Banco Santander Chile Q4 FY2022 Earnings Call

Good morning, and welcome to Banco Santander-Chile's Fourth Quarter 2022 Results Conference Call. I will now hand over to Mr. Emiliano Muratore to begin the presentation.

Good morning, everyone. Welcome to Banco Santander-Chile's fourth quarter 2022 results webcast and conference call. This is Emiliano Muratore, CFO, and I'm joined today by Robert Moreno, Head of Investor Relations, [indiscernible], Head of Strategic Planning, and Claudio Soto, Chief Economist. Thank you for attending today's conference call. Today, we will be discussing the trends and results from the fourth quarter and providing insights into our expectations for this year. Our successful digital strategy and customer-oriented product offering continue to attract new clients, indicating great growth opportunities ahead. To begin, I invite Claudio Soto to update us on the macro scenario starting on Slide 4.

Thank you, Emiliano. The economy has continued slowing down although at a slower pace than expected. According to the latest figure of the Central Bank, GDP grew 2.7% in 2023, above our previous estimate of 2.25. Consumption has been more resilient than expected and investment has rebounded as postponed projects resumed in the second part of last year. Also, a weak peso has helped the external sector of the economy. Going forward, we forecast the economy will continue slowing down as financial conditions remain tight. While political uncertainty has moderated, it is still relatively high and will continue conditioning investment. On the other hand, the economy will benefit from the reopening of China, which has pushed up copper prices. All in all, we estimate the economy will contract between 1% and 1.5%. In 2024, we will see a recovery back to its trend. The labor market remains relatively weak and employment has been oscillating around 8%, and total employment is still below its pre-pandemic trend. This year, the impairment rate may increase slightly as the economy moderates. The current account deficit, which was widening until the third quarter of last year, should start shrinking during the coming month, as domestic demand contracts and trade improves. Inflation remained elevated but has shown some signs of slowing down. December CPA was in line with expectations after a negative surprise in October and a positive one in November, finishing the year with a 12.8% increase year-on-year. During the first quarter, CPA will continue increasing quickly in part due to seasonal factors. But from the second quarter onwards, we will see moderation due to the selectness of the economy, the appreciation of the currency, and the flow of fuel prices. As a result, we expect the CPA inflation will be running at 4.75% by the year's end. The Central Bank concluded its hike in cycle with a monetary policy rate at 11.35% in October. We expect the board will begin issuing cuts during the second quarter as inflation moderates. Given the high level of the monetary policy rate, once they begin cutting, the board will proceed at a fast pace. As a result, we expect the monetary policy rate to finish the year between 6% and 6.5%. The government position improved in 2022 amid strong revenues and a sharp fall in expenditure. All in all, the fiscal balance ended with a sub 10% of GDP, somewhat lower than what we were expecting. Gross debt increased moderately up to 37% of GDP. This year, there will be a mild expenditure expansion with gross debt climbing up to 39% of GDP. As a result, public finance will remain in good shape. On Slide 5, we have the details of two of the main reforms of the government, a tax reform and a pension reform. So far, progress has been slow. For them to advance in Congress, a political agreement must be made with the position that has a majority in the Senate. Therefore, the discussion on these reforms will require certain compromises by the government. We do not expect they are going to be approved anytime soon. On the 4th of January of 2023, the new fintech law became officially allowed, updating the regulation of the financial industry and recognizing the existence of new business models based on technology. According to the law, new technological players will be under the regulatory parameter of the CMF. Also, the law regulates finance, establishing that consumers are the owners of their financial information. Although there are pieces of regulation still due by the CMF, we consider this new law a step forward that opens different opportunities for the financial industry.

Thank you, Claudio. We will now move on to Slide 9 to begin discussing our positive client and business trends. Year-to-date, the bank's net income totaled CLP809 billion, an increase of 3.8% compared to the same period last year. With these results, our year-to-date return over average equity reached 21.6%, in line with our guidance. Our net income to shareholders in the fourth quarter reached CLP102 billion, weaker than previous quarters and mainly due to lower NIMs in the quarter as inflation decelerated and interest rates continued to rise. As we show on Slide 10, this was offset by very strong results from our business segments. The net contribution from our business segments increased 19.7% year-to-date with all segments presenting a significant rising profitability. It is important to note that the results from our client segments exclude the impact of inflation and the cost of our liquidity and therefore present a clear view of the sustainable and long term trends of our business. Moving on to Slide 11, the results of Santander Corporate and Investment Banking or SCIB have been impressive during the year. Total net contribution from this segment increased 49.3% year-over-year, driven by an increase in all profit lines items. Net interest income was 49.1% year-over-year due to the increase in loans and a higher spread earned over deposits. Also noteworthy was the year-on-year increase in treasury income of 44.4% and 19.8% in fees income, in line with this segment's focus on non-lending income. Net contribution from the Middle Market increased 30.6% year-over-year with an increase in total revenues of 20.4% due to a 19% growth in net interest income as a result of a better loan and deposit spread and volume growth. Additionally, commissions increased by 25.7% in line with the greater client activity with the banks.

