Earnings Call Transcript - CIB Q1 2024

Operator, Operator

Good morning, ladies and gentlemen, and welcome to Bancolombia's First Quarter 2024 Earnings Conference Call. My name is Daryl, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. Please note that this conference is being recorded. Please note that this conference call will include forward-looking statements, including statements related to our future performance, capital position, credit-related expenses, and credit losses. All forward-looking statements, whether made during this conference call, future filings, or press releases, address matters that involve risks and uncertainties. Consequently, these factors could cause actual results to differ materially from those indicated in such statements, including changes in general economic and business conditions, changes in currency exchange rates and interest rates, introduction of competing products by other companies, lack of acceptance of new products or services by our targeted clients, changes in business strategy, and various other factors that we described in our reports filed with the SEC. With us today are Mr. Juan Carlos Mora, Chief Executive Officer; Mr. Julian Mora, Chief Corporate Officer; Mr. Jose Humberto Acosta, Chief Financial Officer; Mr. Rodrigo Prieto, Chief Risk Officer; Mrs. Catalina Toba, Investor Relations and Capital Markets Director; and Mrs. Laura Clavijo, Chief Economist. I will now turn the call over to Mr. Juan Carlos Mora, Chief Executive Officer; Mr. Juan Carlos, you may begin.

Juan Carlos Mora, CEO

Good morning, and welcome to Bancolombia's first quarter results conference call. Please turn to slide 2. During the first quarter of the year, Colombia encountered economic challenges marked by elevated interest rates and reduced consumer confidence. Despite subsequent declines in inflation and interest rates, consumer demand and investments remained restrained. Nevertheless, by utilizing our commercial expertise and conducting comprehensive risk assessments, we accomplished a notable 2.5% quarterly loan growth. However, this growth is offset by a 2.6% annual contraction resulting from the substantial appreciation of the peso by 17.3% during the quarter. Efforts to reduce credit deterioration resulted in a significant 24% decrease in provision expenses compared to the previous quarter. Consequently, the cost of risks for the reporting period was recorded at 2%. Additionally, an 8% quarter-over-quarter reduction in operating expenses contributed to achieving a net income of COP 1.7 trillion, representing an approximate 15% increase compared to the preceding quarter. However, it is worth noting that these figures still reflect a 3% decline year-over-year. Furthermore, the efficiency ratio decreased to 46%. ROE rebounded to 17%, and our capital position remains robust with a total solvency ratio of 12.3% and a core equity Tier 1 ratio of 10.4%. The Central American banks and offshore operations sustained their positive performance, contributing to the overall group's results and diversification strategy. On the other hand, we believe that the declining trend on inflation in Colombia will solidify in the coming months, facilitating a gradual reduction in interest rates. This should stimulate a recovery in credit demand and alleviate the pressure on asset quality. We expect that there will be opportunities for credit growth in agribusiness, mining, and public administration sectors because of the government's advancement on public policy programs. This growth is expected to partially offset the slowdown being experienced in the construction, manufacturing, and retail sectors. However, it is important to note that there are still concerns regarding the progress of regulatory changes in the health sector as well as the performance of the energy sector, which is currently facing challenges due to the El Nino phenomenon. It is important to acknowledge that our involvement in the healthcare industry is relatively small, with our services reaching over 11,400 clients, which constitutes only 1.6% of Bancolombia’s independent loan portfolio. On the business development front, we are pleased to share the recent launch of Wenia, a Bancolombia's investment in a digital asset company. Wenia is registered in Bermuda and has been granted a Class F license by the Bermuda Monetary Authority. By utilizing innovative technology, Wenia serves as a bridge between the traditional financial system and the expanding digital economy. Initially, Colombian residents will be able to engage in the buying, selling, converting, receiving, and sending of digital assets such as Bitcoin, Ether, and USDC in a swift and secure manner. This initiative aims to empower individuals interested in the digital assets realm to confidently diversify their investment portfolios. This innovative solution is framed within rigorous compliance with regulatory standards and internal country policies, including Know Your Customer, Know Your Transaction, and Travel Rule protocols, ensuring comprehensive stewardship and confidence among all parties involved. After these highlights of our first quarter results, I am pleased to introduce our Chief Economist, Laura Clavijo, who will provide further insights into the macroeconomic landscape. Laura?

