Earnings Call Transcript - BCH Q3 2024

Operator, Operator

Good afternoon and welcome to Banco de Chile's Third Quarter 2024 Results Conference Call. If you need a copy of the management financial review, it is available on the company's website. With us today, we have Mr. Rodrigo Aravena, Chief Economist and Institutional Relations Officer; Mr. Pablo Mejia, Head of Investor Relations; and Daniel Galarce, Head of Financial Control and Capital. Before we begin, I would like to remind you that this call is being recorded and the information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements. I will now pass the call over to Mr. Rodrigo Aravena. Please go ahead, sir.

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

Good afternoon everyone. Thanks for joining this conference call today. We are pleased to present the performance of Banco de Chile during the third quarter of this year. Once again, our bank demonstrated its unquestionable leadership and consistency over time. Some of the main achievements of this period include: we continue leading the industry in profitability after posting a net income of CLP288 billion, equivalent to 21.3% return on average equity in the quarter and 22.8% year-to-date. We also outperform our peers in terms of NIM, fees and operating margins. In addition, our customer income continues to grow on an annual basis, primarily stirred by income from loans on the grounds of improved lending spread. Despite the low industry business growth environment, we grew faster than the market in loans, gaining market share in all segments in line with our main long-term strategic goals. We also had positive advances on efficiency, posting a cost-to-income ratio of 36.5% year-to-date, outperforming our peers and our long-term target. On the non-financial side, we were distinguished by external entities due to our excellent service quality and corporate reputation and we also continue carrying out several initiatives aligned with our strategic pillars, which will be presented later in this presentation. As usual, we will begin this webcast with a brief analysis of the macro environment. Please go to Slide number 3. The Chilean economy continues posting signs of recovery as you can see in the chart on the left of this slide. In the second quarter, the GDP increased by 1.6% year-on-year following the 2.5% year-on-year expansion observed in the previous quarter. It's important to mention that in 2023 the economy grew only 0.2% as a consequence of the normalization after the several imbalances we experienced during the pandemic. The local recovery has mostly been attributable to the greater contribution in net exports as the chart on the top right displays. As of June 2024, the trade balance posted a surplus of $17 billion in the last 12 months, a figure 43% higher compared to the balance seen last year. This trend continued in the third quarter as the last 12 months trade balance surplus further improved to $20 billion, increasing 51% year-on-year. In a breakdown of domestic demand, consumption continues to show a slight recovery. In the second quarter, it expanded by 0.8% year-on-year after posting 1.5% growth in the previous three months. This trend has been consistent with the behavior seen in the labor market; the unemployment rate has been hovering around 8.7% with higher real wages. Nevertheless, gross investment remains subdued as it has contracted by 6.1% and 4.1% year-on-year in the first quarter and second quarter of 2024 respectively. Available information from the third quarter suggests that the recovery is underway. The GDP expanded by 2.2% year-on-year and 2.1% year-to-date. However, the breakdown from domestic demand still reflects mixed trends. While several consumption-related figures, such as retail sales and services, continue to improve, the main investment indicators, such as capital goods, imports, and real estate indicators, continue suggesting weak investment, at least in the short term. Now I’d like to move to our analysis of prices and rates. Please go to Slide Number 4. The headline inflation rate continues hovering around the upper bound of the Central Bank target. As seen in the left chart, the annual inflation rate in September was 4.1%, in line with the 4.2% year-on-year posted in June. The persistence of the CPI has mostly been attributable to energy, which increased by 9.6% year-on-year in September due to adjustments in electricity bills, adjustments that, according to the Central Bank estimates, could raise the CPI by 150 basis points between mid-2024 and mid-2025. Services have also contributed to higher inflation as they rose by 4.9% year-on-year in September. On a sequential basis, the CPI increased by 1.1% in the third quarter after rising by 