Thank you, Tristian, for that excellent highlight of our strategy. We will now move on to discuss the balance sheet and results. Moving on to Slide 21, we start with loan growth, which grew 5.5% year-over-year and remained flat in the quarter. During the quarter, loan growth was subdued mainly as a result of the translation loss produced by the 12% quarter-on-quarter appreciation of the Chilean peso against the dollar; approximately 20% of our commercial loans are denominated in foreign currency, mainly dollars, especially in the Middle Market segment. As the large corporate segment continues to grow by 3.4% Q-on-Q and 32% year-over-year due to various successful large loan operations, large companies continue seeking short term financing through corporate loans because of the local fixed-income market remaining somewhat illiquid. Retail banking loans grew 1.8% Q-on-Q and 5.5% since December 2021. With loans to individuals increasing 11% year-over-year and 3% quarter-over-quarter. Consumer loans increased almost 5% quarter-on-quarter and 6% compared to the close of 2021. This was driven by an increase of 23% in the year by Santander Consumer, our subsidiary that sells auto loans, and a 20.6% increase in credit cards. During the pandemic, credit card loans decreased 7% as clients reduced large purchases such as travel and hotels, which yields credit card loans. At the same time, many clients paid off credit card debt with the liquidity obtained from government transfers and pension fund withdrawals. In the fourth quarter of '22, as household liquidity levels return to normal and holiday travel resumed, credit card loans began to grow again, and this trend should continue to be visible in 2023.

Origination of new mortgage loans has fallen as inflation and rates remain high. As for SMEs, the demand for new loans remained moderate after a strong increase in 2020 and 2021 for the FOGAPE programs. Given the above, the SME segment loan book decreased 5.7% Q-on-Q and 20.6% year-over-year as SMEs repaid for FOGAPE loans. For 2023, despite negative GDP growth, we expect loans to grow in the mid-single digit range. Consumer loans will continue to be led by the rebound of credit card loans; SMEs will probably benefit from a new FOGAPE program to be announced soon. At the same time, we expect similar growth rates as the average portfolio in our corporate segment.

Moving on to Slide 22, we show the evolution of our funding. Total deposits decreased 3.4% year-over-year and 4.3% quarter-on-quarter as the bank focuses on reducing funding costs. The Central Bank continues to raise the monetary quality rate, which reached 11.25%, and the yield curve is sharply inverted. In order to control funding costs, we have been maintaining our market share and demand deposits while replacing wholesale time deposits with longer-term funding sources that today are much cheaper than time deposits. Moving on to Slide 23, we can see how the movements of volumes, rates, and inflation have been affecting our margins. The U.S. variation continued to decrease from the highs of mid-2022 and reached 2.5% in the quarter. This was coupled with an increase in the average monetary policy rate. Although these factors drove down the bank's NIM to 2.2% in the quarter and 3.3% for the full year. As shown on this slide, this is mainly a phenomenon that affects our non-client NIM from our ALM activities, including the U.S. GAAP and our liquidity.

The client NIM, which is defined as the NII from our business segments over interest-earning assets, has and will remain stable in 2023. On Slide 24, we give further insights into our margins for this year. For every 100 basis points decline in inflation, our NIM falls on average by 20 basis points. And for every 100 basis points rise in the average monetary policy rate, our NIM falls by 30 basis points. Our base case scenario for 2023 is an average monetary policy rate of 9.2% and UF inflation for the full year of 5.3%. Under this base scenario, the Bank's NIM in 2023 should reach 2.8%, starting below this level in the first quarter of 2023 and rising back to levels of 3.6% by the end of this year. Moving on to asset quality on Slide 25. The rise in the NPL ratio to 1.8% in the quarter is mainly related to household liquidity levels gradually returning to post-pandemic levels and the softer economy.

This has mainly affected clients who already prepared pre-pandemic. The coverage of NPLs as of December reached 185% and there have been no reversals of the voluntary provisions. As we can see on Slide 26, these overall positive asset quality indicators led to a cost of credit of 1% for the full year, in line with our guidance for the year. During 2022, our regulator, the CMS, published a draft of a new standardized provisioning model for consumer loans. We expect this new model to be implemented in the second half of 2023. Our initial estimate is an increase in provisions of between CLP100 billion and CLP150 billion, mainly in our auto lending and credit card portfolios. We are permitted to use voluntary provisions to comply with this new regulation.

