Earnings Call Transcript - BAP Q3 2021

Operator, Operator

Good morning, everyone. I would like to welcome all of you to the Credicorp Ltd. Third Quarter 2021 Conference Call. We now have all of our speakers in the conference. With us today is Mr. Walter Bayly, Chief Executive Officer; Mr. Gianfranco Ferrari, Deputy Chief Executive Officer; Mr. Alvaro Correa, Deputy Chief Executive Officer; Mr. Cesar Rios, Chief Financial Officer; Mr. Reynaldo Llosa, Chief Risk Officer; and Mrs. Milagros Ciguenas, Chief Investor Relations Officer. It is my pleasure to turn the conference over to Credicorp's Chairman of the Board, Mr. Luis Romero. You may begin.

Luis Romero, Chairman of the Board

Good morning, everybody, and welcome to our Credicorp Conference Call. I hope you and your families are healthy and safe. Before Cesar begins the presentation on our results, I would like to share some opening remarks with you. I'm very pleased to join you today in a special period when our strong third quarter results reflect an inflection point in our business's recovery and in our digital as well as sustainability journeys. This coincides with the transition in our top management scheme, and this happens to be Walter's and Alvaro's last conference call. I wanted to take this opportunity to express our deepest gratitude to both Walter and Alvaro for their invaluable contributions to Credicorp. They are the main leaders who have inspired our teams, transformed our business, and driven our success. Alvaro has had an exceptional 24-year career within the group, including the last 3 years as Deputy CEO, overseeing insurance, pensions, investment banking, and wealth management. Over the last 2 years, he has played an invaluable role in driving and steering our process to integrate sustainability in our business strategy. Alvaro's technical skills, transparency, and fidelity, coupled with deepening value over the years by the investors and colleagues alike. Walter has had an extraordinary 28-year career at the group, including the last 3 years as CEO of Credicorp and prior to that, 10 years as the CEO of BCP. With strong vision and a steady hand, Walter has led us as we embarked on new journeys, including penetrating the micro-finance business and new LATAM markets, which now represent our main avenues for regional growth. Most importantly, Walter has been an inspirational yet approachable leader who has attracted and developed a talented and professional management team. Alongside these individuals, he has helped build a resilient organization over decades of both challenging and promising periods. It has been our privilege to have Walter at the helm of our group. We have planned and managed this transition process very carefully and are fully confident that Gianfranco has both the skills and experience to lead Credicorp to new heights. He will build upon the foundations of the organization before us today, a leading and diversified financial services group with more than 40,000 employees and a solid presence in Peru, Colombia, Chile, and Bolivia. Gianfranco knows our organization inside and out and has actively participated in the process to define critical strategy. Over his 25 years with the group, he has successfully led a myriad of areas in BCP, including corporate banking, investment banking, BCP Bolivia, and retail banking, where he spearheads the bank's digital transformation journey. Gianfranco is an inspirational leader who energizes and engages his management teams to set the bar higher. We are very pleased to have him as the next CEO of Credicorp. Again, many thanks to both Walter and Alvaro. Now I would like to give the floor to Cesar and the management team, who will conduct the conference call on the results for the third quarter of '21. Thank you. Go ahead, Cesar.

