Earnings Call Transcript - BCH Q1 2025

Operator, Operator

Good afternoon, and welcome to Banco de Chile's First Quarter 2025 Results Conference Call. If you need a copy of the financial management review, it is available on the company's website. Today with us, 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 & 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 turn the call over to Mr. Rodrigo Aravena. Please go ahead.

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

Good afternoon, everyone. Thank you very much for joining this conference call. As usual, today, we will review the main results and advances in our strategic project during the first quarter of this year. Once again, our bank has affirmed its strong position in the Chilean banking industry, reaffirming its leadership in different areas. In the quarter, the net income was CLP 329 billion, surpassing our peers and achieving an ROAE of 23%. As we will see later in this conference call, these outstanding results were explained by strong margins, improved asset quality and enhanced efficiency levels. This performance becomes particularly important given the increasing uncertainty of the macroeconomic environment due to the revised foreign trade approach adopted by the U.S. administration, which could likely reduce the global and even local economic growth in the future. Therefore, our solid fundamentals such as asset quality, a large amount of additional provisions and a strong capital base are undoubtedly aspects that generate even greater differentiation for us, not only in Chile but also at the regional level. Before discussing in detail the financial results of our bank, I'd like to share with you our analysis of the current macro environment. Please go to Slide #3. The Chilean economy has shown a recovery in recent quarters. As can be seen in the graph on the left of this slide, the activity posted an important increase in the second half of 2024 with a peak in the fourth quarter, when the economy grew by 4%. As a result, the country achieved an above-expectations expansion of 2.6% for the year. The breakdown of the figure, as seen in the top right chart, shows that domestic demand, reflected in the strong rise in the commerce sector, was one of the main drivers of greater dynamism. Different factors contributed to this, such as the lagged effect of interest rate cuts, the recovery of waged employment and the temporary effect of foreign purchases in Chile. In addition to these figures, several leading indicators, such as imports of capital and consumer goods, shown in the bottom-right chart, are consistent with the existence of favorable expectations regarding domestic demand, at least in the short term, if external risks are set aside. Please go to Slide 4 to analyze the evolution of inflation and interest rates. Inflation has remained above the Central Bank's target of 3% since late 2020, as shown in the graph on the left. In March, annual inflation was 4.9%, a figure that although higher than the 4.5% recorded at the end of last year and the 3.7% seen a year ago, is important to consider the figure posted this year was affected by some temporary factors. Among them, the rise in energy prices, which posted a 14.2% year-on-year increase, which, according to Central Bank estimates, has contributed almost 130 basis points to annual inflation. Additionally, inflation of tradable goods went up by 5.2% year-on-year, influenced by the weakening of the Chilean peso in 2024. Sequentially, inflation rose by 2% in the first quarter of the year. However, as shown in the chart, the CPI variation, excluding volatiles, is below the change in the headline measure, reflecting the existence of more moderate pressures at the core level. This reaffirms the fact that inflation has been driven by specific factors, particularly over the last quarters. Although the recent evolution of inflation has led the Central Bank to keep the reference rate at 5% in the first quarter, it's important to consider that the Chilean overnight rate has dropped the most globally, from the peak of 11.25% in 2023 to the current figure, which, however, remains above neutral levels, between 4% and 4.5%. The path followed by the reference rate has resulted in a steepened yield curve, as shown in the bottom-right chart, measured as the difference between the 10-year sovereign rate and the overnight rate in Chilean pesos, which should have a positive effect on banking results, as bank liabilities typically reprice faster than assets due to the duration gap. In this regard, the yield curve is expected to become more positively sloped as the monetary policy rate converges to neutral levels by the end of this year. Notwithstanding the positive trends seen in the Chilean economy over the last quarters, the recent and