During the fourth quarter, we saw the cost of credit picking up, reaching 1.2%. This was mainly due to specific clients in the Middle Market segment and construction sector. Given the trends and our economic outlook for this year, we are updating our guidance for the cost of credit for 2023 to 1.1% to 1.2%. On Slide 27, we move on to non-net interest income revenue sources, which continue showing exceptional growth trends. Fee income increased 16% year-over-year and 1.2% Q-over-Q driven by higher client activity, new products such as Getnet, and the growth of our client base, as previously described. We expect these trends to continue in 2023.

As shown on Slide 28, we can also see the bank's efforts to continue increasing productivity and controlling costs. Operating expenses increased 6.7% year-over-year and decreased 5.7% Q-over-Q, well below inflation trends. The bank continues ahead with its CLP260 million technology investment plan for the years 2022 to 2024. And because of these investments, we are expecting costs to grow significantly below inflation levels in 2023.

As shown on Slide 29, the bank continues with its process of optimizing the branch network. This year, we've closed 12% of our branches and have opened 11 new Work Cafes, which not only improve client experience but are also more efficient. As a result of these initiatives, coupled with our digital strategy, productivity is rising significantly with volumes per point of sale increasing 16.2% and volumes per employee increasing 8.5% year-over-year. Moving on to Slide 30, we observe an excellent evolution of our capital ratios. At the end of the fourth quarter, the bank reported a core equity at CET1 ratio of 11.1%, up from 9.2% in December 2021. Our total CET1 increased 20.6% compared to a 0% rise in risk-weighted assets year-over-year.

With this high capital level, we expect to maintain our historical payout of 60% over 2022 earnings. This still requires final Board and shareholder approval in April 2023. With this payout, our current dividend yield is close to 8%. On Slide 31, we will conclude with some guidance. Despite 2023 being a somewhat more challenging year on the macro front, we believe our strong client activities will continue expanding. Coupled with this, we will continue with our investment program, which focuses on digitization and automation. We will continue investing to improve our leading NPS scores as well. We also expect client growth to remain robust as in 2022, led by Santander Life and Getnet. In terms of loan growth, we expect mid-single digit growth with a focus on all segments and non-NII to expand by at least 15%. NIM should contract to 2.8%, but with solid client NIMs. As the NPR comes down, we expect NIMs to rebound to 3.6% by year-end. Asset quality should deteriorate somewhat, but the cost of risk will remain at a manageable level of 1.1% to 1.2%. Cost control will be a major focus and we expect low-single digit expansion of costs. Regarding capital, book value growth should continue. As we mentioned, we currently have an attractive dividend yield. In summary, we will start the year with ROEs in the low-teens. As the year progresses, ROE should improve, and for the full year, we are guiding an ROE of 18%. With this, I finished my presentation, and we will gladly answer any questions you may have.

Thank you. We will now begin the question-and-answer section. Our first question comes from Yuri Fernandes at JPMorgan. Please proceed.

Hi, everyone. Thank you for the question. I have a question regarding our ROE guidance of 18% for 2023. Robert, it's evident that we expect a more challenging first half for PAT, with ROE improving in the second half. However, when we consider the margin guidance, it suggests a 50 basis points decrease in our NIMs, dropping from 3.30 to 2.8. It's difficult to see how we can achieve the 18% ROE for the full year given that we have around CLP50 billion to CLP53 billion in interest-earning assets, and the margin pressures could lead to a reduction of CLP200 billion to CLP250 billion in our NII. Additionally, with our other numbers like G&A, it's tough to reach 80%. So, my question is, what are the sources that could help us get to that 18%? Are there potential lower taxes, possibly higher fees, other than good G&A management, and given the NII pressure, what could be the drivers for reaching the 18%? Can I also ask a second question after you respond to this one? Thank you.

Yuri, you have the margin situation clear. The margins for 2022 were 3.3, and for the full year of 2023, they are expected to be 2.8, a decline of 50 basis points, which means NII will likely decrease. The challenging aspect, as mentioned previously, is that ALM is the main factor behind this. However, the client NIM should remain relatively stable. The key aspect for NII is the speed at which the Central Bank reduces the monetary policy rate. For this to happen, we know inflation needs to decrease, which could serve as a temporary headwind. However, if this leads to a quick drop in rates, that will be beneficial. We should view this more as a scenario where falling rates play a bigger role than new lending opportunities. A quicker decline in rates will improve the outlook for NIM, but the base scenario is set at 2.8%. Provisions may rise slightly but will remain manageable. Moving forward, we anticipate positive developments. Firstly, we expect fees to grow by 15-20%, which includes both fees and treasury. This is a point we've tried to emphasize throughout our presentation. Client-related services are performing very well. The results from corporate banking and Middle Market retail reflect this trend. In terms of client growth, non-lending activities are likely to continue to expand. For instance, we saw a 30% increase in SME checking accounts last year and about a 20% rise in individual checking account clients, indicating strong product usage. Regarding costs, which encompass personnel, administrative, depreciation, and other operating expenses, we expect very modest growth in our overall operating expenses, discussing an increase around 2% that could potentially be even lower. The difference in your model likely pertains to other operating income and costs, where we anticipate significant improvement. For example, we incurred many insurance and cybersecurity expenses in 2022, and we expect these costs to decrease significantly. This reduction will greatly enhance our bottom line, bringing us closer to our target. As for taxes, with lower inflation, our tax rate will be around 16 to 17%, but overall, apart from margins, we feel confident reaching an 18% ROE.