Cesar Rios, CFO

Thank you, Luis. Good morning, and welcome to Credicorp's conference call on our earnings results for the third quarter of 2021. I hope you and your families are healthy. Official data indicates that in August, economic activity grew 11.8% year-over-year and 1.6% compared to the figure reported in August 2019. Our estimates indicate that in the third quarter of '21, the economy expanded around 11.2%, topping pre-pandemic levels. It is worth noting that the construction sector grew 21% with regard to the third quarter of 2019. In addition, the statistical rebound recovery in recent months has been boosted by a favorable external environment where copper prices stand at historically high levels and Peru's main trading partners are registering an acceleration in growth. Regarding the sanitary situation, mortality rates have fallen considerably after reaching a peak at the beginning of the second quarter. This improvement has been driven by noteworthy advances in the vaccination program as 81% of the adult population have received at least one dose. The government's goal is for all adults and children between 12 and 18 to be vaccinated by year-end. We expect Peru's GDP to rebound around 12% in 2021, which is better than initially expected due to strong commodity prices and expansive monetary and fiscal policies. Next slide, please. President Castillo's recent cabinet reshuffle was perceived by economic agents as a signal of potential moderation. This move, coupled with the ratification of Julio Velarde as Chair of the Central Bank, bolstered Peru's financial markets, and some indicators improved. For example, the exchange rate has fallen from PEN4.13 to PEN4 soles per dollar. Additionally, the 10-year local currency government bonds yields dropped from a peak of 6.8% to 5.9% as of November 3, while the level of non-resident holdings of solid denominated government debt recovered from a low of 44% in June to stand at 52% in October. Net international reserves came in at $75.4 billion in October after standing at $71.8 billion in June. It is worth mentioning that the Central Bank has raised its policy rate by 100 basis points in August to control inflationary pressures. This rate currently stands at 1.5%. On the political front, the new Prime Minister appeared before Congress to request a vote of confidence for her cabinet. Additionally, the executive branch presented a plea to Congress to request extraordinary power to legislate on several relevant bonds. The main points of this proposal include increasing the personal income tax for individuals who earn more than PEN300,000 a year, extending the application of dividend taxes to domiciled legal entities, creating a new mining tax regime, imposing a sales tax on life insurance policies, enhancing measures to adapt capital requirements in the financial system to Basel III standards, increasing the level of economic sanctions that a regulator can impose on financial institutions, and implementing initiatives to ensure a more active role for Banco de la Nacion. We will continue to closely monitor political and regulatory events and their impact on our businesses. Next slide, please. Going on to Credicorp's performance, we continue to foster financial inclusion and business growth through digitalization while we recover profitability across the board. In line with our ambition to create a more sustainable and inclusive economy, in the last nine months, we have included 785,000 individuals in the financial system through Yape, Mibanco, and Soli, our GAAP equivalent in Bolivia. Complementarily, millions of individuals and micro-businesses have also benefited from our ADB financial education program BCP and Pacifico. We operate in under-penetrated markets, and the size and growth opportunities are accelerating our digital transformation. BCP is growing its client base mainly through digital clients, which, as of September, accounted for 57% of individual clients. Mibanco has already reaped the benefits of the implementation of this hybrid model in September with 10% of loan operations working towards our terminal channels. Regarding quarter-over-quarter results, Credicorp's loan portfolio rose 2.4% in quarter-end balances, boosted by local currency devaluation. However, excluding the exchange rate effect, the loan portfolio remained flat, given that 1.7% achieved in restructured loans was offset by an 8.6% drop in the government program portfolio. Core income, which is composed of net interest income, fee income, and FX transactions, grew 4.8% due to an uptick in restructured loans and higher interest rates. Additionally, the income was boosted by growth in transactional activity and interbank transfers. Provisional expenses dropped due to improvement in the trading behavior of clients of BCP and Mibanco, which led the cost of risk and structural cost of risk to drop to record low levels of 25% and 0.54%, respectively. Insurance underwriting results for the quarter after COVID-19-related claims in the life business registered a material reduction, which reflects the improvement in the sanitary situation. In the third quarter of this year, credit cards registered PEN1,164 million in net income and an ROE of 18.57% year-to-date. ROE is still at 13.46%, which is within our guidance. Finally, our balance sheet remains strong with ample liquidity and adequate capital ratios. Next slide, please. I will briefly describe the results of the lines of business and then provide further details in the section on consolidated performance. Wholesale Banking is registering a strong rebound at BCP accelerated transformation investments. In the third quarter of '21, BCP contributed PEN1,058 million in earnings with a return on equity of 23.1%. BCP's ROE this quarter is exceptionally high due to the 69% quarter-over-quarter contraction in provisional expenses, which reflected an improvement in payment behavior that was driven by better-than-expected reactive and economic reactivation. Core income reported growth of 3.3% quarter-over-quarter, which was mainly driven by growth in restructured loans and interest rates and by an increase in transactions, fueled by an increase in consumption of interbank and international transfers. BCP Stand-alone registered a 14% year-over-year increase in expenses, which was primarily attributable to an uptick in Banco sweeping expenses for digital transformation. ROE at BCP for the first nine months of 2021 stands at 19.7%, which reflects a strong rebound from the COVID crisis. BCP Bolivia results showed little variation in growth, which reflects a lower risk appetite in an uncertain economic environment. Next slide, please. Macro finance continues to recover as business activity picks up and implementation of the hybrid model begins to pay off. At Mibanco, the use of data analytics and alternative channels has begun to yield improvements in productivity and has allowed us to streamline loan underwriting for good quality borrowers. The structural disbursement has exceeded pre-pandemic level in results. Net interest income grew 7.5% quarter-over-quarter, boosted by a reversal of interest income provision set aside previously for reprogrammed loans. The increase in net interest income was also attributable to an uptick in origination volumes. Loan provisions dropped slightly due to an improvement in client payment performance and new originations with dollar risk profiles. Our hybrid model has helped us control operating expenses and improve origination volumes, and in parallel, we have reduced branches and the sales force. At Mibanco Colombia, results improved with an uptick in origination volumes. Micro-loans are gaining relevance and boosting yields, while the decrease in the level of provisions reflects an improvement in credit quality and risk models. The company is now focused on implementing Mibanco's Peru best practices as it improves the productivity of the sales force and develops digital capabilities. Next slide, please. Regarding the insurance business, Pacifico's earnings rebounded this quarter and witnessed a positive range due to a decrease in claims in the Life segment and growing premiums in the life and property and casualty businesses. In life, COVID-19 claims dropped 82% quarter-over-quarter after IBNR results were released in the context of a significant drop in mortality. Life results were also boosted by growth in net premiums, which surpassed pre-pandemic levels. In property and casualty, results were impacted by an increase in claims as COVID-related restrictions were lifted. This effect was mitigated by an increase in net premiums. Results in our Corporate Health Insurance segment also bounced back due to a reduction in COVID-related medical claims. Conversely, medical services were impacted due to a decrease in pandemic-related targets. In the pension business, Prima fees remained resilient despite an 18% reduction in assets under management quarter-over-quarter in a context of pension fund releases. We are closely monitoring the regulatory risk in this business. Next slide, please. Regarding our investment banking and wealth management businesses, income dropped quarter-over-quarter, mainly due to the capital market and asset management business owing to lower traded volumes and asset under management outflows, respectively. In this quarter-over-quarter analysis, assets under management grew 1.6% in local currency but registered a drop of 5.2% in U.S. dollars. Asset under management contractions were driven by the asset management business where traditional funds experienced outflows. Assets under management in the wealth management business remained relatively stable after Peruvian clients migrated assets to our offshore plants, where we are growing the value proposition to cover our clients' changing needs. The income contribution from this business decreased 11.4%. This was mainly attributable to the capital markets business as