0.7% in the previous quarter. The downward trend in inflation has allowed the Central Bank to continue reducing the interest rate. In its latest monetary policy meeting held in October, the board decided to cut the interest rate by 25 basis points to 5.25%, accumulating a total reduction of 600 basis points since the beginning of the current easing cycle in July of 2023. Chile has been one of the countries with the most aggressive reduction in interest rates over the last year. In fact, the spread with the upper bound of the FED funds in the United States has narrowed from 575 basis points one year ago to only 25 basis points today. This situation has driven a weakening in the Chilean peso in multilateral terms. Now, I’d like to present our baseline scenario for this year. Please go to the next slide, Number 5. We expect the economy to continue posting signs of recovery. In this environment, we foresee an increase in GDP growth from 0.2% in 2023 to 2.3% this year. This expansion would be driven by an increase of around 6% in exports, positively influenced by external factors such as copper prices and the improved dynamism of our trade partners. Consumption is also expected to perform better relative to 2023, as a consequence of lower interest rates and the partial recovery in employment. On the opposite, we expect investment to continue in negative territory this year as uncertainties surrounding the track of reforms in diverse economic fields have continued to drive and delay investment decisions, coupled with lengthy approval processes in the case of large-scale projects. Inflation expectations have increased this year mainly due to the unexpected rise in energy bills as I mentioned earlier in this presentation. Due to this, we expect the CPI to post a 4.5% increase this year in an environment where the central bank will likely maintain a contractionary monetary policy; since the interest rate would end the year at 5%. In the table of this slide, you can see a summary of our estimates. While the chart on the right clearly shows the upward trend in consensus forecasts for both interest rates and inflation. It is worth mentioning that these forecasts are subject to several risks. The evolution of the global environment is extremely important for Chile, given its deep integration into the rest of the world. Factors such as the GDP growth of China and the U.S., the potential escalation of armed conflicts in the Middle East, Eastern Europe, and uncertainties related to the change of government in the United States are worth monitoring. On the local side, it's important to analyze the evolution of inflation, especially considering potential second-round effects after the rise in electricity bills, as well as leading indicators of gross investment since they are the main concern for local growth. Finally, monitoring discussions in the political agenda is also relevant, given discussions related to pensions and taxes in an environment marked by several elections. Before moving to the bank, I'd like to refer to some trends in the banking sector briefly. Please go to Slide number 6. The banking industry profitability remains strong even though we are in a slow economic environment. As you can see in the chart on the top left, return on average equity reached 15.8% this quarter, above the 12.7% posted in the same period last year. This rise was due to greater operating income, lower cost of risk related to the release of additional provision, as well as greater recovery of loan write-offs. This was partially offset by a rise in operating expenses related to personnel and administrative expenses. In terms of volumes, as you can see in the chart on the right, the weak economic environment has maintained loan growth at low levels for the industry, expanding only 2% year-on-year. Mortgage loans have been the main driver of growth, up 6.7% year-on-year, and consumer loans increased 3% in the same period. However, commercial loans are taking a hit, dropping 1.2% year-on-year. This has resulted in a change of mix in the portfolio, where today mortgage represents 36% of total loans, up from 34% one year ago. Commercial loans have dropped from representing 54% to 52% of the total in the same period, while the consumer portfolio has remained relatively stable. Consequently, due to both the weak economy and the normalization of customer liquidity, NPLs have consistently increased to 2.5%, and the coverage ratio has decreased to 1.5 times. Despite these weaker business results, we should begin to see greater activity in line with the expected improvement in GDP and the reduction of interest rates. Now, I’d like to pass the call to Pablo who will go into more detail about Banco de Chile's advances and financial performance.