No, that's quite clear, Robert. There may be a bit of cost of risk with the detractors, but all the other factors are contributing to a better 2023. I have another question regarding capital. Congratulations, by the way. Our capital position faced some pressure. In 2021, we encountered a lot of mark-to-market issues, and shareholders were affected. However, this was a good quarter for capital. Could you elaborate on what contributed to the reduction in RWAs? You've commented on some derivatives strategies and the mark-to-market effects, so it's clear that you're maintaining a 60% dividend payout. Can we expect ongoing capital improvements at similar levels? What should we anticipate for your capital position moving forward? Thank you.

Hello, Yuri. Thank you for your question. During the quarter, the primary factor contributing to the contraction in risk-weighted assets was market risk associated with our assets. As previously discussed, changes in regulations regarding market risk have introduced a more basic approach in line with Basel III, which tends to penalize sophisticated businesses like ours, particularly as we lead in the derivatives market as of January. A larger portfolio results in higher risk-weighted assets without accurately reflecting the actual sensitivity or risk profile of our book. In response, we initiated a significant program in the fourth quarter to compress positions by netting out balancing positions without risk and removing both from our books. This has positively impacted our risk-weighted assets. Additionally, the decline in inflation during the latter half of the year and in recent months has positively affected the mark-to-market of our inflation hedges. Looking ahead, we remain optimistic about our capital position and still see potential for efficiency improvements in risk-weighted assets related to market risk, which should provide favorable momentum this year. Our book value is also performing well in the context of declining moderate interest rates. Thus, we anticipate maintaining a CET1 ratio between 10.5% and 11%, even after distributing a 60% dividend in April, should the board propose it for approval. We expect our CET1 to remain at 10.5% or higher, which would represent our strongest CET1 after dividend distribution in recent years. We are optimistic about our capital, book value, and the trend in risk-weighted assets moving forward.

Thank you very much.

Thank you. Our next question comes from Carlos Gomez from HSBC. Please go ahead.

Hello. Good morning. Thank you for taking my question. Could you talk about the high and update on regulation on provisions for the consumer portfolio and how you would have to provision for that? Any changes in that, and what is your expectation? And second, going back to the initial question about the margin. I mean, you emphasized a lot that rates are going to come down and what impact is going to have? What if rates to stay up and it don't decline as you expect? Would that be positive or negative for you? And could you give us an order of magnitude? Thank you.

Hello, Carlos. Thank you for your questions. Regarding the new provisioning for consumer loans, there is no change. We are still anticipating an impact of around CLP150 billion in our stock of provisions. Initially, this was expected to take effect in the second quarter of this year, but there has been a postponement, so we are now looking at the second half or possibly the last quarter of this year, while the anticipated impact remains unchanged. In response to your question about interest rate sensitivity, if rates decrease at a slower pace, it may negatively affect us, whereas if they decrease more rapidly, it could be beneficial. That’s why we included a heat map on Slide 24, where you can see the different impacts based on various inflation scenarios and monetary policy rates. For instance, if the average monetary policy rate for the year is 100 basis points higher than our base case, we would see a 30 basis point impact on our net interest margin. Overall, the effect is quite linear, so it's really a matter of estimating the average monetary policy rate. We included this two-axis chart because inflation will also vary if rates change, which is why we believe it is important to assess the sensitivity in the same chart. This allows for a consideration of different outcomes if you lean towards higher inflation or rates, as opposed to lower inflation or rates.

Thank you very much. And this is very clear. Thank you very much for showing this slide. To what extent can you change this during the year? I mean, this is your restructure of position presumably as of now. If you change your view if you think rates are going to evolve in a different way, can you change this in the next two or three months or is this set for the NIM of the year?

No, I would say that the midpoint for the net interest margin for the year would be around there, and what we can adjust. If you compare this chart to the one we presented last quarter, you'll notice that the sensitivity to inflation has decreased because we adjusted the U.S. GAAP. This change is due to inflation; we have essentially secured higher levels of inflation, which means we face less risk related to it. Ultimately, managing this depends on the trajectory of future rates implied by the market prices. We can adapt this by adjusting sensitivity through fixed rates or reducing them. Currently, we observe that the market's implications are close to our base case scenario regarding inflation and interest rate trends. Therefore, we don't see much value in locking in that scenario. For now, we expect to maintain this position at least during the first part of the year.