income was affected by results of profitable portfolios in a context of rising interest rates and a decrease in transactional activity. For this extent, the drop in income contribution was driven by the asset management business where assets under management contracted. Next slide, please. Now, I will discuss Credicorp's consolidated performance. The interest-earning asset mix improved in a context marked by an increase in restructured loan share of total assets and a decrease in reactive loans balances. This was partially offset by a 12.2% quarter-over-quarter contraction in the investment portfolio due to the expiration of certificates of deposits which were not renewed and increased the liquidity assets. A mortgage loan-driven portfolio, coupled with an increase in market rates, leads to a rise in our interest-earning amounts. Quarter-over-quarter, the credit card loan book grew 2.4% in ending balances and 4.8% in average daily balances fueled by an uptick in the exchange rate. If we control both the exchange rate effect and the government program loans, the structured portfolio grew 1.7% in quarter-end balances and 5.1% in average estimated balances. On the liability side, a reduction in funding from government loans was offset by an uptick in low-cost deposits, which resulted in a less expensive funding mix. Moreover, interest rate hikes had a limited impact on our funding costs, which is not very extensive to interest rate movements even back. The low-cost deposits account for approximately 58% of our funding, and most of our wholesale funding benefits from fixed interest rates for upgraded locking. Next slide, please. This quarter, both the restructured portfolio and payment behavior continued to evolve favorably across all segments. Consequently, both the structural NPL ratio and the cost of risk ratio improved. Loan volumes and payment behavior registered improvements in retail banking and at Mibanco this quarter. This positive evolution was attributable to an economic reactivation, an uptick in employment, growth in levels of personal liquidity via pension fund withdrawals, and increasing public investments. In this context, Credicorp's structural NPL stood at 9.2%, which represented a quarter-over-quarter reduction of 40 basis points. A downward trend in the cost of risk is also noteworthy as it represents record low levels. This improvement was seen across all our subsidiaries, driven by better payment behavior and partially offset by an increase in provisions related to an adjustment in write-off policies at Mibanco. In this scenario, Credicorp's restructured cost of this contracted 69 basis points, falling from 1.23% to 0.54% in year-to-date figures. The cost of risk stood at 1.15%. The level of structural allowance of loan growth in the quarter-end was equivalent to 7.1% of Credicorp's loan portfolio. It is important to note that the quality of the government loan portfolio deteriorated this quarter due to grace period expirations. This deterioration negatively impacted asset quality ratios for the total portfolio, yet we are not highly concerned about this evolution because the loans in the Peruvian portfolio are safeguarded by state guarantees. Credicorp's structural yield increased 21 basis points quarter-over-quarter to stand at 4.53%. Recovery was attributable to an increase in yields and a more favorable asset mix driven by the strongest portfolio loan origination and a reduction in reactive loans. Risk-adjusted NIM increased 57 basis points this quarter and reached 3.95%. This metric recovered faster than our NIM, boosted by a significant increase in provision levels. Core income increased 4.8% quarter-over-quarter, which was primarily driven by growth in net interest income. The income grew alongside an uptick in transactional activities in several channels, as well as interbank and international transfers at BCP Stand-alone. This whole offset the impact of recent regulatory changes, which paved a few restrictions for variable sources of income beginning in the second quarter. This 15.3% year-over-year improvement in core income was primarily attributable to growth and interest income and secondary linked to an increase in fee income, given that the few restrictions that were in place last year due to the pandemic are no longer in effect. Next slide, please. In the first nine months of the year, credit cards efficiency ratio improved by 120 basis points year-over-year. Improvements were driven mainly by the positive evolution of operating income in the banking businesses, insurance, and pension lines of business. This evolution offset higher expenses as BCP extended loans for digital transformation. Pacifico's fee income registered growth this year after it won a larger tranche of the SISCO V tender for ASP-related coverage. The premium rate for this tender was higher than that offered by the SISCO IV, the previous biannual program. At Mibanco, operating income grew 19% year-to-date, while operating expenses grew only 1%. Expenses remain under control despite a significant increase in digital transformational expenses to implement a heavy business model. It is worth mentioning that of the 38% monthly operational loans in September, which represented 9% of total disbursement amounts, were processed through alternative channels. This alternative channel complemented our traditional business by originating low ticket cost-efficient loans that boost Mibanco's operating income. Next slide, please. At BCP, we continue to work on key digital initiatives to achieve our objectives for customer experience and efficiency and ensure our competitiveness in the long term. Regarding technology, in the first 9 months of 2021, our software releases increased 87% year-over-year, our downtime in key channels was low, and we made strides in the management of risks. Our aim by year-end is to fully comply with all the statements of the FFIEC cybersecurity assessment tools at the baseline evolving an intermediate level and fulfill 90% of all these payments at the advanced level. Today, we have fulfilled 84% of what we started. The Consumer segment customer satisfaction has evolved favorably, driven by improvements in key customer requirements for both digital and personal processes. Growth in digital clients, which represents 57% of the total client base this quarter, continues to be steady. The use of data in real-time has helped with digital sales, which stood at 37% this quarter. BCP's firm progress in driving digital channel use has facilitated a 9% reduction in branches over the last 12 months. Digital transactions continue to grow exponentially, and it is worth highlighting how Yape's share of total transactions has grown. This quarter, Yape surpassed mobile banking in terms of monetary transaction level, while just two years ago, Yape numbers were mid-level. Next slide, please. Yape was launched as a P2P application to allow BCP clients to make small data transfers using the telephone number or QR code instead of using cards. Yape has evolved to offer new features and numerous partnerships. Over the last year, Yape usage has grown exponentially and today boasts more than 7 million users. We expect to reach the 10 million user mark early next year. As the largest small payment ecosystem in Peru, Yape's mission is to become the third-party distribution channel for companies in Peru. The Yape card is an important level for growth in financial inclusion and is used by 34% of Yape subscribers, who are able to open a digital wallet with a national identification number. No bank account is required. By channeling government, social, and feasible payments to vulnerable families, the Yape card will capture new users who have yet to be banked. Yape will channel a new branch of government-assisted payments to beneficiaries in the fourth quarter of this year. 49% of total users are active on a monthly basis. Of these users, 61% are BCP clients and 19% are SME clients, which have digitalized their small and big installations and transactions through Yape. The frequency of usage and transactions have also grown in recent months. Today, the active transaction numbers are nearing 1 million for a volume of PEN2.4 billion. Yape’s focus thus far has been on growing the user base and increasing frequency of use. Today, we are initiating the monetization phase. Before the end of this year, Yape will launch micro-loans, mobile top-ups, and dynamic QR codes for companies. We are also working on an interesting monetization pipeline, which we will launch down the road. Next slide, please. As part of our innovation efforts, we have developed several disruptive initiatives to pinpoint exponential growth opportunities within new sources of value. These initiatives have ambitious objectives that force us to think outside the box, and success relies on impeccable execution. Some initiatives are close to our core and are developed within a specific product segment. Initiatives that adjust our core roles that are considered more transformational are developed at innovation centers at multiple companies where work transport and product-market fits for interesting ideas. In the pending initiative investment to Krealo, our corporate venture capital company, we are in the early stages of testing new business models based on an easy perspective. The scale initiatives such as Yape, which was conceived in BCP’s innovation sector, has leveraged the BCP customer base and commercial market to grow its user base quickly along with interactional and transactional level initiatives such as Tenpo and Tyba, which were developed in the country to Krealo’s augmented physical funds. They have flexible architectures that can be easily adapted for Uruguay and time-to-market purposes when developed in the near future. Having learned from different experiences, we are now revisiting the strategy for our payment systems to review assets relative to investment business.