abrupt change in global trade conditions is something we must take into consideration, especially given the high integration of the Chilean economy with the rest of the world. However, despite the external risks, Chile has some differentiating strengths that could partially mitigate the potential impact of constrained global trade. Please go to Slide #5 to analyze them. Although Chile is one of the most open economies in the region, it has a well-diversified export basket in terms of destinations. As can be seen in the top-right chart, Chile has significant integration with China, a country that represents around 40% of the country's total shipments. If other Asian countries are considered, this region represents in total around 60% of Chilean exports. The U.S. economy, in turn, represents 16% of Chile's total export. It's also important to mention exemptions for some relevant Chilean products, such as copper, as well as lithium and wood derivatives, as shown in the right graph. Thus, the effective tariff rate on Chilean exports is lower than the 10% rate recently imposed by the U.S. administration. Another aspect to consider is the room to implement countercyclical measures in the event of a recession. Along with the normalization of inflation, which has allowed interest rate cuts by the Central Bank, Chile has also greater capacity than other countries in the region to implement fiscal policy measures based on lower debt levels and interest rate burdens, as shown in the bottom-right chart. The existence of better fundamentals has been recognized globally. As such, the value of risky financial assets has been less affected in Chile when compared to other comparable countries. Likewise, it's worth highlighting, for instance, that the value of the peso has been less affected than other currencies, as the bottom-left chart shows. Now I'd like to present our base scenario for the year 2025. Please go to Slide 6. We expect GDP to expand by 2% in 2025. This figure has several elements to consider. First, it represents less dynamism than in 2024, partly due to the expected slowdown in the global economy and further deceleration of some of Chile's trading partners. The recovery in domestic demand would be the driver for GDP growth this year, which would offset a slowdown in exports. This situation would result in a slight decline in headline inflation that would end up the year below 4%. However, this forecast assumes neither a significant rebound in external inflation nor exchange rate depreciation for the rest of the year. Under these circumstances, the Central Bank would reduce the interest rate to a neutral level of around 4.25%. Finally, it's important to take into consideration the higher uncertainty we face as well as the downside risk in terms of growth mainly due to global factors. Locally, a source of attention will be the upcoming presidential and parliamentary elections in November this year. Before analyzing the bank's results in detail, I'd like to share a brief analysis of trends in the banking industry. Please go to Slide 7 to discuss it. This quarter, return on average equity for the Chilean banking system was 16.5%, which is slightly higher than both the previous quarter and the last year as depicted in the top-left graph. This consistent profitability can be attributed to several factors, including effective cost control, diversified income streams and stabilizing market conditions. Despite global economic hurdles, financial institutions have demonstrated resilience and adaptability in a dynamic landscape. Furthermore, technological and digital advancements are optimizing operations, cutting costs and enhancing customer experience, thereby positively impacting overall financial performance. Regarding business volumes, as shown by the chart on the right, Chile's improved economic performance has not resulted in significant loan growth. Loans increased by 2.6% year-on-year. Mortgages were the primary contributor to this growth, rising by 6.3% year-on-year, while consumer loans increased by 5.1% during the same period. Commercially, commercial loans did not experience any growth in nominal terms. Weak growth in commercial loans has resulted in a change in the portfolio composition compared to pre-pandemic levels. Currently, as shown in the chart on the bottom-left, mortgages constitute 36% of total loans, up from 29% in 2019. During the same period, commercial loans have reduced from 56% to 52%, and the consumer portfolio has decreased from 15% to 12%. This shift in mix due to weak demand for consumer and commercial loans led banks to maintain lower-risk portfolios, preventing a significant rise in NPLs as shown in the chart on the bottom-right. Next, Pablo will share information regarding Banco de Chile's development and financial results.