Thank you so much.

Thank you. Our next question comes from Tito Labarta from Goldman Sachs. Please go ahead.

Hi, good morning. Thank you for the call and for taking my question. I’d like to follow up on Yuri's inquiry regarding the ROE guidance. I apologize for asking from a short-term perspective, but could you share your thoughts on how you see interest rates evolving? When do you anticipate they might start to decline? Additionally, how do you expect inflation to change? It seems that inflation might be lower in the first quarter, yet rates haven't decreased. I'm unclear on how margins could improve next quarter to reach that low-teen ROE, especially since this quarter featured a negative tax rate. It would be helpful to understand how you foresee ROE evolving throughout the year, based on your macro assumptions in the short term. Thank you.

Okay, Tito. So in the first quarter, as we said, the NIMs in the fourth quarter are like 2.2, and they should be like 2.2 in the first quarter. At the same time, remember, there's a lot of seasonality in costs in the first quarter. So that's going to help. But effectively, the ROE in the fourth quarter was in the 10% range. In the first quarter, there's a lot of moving parts, but the margin is slightly lower. Provisions should be stable or lower fees, more or less the same, and costs are seasonally lower as well. So overall, I think the first quarter and also there's what I was talking with Yuri, I think cost is going to be a big difference, okay? So in the end, you end up having a very similar net income in the first quarter.

And then going on basically what we have is, is the seasonality of the race. And here, I think I'll turn it over briefly to Claudio if you can mention that. And then I'll wrap it up, okay? In the first quarter, we need to consider several important factors regarding inflation. Firstly, there will be a change in access to services that will affect the Consumer Price Index in January, but this will be temporary. Additionally, we anticipate high teen prices due to these one-time events, which will support the UF. March typically experiences high inflation in Chile due to seasonal influences, so we expect the first quarter will show a relatively high CPI. Following this, the Central Bank's decision to cut rates is anticipated. There will be three meetings in the second quarter, and any of these could be when the decision is made. By that time, we expect inflation to decrease significantly, which will facilitate a rapid reduction in rates by the Central Bank.

In the first quarter, the net interest margin is approximately 2%. Looking ahead, we anticipate that the second quarter will see inflation increase slightly due to seasonal factors, which may result in a net interest margin of around 2.6 to 2.7. The third quarter is expected to be about 2.9, while the fourth quarter could reach 3.6, depending on the growth of interest-earning assets. We're currently experiencing volume growth in the range of 5% to 6%, leading to an overall net interest margin of approximately 2.8% for the year. This, combined with an increase in non-interest income and careful cost management, indicates our sensitivity to monetary policy changes. There is a notable variance between the first and fourth quarter margins. Additionally, a significant amount of liquidity is held in our held-to-maturity portfolio, which matures in 2024. This portfolio serves as collateral for our Central Bank line, where we have accessed inexpensive funding. Although this liquidity does not cause any volatility in equity, it does mean we're dealing with lower rates. Looking ahead to 2024, we anticipate a return to normal interest rates and inflation. As we repay our obligations, the collateral that matures will allow for a revaluation at higher rates. Thus, after navigating through the first half of 2024, we expect upward momentum in our net interest margin as Central Bank financing matures.

Great. Thanks, Robert and Claudio is very clear. Just one quick follow-up, I guess. Should we also expect a negative tax rate in 1Q like we saw this quarter or…

Regarding the negative tax rate, it's quite complex, but the explanation is straightforward. For tax purposes in Chile, inflation accounting is still applied, even though it isn't reflected in our financial reports. Every company and individual in the country continues to account for inflation in their taxes. Consequently, our equity is increasing due to inflation. Essentially, the adjustment for capital due to inflation was larger than our net income. This led to a tax reversal in the fourth quarter. In the first quarter, we expect the tax rate to remain low as we continue to experience some inflation and our book value is still growing. As previously mentioned, our book value is expanding at a faster rate for various reasons and is adjusted for tax purposes according to price level restatement. Therefore, our tax rate should exhibit a trend similar to our return on equity. We start with a low rate, which could potentially rise to the low-single digits or low-teens, and gradually increase through the year, averaging around 17% by year-end. It should follow a relatively steep trajectory, much like our return on equity.

Okay, perfect. That's very clear, Robert. Thank you.

Thank you. So our next question comes from Anand from White Oak Capital. Please go ahead.

Thank you for the opportunity. Two questions from my end. One, the CLP260 million CapEx. Can you give us some details around it? What is it about and in which quarters do you intend to spend this?

