, Mibanco in Colombia, and AS Bank, we continue to see single-digit ROE. So what will be the strategy to improve the ROEs of those subsidiaries that I think at the end will help also to Credicorp's ROE at a consolidated level?

Great question. Three different answers actually. Mibanco, Colombia is currently in growth mode. I totally agree with you, ROEs are still low, but they are totally in line with our projections when we decided to step up the business in Colombia. We're really positive about what can be done in Colombia and the future for Mibanco in Colombia. That's the first answer, sorry. Bolivia is a completely different story. Unfortunately, in Bolivia, there are rate caps both on the deposit side and on the lending side. There the taxes are quite high, and unfortunately, the whole system's ROE is quite low. So we're trying to optimize the business there. We've been there for 28 years, but we don't see an improvement, at least in the short term. Finally, the investment banking and wealth management business – or Credicorp Capital, sorry. Cesar mentioned before, going forward, what we see is that the Latin American markets are going to be smaller than what we expected. So we're currently in the process of making decisions, actually in the process of a project to define our strategy going forward.

Our next question comes from Thiago Batista with UBS.

As for the results. In the slides, in the beginning of the slides, you showed some information about the digital innovation in BSP. When you look at Mibanco, do you believe it's only a question of time to see this evolution of the digitization process? Or do you believe it's more difficult to really implement these digital innovations in Mibanco operations? And a follow-up on this, the bank's Credicorp ratio is right in the low 40s, which is not so different from the pre-COVID level. Your guidance for this year is mid-40s. But when you look at the medium term, what's the target for efficiency ratio of Credicorp considering this increase in utilization that probably tends to improve your efficiency ratio?

Yes, Francesca, can you take the one on Mibanco's digital strategy?

Yes. Part of the conversation will be around Credicorp's innovation strategy and the domains that we shared in the Digital Day. Mibanco has been working hard towards digitizing their current process and gaining great efficiencies while seeing opportunities for growth. Moving forward, we see a definite opportunity for a neo bank around digital. But because looking at Credicorp's entire strategy, we have Yape, which is entering the micro-entrepreneur segment as well. We still have a way to understand the approach we're going to take. If it's going to be something built on the side or maybe more of an ecosystem view looking at Credicorp. This is what we're working on, and we're going to be addressing during 2023 for sure.

And maybe just to complement Francesca's answer, the main lever for efficiency at Mibanco is workforce, is the sales force, sorry. What Mibanco is currently doing is what they call the hybrid model under which the core model hasn't changed, but with adding efficiency to those RMs through digital tools. That's building on what Francesco mentioned. That's the reason why you see the cost to income at Mibanco has decreased substantially over the last quarters. Going forward, regarding your question on Credicorp's cost to income, it's a tricky question really. The reason is, obviously, the digital investments we're doing are helping or helping in reducing our cost to income. Having said that, we really don't know when we are going to stop investing in digital transformation. I would call it digital investments, so as to become more efficient and provide a much better customer experience going forward. As I mentioned in the previous call, we are not going to be shy in terms of investing in order to keep providing the best customer satisfaction in Peru and in the countries in which we operate.

Our next question comes from Daer Labarta with Goldman Sachs.

A couple of questions. First, just on your guidance. Looking at the year-to-date results and the third quarter results. It looks like there could be some upside to your NIM if it's running above around 5.3%. The guidance year-to-date is 4.8%. Is there some potential upside? Or do you expect any pressure in 4Q, kind of similar for the ROE, right? Our guidance around 17.5%, you're already above that. So just how should we think about the guidance? And then I have a second question afterwards.

Sure. You're right. Obviously, we're in November, and we're not going to change the guidance for the next 45 days. But yes, we will expect to be on the upper side of the guidance we've provided. Specifically on ROE, our vision was around 17.5%. We're currently above that still around. So your comments are right. We may end up with a slightly higher ROE going forward.

Okay, Gianfranco, that's clear. My second question is about insurance. You mentioned a 30% return on equity this quarter, but there were some write-offs that affected that. How much were those write-offs? Additionally, what should we consider as the normalized level of return on equity for insurance?

Yes. Let me answer the broad question, and then I'll ask Cesar to complement me. If you recall a couple of calls ago, what we said was that our vision and expectations on the insurance business should be that should navigate in the medium term around 18% to 20%. That's what we do believe is a sustainable ROE going forward. Cesar, can you complement me on the specifics regarding this quarter?