Pablo Mejia, Head of Investor Relations

Thank you, Rodrigo. Let’s begin by reviewing our strategic progress. Please go to Slide number 8. We are steadily achieving strong results in executing our strategy, which emphasizes customer satisfaction, efficiency, and long-term sustainability. This strategy is driven by six main priorities, illustrated at the center of this slide. On the right are our mid-term targets. Our primary goal is to lead as the most profitable bank among our peers. In summary, this translates into a long-term return on average equity of around 18%, assuming a positively sloped yield curve and that the Central Bank's inflation rate targets are met. Regarding cost to income, our performance continues to exceed our long-term targets. While this is partly due to robust top-line growth that has stemmed from both increased revenue and extraordinary FX that have temporarily remained after the pandemic, we are confident that our productivity levels will continue to improve through current and upcoming efficiency initiatives, which we’ll discuss later in the presentation. For market share, our goal is to lead in commercial and consumer loans, as well as demand deposits in local currency. In this regard, over the year, we have gained market share in high-margin lending products such as consumer loans by maintaining an adequate risk-return relationship based on responsible credit risk management practices. Additionally, we have regained leadership in local currency demand deposits, which has been a traditional competitive advantage for us, providing us not only with competitive funding but also with a very stable funding source. Lastly, we remain committed to delivering exceptional customer experience and positively impacting society. This commitment is reflected in our high Net Promoter Scores and a corporate reputation that ranks among the top three in Chile, achieved through evaluations from reputable independent firms. In the next slide, we will go over some advances in digital banking, efficiency, and ESG. To maintain our leading position, we continue implementing new innovations in digital banking. This quarter, we added new functionalities in our main banking app, including notifications about benefits, transaction blocking, and profile updates, providing users greater control and real-time information about their accounts and transactions. We also introduced a mortgage loan credit simulator on our website to simplify the home loan process and launched a digital account with a credit card option tailored for university students. Finally, we implemented tools to enhance the digital experience for companies, ensuring that they can seamlessly manage their finances through our apps and web pages. Our constant efforts in digital banking have contributed to a substantial increase in our digital client base, which grew 36% year-on-year, reflecting the positive impact of our strategy. Regarding efficiency and productivity, we continue efforts to optimize our branch footprint, closing five locations this quarter, reducing 10% of the total network in the last 12 months. Also, the higher adoption of digital processes allowed us to achieve significant efficiencies in investment and commercial support functions. It's important to note that the gradual approach is the key element to ensuring that efficiency actions do not impact customer satisfaction. We have also made significant progress in transforming our retail service models, increasing technology adoption at branches. Additionally, during the quarter, support areas have streamlined layers and dependencies, enabling synergies and agility, including optimizations at subsidiaries. By executing these initiatives and leveraging IT CapEx, we are confident that we are well positioned to maintain our leadership in the financial sector. In terms of ESG matters, we have actively participated in volunteer programs, including beach and river cleanups, removing over 6 tons of waste to help preserve the environment. Aligned with our commitment to entrepreneurship, we continued supporting SMEs, maintaining our market-leading position in the FOGAPE Chile Apoya program. We also launched the ninth edition of the Entrepreneurial Challenge to encourage businesses that create a positive and innovative impact on society. Finally, thanks to a dedicated team, strong reputation, and best practices in talent management, we were recognized by MERCO as the best bank in attracting and retaining talent for the 11th consecutive year. Please turn to Slide 11, so we can discuss the key highlights of our financial results for the quarter. I am pleased to report that we delivered another quarter of solid results, thus continuing our strong performance track record. Our net income reached an impressive CLP288 billion, up 11% compared to the same period last year. This translates into a return on average equity of 21.3%, a clear indicator of our efficient use of capital. Moreover, when we benchmark our results against our peers, we continue to outperform across the board. As demonstrated in the charts on the right, we have maintained a wide margin year-to-date in net income and sustained a superior return on average equity, further reinforcing our competitive advantage in the market. These metrics illustrate our ongoing leadership in the sector and the consistent execution of our strategic initiatives. Please turn to Slide 12. In terms of operating revenues, we continue posting excellent results, growing 6% year-on-year fueled by an 8% rise in customer income. This was partially offset by a 3% reduction in non-customer income, primarily driven by the end of the FCIC program at the industry level, which represented a low-cost funding source. In turn, improved income from the trading investment portfolio due to favorable shifts in interest rates allowed us to partly mitigate this impact. The annual rise in customer income is explained by an expansion in revenues from loans equal to CLP20 billion on an annual basis, a rise in the contribution of deposits by CLP11 billion, as well as an increase in fees by CLP13 billion. In terms of income from loans, the consumer portfolio was the main driver of growth. Specifically, our focus on profitable growth has gradually allowed us to increase average lending spreads during the period by 13 basis points overall and 128 basis points in consumer loans, due to both the maturity of former FOGAPE operations and improved consumer originations. This was further boosted by a rise of 4.3% year-on-year in average consumer loan volumes. In terms of funding, we have also seen a higher contribution from deposits due to an expansion in margins from time deposits, thanks to a proactive and targeted pricing strategy, as well as a moderate increase in demand deposit volumes. Finally, the yearly rise of 10% in net fees was mainly driven by two business areas. First, revenues from mutual funds and investment fund management grew by 23% year-on-year, driven by a significant expansion in assets under management that rose 37% year-on-year. Second, fees from transactional services posted an annual rise of 15%, primarily due to a positive effect from the appreciation of the Chilean peso against the dollar on our credit card loyalty program and, to a lesser extent, a rise in usage rates from both credit and debit cards thanks to campaigns and attractive benefits that incentivize customers to use our cards actively. This allowed us to reduce the impact of lower interchange fees that the industry experienced due to new regulations. Finally, fees from cash management services were also positively influenced by revised fares associated with commissions for interbank transfers carried out at the industry level. The chart to the right shows how we perform compared to our competitors. This quarter, we continued outperforming all of our peers in the main profitability ratios. Net interest margin reached a notable 4.6% in the third quarter of 2024. Fee margins posted 1.3%, and the total operating margin also remained ahead of the pack with a level of 6.4% for the quarter. This performance is a result of our well-executed business strategy and our commitment to offering enhanced value propositions to customers across lending and non-lending products and services. This has proven effective, allowing us to adapt to changing market dynamics. Please turn to Slide 13. The breakdown of our loan portfolio is strategically balanced across economic sectors, giving us stability in our revenue-generating capacity. Our total retail loan portfolio represents 65% of the total loan book, while wholesale commercial loans reach 35% of the total loan portfolio. Also, as you can see on the chart on the bottom right, total commercial loans by economic sector are well diversified. The weak dynamism in the Chilean economy has affected loan growth for the industry as a whole. Lack of investment, as well as low business and consumer confidence, has impacted growth. As a result, we see a moderate improvement in total loan growth with an expansion of 3.9% year-on-year and 1.6% quarter-on-quarter. We compare well against the industry figure of 1.7%. Most of this growth has come from the mortgage loan book and more recently from the consumer sector.