Sorry, you're asking about our investments.

Yeah. The CLP260 million investments that you're talking about, what is that?

Okay. So basically, we usually do an investment plan that expands over three years. So we're in the middle of our CLP260 million investment plan that we announced in 2022 – sorry for 2022 to 2024. It’s roughly equal per year. That's just digital, okay? Obviously, there are other investments and fixes that, whatever. But basically, that entails the transformation of the branch work, automation, everything that's the new robot, taking a lot of the systems and products to the cloud. So basically, it's a big overhaul in line with the digital transformation that a lot of companies and banks are doing worldwide. For us, it's very important because obviously with margins coming down, we're cost-conscious, okay. We're doing a lot to control costs, but the idea here is not to touch the technological part and not to like cut costs today and then have to reinvest or invest more in the future. So basically, we have been reducing branches. Headcount has been coming down a bit. There are other cost initiatives, but the whole investment plan, which is transformation of the branch office, the front end, and transformation of the back end operations, which means a lot of automation and digitalization and other technological improvements is what is covered by that plan, which is CLP260 million total and roughly one-third per year. By the end of this year, we will announce a new plan for the next three years.

Okay. And from the corporate tax perspective, given the current changes in the contradiction being contemplated. Is it fair to expect that this corporate tax rate of 17 would not continue and it should rise in the future by a certain percentage point? If yes, then what is the expectation you have for the increase in corporate tax rate?

In Chile, the corporate tax rate is 27. We consistently account for this in our tax records. However, in our financial reporting, we must adjust for inflation. For banks, this means that equity increases with inflation each year. For instance, if your equity is 100 and inflation is 10%, your equity in tax records rises to 110. That extra 10 represents a tax loss in your tax records, which is why the effective tax rate is lower than the statutory rate. As inflation increases, the monetary adjustment of equity rises, leading to a higher effective tax rate. As inflation gradually stabilizes, the tax rate will also increase. In a typical inflationary environment of around 3% to 4%, we expect our effective tax rate to be about 21%. This figure aligns with the 27% corporate tax rate plus the adjustment for monetary inflation. Regarding the conversation on constitutional or tax reforms, there is currently no discussion about raising the corporate tax rate. The focus is more on personal and wealth taxes, but no plans to increase the corporate tax rate have been discussed.

Sure. Thank you, and all the best.

Thank you.

Thank you. So we have one more question from Mariel Abreu from T. Rowe Price. Please go ahead.

Hi. Thank you for the time. I have two questions. One, if you can remind us what are your refinancing needs for this year and next? And how do you plan to cover for those? And are liquidity conditions still pretty favorable overall? And if you can comment about that? And the second question is on asset quality. I'm looking at your non-performing loans and it almost doubled for consumer; the increase was also pretty meaningful even for commercial and mortgages. Is that all explained by the change in liquidity conditions, or is there something else? Perhaps you can give a little bit more color on maybe a specific industry or products that are driving that as well? Thank you.

Okay. So thank you for your question. Regarding the first one, our funding needs will be seen here like, say, below the average we usually have on a yearly basis; I would put it in the CLP1 billion ballpark. So we are quite comfortable with that and we plan basically to use the same mix we have been using lately between deposits coming from clients and institutional investors, some funding lines from banks abroad, and being very active in the capital markets domestically and abroad, I mean, more on the private placements side. Even though this last few days, weeks, the public capital markets abroad have improved dramatically. So now even public transactions in the U.S. market and another public market, it could be an offset. So on the funding needs for this year, we are quite comfortable, and about liquidity conditions, the capital markets, the domestic capital markets are in better shape than they used to be in the middle of the pension fund withdrawals and all that tension the market had. Now the situation is better, even though the total sizes of the transactions are not the ones we had in the best moment of the market, but the situation is quite favorable. Definitely, any potential risk of additional pension fund withdrawals would put pressure on that, but it's not, let's say, our base case for the year. And the good news is that public markets abroad are also improving, and that gives us much more flexibility either to that the domestic or international markets for our funding needs, which are below the average on a yearly basis. And Bob, do you want to comment on asset quality?