Well, thank you very much for the question. And maybe it's important to remember that during the last year, after the main pandemic impact, we strengthened our underwriting policies to reduce our exposure to not vaccinated candidates. We increased rates, and we increased premiums, mainly in the group life insurance that includes corporate insurance, credit life, and mandatory disability insurance we have with AFP with the ISPs. We enforced our ALM control to manage the impact of inflation and the change in interest rates. During this quarter, we saw important impacts from some seasonality, new premiums related to group life insurance, which had good results during this quarter. We have had a low loan ratio, especially in the life insurance business. It means that we have had this good result for this quarter. Because of this positive impact and what we implemented during the last year and this year. For the future, as Gianfranco said, we expect to be around this 20% return of equity. And of course, we need to continue our investment in the capabilities of the technical teams while maintaining our discipline in underwriting and investment management. So we expect to be around this 30% ROE.

Okay. Great. That's helpful. And could you just quantify how much was the specific write-off this quarter that impacted equity?

There was not a write-off. The mention referred to unrealized losses in the long-term investment portfolio; it had a minor effect but it is not a write-off. It merely reflects the impact of higher interest rates on the value of the assets we have on our books.

Our next question comes from Yuri Fernandes with JPMorgan.

I have a question regarding margins here. This 5.3% is very close to the previous 5.4% or 5.5% in 2018-19. So my question is how much more can it expand next year? Because we still see active amortization, you have been repricing our assets. I guess the concern here is regarding funding costs, right, because funding costs today are running at 2.1%. Rates are at 7%. This is about 30% of the rates. I know like in Peru, most of the term deposits are fixed-rate, right? But you reprice your time deposits, right? And I see BCP paying around 6.5%, with some banks paying 90%. My question is, can you keep funding costs so low like considering this level of interest rates? And again, how will NIMs behave right in 2023-24? Can you expand above the levels you had in 2018-19?

Cesar?

Okay. Thank you. I will split my question into probably a couple of chapters. First, I will say that we have some short-term effects and others that are more structural ones. Under the foundation that we are not going to provide now a specific guidance, we are going to provide a specific guidance next quarter, but I can give you a general answer that I hope will be helpful. In the short term, we expect an expansion in NIM because the repricing process still continues in dollars is still accelerating, and we expect higher rates in dollars to be very relevant for us, given that 50% of our portfolio is in dollars. In the case of Peru, we expect to have providing higher rates for next year. After the year 2024 or 2025, it is starting to come down as the reference rates decrease. But there are structural reasons that will propel our NIMs higher, including the change in the structural cost of funds because during the pandemic, as you remember, we increased our share of transactional deposits. While these deposits could decrease slightly in the short term in comparison with the previous year, they are at a higher level. At this point, it's 56%, which is substantial. We expect that it's going to be more structural. Another change is the composition of the portfolio; we have become more and more a retail group, and inside of retail, the consumer and SME segments are growing faster than mortgage, for example. So these changes are going to be more structural. Summarizing everything, we are expecting higher NIMs due to reference rates next year, and after that, we expect to have still higher-than-pre-pandemic levels of NIM but for the structural reasons that I just described.

Just to add to Cesar's response, from a strategic standpoint, at BCP, we have been developing a transactional value proposition for several years. While I don't have the exact number, approximately 40% to 45% of total transactions in the Peruvian financial system are processed through BCP. In the past, this strategy didn't yield significant returns due to low rates, but currently, we are experiencing substantial benefits from it. This is one of the reasons we introduced Yape a few years ago, and it also connects to my earlier response to Jason. We firmly believe there is still a significant opportunity to increase the adoption of noncash payments in Peru, benefiting both the population and us in terms of lower funding costs.

No, it makes a lot of sense. Basically, it's a competitive advantage, right? Like you have a structural change on your transactions Yape, as you said, and all those initiatives; and now we are seeing the benefits on the funding costs, and this should remain. If I may, just a second one, a follow-up from on insurance. We were checking here the ROE of the insurance business, and it was like 13%, 14% in 2018-19. I guess you said from 18% to 20% ROE now, like closer to 20%, ROE what has changed since 2018-2020 in the issuance business? Is it just the rates that are higher, and you have higher financial income? Or is it the mix of products, structural lower loss ratio? What explains this higher ROE for insurance now versus pre-COVID levels?

Cesar?