Unidentified Analyst, Analyst

Thank you so much.

Daniel Galarce, Head of Financial Control and Capital

You're all welcome.

Operator, Operator

Thank you very much. Next question comes from Mr. Yuri Fernandes from JPMorgan. Please go ahead.

Yuri Fernandes, Analyst

Hey guys, good morning. Good afternoon. Just some color on loan growth for 2025, I remember in the previous call you mentioned that politics could be affecting some wholesale demand. I know you still have elections next year for president, but at least the regional elections, I guess it's a little bit clearer now. So just asking if you are seeing an uptick in volumes. And if you can provide any color on the outlook for the next year for loan growth. Thank you.

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

Hi Yuri, thank you very much for the question. This is Rodrigo Aravena. Yes, our focus for growth in the industry for the next year is around 5% in nominal terms. There are different aspects to consider regarding that focus. First of all, we're expecting a return from the current level of activity towards more sustainable growth in terms of electricity consumption and GDP. In the past, we used to see loan growth of around two times the growth of GDP. Today, we think that given the state of development of Chile, banking penetration in the economy, etc., it's more reasonable to expect elasticity or multiplier around 1.5 times in the very long term. For the next year, we're expecting a normalization with positive growth in different segments in real terms. When we consider the inflation expectation for the next year, which is 3.5%, it's reasonable to expect loan growth around 5%, something like that, for the next year. Looking forward, we have different forces. As you mentioned, politics will be an important aspect to monitor. The elections held two weeks ago showed an important shift in the support of different political coalitions in the country. When we compare this to the elections held four years ago, there was great support for parties from the center-right and right-wing coalitions, which represents an important change in terms of the political support for the country. Historically, municipal elections have been a very important leading indicator for congressional elections. It's essential to remember that next year, in Chile, there will be elections for the presidency, the Senate, and half of the lower house as well. So given the results of the municipal elections, it's reasonable to expect some shift in the composition of Congress for the next year. Nevertheless, we also have to remember that Chile is a very urban economy. In fact, Chile is the most integrated country into the rest of the world. Hence, the evolution of the global economy, especially considering the perspectives for China, the United States, overpricing, and long-term interest rates, is especially important. Today, there is a consensus regarding the probability of higher interest rates overseas next year, which could reduce the external contribution from our main partner, effectively using the engine of growth for the country. So where we can draw conclusions for the next year in the local environment, we can rule out a potential improvement in business confidence next year. However, we have to be especially concerned with the perspectives for the global economy given the openness of the Chilean economy. Overall, we expect a normalization of results in 2025 with greater dynamism in loan activity, but at the same time, a lower contribution from inflation and interest rates.

Yuri Fernandes, Analyst

No, that's very clear, Rodrigo. If I could just follow up on this lower contribution from inflation. Can't we consider factors like higher global tariffs and a stronger dollar? Perhaps the solution is more resilient than we anticipate, and we could earn more from it?