Laura Clavijo, Chief Economist

Thank you, Juan Carlos. Please go to Slide 3. Economic activity in Colombia is going through a phase of substantial weakness that will continue for much of 2024, due to stagnated consumer demand and a significant fall in fixed investments. Consequently, our updated forecast incorporates a slight downward provision for some key macro variables. For 2024, we anticipate economic growth of just 0.6%, in line with the previous year's overall economic results. Inflation is expected to close at 5.7%, leading to more margins for Central Bank interest rate cuts for an end-of-year repo rate of 8.75%. Indeed, first quarter results suggest that even though the economy as a whole is still sluggish, as in the case of construction, retail, and manufacturing, some sectors have managed to outperform under uncertainty. The agriculture sector, for instance, managed to grow 1.9% year-over-year during January, and 2.5% in February, according to a leading economic indicator ISE. As farmers anticipated the drought season, the unpredictable El Nino phenomenon affected crops such as coffee and cacao drives in the earlier months of the year. Also, the services sector, which includes public administration and entertainment, showed favorable activity, expanding close to 5% during the first quarter. Furthermore, the economy has continued to benefit from receding inflation, maintaining a consistent downward trend, closing at an annual rate of 7.36% during March. This trend has been mainly led by declining food prices, registering just under 2% year-over-year, and goods prices around 3%, especially imported goods that have eased thanks to the appreciation of the exchange rate. Given the scenario, the Central Bank accelerated the pace of interest rate cuts to 50 basis points during March and April. Thus far, policy interest rates have declined by 150 basis points from their 2023 peak, enabling the retail rate to defend to its current level of 11.75%. Going forward, we expect the Central Bank to continue a cautionary approach to monetary easing, given the upside risks that still prevail in bringing inflation back towards the target range of 3%. Indexation effects are tangible, and potential hikes in gas and diesel prices are still on the table. Finally, recent months have drawn much attention to the fiscal outlook. Underwhelming economic activity has significantly impacted tax collection, and other sources of revenue have suffered setbacks, such as those expected from lawsuit windfall gains and mining sector royalties. Declining sources of revenue contrast sharply with the high levels of planned expenditure that the government has set out to meet social policy goals. As a result, the government expects to expand its fiscal deficit to 5.3% of GDP in 2024 from 4.3% in 2023, which implies testing the limits of compliance with the fiscal rule. In sum, the Colombian economy faces growth challenges, but macro-financial conditions are slowly improving and should help alleviate household budgets, leading to an uptick in demand during the second half of the year. Now please let me turn the presentation back to Juan Carlos, who will present Bancolombia's quarterly performance.