Pablo Ricci, Head of Investor Relations

Thank you, Rodrigo. Let's begin by turning to Slide #9, which provides a comprehensive view of our strategic framework and midterm targets. Together, they define our road map for sustainable value creation. On the left side of the slide is our strategy, structured around three key components: our strategic plan; our strategic pillars; and our purpose. Our strategic plan is built on six areas aimed at transforming the way we operate and serve our customers. These initiatives are interconnected and designed to make us more agile, competitive and responsive to the evolving needs of our clients. Supporting this plan are our strategic pillars, which guide us on how we execute our strategy with efficiency and productivity through collaboration and always with a customer-first mindset. These pillars ensure that our operations, culture and decision-making processes remain aligned with performance and innovation. And finally, at the center of our strategic plan and pillars is our purpose. We aim to support Chile's growth and its citizens and businesses, enhancing our competitive advantages through long-term trust and strong relationships. On the right side of the slide, our midterm targets show our strategic goals and commitment to measurable results. Return on average capital and reserves, we aim to be the leading bank among peers. Cost-to-income ratio, we're targeting a ratio below 42%, and we're currently operating at 36.1% outperforming expectations. This result not only is from a strong revenue generation but also disciplined cost management and strong operating income. Market share, our objective is clear, to lead in commercial loans, consumer loans and demand deposits in local currency. Currently, we are the leaders in demand deposits and hold second place in both commercial and consumer lending. I'd like to emphasize that we aim to reach these targets by growing responsibly in terms of credit risk. Net Promoter Score, we've exceeded our target of 73%, reaching 75.8% in March 2025. This reflects sustained efforts in improving customer experience through employee training, digital enhancements and better service models. Corporate reputation, according to the 2024 Merco ranking, we've reached top 2 amongst all companies in Chile, including banks surpassing our goal of being in the top 3. This recognition is driven by our broad engagement in social impact initiatives, including education, entrepreneurship and volunteerism, along with our commitment to ethical and responsible business practices. In summary, we're executing a strategy that is ambitious and disciplined with a focus on efficiency, customer satisfaction and sustainability. Our progress is measurable, our foundations are strong and we are confident in our ability to generate long-term value for our stakeholders. Please move to Slide 10, where we will go over our key business advances in the first quarter of 2025. We have continued advancing in initiatives to drive productivity across the entire organization. Functions from our subsidiaries are being centralized to the bank and some organizational structure is being continually refined. Additionally, we have sustained our efforts to streamline technology expenses in areas including data centers, cloud and telecommunications. These measures are expected not only to optimize costs but also to enhance our technological capabilities and support our long-term growth objectives. On the digital transformation front, we made many advances this quarter. First, we are proud to be strategically using AI tools. In fact, we've made available AI Copilot Chat across the entire organization. This important step forward in using AI is making our workdays more productive, secure and insightful. We also introduced new products and enhanced existing ones. To name a few, we launched a new credit card and microlending product for FAN customers as well as making changes to the Digital Student Plan to reach a broader university student audience. These and other advances have driven the expansion of our digital accounts achieving a 21% year-on-year growth in our FAN customer base. It's also important to note that this has not only expanded our presence in these segments, but it has also been relevant for increasing our financial inclusion in Banco de Chile. In addition to our progress in the FAN product, we advanced in improving other digital initiatives that are focused on internal processes. These changes have resulted in boosting our productivity by a staggering 35% year-on-year in current account originations. In line with our commercial initiatives, we launched new accounts for companies of Yuan, Yen and British pounds. These accounts offer diverse functionalities, including foreign exchange transactions and financing options for customers operating internationally. We also upgraded our personal banking credit products by introducing new preapproved credit lines and credit card limits, resulting in a 25% increase in the average number of these operations. New installment options were released for credit card balances, providing customers with more flexibility to pay their debts. Our constant innovation and commercial initiatives enable us to offer customers a wider range of product options, strengthening our relationship and enhancing our ability to meet their financial needs. In terms of ESG reporting, this quarter, we published our 2024 annual report, which covers our financial and sustainability performance and marked significant advances in meeting local and international standards, such as SASB and GRI. All of these initiatives position us to maintain our leadership in the banking industry and prepare us confidently to navigate future opportunities and challenges. Please turn to Slide 12 to begin our discussion on our results. We started 2025 with solid results of CLP 329 billion this quarter, equal to a return on average equity of 23.3%, as shown on the chart to the left. When compared to our peers, we outranked all of them in both market share and return on average assets, as shown on the charts to the right. Specifically, in market share, we achieved a 22.8% participation in net income and in return on average assets we reached 2.5%. Our robust financial performance underscores our enduring customer-centric approach and commitment to establishing a sustainable bank as evidenced by consistent increases in customer revenue, risk management and positive advances in cost control. In line with this expansion, our aspiration is to be the industry leader in profitability. Let's take a closer look at our operating income performance on the next slide, 13. We continue to demonstrate the strongest operating revenues in the industry, thanks to our superior business model and its clear resilience through market cycles. On the chart on the left, we see a consistent operating revenue growth quarter-over-quarter despite subdued business dynamism by totaling CLP 779 billion in the first quarter of 