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

Well, in terms of inflation today, we are aware of the asset risks for inflation, considering some sticky prices and persistence of inflation in Chile. We have several prices denominated in U.S. dollars. Therefore, the past inflation is important in terms of inflation expectations. We must pay special attention to the evolution of the exchange rate. The pass-through in Chile is between 10% and 15%, which means that a 10% weakening of the Chilean peso would raise inflation by approximately 100 basis points. However, it's not very likely that inflation next year will be higher compared to this year's inflation. It's quite likely that inflation by the end of this year will be a figure considering the number released this morning—it’s likely that the inflation rate will be around 4.6% or 4.7%. Also, considering the upside risk for inflation next year, it's not likely that inflation in 2025 will exceed the inflation we expect for this year. We're aware of the possible upward risks, but even considering these factors, we still expect next year's inflation rates to be lower than those we anticipate for 2024.

Yuri Fernandes, Analyst

Super clear. Thank you very much, Rodrigo.

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

You're welcome. Thank you.

Operator, Operator

Thank you very much. Our next question comes from Mr. Andres Soto from Santander. Please go ahead.

Andres Soto, Analyst

Good morning, Rodrigo, Pablo. Thank you for the presentation. My question is regarding your coverage level. You have a 262% NPL coverage. This is not only significantly above your peers but also above your historical levels. What do you see as a normalized coverage level given that some of the negative events that you were expecting to happen actually didn't materialize and you are now sharing a more optimistic outlook for the economy?

Pablo Mejia, Head of Investor Relations

Hi Andres. Yes, so today we have a very good level of coverage, as you mentioned, higher than we've had in the past. In the past, this level has hovered well below this figure, closer to 200, slightly below that. The result, maybe to clarify for everyone, the result of these additional provisions was the permanent implementation of our prudent policies to take into account what was happening over the last four or five years. Due to various events and inconsistencies during the historically low levels of non-performing loans that occurred during the pandemic, uncertainties generated by the recession in Chile, as well as institutional and political uncertainty in Chile led us to increase coverage levels through the use of additional provisions, which are something the board has to implement. Considering all of these factors, we can't rule out that the level that we have today based on these uncertainties is less than it was before, hence this could result in a release of a portion of these additional provisions in the future. However, the triggers for these timings haven't been defined yet. It's important to understand that we still need to approach these matters with caution based on what is occurring in Chile.

Andres Soto, Analyst

Thank you, Pablo. When you look at the possibility of releasing some of those provisions, would you imagine that being a gradual process, and therefore we should assume Banco de Chile will deliver very low levels of cost of risk over the next few years, or will it be more of a one-off process and, at some point, we can expect an extraordinary dividend to be paid out of that?

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

As I mentioned, the triggers and the definitions of how this would evolve and when have not been discussed or implemented. It's something that the board is evaluating and considering for the future.

Andres Soto, Analyst

Understood. Talking about asset quality and cost of risk, do you believe that for the system as a whole we are reaching an inflection point and we should see improvement? Or what are the trends you are forecasting for asset quality for the system? I know that you have a very good level, but for the system as a whole, what will be the trigger for asset quality to improve?

Pablo Mejia, Head of Investor Relations

I think there are many challenges that Chile is facing and at certain points, things are getting better. The current levels of inflation are a negative factor because if we look at different times in history when inflation has been higher, closer to the periods of 2007, during the pandemic, which was a special case, historically with higher inflation, it negatively affects the purchasing power of individuals, which can impact the economy and payment behavior. Therefore, it’s something to consider as it evolves in the future. While we've seen a plateauing, probably in the medium term, as the economy improves, we should see improvement. However, there are uncertainties based on the current level of inflation and how this will continue to affect households in the future.

Andres Soto, Analyst

Got it. Thank you, Pablo.

Pablo Mejia, Head of Investor Relations

Thank you.

Operator, Operator

Thank you very much. It looks like we have no further questions at this point. I'll be passing the line back to the management team for concluding remarks.

Pablo Mejia, Head of Investor Relations

Thanks everyone for joining the call, and we look forward to speaking with you for our year-end results.

Operator, Operator

Thank you very much. This concludes today's conference call. We'll now be closing all the lines. Thank you and goodbye.