Juan Carlos Mora, CEO

Thank you, Laura. Before we move into the detailed quarterly results, I would like to present an overview of some initiatives aligned with our four value-driving pillars. Through these pillars, we developed innovative solutions and exceptional capabilities that not only reinforce our market leadership but also lay the groundwork for sustained growth and profitability. Please proceed to Slide 4. As a part of our first and second strategic pillars, which cover our integrated client-centric solutions approach and our digital capabilities under a multichannel platform, I would like to share the recent launch of our enhanced value proposition to address SMEs' merchant cash management and collection needs under a simple and innovative acquiring app operated by 1P, a payment platform subsidiary fully owned by Bancolombia. We consider 1P a strategic channel due to its substantial market share potential in payment flows. Small and medium-sized enterprises make up approximately 90% of Colombia's total productive sector and lack formal and cost-effective cash management and acquiring services to facilitate their in-store and online sales. These services are inherently recurring and scalable, generating fee-based revenues that aim to dilute fixed costs and IT investments. With the introduction of novel capabilities such as tap to phone and tailored solutions, it will complement rather than compete with the traditional acquiring and cash management services offered by the bank. Moreover, from a channel ecosystem perspective, it leveraged the significant customer base, as these customers represent the end-users of acquiring services provided by 1P to merchants. In fact, 1P experienced impressive growth of approximately 30% year-over-year in terms of clients, 33% in terms of revenues, and 7% in terms of the number of transactions. We anticipate this positive trend to be further enhanced by the new value proposition, thereby contributing to the consolidated group performance. Furthermore, we envision 1P as a vehicle to capitalize on the open banking opportunities through API connectivity, leveraging the bank's progress in this domain. On Slide 5, under our fair value driving pillar of structural capabilities that create distinctive market advantages, I would like to examine the key factors behind the net interest margin performance in Colombia. These factors largely explain the bank's superior results compared to its peers over the past two years and will provide tools to defend the margin in the current descending interest rate cycle. Firstly, we offer a comprehensive portfolio of assets and liabilities with a range of diverse and complementary products that provide greater flexibility to manage rate and index gaps. Secondly, the diverse sources of counterparties of time deposits, including retail, commercial, and institutional clients, facilitate the diversification of turners and indexes, thereby enabling the construction of an efficient pricing curve. Thirdly, the substantial volume of low-cost and stable deposits that exceed low sensitivity interest rate fluctuations serve as a reliable anchor ensuring the maintenance of highly competitive funding costs across various interest rate cycles. Lastly, we have developed a sophisticated model and an experienced team that effectively utilizes comprehensive transactional data and market insights to strategically adjust the tenure and rate gaps of assets and liabilities. These enable us to effectively manage duration risk and optimize the net interest margin throughout diverse interest rate cycles. For instance, as illustrated in the initial two upper pie charts, in 2021, when the interest rate hike cycle had recently started, we strategically adjusted our assets and liability structure to enhance our asset-sensitive position. This involved increasing the proportion of floating loans relative to flooring rate deposits with the objective of expanding our net interest margin, which subsequently materialized. However, in the current environment characterized by an interest rate cut cycle, we have been implementing adjustments to our liability structure to mitigate our asset-sensitive position. This involves a three-element strategy. Firstly, reducing the proportion of non-rate-sensitive liabilities; secondly, correlating the repricing of time deposits by increasing the share of time deposits with maturity occurring within the next 12 months; and thirdly, increasing the proportion of floating rate time deposits to capitalize on the interest rate reductions. The duration of assets and liabilities has changed significantly as reflected in the lower backhand side chart. In 2021, assets were repriced much faster than liabilities. However, currently, the duration of liabilities has decreased to accelerate the repricing of time deposits while the duration of assets has increased to maintain higher billing loans for a longer period. As we progress through the current monetary expansionary cycle, we will continue to adjust the gaps between our assets and liabilities to mitigate our margin sensitivity to rate cuts. However, we will remain vigilant and consider the potential impact of the next cycle. Finally, on slide 6, under our four-value driving pillar, which is the culture of efficiency and productivity, I will review the expense control strategy we implemented at the beginning of the year. This strategy seeks to identify opportunities for efficiency enhancement and reduce recurring expenditures. The plan takes a short, medium, and long-term approach and covers an in-depth assessment in six key areas: technology, fixed assets, pre-expenses, operational risk results, realignment, and regulatory expense management. Each area has a dedicated team led by senior management, and a centralized governance oversight and control mechanism ensures alignment with our objective. By way of illustration, we are presently evaluating the potential avenues to optimize cloud-based services, minimize expenditure on credit and debit card fees, terminate real estate leases, capitalize on resource realignment facilities with IT tools, and implement comprehensive fraud mitigation measures. We will provide a periodic update on the progress made in each of these areas as we believe that the above-mentioned strategy will yield the desired outcomes, thereby ensuring operational efficiency. Now, I would like to invite Jose Humberto Acosta to provide further information on our first quarter 2024 results. Jose?