Operator, Operator

Pardon me, ladies and gentlemen, we seem to be experiencing some technical difficulties. So please hold for a moment while we reconnect our speakers. And I have reconnected our speaker line. So I'd like to turn it back to Cesar.

Cesar Rios, CFO

Sorry for this technical issue. Probably, I'm going to repeat the last rate. Having learned from different experiences, we are now revisiting the strategy for our fintech ecosystems to review assets relative to investment vehicles, the governance model, and management initiatives. Our aim is to develop the best disruptive business models by leveraging our incumbents, market knowledge, and customer relationships. The goal is to enhance decision-making at credit card level while avoiding conflict of interest within our incumbents. We expect to share our revisited digital strategy with the market in the first quarter of next year. Next slide, please. Regarding the sustainability front, we have recently published an ESG update in accordance with investors to comment on our recent milestones and upcoming initiatives. You can find this document in the Presentations section of our website. We want to highlight some specific milestones from this update. First, this year, we made a solid commitment to the environment by declaring our goal to achieve carbon neutrality in our direct operations by 2032. We have also made progress in other initiatives related to this commitment. On the social front, we successfully extended the benefits of our hybrid model for cost optimization of Mibanco to our smaller macro finance values and implemented other initiatives related to our general security program. Additionally, we continue to make progress in bolstering financial inclusion education, banking more individuals under SMEs, and also reaching a very large audience with innovative financial education initiatives. Regarding governance, we have incorporated gender diversity guidance in our process for the goal in our corporate growth policy. Additionally, we are seeking to ensure that the Board actively engages with investors and other relevant stakeholders. All these efforts are directed and supervised by our senior managers and sustainability sponsors. We have focused on providing leadership of the company with the knowledge to be effective role models for sustainability, which will ensure that the sustainability mindset is both communicated to and internalized by the entire organization. Next slide, please. We are confident that our trend in profitability weakness this quarter will continue in the short term. We expect Peruvian GDP growth for 2021 to stand around 12% in a context marked by better-than-expected economic recovery that tops pre-pandemic levels and record high prices for growth. Loan portfolio growth measured in average daily balances is expected to be situated slightly above the guidance range impacted by local currency devaluation. We expect NIM to situate in the mid-branch of guidance in line with a more profitable interest-earning asset mix and higher interest rates. Regarding cost of risk, we expect to close the year below given year-to-date levels. Regarding efficiency, the ratio is expected to situate at the upper end of the guidance range as higher expenses are recovered in the last quarter as we accelerate transformation initiatives. Finally, in the context of ongoing gains in profitability, overall, ROE for 2021 is expected to situate in the upper end of guidance. We will continue accelerating value creation by executing our digital strategy, which, coupled with our sustainability efforts, will ensure that we sustain long-term competitiveness. With these comments, I would like to start the Q&A session.