2025. This was composed of strong customer income amounting to CLP 617 billion, up 4.3% year-on-year, and noncustomer income that reached CLP 162 billion, below the CLP 188 billion recorded a year earlier. The decrease in noncustomer income was mainly caused by the maturity of FCIC funding from the Central Bank in the first half of 2025, which explains CLP 75 billion in higher revenues in the first quarter of 2024 when compared to the same period of 2025. This was partly offset by higher revenues from directional inflation index positions. This decline was partially offset by an annual rise of CLP 20 billion in the contribution of our structural UF-indexed net asset exposure that hedges our equity against inflation due to higher inflation that increased from 0.8% in the first quarter of '24 to 1.2% in the first quarter of '25 as well as larger UF GAP on the balance sheet. In terms of customer revenue, growth was driven by income from loans and fees that were up 7.2% and 14% year-on-year, respectively. The consumer loan book contributed to most of the loan revenue, which increased by adding CLP 9.8 billion due to higher lending spreads and a 3.5% annual rise in average loan balances. The remaining increase was fostered by improved lending spreads in both the commercial book and the residential mortgages, which resulted in further income by CLP 4.6 billion and CLP 2.4 billion, respectively. It's also worth noting that most of the growth in the commercial loan book was from SME loans and that lending spreads in the business unit are gradually returning to normal as FOGAPE loans continue to mature. Likewise, the SME banking unit managed to grow above 8% year-on-year in other than FOGAPE loans. As a result, our net interest margin reached 5% this quarter, significantly outperforming our peers. In turn, the increase in fee income was primarily conducted by transactional services and mutual fund management. Transactional services experienced a rise of CLP 12 billion, partly driven by a favorable exchange rate impact on fee expenses related to our credit card loyalty program due to the Chilean peso appreciating 4% against the U.S. dollar in the first quarter of 2025, compared to a depreciation of 12.3% in the first quarter of 2024. The remaining increase was due to a rise in credit and debit card transactions of 9.7% and 7.8%, respectively. Fees from mutual funds and investment funds management grew by 22.8% year-on-year. This growth was driven by an 18.4% increase in average balances of assets under management. And furthermore, stock brokerage and investment banking also posted increases in the year-on-year performance fueled by a rebound in the local stock market over the last months and particularly M&A transactions carried out in the local market. In terms of our fee margin over average interest earning assets, we are posting strong levels, as shown on the right side of this slide, with a 1.4% ratio as of the first quarter of '25, also above our peers. Our remarkable operating revenue performance is responsible for an impressive operating margin of 6.7% this quarter. This achievement is proof of our consistent business strategy and our ability to deliver enhanced value offerings to our premium customer base over time in both lending and non-lending products. As a result, we have established a solid track record in customer income regardless of economic conditions. Please turn to Slide 14 to take a deeper look at our loan portfolio performance for the first quarter of 2025. As shown on the left, total loans reached CLP 39 trillion, marking a 1.1% increase compared to the previous quarter and a 3.2% increase year-over-year. We expect this pace of growth to transition in the coming quarters to more normalized levels in line with the better economic figures that we are seeing. Generally, there's a lag of a few quarters when we start to see positive figures in the economy to translate into loan growth. In this regard, although loan growth multipliers to GDP will probably remain below average levels seen in the past decade, we believe the rebound foreseen in private investment this year and enhanced household consumption should drive more dynamism in commercial and consumer lending in coming quarters. In terms of composition, personal banking to commercial loan mix continues increasing. The retail portfolio drove loan growth. This book is comprised of individuals and SMEs, representing 65% of total loans, expanded 5.6%, while wholesale lending remained basically flat year-on-year. Specifically, mortgage loans led the rise, up 8.1% year-on-year, reaching CLP 13.5 trillion. Despite higher than pre-COVID interest rates, this segment has proven resilient with originations for new loans rising 12% year-on-year. Industry-wide, residential mortgage loans grew 6.3% year-on-year, allowing us to post market share gains rising from 15.3% to 15.6%. Consumer loans increased by 3.9% year-on-year to CLP 5.5 trillion. Although this growth is below historical levels, due to high interest rates and persistent unemployment, a gradual improvement is anticipated if the trade war does not escalate and affect the local economy. Commercial loans to SMEs reached CLP 5.2 trillion, up 3.7% year-on-year. This expansion has been negatively impacted by significant growth in prior periods in FOGAPE government-guaranteed loans that are amortizing at a high rate, offset by FOGAPE loans that have expanded at a rate of 8.2% year-on-year. On the other hand, commercial loans in the wholesale banking segment remained flat year-on-year. Originations in this segment offset the negative impact of exchange rates on foreign trade loans and lower demand for this product. When setting aside the potential effects of the trade war on both global and the local economy, we expect this segment to grow throughout the years on the grounds of expected reactivation in the private investment regardless of the lag between economic figures and demand for loans. Please turn to Slide 15 to discuss our competitive balance sheet structure. As depicted in the charts on the top-left, our assets and liability structure is solid. Our business strategy is primarily focused on commercial banking, with loans constituting 73% of total assets as of March 2025, while financial instruments represent only 10%. Also, I want to highlight that our held-to-maturity portfolio represents less than 2% of total assets. This is relevant because during the pandemic, we and most of our peers increased the level of these financial instruments which generally yield significantly lower than the current market rates, thus affecting net interest margins. On the liabilities side, deposits are the main source of funding, representing 56% of our assets. Within deposits, time deposits are the most relevant financing source on our balance sheet, followed by demand deposits, one of the most important competitive advantages that we have, as you can see on the chart to the right. Zero interest-bearing demand deposits funded 