Yeah. So asset quality, regarding consumer lending, that's really the rebound post and the excess liquidity. So that's just going to go back to where it was pre-pandemic. It might overshoot a little bit depending on how strong the recession is. But remember last year, I believe NPLs and consumer were like 0.9%. We had never seen it that low, and clearly, this is a direct result of normalizing liquidity, and the levels of last year were extremely low. The good news is that we still have very high coverage. We haven't touched the voluntary provisions and we're good for worse. We're going to add on 120 billion, 150 billion more of provisions in consumer, obviously redirecting voluntary; it's not going to have an effect on the P&L, but the consumer coverage is going to be on the year at very high. And mortgage, I think it's very similar. Even though I think mortgage, there is some impact of the higher inflation and rates, especially higher inflation. We always talk about the good news on margins, but obviously, higher inflation results in higher mortgage payments, and there was a little bit of impact there. Once again, still very low, and we have much higher coverage, and the value of collateral is still quite good even though it's done very conservatively. In commercial loans, a bit the same, but in commercial loans, there have been some sectors with a little more weakness. As we said in the presentation and in that management commentary, I would say, particularly in the core of the construction sector. Without being near a crisis, there has been some weakness in the construction sector, and that drove up provisions, especially in the Middle Market. In the Middle Market, it's a broad segment, but it includes everything that's construction and real estate. The real estate developers have been very, very, let's say, healthy. When you have very little construction going on with high rates, obviously, construction companies of all sectors are probably the ones that are suffering the most in Chile. We have like 1% of our loan book, I believe, in construction. So that will be a weakness probably for a while until rates go down and until real estate developers begin their projects again. So therefore, that's why we finished the year with a cost of credit of 1%, but in the last quarter, 1.2%, and we think for this year, the average will be 1.1% to 1.2%, okay? So once again, a rise, but still we have a lot of coverage. We haven't touched our voluntary provisions. We think that 1.1%, 1.2% is quite realistic.

Okay. Thank you very much.

Thank you. We have a question from Daniel Mora Ardila at Credicorp Capital. Please go ahead.

Hi. Good morning, and thank you for the presentation. I have just one question regarding derivatives. What is the strategy concerning derivatives? For instance, looking at the first three quarters of 2022, the accounting hedge for interest rate risk accounts for about 48% of the total interest expense, not factoring in adjustments to net interest income. Additionally, the royalties have decreased from CLP17 trillion to CLP11 in this quarter. What impact will these changes have on margins moving forward? What will be the approach for derivatives, and how will the reduction in derivatives affect margins going forward? Thank you very much.

Okay. So there's two effects there, and they're kind of unrelated, okay? So first of all, we have, let's say, three big groups of derivatives, okay, that are in the balance sheet. What is the biggest is what we do with clients, okay? The client needs a forward on an interest rate swap and that is all managed with advancing our risk metrics, et cetera. Okay. And those are basically matched on the asset liability, okay? But given that we're a big bank, we're a lot of clients come to ask for protection, especially against FX movements, yeah. So our derivatives, and with a little bit of what Emiliano said before, in Chile, accounting for derivatives, basically, you have the asset and the liability, okay, and there isn't much netting, okay? So basically, when the Chilean peso depreciated, that inflates the asset and liability of our derivative volumes, but the net doesn't really change, okay? So the big growth you saw in the derivatives as a percentage of assets and liabilities was because as a bank that does a large forward derivatives, especially with clients and through these types of things. The depreciation of the peso leads to an inflation of that volume asset liability, and now when the peso appreciates, that comes down, okay?

And also the compression we have been performing in order to net that out and to reduce the decrease with assets for the capital ratio has also helped.

So we have in our financial statements when we publish them for the full year, but we always include a table that shows the derivatives, the assets and liabilities, which ones have the threshold in the collaterals, and the big majority do daily margin calls. Okay. So that's really good. So basically, we put that because now we want to make sure that people feel comfortable that this is correctly done.

Yes, perfect. Very clear. Thank you so much for this financial.

Thank you. So we have a question from Alonso Aramburu from BTG Pactual. Please go ahead.

Yes. Hi. Can you hear me?

Yes.

Yes. Okay. Thanks. Yeah. I wanted to follow up on the return-on-equity. Clearly, it's going to be lower in the first half of the year, increasing in the second half. For you to get to 18%, you probably need to be closer to 20% towards the second half of the year, and you're talking about potentially margins being even higher in 2024. So my question is, when you look at your sustainable ROE, potentially in a mid-cycle situation with rates, let's say, around 4 or 5 normalized inflation, should we think that your sustainable ROE is now above 18% given this trend and this momentum 2024 looks like it will be probably closer to 20%?

We have consistently stated that our long-term return on equity target is between 17% and 19%. It's challenging to predict the future, but we believe that if we return to normal interest rates and inflation, with margins aligning with historical standards, a 19% return on equity is certainly achievable in the long run, provided there are no unexpected events like new legislation. We maintain the 17% to 19% range to account for uncertainties, but assuming conditions normalize and our strategy remains effective, reaching the upper end of that range, or 19% return on equity, is clearly within reach.

Thank you. And we have a follow-up question from Anand from White Oak Capital. Anand, please go ahead.

Thank you. Sorry. Thank you for the opportunity. Three questions. The credit cost for the full year, the guidance is 1.1 to 1.2. In terms of quarterly, do we have any expectation of whether it will be like front-loaded or back-loaded? That is question one.