Operator, Operator

Our first question today will come from Jason Mollin with Scotiabank.

Jason Mollin, Analyst

My question is, after all this, I mean, it seems like really the economic reactivation has been moving ahead in full steam, even faster than many expected. I mean, what happens next? How are you thinking about the economic outlook for next year 2022? And what that means for the banking system? And in that context, I guess, if I were to calculate the depreciation of the Peruvian Sol from probably the beginning of 2020, it would probably be close to 20% off the top of my head, something like PEN3.30 to PEN4 sols per dollar. We've seen a big move there. And I guess it was the end of 2014 that we saw a push to de-dollarize the loan book. But if you can also, in that context of what you're looking for, talk about how the movements in the FX have impacted the economy and your business? And if you see that being an important factor going forward?

Walter Bayly, CEO

Thank you, Jason. This is Walter. I will share my thoughts briefly, and then I'll let Cesar provide more details. Our current view is that we can expect an economic recovery next year, with growth likely between 2 and 2.5 percent. Estimating loan growth is challenging due to distortions in our loan portfolios caused by the significant influx of funds from the Reactive program. Historically, loan growth has been about 1.5 times nominal GDP, but that trend has been disrupted, making predictions for next year uncertain. However, if GDP grows at around 2.5 percent, we anticipate loan growth in the region of 6 percent, possibly between 5 and 7 percent, with notable differences between retail and wholesale sectors. The retail side is expected to be more dynamic, while the wholesale side may see less growth. Regarding foreign exchange, we expect stability moving forward. Political factors have significantly influenced the current exchange rates, and without this noise, the rates would likely be lower. While we don't foresee an increase in political noise, we do believe that strong global economic factors will help maintain the current levels of political unrest. The recent devaluation, while it has caused inflation, is not expected to have long-term detrimental effects on the economy. The adjustment period has been relatively quick, and the economy has adapted without creating sustainable damage. There has been some impact on our common equity Tier 1 at BCP due to increasing risk-weighted assets in local currency, but considering BCP's strong profitability, this is not a major concern. I will stop here, and Cesar, please feel free to add your insights.

Cesar Rios, CFO

Thank you, Walter. Probably only some additional opinions. As you mentioned, the devaluation has been significant this year, around 20%, and the top was around 25%. But we didn't say that the impact on inflation was moderated. The expectation is that it's going to be around 1%, and the Central Bank is acting decisively to control that using a number of instruments, including direct sales in the market and derivatives. The direct sales have been probably $100 billion and the derivatives around $4-additional billion. But due to the stability, the country has already suffered an outflow of funds. It's estimated that probably from the beginning of the relation process to the close of October, it has been around $15 billion. But it's not worth it to say that the trend has decreased significantly. And in the last month, it probably has been neutral. So probably the biggest part of the instability process has already passed on, and it has caused international reserves to have some impact on the level of the service of the Central Bank. But at the Central Bank, at the end had $75 billion of reserves now, and the exchange rate is trading in a narrow range at this point. So probably the most volatile part of the impact has already been absorbed by the economy.

Walter Bayly, CEO

Thank you, Cesar. I think we have covered Jason's concerns.

Jason Mollin, Analyst

Yes. I was looking at the proportion of dollars as a percentage of total deposits, which has increased to about 51% from around 46% a year ago. Should we expect that to reverse or is it likely to remain?

Walter Bayly, CEO

I would expect that, that is going to stay there for a little while and will only gradually start to decrease to where we were before. As people realize and understand that there is no concern or expectations of further devaluation of the currency. But it will stay there for a while.

Operator, Operator

Our next question comes from Ernesto Gabilondo with Bank of America.

Ernesto Gabilondo, Analyst

And good luck, Walter and Alvaro. Congratulations on your results. My first question is on the political and economic landscape. We have seen the vote of confidence for the cabinet; we have seen a more moderate speech from Castillo's government. So we think all of these should be helping in the short term. However, I would like to know your thoughts about the medium-term outlook. I think the country needs to implement a tax reform, maybe some structural reforms to promote growth. But how do you see all this under a divided Congress? And also, I don't know if you have been hearing the noise of a potential impeachment of Castillo at some point. And also in all these environments, as you pointed out in your initial remarks, there could be more competition from state banks. So I would appreciate your thoughts on this.