37% of our loans, significantly higher ratio than our peers and one of the drivers of our net interest margin advantage. Also, as shown on the table on the bottom left, we have a high level of liquidity that largely exceeds the limits set by the regulator. Our liquidity coverage ratio reached 186% as of March 2025, 86 percentage points higher than the regulatory limit and the net stable funding ratio reached a level of 119%, 29 percentage points higher than the limit during the same period. In addition, it's worth noting that our UF asset GAP was CLP 9.7 trillion by the end of March 2025, meaning that our sensitivity to 1% inflation is about CLP 97 billion in net interest income. It's important to mention that this GAP is composed of two parts. First, we have a UF position that is structural, which is related to hedge capital gains inflation; second, we have directional UF positions that are managed by treasury to profit from the differential between the Chilean peso and UF rates in the short term. Given recent inflation trends, which have remained above the Central Bank's target range and the treasury's expectations on how inflation will evolve going forward, we have temporarily increased our UF position overall. The income obtained from this strategy has clearly offset the risk taken, which is well controlled by the solid corporate governance we have in these matters. Please turn to the next slide, 16, to discuss our sound capital base. Banco de Chile is the best-capitalized bank among its peers in the industry. As of March 2025, our Basel III ratio stood at 17.4%, significantly surpassing our fully loaded requirement of 12.4%, as indicated on the accompanying table. Our CET1 ratio shows a decline this quarter due to an effective payout in dividends that exceeded the 60% amount provisioned as of December 31, 2024, following our shareholders' decision to distribute 100% of the distributable earnings from 2024. Despite this reduction, our CET1 trend over the past few years has significantly outperformed both our main competitors, as illustrated in the chart on the bottom left, and remains well above the regulatory limit. Based on these strong capital levels, we are comfortably meeting our phase-in Basel III requirements while remaining confident in addressing the final steps in Basel III implementation. More importantly, given this scenario, we possess the necessary capital to pursue growth opportunities should market conditions permit. Please turn to Slide 17. In the first quarter of this year, expected credit losses reached CLP 90 billion, 20% lower than the same period last year and 13% lower when compared to the fourth quarter of 2024. Cost of risk for the period dropped to only 0.93% below our long-term expectations. As discussed in previous earnings calls, delinquencies have shown signs of stabilization as illustrated in the accompanying charts. The top-right chart demonstrates our performance relative to our peers. Notably, we reported nonperforming loans of only 1.5% this quarter, which is significantly lower than that of our peers. The bottom-right chart provides a breakdown of this figure, indicating that NPLs have started to stabilize by product and have even improved for consumer loans. We believe that if the economy continues to strengthen and uncertainties decrease, we could observe a moderate improvement in NPLs across products. The chart on the bottom left indicates that our loan portfolio has a coverage ratio of 2.6x, including additional provisions amounting to CLP 631 billion, which is the highest amount in the local banking industry while positioning us favorably for managing unexpected credit risk deterioration. These additional provisions are particularly valuable in uncertain times as they provide a robust buffer against potential negative economic scenarios that could arise in the global economy. It's also important to note that the CMF standardized provisioning model for consumer loans went into effect in January 2025. To mitigate the CLP 69 billion expected impact on risk expenses for 2025, we released additional provisions as anticipated in previous calls. Please turn to Slide 18. This quarter, expenses amounted to CLP 281 billion, 1% lower than the same period last year and 7% less in the fourth quarter of 2024. This decrease is even more significant when adjusted for inflation as most cost items are linked to CPI variation, which reached 4.9% over the past 12 months. These figures reaffirm our commitment to productivity and efficiency, which is supported by our digital strategy that has demonstrated to be effective and strict cost control initiatives. In more detail, as shown in the chart on the top right, the annual contraction was mainly explained by lower admin and personnel expenses. The CLP 2.1 billion decrease in admin expenses was primarily driven by reduced fixed assets, maintenance costs and IT expenses. Regarding personnel expenses, the CLP 494 million decrease was mainly explained by lower total salaries in line with the annual decline of approximately 7% in headcount. This was a result of efficiency initiatives we have deployed over the past years aimed at increasing our productivity with a comprehensive approach. These factors were partially offset by an increase in severance payments related to organizational restructuring as certain functions have been centralized and optimized. In terms of our efficiency ratio, during the first quarter of '25, we achieved a 36.1% level, which is comparable to the ratio recorded in the first quarter of 2024, which is noteworthy as revenues continue to normalize. The chart on the bottom-right shows our consistent track record of efficiency and how we've been able to reach lower levels than prior to the pandemic. We are confident that through effective cost management, enhanced productivity and strategic use of technology, we will sustain our strong efficiency levels, aiming for approximately 39% in 2025 and maintaining below the 42% in the long term. Please turn to Slide 19. Before moving to questions, I want to go over some key takeaways. Despite the several risks and significant global uncertainties affecting our GDP forecast of 2% for this year, Chile's strong economic fundamentals and our ability to implement countercyclical measures will be crucial in mitigating potential negative impacts. Banco de Chile is uniquely positioned to address these challenges due to our exceptional customer base, superior asset mix and quality as well as having the highest coverage ratio among peers. We remain confident in our ability to sustain our status as Chile's most profitable bank over the long term. Our commitment to innovation, customer satisfaction and prudent risk management will continue to drive our success and ensure sustainable growth. By adapting to market changes and prioritizing our customer needs, we aim to maintain our industry-leading position for years to come. Thank you. And if you have any questions, we'd be happy to answer them.