Okay. Yes. I think we have a combination of factors that have changed the portfolio. Again, we are a more retail bank, more digital one. We have a much higher composition of bancassurance in our current and expected portfolio through BCP, through Mibanco. This product has better margins, and another reason is that overall we have improved the efficiency of the business. When you combine these better income-generating capacity and structural efficiency in the business, we can land up in a higher structural ROE.

Congrats on the results.

Our next question comes from Andres Soto with Santander.

Congratulations on the results. My question is regarding the digital strategy. We have seen impressive results this year. I'm not sure if those are just in line with your expectations or you are a bit ahead of what you were expecting to see when you presented your digital plan that was in March this year. In that sense, when you presented this plan, you said that you expected the income coming from the monetization of these initiatives to offset the cost by 2024, 2025. I would like to understand if there is any change in that expectation, and are you now expecting to see a faster-than-expected monetization of your digital strategy? From that perspective, can Credicorp exceed 18% ROE earlier than expected?

Thank you, Andres. Francesca, could you take that one?

Yes. We do expect to see some lines of business improve, and we're seeing that with Yape in terms of, for example, financial products being distributed because of the potency of the distribution channel. On the other hand, we are very aggressive, and we're challenging ourselves to create new businesses such as marketplaces that we talked about in the Digital Day. That is very difficult, especially in the environment we operate in, where nothing changes fast. I don't see the overall expectancy to be positive by 2024 or 2025 changing significantly. But these are plans that are constantly being evaluated to govern stops and new processes initiated because they are planned. We don't execute exactly on what we plan because we are very mindful of what works in the market and where customers and product market fit really exists.

Your ROE expectation overall, I would like to hear your thoughts. We are in a higher-than-expected interest rate environment, and that has definitely helped the margins. You mentioned you have benefits on the funding side. Can we expect Credicorp running about 18% ROE in the next few years?

Our expectation during the Digital Day was around 18%. We maintained that as an achievable medium-term target. But at the same time that we are obtaining higher margins, we are aggressively investing into the future to be more competitive down the road. We are going to privilege long-term sustainability and profitability over a spike in a specific quarter.

Our next question is a follow-up from Jason Mollin with Scotiabank.

Yes, I reentered the queue to ask another question. Mine is on client engagement. On Slide 7, you shared products per client under a new methodology for digital and nondigital clients. Do you have targets for engagements under this new methodology that you can share with us?

Since the beginning of the transformation, our target is to multiply the level of engagement by two, and that's what we have seen. That’s still what we're striving for. We began with the nondigital customers for the consumer segment at 1.2, and now we're at 1.10. So our target continues to be around 2.5, 2.4 as a target for customers. Having said that, we are also looking not only at cross-sell but the level of engagement, the number of services, and the day-to-day usage that we're seeing. We shared with Yape the example, the number of activities the customers have per month. We have a lot of activity through our mobile banking app for services like top-ups, payments, how you turn off and on your credit card account, and so forth. So this is we're looking at engagement now from a broader view than just cross-sell.

It appears there are no further questions at this time. I will now turn the call back over to Mr. Gianfranco Ferrari, Chief Executive Officer, for closing remarks.

Thank you all for joining us in this conference call. I'd like to highlight that the fundamentals of Peru remain strong, and our expectation for GDP growth is now above our initial guidance despite the continued political noise. Latin America also continues to be an attractive alternative in terms of global capital inflows based on supported commodity prices and the steps our economies took to increase rates early on. If it weren't for the political noise and course changes of government, we could be in a much better position to solve the long-term structural issues such as quality of health, education, and basic services. In this context, we are confident that we will continue to generate robust results into the future as we continue to see loan growth with an ability to pass on rate hikes, a differentiated funding structure, and increasing levels of transactions, all of which drive core income expansion. We're also focused on remaining competitive in the longer term, rapidly scaling new fee and income-generating opportunities while deepening our connections with our customers, with the aim of being their primary banking relationship. We're upskilling our workforce and attracting and retaining the best talent while accelerating the development of core enablers of our digital transformation strategy, including data and analytics, IT, and cybersecurity. We've made significant progress on all fronts but acknowledge that we are only at the beginning of this journey. Our strategy and position also enable us to be a powerful agent of change. We take this responsibility very seriously and are committed to aligning our business objectives with our sustainability-based responsibilities of financial inclusion, financial education, and developing the workforce of the future. We will continue to deliver our strategy to drive sustainable, profitable growth, advance on our digitalization initiatives, and attract and retain the best talent. Thank you all for joining us, and have a great weekend.

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