Walter Bayly, CEO

Thank you for your question, Ernesto. I had planned to cover many of your points in my closing remarks, but I'll mention them now and reiterate later. We need to move the discussion about Credicorp away from politics. What we've observed in the first 100 days of this administration is likely to continue, which includes decent macroeconomic policies accompanied by a lot of political noise and a questionable ability to execute changes effectively. This has been evident in the past 100 days, and I expect it will persist for the next couple of years. Therefore, it's important to shift our focus from political matters to the fundamentals of economic development in the country and what’s happening within Credicorp. In summary, I don't anticipate any significant changes from what we've experienced in the past 100 days. Did I address your question?

Ernesto Gabilondo, Analyst

Yes, yes. Very helpful. Thank you very much. And then I have a second question related to your NIM. We saw a year-over-year expansion; also in Cesar's remarks, he was saying that we should expect probably a NIM expansion in the next quarters in light of higher rates. But considering that the Reactiva loans were extended for the end of the year, what should be the impact of the Reactiva loans on your NIMs in the next quarters?

Walter Bayly, CEO

Sure. I will let Cesar take the first crack at your question, and Gianfranco that is sitting here with me would like to add a comment after Cesar's first response. Cesar, go ahead.

Cesar Rios, CFO

Yes, Ernesto. In general terms, we expect that NIM is starting to expand driven by a mix in the portfolio and the increase in the short-term and long-term interest rates that go through the pricing process. So the general trends should be upward. The impact of Reactiva was around 40 basis points on the NIM, but this part is going to decrease gradually in the next quarters, which will be measurable in 1.5 years.

Gianfranco Ferrari, Deputy CEO

Yes. Just a quick addition, a short addition. Exactly. Even though we do not expect an important growth in terms of the size of the book, in terms of NIM, it should improve because the Reactiva loans get paid; we expect some substitution with higher margins.

Operator, Operator

Our next question comes from Thiago Batista with UBS.

Thiago Batista, Analyst

Yes. I had just one follow-up on this last question about the margins. When we look for the margins of Credicorp, now we're talking about 4.5% of NIM. I mean looking at the structural NIM. And pre-COVID this used to be, let's say, 5.5% per year. Now, more or less 100 bps below the pre-COVID level. Do you believe it is possible to see margins going back to the pre-COVID level or all there changes directly to Peru, the cap, etc.? I know that there is no big impact for cut cost, but we saw the changes in Peru. Do you see it's possible to return to the pre-COVID level? And the second one, very fast here. Sorry for the second question. It's about ROE. What is the level of ROE that is possible for the third quarter in coming years? So will it be, say, 14% or can we see the high teens? What is the level of ROE that is feasible in the current scenario for the third quarter?

Walter Bayly, CEO

Thank you, Thiago, for your questions. The answer to the first question is yes. We think NIMs will get back to where we were pre-COVID and just off the top of my head, will probably be there sometime around the last quarter of next year. And second, regarding your return on equity, we are very confident that the sustainable return on equity for Credicorp will be around the 17% level.

Operator, Operator

Our next question comes from Tito Labarta with Goldman Sachs.

Tito Labarta, Analyst

First of all, best of luck to Walter and Alvaro; you guys set a very high standard. So I wish you guys the best. My question is on the cost of risk, very good performance in the quarter, a little bit of deterioration in asset quality. Looking at your coverage ratio getting closer back to historical levels, help us think about the cost of risk going forward from here? Do you automatically now go back to like that 1.8%-2.3%? Can you still keep the cost of risk low through year-end and into next year? When do you expect that to normalize to more normal levels?

Walter Bayly, CEO

Okay. Thank you for your words, Tito. Cesar, could you tackle the question of Tito, please?

Cesar Rios, CFO

Yes, Tito. We expect the cost of risk to remain below pre-crisis levels during this year and some part of next year due to a combination of better quality origination and the maturity of loans probably with better performance than was anticipated and booked in our books during 2020. And we are going to come back to more normal levels given the composition of the portfolio in 2023.

Walter Bayly, CEO

Thank you, Cesar. So in summary, Tito, I think that all throughout the next year, the cost of risk will still be below pre-COVID levels. Just to be very precise. Thank you.

Tito Labarta, Analyst

Okay. Yes. No, thankful to Cesar. That was helpful. And maybe just one follow-up on not necessarily policies, but as you mentioned on the GDP given the political environment. You mentioned for next year, 2 to 2.5, is that what you think sort of the midterm growth outlook for Peru should be, right? I mean I imagine getting back to historical levels will be tough, but is that sort of the sustainable growth level you think from this administration?

Walter Bayly, CEO

Unfortunately, yes, Tito. It is below the potential, but I don’t see that the – in the next 2 to 3 years at least, the investment from the private sector will be able to drive the economy to higher levels of GDP growth as we have the potential to do.

Operator, Operator

Our next question comes from Andres Soto with Santander.