Operator, Operator

Our first question is from Yuri Fernandes from JPMorgan.

Yuri Fernandes, Analyst

I would like to ask Pablo about the capital situation at Banco de Chile. As mentioned in your presentation, you have significant capital. You've recently paid dividends but are still well ahead of your peers. I believe the CMF has discussed some adjustments regarding marketing-related capital Tier 2 pillars. My question is how Banco de Chile plans to deploy this excess capital as visibility improves. Should we anticipate higher dividend payouts, mergers and acquisitions, or more growth? I'm just trying to get a clearer picture. If you could provide some figures, it would be helpful, as I recall you previously mentioned a goal of being 200 to 250 basis points above the minimum requirement. Is that still your target?

Pablo Ricci, Head of Investor Relations

Yuri, I'm here with Daniel Galarce, who will take this question. One second.

Daniel Ignacio Galarce Toro, Head of Financial Control & Capital

Yuri, this is Daniel Galarce. As we have discussed in the previous calls, we are aware that our current positive gaps in terms of capital adequacy and also our position in terms of capital adequacy as well in the local industry. Of course, our Tier 1 ratio, for instance, is 3% or 4% above the regulatory limit. And you have to consider that in March, that ratio decreased approximately 1% due to the dividend payment. As we have emphasized in previous calls, we aim to keep these favorable capital buffers in order to support either future organic growth or also inorganic growth if some opportunities can arise in the future. So in this regard, part of our current capital position has to do with both subdued loan growth, of course, and also the profitability we have observed over the last five years, which has been very nonrecurring, of course, due to different market factors. In addition, I would say that with our current capital buffers, we also need to face and we have to face the final phase of Basel III transition. Of course, there are some pending regulations in the local market like the Pillar 2 regulation, which is still pending from the CMF side. And this can translate into further capital requirements for banks, including us. It's important to take into account that the Chilean Central Bank has announced that probably the countercyclical buffer will convert to a neutral level as well of around 1%. So it's important to note that in terms of our capital composition, we are facing Tier 1 capital needs only with CT1 capital. So given that and due to the lack of a deep local capital markets in terms of AT1 and also the cost involved in AT1 issuances in foreign markets, we are assessing the possibility of optimizing our capital base in the future. But so far, we will face capital requirements of Tier 1 only with CT1. So due to that, the 60% dividend payout ratio is our baseline scenario for the future. And accordingly, extra dividends or a payout ratio higher than 60% would be only possible under certain circumstances, basically loan growth below what we are expecting now and/or results above what we are expecting as well. So if this doesn't occur, probably we will maintain our 60% dividend policy over the next years.

Yuri Fernandes, Analyst

No, no. Super clear. This is a good problem actually to have. If I may, just a related question on this topic of good problems for Banco de Chile. The other common one we discussed is your higher allowances to loans when we add up the additional provisions, right? And this has been coming down gradually. So just checking the box here, if there's a number that you go for these, like if you feel comfortable with this returning below 200% at some point?

Pablo Ricci, Head of Investor Relations

As you know, the additional provisions we accumulated were during the pandemic when the level of delinquencies seemed out of sync with the economic cycle we were experiencing. We started to gather these additional provisions, part of which was used to implement the new consumer loan model that took effect in January 2025, amounting to CLP 69 billion, while the remainder is still on our books. The coverage ratio has been decreasing, but this decline is attributed to non-performing loans (NPLs). Industry-wide, we have seen an increase in NPLs and mortgage loans, although we remain significantly below the industry average. There has been a slowdown or even reversals year-on-year or quarter-on-quarter for commercial and consumer loans. NPLs for commercial loans are relatively flat, while there’s a slight decrease for consumer loans. The change in the numbers reflects the relationship between NPLs and total allowances for loan losses; as NPLs rise, the overall number has reduced slightly, although many of these NPLs are backed by guarantees. If the economy improves and conditions stabilize, we may see NPLs decline, potentially leading to a higher ratio. It’s crucial to highlight that we are currently in a period of significant uncertainty globally. This makes it essential for us to maintain these additional provisions during negative cycles, allowing us to cover potential impacts on the economic sector and our customer base. In the medium to long term, it seems logical that we will either utilize these additional provisions, maintain them, or experience reversals, as indicated in past calls. However, we do not have a clear timeline for when this might happen, and the current uncertainties have increased compared to six months ago. We feel comfortable with our position today.

Yuri Fernandes, Analyst

No. Thank you, Pablo. But there is no number, right? Because this was closer to 400% back in the day. It's 250, as you said, just because of NPLs like your drop in nominal additional provision was very minimal, right? So it went up from CLP 700 billion to CLP 630 billion, it's fine, like but some of your peers, they increased this by 1/4, 1/3, by 1/2, right? So is there a number that you believe like 200% additional coverage, that's fine? Like is there a number that we should believe on this number going forward or not really?

Pablo Ricci, Head of Investor Relations

If we look at the averages before the pandemic, we had numbers around 200%, but it was with a different level of additional provisions and NPLs.

Operator, Operator

Our next question comes from Beatriz Abreu from Goldman Sachs.

Beatriz Bomfim de Abreu, Analyst

My first one is regarding margins. So we saw that you increased the margin guidance to around 4.7%, which is now closer to the top of the range that you had previously, even though you now expect a lower level of policy rate at the end of 2025. So if you could give us some color on what made you increase your margin expectations there? Are you now more confident regarding any mix changes? And my second question is regarding loan growth. So we'd like to know what are your current expectations for loan growth by segment? And what do you think that needs to happen for loan growth to accelerate above the mid-single-digit levels?