It should be front-loaded, maybe second and third, but as I said, this has a lot to do with the involvement of the economy. So as we're seeing the weaker economy now and then picking up at the end of the year, sometimes there's lags and asset quality, but I would say that it's going to be probably higher in the beginning of the year coming down towards the end, and obviously that the goal of the bank is to reach a cost of credit of 1% in 2024. So our view is that it will be higher in the first half coming down, especially in the fourth quarter probably.

But it will not be too much speed impact. Yeah, the trend should be like promoted, but not significantly.

Perfect. Secondly, when you were addressing the previous question regarding derivatives, there were three different points raised. The first was about the predicted derivatives. The last one concerned our balance sheet, specifically regarding long inflation and short positions. In between, you mentioned the UF account. Could you explain that again? I didn’t quite catch it.

The Chilean banks typically operate in a straightforward manner, with a unique currency known as the UF, which is particularly relevant for inflation-linked pesos. This means that most long-term loans in Chile are tied to inflation. Consequently, banks generally accept deposits that are either non-interest-bearing or time deposits, with the latter providing a stable yet short-term funding source. Essentially, we're collecting nominal pesos and lending in a way that is inflation-linked while predominantly dealing in pesos that are not subject to inflation. This creates an inflation gap. If we do not take action, the inflation gap could widen significantly, leading to excessive interest rate risk for the bank. Therefore, we impose a limit on how large this inflation gap can become. To manage this gap, we can issue inflation-linked bonds, which we do, although they are limited in availability in the Chilean market. Another method for managing the inflation gap involves using derivatives under cash flow hedging. In this process, we bundle mortgages and apply a derivative to effectively lower or control the UF gap. This approach is efficient and well-documented, but as it is categorized as a cash flow hedge, accounting rules require it to affect equity. If we issued a bond, the assets and liabilities would be balanced with no market adjustment. However, without a bond and relying on derivatives, accounting regulations prevent us from adjusting the asset's market value, while the derivatives do get adjusted, affecting equity. Furthermore, under Basel III, these cash flow hedges do not count toward CET1 capital requirements. As we transition to CET1 regulations, these hedges currently affect capital, but later they will have no impact on CET1. Anticipating that inflation expectations will decline, we expect the influence of these derivatives on capital to lessen. In line with Basel III guidelines, their impact will eventually be neutral. I hope that clarifies things.

No, that's perfectly clear. Many thanks. The last question is about the derivatives of the three varieties and whether they are a reasonable part of our overall operation. From the perspective of counterparty risk, how can we be confident that the counterparty will fulfill their obligations? Can you provide us with insight into who these counterparties are, whether they are international investment banks, central banks in some cases, or domestic corporations? How can we be assured that these derivatives will be stable in the event of excessive volatility?

Yes. Hello. Can you hear me?

Yes, I can hear you.

The majority of our loan book consists of activities with clients, primarily corporate and sometimes small to medium enterprises. The nature of the client may require collateral agreements that involve daily revisions and postings of collateral for decision-making. In this context, we evaluate the equivalent credit risk of derivatives as loans to clients. This is an integral part of our credit risk management. Some clients utilize their credit lines through derivatives, and if we don’t have the capacity for the derivatives, that could pose a risk. Thus, managing our credit exposure with clients incorporates derivatives as one of the products we consider. When we hedge or enter the market for hedging that client exposure, our counterparties primarily consist of banks, both domestic and international, depending on the specific product—for instance, local banks for peso swaps and usually international banks for dollar swaps. We have agreements in place with these entities that include daily revisions, daily mark-to-market, and either cash or high-quality collateral. Our trading is often bilateral, and we also work with platforms like SCH or CME, alongside local commercial derivatives such as the TCF in Chile. From a credit exposure perspective, our derivatives portfolio is secure since it is either collateralized daily or managed just like any other client exposure according to our credit risk management policies.

Sure. Thank you.

Just one follow-up, we have in our financial statements when we publish them for the full year, but we always include a table that shows the derivatives, the assets and liabilities, which ones have the threshold in the collaterals, and the big majority do daily margin calls. So that's really good. So basically we put that because now we want to make sure that people feel comfortable that this is correctly done.

Sure. I have a follow-up, if I may.

Thank you for your patience. If you can please continue to be patient while trying to reconnect them now? Thank you.

Okay. So we have in our financial statements when we publish them for the full year, but we always include a table that shows the derivatives, the assets and liabilities, which ones have the threshold in the collaterals, and the big majority do daily margin calls. Okay. So that's really good. So basically, we put that because now we want to make sure that people feel comfortable that this is correctly done.

Thank you. Operator, I think we should conclude the call.