Andres Soto, Analyst

My first question is a quick follow-up on the margin outlook. I would like to understand how the new origination clients are responding to the interest rates they previously paid for the Reactiva loans. Are they willing to accept those rates again, and have there been any impacts on pricing considering the low rates they were receiving before? Also, could you remind us of your balance sheet's sensitivity to the policy price?

Walter Bayly, CEO

Sure. The first part of the question will go to Gianfranco, and the second part to Cesar. Go ahead, Gianfranco.

Gianfranco Ferrari, Deputy CEO

Yes. Andres, we haven't seen any resistance whatsoever among clients that are getting new loans under market conditions in order to replace the Reactiva loans. Not only at BCP but, most importantly at Mibanco where, as you know, the margins or rates are much higher. So we don't foresee any issues regarding that substitution process.

Walter Bayly, CEO

Cesar, go ahead with the second part, please.

Cesar Rios, CFO

Yes. Doing, I would say, a static flexibility analysis of 100 basis points of increase in rates along the curve will mean PEN200 million additional margins on a consolidated basis.

Andres Soto, Analyst

Perfect. And what is the timeline, Cesar, for that? How long does it take for your assets to reprice?

Cesar Rios, CFO

The whole period is longer, but what I'm giving you is the one-year sensitivity. If you start talking now and you move 100 basis points, what is the PEN200 million? It's the net result in our books.

Andres Soto, Analyst

Perfect. Thank you so much for that. And my second question is regarding digital transformation and the investment that you guys are planning which is stepping up this quarter and probably next one. I would like to understand if this is something that will continue into 2022 and therefore we should expect efficiency to remain at the current level.

Walter Bayly, CEO

Thank you. Gianfranco, go ahead.

Gianfranco Ferrari, Deputy CEO

Yes, the answer is yes. We will definitely keep investing and may accelerate our investments in digital transformation as we see results. As you all know, the digital investments, particularly in new ventures, are not cash flow positive in the short term. A prime example is Yape; as Cesar mentioned, we already have over 7 million clients. We do not anticipate that it will be cash flow positive next year, and perhaps by the end of 2023 or in 2024, it still won’t be. So yes, we will continue to invest in the ventures we believe are successful and essential for remaining competitive and shaping the new digital market where we operate.

Andres Soto, Analyst

And to Walter and Alvaro, thank you so much for all these years, and good luck to you.

Walter Bayly, CEO

Thank you.

Operator, Operator

Our next question comes from Yuri Fernandes with J.P. Morgan.

Yuri Fernandes, Analyst

And congratulations on the results. I have a question regarding dividends. I guess, the historical payout when we do the adjustment for the outstanding shares in the past years would be around 50% to 60%, right? And as you said, maybe low growth will not be there in 2022. I mean, it's going to be the 5% to 7% you just mentioned. And your ROEs, it's likely they will be in a more normalized level. So my question is, do you plan to increase the payout? Can you share some color on that or no? Maybe you say, Yuri, maybe we want to create more capital, so maybe in 2023 we want to grow more. So what is the view for capital allocation?

Walter Bayly, CEO

Yes. Good question. Thank you, Yuri. The answer is increased dividend payout. We do not need additional capital. We have the levels of capital that we think are appropriate. And so as we have higher return on equity that exceeds obviously the growth in risk-weighted assets, we will be distributing more dividends.

Operator, Operator

Our next question comes from Carlos Gomez Lopez with HSBC.

Carlos Gomez-Lopez, Analyst

I would also like to say thank you and goodbye to Alvaro and to Walter. In particular to Alvaro because he had a very, very tough job in the insurance business, and I think he did very well over there. So from the point of view of the analysts and investors, thank you very much. And Walter, I know you want to focus on the bank, but I have a policy question. We now have a new composition of the Central Bank Board. You have mentioned in the past how this could be determinant as to the policies there. And obviously, the interest rate caps are very important for the banking sector now. Do you expect any movement here over the next couple of years? Or do you think that we have seen what we are going to see in terms of caps?

Walter Bayly, CEO

We should wait, thank you, Carlos, for your question. We expect to first see the complete Board of Governors of the Central Bank before any changes. Only three members have changed, and there are three more coming from Congress. However, even with that uncertainty, the answer is no. We do not anticipate any changes in the interest rate caps for the next year or two.

Gianfranco Ferrari, Deputy CEO

Carlos, this is Gianfranco, just to complement Walter's comment; it is clear that the rates in Peru are where they are because there are a lot of costs to assess risk because of the level of informality in the economy. I would say that the current authorities at both the Central Bank and both the Superintendencies are very, very aware of the negative impact that caps on rates have on getting financial inclusion.

Carlos Gomez-Lopez, Analyst

Sorry, if I can follow up because, yes, I think the Congress is aware of the impact on financial inclusion. That would also extend to the discussion around the pension funds, and we have not heard much over the last few months. But obviously, that's a debate that will come back. You are pessimistic as you were a few months ago regarding the future of the private pension system?