Pablo Ricci, Head of Investor Relations

In terms of net interest margins, we did have a first quarter that was quite strong in terms of inflation and throughout the rest of the year, we're expecting that there should be, as long as the global economy isn't impacted materially in Chile, an improvement in terms of mix and the types of loans that we're growing. So there should be an improvement in terms of mix. We've been benefiting from the decrease since last year to this year in terms of spreads and the overnight rate, which has decreased, reducing the cost of our time deposits. So this has been translating into a slight change. But in general, the change in terms of our NIM guidance is more or less in line with what we had in the prior conference call, just slight adjustments considering the evolution of the first quarter and expectations for the rest of the year. In terms of, as I mentioned, mix, and there's a little bit of reduction in terms of the guidance of the overnight rate. So we're seeing in the beginning in the year, Rodrigo can go into that, an overnight rate that was a little bit different from what we're expecting today. Rodrigo?

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

Thank you for the question. I want to share a few thoughts. Currently, there is increased uncertainty regarding key market factors that influence profitability and margins, particularly concerning inflation and interest rates. Although our baseline scenario anticipates an inflation rate of approximately 3.8%, possibly reaching 4% by year-end, this aligns with an expected interest rate of around 4.25% by the end of the year. These projections assume that global inflation remains stable and are based on an exchange rate around CLP 940 to CLP 950. However, we recognize the uncertainty due to a supply shock, which presents challenges with lower global growth and inflation pressures. Therefore, it's unclear what the final equilibrium will be. For now, we believe it's reasonable to expect a minor adjustment in Chile's interest rate, likely around 75 basis points by year-end. We continue to foresee a neutral interest rate in Chile between 4% and 4.5%, with inflation expected to decline, converging closer to 3.8% by year-end and around 3% in 2026. Nevertheless, our primary uncertainty regarding factors impacting margins and profitability relates to macroeconomic elements, particularly GDP, interest rates, and inflation in the short term.

Pablo Ricci, Head of Investor Relations

In response to your second question and connecting it to the first regarding our growth and changes, we're observing a decrease in the economy in Chile. The industry is experiencing a slight decline in loan growth. Consequently, our guidance has been adjusted, and we anticipate more uncertainty from businesses, which could lead to a slower recovery. However, we expect some improved activity in retail products, particularly in consumer loans. The overall mix is different from what we initially anticipated this year, which could positively affect the net interest margin, even though total loan growth may be somewhat lower. We expect our growth to be slightly above industry levels, with the industry's loan growth expectation at approximately 4%. Our growth, primarily driven by consumer and mortgage loans, is set to be a bit above that figure. On the other hand, commercial loans may underperform compared to our earlier expectations, with more activity expected from small and medium-sized enterprises rather than large companies.

Operator, Operator

Our next question is from Neha Agarwala from HSBC.

Neha Agarwala, Analyst

What are your main macro concerns for the year? Earlier in the year, there was a discussion about higher taxes, but that seems off the table now. Is there a chance that could return? Also, inflation has been running higher than expected this year. How do you see it affecting 2026? If inflation declines more steeply, could that pressure margins next year? How are you preparing for that, and how much is being managed by the UF GAP you mentioned?

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

Thank you for your question. Our primary concern this year is related to the global economy. It's important to recognize that Chile is one of the most open economies in Latin America, with total trade volume around 55% of GDP. We have free trade agreements that cover about 90% of the global economy. Therefore, global growth, particularly among our main trade partners, is crucial. While China remains our largest trade partner, accounting for 40% of total exports, the United States follows as the second largest at nearly 16%. Consequently, any changes in trade policy or potential economic growth impacts from China are significant concerns for us this year. On a local level, the upcoming presidential election in November is another vital event to watch, along with congressional elections that will result in a complete turnover in the lower house. Recent surveys indicate that nearly half of the population has not yet decided on their presidential candidate, creating uncertainty regarding the next President and Congress composition. Regarding taxes, we have not seen any proposals that suggest an increase, and there are even discussions about reducing corporate tax rates. However, we need to monitor how these discussions evolve in the future. In terms of employment and internal demand, our concerns remain focused on the global economy and the election results. Inflation is also important, particularly the exchange rate's evolution, as the pass-through effect in Chile is between 10% and 15%. A depreciation of the exchange rate could lead to a potential inflation impact of around 100 to 150 basis points over the next 12 to 18 months. We anticipate that if economic growth remains around 2% this year and next, combined with a stable exchange rate, inflation might be consistent at approximately 3.8% this year and 3% next year. Pablo will now address the final part of the question.