Gianfranco Ferrari, Deputy CEO

Okay. Regarding the pension system, as you know, the government has called for a reform, and a commission has been formed; they will study and review. There’s been a lot of work that has been done. As I have mentioned in the past, from Credicorp’s perspective, it is more important that the country ends up with a pension system that works, and it’s financially sustainable, and fiscally sustainable over time, more than what happens with Prima as a very good contributor to the profits of Credicorp. I would expect that the industry is going to change completely. Our likely scenario is that, yes, we will have a smaller contribution from Prima to Credicorp going forward. So our vision has not changed.

Operator, Operator

Our next question comes from Jose Wanka with CitiGroup.

Jose Wanka, Analyst

I would like to follow up on which segments you anticipate will experience more dynamic loan growth in the coming year. You mentioned that credit card and retail might be more active, but I am curious about how this aligns with the recent weaker growth observed in credit cards, despite improvements in the economy and overall COVID conditions. How should we view retail growth moving forward based on current data? Additionally, considering that we are expanding in a particularly riskier segment, what implications might this have for core and non-performing loans?

Walter Bayly, CEO

Sure. I'll give you a first comment and then Gianfranco, maybe you can complement. Actually, what I was thinking when I mentioned retail, I was really thinking a lot about mortgages, in my mind, and I should have been clear on that. So I think that but I think there is an appetite. I feel there is an appetite for the low end of the consumer market, and that includes consumer loans, more than actual credit card portfolio. Our credit card portfolio, as you probably know, is more focused on the bit of the upper end of the consumers. But I think there continues to be a good dynamic on the low end of the consumer, probably installment loans, particularly as we utilize more data coming from all the new Yape customers and our ability to distribute loans via digital channels that lowers the distribution costs and make smaller loans more economically viable for us. So installment loans and mortgages are where I see nice demand going forward. Gianfranco, maybe you could...

Gianfranco Ferrari, Deputy CEO

Just specifically on credit cards, if you see the overall market, the market due to COVID, Frank, like for the outstanding balances shrunk by 30% to 35%, mostly driven by big-ticket items that, obviously, because of the situation, like, I don’t know, travel, tourism, appliances, and so on. So even though the economic outlook is not positive, we do expect that somehow that demand will come back. So that’s the main reason. On top of what Walter said, that’s the main reason why we see opportunities for growth in that product specifically.

Operator, Operator

This concludes our question-and-answer session. I'd like to turn the conference back to Mr. Walter Bailey for closing remarks.

Walter Bayly, CEO

Thank you. Before we conclude this call, I would like to say a few words. As Luis has generally mentioned, I will be retiring from Credicorp by year-end after almost 29 years of being part of this company. Thus, this will be the last quarterly conference call that I will be participating in. I joined BCP in 1993 before Credicorp was formed and was very much part of the team that worked on the exchange of shares of BCP, Atlantic Security in Pacifico. By the way, that is the origin of the letter’s BAP, thus Credicorp was created. Since then, I have been in several roles and positions being part of Credicorp senior management and have participated actively in almost all major strategic decisions. With Credicorp, I have gone through all the possible business and political cycles, and we have managed to steer the company to always emerge solid, healthy, and profitable and focus on delivering value to customers and society. Undoubtedly, along the way, I have made my share of mistakes and made decisions that proved to be the wrong ones. This, of course, is very much part of what being a manager is all about. As an advice and lesson to those taking the leadership, having the clarity and humility to recognize those mistakes is what allows us to grow as an organization and individuals. I would like to be very emphatic in thanking the members of Credicorp’s team that have worked with me over the years. It is this wonderful and talented team that always brought the best in me. Their support has always been unconditional, even under the most difficult and strange situations. I know that some of you are listening today. Thank you again. You have made it all worthwhile. To the international investment community, thank you as well for your support, understanding, and patience. I took the role of being the main spokesperson for Credicorp approximately 15 years ago and have always enjoyed the dialogue challenged and challenged by our investors and analysts. I am confident that Credicorp is in a very solid position, having fully recovered its profitability after the very dramatic impact of COVID in our markets, particularly in Peru. Going forward, I believe the future of Credicorp changes on three very fundamental issues: one, the continuation and maintenance of prudent macroeconomic policies, both on the fiscal and monetary front in the countries in which we operate. In this regard, I believe it is time to shift the conversation around Credicorp away from politics. Over the past couple of months, the market has been rightly so, very concerned with the political scenario. What we have seen in the last 100 days is probably a good indicator of the next couple of years, namely, decent macroeconomic policies, continued political noise, limited capacity to execute government policies. Thus, I reiterate the recommendation given to us by one of our long-term institutional investors in that it is time to shift away from politics and focus on fundamentals. The other two key factors that I believe will determine Credicorp’s future depend on management. And they are the successful outcome of our multiple digital initiatives relative to the day-to-day interactions with our customers as well as the escalation of the various disruptive initiatives. The combination of both sets of initiatives will ensure the continuation of our customer preference as well as the cost reduction that will allow us to successfully compete with alternative business models. And last but not least, our wholehearted embrace of our very well-articulated ESG initiatives. The talent and commitment of the team that is taking leadership gives me tremendous confidence in the continued success of Credicorp. Thank you all very much. And with this, we conclude the call.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.