Pablo Ricci, Head of Investor Relations

In terms of how we have been funding the bank, it has evolved over the years, particularly as our balance sheet shows a larger bank in terms of UF GAP. There are two components to this: the structural part and the treasury positions. The structural part is approximately CLP 5 billion to CLP 6 billion, indicating that we have more assets than liabilities in UF. This amount reflects the structural gap on the balance sheet. The remainder of this position is due to treasury, which is influenced by their expectations regarding inflation and interest rates across different currencies. The treasury's outlook has resulted in a temporary increase in the gap on the balance sheet, evident at the end of the first quarter. Future developments will depend on the treasury's evolving expectations. Currently, this approach has successfully generated higher returns from this revenue source, with the structural gap around CLP 5 billion to CLP 6 billion and the rest being a treasury position based on expectations and temporary factors.

Neha Agarwala, Analyst

Could you please repeat the sensitivity that you mentioned earlier?

Pablo Ricci, Head of Investor Relations

The sensitivity of a 1% change in the UF GAP is that at the end of the quarter, we had a UF GAP of CLP 9.7 trillion, so a 1% change in inflation would result in CLP 97 billion in net interest income.

Operator, Operator

Our next question is from Andres Soto from Santander.

Andres Soto, Analyst

My question is about your medium-term ROE target. I noticed in your presentation on Slide #9 that your medium-term goal is to be among the top two, but currently, you are trailing your main competitor. I would like to know how you expect ROE to evolve in the medium term, considering you continue to achieve above-average ROE levels and the structural changes you’re making in terms of loan growth, loan composition, and expenses, particularly with the significant reduction in headcount since the pandemic. Specifically, is Banco de Chile anticipating the ability to deliver around 20% or even above 20% ROE in the medium term, given that this is the expectation set by your main competitor?

Pablo Ricci, Head of Investor Relations

Thank you, Andres. Our goal is to become the most profitable bank in Chile through all economic cycles. This ambition relies on the economic cycle and the growth expectations from each bank. We believe our strong capital base will enable us to adapt to regulatory changes and capitalize on growth when it occurs. It's crucial to highlight that we have the capital to expand if needed, which should lead to attractive returns on equity in the future. Our long-term aim is to be the most profitable bank in Chile. For this year, we've adjusted our return on equity forecast to approximately 20%, which is an increase from previous levels due to the factors outlined in the presentation. Currently, we anticipate the cost of risk to be around 1.1%, potentially reaching 1.2% if we return to our prior mix. The bank's current position allows us to grow significantly in the future, leading to continued attractive returns.

Andres Soto, Analyst

And regarding the loan growth comments that you are making, what will be a reasonable number for loan growth over the medium term or even in 2026? 2025, you say it's going to be a lag between recovering private investment and that to be translated in terms of loan growth. But for 2026, can we expect high single-digit level of loan growth? Or what is the multiplier that you are seeing to loan growth once those factors abate?

Pablo Ricci, Head of Investor Relations

I think there's uncertainties because of everything that's happening, much more today than there were 3 months ago or 6 months ago. And what we would expect is that there's a lot of piped up demand in the pipeline. So this could increase maybe higher than the levels of GDP/loan elasticity than we've had in the last period. And maybe Rodrigo can go into a little bit more detail in terms of the macro scenarios on how that could occur.

Rodrigo Aravena, Chief Economist and Institutional Relations Officer

Yes. Andres, thank you for the question. So I think it's important to analyze some structural trends that we've seen in Chile in terms of loans, especially during the last year. So for example, today, the ratio between loans to GDP, it's around 75%, around that, but it was before the pension fund withdrawal, before the pandemic, that number was between 85% and even 90%. So we've seen an important delay in terms of the loan cycle compared to the cycle of the GDP. So when we adjust by any long-term measure, we would see that given the level of the GDP of Chile, given the GDP expectations as well, the level of loans should be higher than the level that we have today. We've seen an important delay, for example, in terms of commercial loans because of the lack of investment in Chile, a similar situation we have in terms of consumer loans. We have to understand as well that still the interest rate is in a contractionary level. So it's reasonable to expect a recovery of loans in the future. In terms of multiplier, of the elasticity, despite in the past we used to see levels of around 2x, but today, the scenario is different. But it's reasonable to expect numbers higher than 1x, probably 1.4x, 1.5x. We don't know. It depends on what's going to happen in the future. But if we assume that the economy could grow between 2% and 2.5% for the next year, plus an inflation rate between 3% and 3.5%, something like that, plus the elasticity, a more normalized elasticity of loans to GDP, it would be reasonable to expect loans for the system growing in high single digits over the next years.

Operator, Operator

Thank you very much. I will now hand it to Pablo and Rodrigo for the closing remarks.

Pablo Ricci, Head of Investor Relations

Thanks for listening, and we look forward to speaking with you on our next quarterly results. Bye.

Operator, Operator

This concludes the call. Thank you, and have a nice day.