Jose Humberto Acosta, CFO

Thank you, Juan Carlos. Please go to slide 7 to discuss the results of our Central American operation. During the first quarter, the share of all banks in Central America grew quarter-over-quarter with respect to Colombia, driven mainly by a couple of large corporate loans. However, when analyzed on an annual basis, such growth is offset by a 17% base appreciation. Banco Agricola and under a strong quarter on the back of payroll and commercial loans growth that increased its NII, whereas Banistmo and Banco Agricola's growth was mainly focused on commercial loans as consumer remains muted, thus the NIMs contracted. Regarding asset quality, all banks are tending towards a slower pace of deterioration but posted mixed results in terms of cost of risk, as Banistmo had provision release related to a parameter update, whereas Banco Agricola returned to a normalized cost of risk after a one-off accrued last quarter. On the other hand, Agromercantil recorded a lower provision expense quarter-over-quarter, partially explained by a seasonal effect and a lower growth in consumer loans. Banco Agricola recorded a return on equity of almost 18%, Banistmo of 9.5%, whereas Banco Agromercantil returned to 10% annually. Despite the overall positive results of all banks, the net income contribution decreased year-over-year compared to that of Colombia also due to the peso appreciation. We remain cautious regarding the economic and political outlook of all three geographies, particularly with respect to Panama due to the more challenging fiscal performance and expectations around the new government recently elected. Please go to slide 8. Driven by an almost 4% quarter-over-quarter growth in commercial loans, the consolidated loan book resumed its growth, but with a 2.5% quarter-over-quarter increase, despite still recording a 2.6% year-over-year contraction explained by the 17% peso appreciation that reduced the contribution of the loans denominated in US dollars. Absent the FX impact, the loan book would have grown 3.8% on a yearly basis. The growth in commercial loans is in part attributable to the good performance of the subsidiaries in Central America that originated a couple of large corporate loans coupled with the delivery strategy to save market share growth in this segment in Colombia as lower interest expense incentivized demand. It is also worth mentioning the positive performance of the mortgage segment that accomplished a 1.9% growth in the quarter, signaling a slight recovery after several months of subdued demand, driven by social housing as per the establishment of the government subsidy program at the beginning of the year. On the flip side, the consumer segment continues to contract due to a combination of reduced appetite and low demand given the still high rates for these unsecured types of loans. Consistently with the above, the share of consumer loans added to commercial loans during the quarter declined to 20.8% of the total portfolio versus 22.1% a year ago. Please go to slide number nine. Despite the commented growth of the loan book, total deposits decreased 1.2% quarter-over-quarter as we used excess liquidity and reports to fund the loan growth and to prepare medium-term bank loans, which fell almost 10% quarter-over-quarter. Year-over-year deposits recorded a 2.5% drop, whereas loans with banks and debt instruments contracted by more than 25% and 24%, respectively, consistent with weaker credit demand. In terms of products, time deposits grew the most with 1.5% quarter-over-quarter growth, exclusively on digital time deposits, whereas savings fell 2.2% and current accounts 3.2% as clients shifted again towards higher-yielding instruments after the preferred year and liquid position. Year-over-year, time deposits grew 2.8% where we are savings fell 4% and current accounts 10%. From the funding mix perspective, banks maintained their stake, whereas current accounts and loans with banks due to time deposits that increased to 36%. Provided the central bank rate cut and the lower pressure to secure funding, the cost of funding dropped to 5.3% in the quarter. However, it's important to highlight that with regards to time deposits, we were able to cut the weighted average rate by 219 basis points, exceeding the accumulated central bank rate sort of 100 basis points as of March. A proof of our ability to adjust our time deposits maturing profile to secure fast repricing, as discussed earlier. Please go to slide 10. Total interest income on loans and financial leases contracted 4.1% quarter-over-quarter, driven by the lower rates applicable on credit originations and the repricing of the loan book coupled with the reduction in the consumer loan share that yields higher than commercial loan. Moreover, there was a 5.7% quarter-over-quarter decrease in interest and valuations on financial instruments driven by lower income valuation on the test portfolio. Thus, total interest income and valuation of financial instruments fell 4% quarter-over-quarter and 3% year-over-year consistent with the interest rate and portfolio performance. Furthermore, interest expense fell 7.3% quarter-over-quarter and 2.1% year-over-year, given the contraction of deposits, the prepayment of medium-term loans, the reduction in debt instruments, and the ability to grow rates on time deposits to a larger extent when compared to the central bank's policy. However, despite the effort on interest expense reduction, NII fell 1.5% quarter-over-quarter and 3.7% year-over-year, mainly attributable to the drop of interest and valuation of financial instruments. Thus, NIM fell 14 basis points quarter-over-quarter to 7.1% on the back of the 77 basis points lower NIM of investments, whereas the lending NIM only contracted four basis points because of our margin protection strategies in place. Going forward, our NIM will benefit especially from the repricing dynamics of the 67% of total term deposits that will become due in the next 12 months. Please go to Slide 11. Net fee income decreased 2.4% quarter-over-quarter due to seasonal effects, as transactions increased on a year-end. As a result, the income ratio fell to 18%. Year-over-year, net fee income was flat, as the expenses growth outpaced fee income growth due to the higher third-party provider costs and processing charges. When breaking down by products, credit and debit cards, payments, collections, and banking service fee income fell quarter-over-quarter as per lower volume of transactions in the first quarter, while posting roll rates year-over-year. On the flip side, fee income related to Bancassurance fell 27% quarter-over-quarter and 2.3% year-over-year, driven by a smaller share of income, as the claims ratio has increased coupled with a lower volume of policies issued impacting the contraction of personal loans. Regarding other sources of operating income, the fleet leasing operation reduced by 2.3% quarter-over-quarter as per lower demand, but still boasts 10% growth year-over-year. Please go to Slide 12, for an overview of the asset quality. Net provision expense for the quarter was COP 1.3 trillion, an almost 24% drop quarter-over-quarter and 36% year-over-year. Consequently, the quarterly cost of risk fell from 2.7% to 2%, whereas the annual rate will drop to 2.6% cost of risk. The explanation of this sharp drop in net provisions is threefold. First, there was a COP 213 billion reduction on consumer loans given the slower pace of deterioration in Colombia, as we will further elaborate. Second, a COP 198 billion release was mainly attributable to the update of macroeconomic inputs which incorporate the downward part of the interest rate, which is the main variable associated with consumer loans performance, and a release related to a parameter update in Banistmo. Third, a COP 34.6 billion release on a large exposure segment was noted, given prepayments of several past due loans. On the other hand, a COP 55 billion provision expense was accrued on SMEs due to an increase in past loans as expected. Thus, despite the better performance of consumer loans in Colombia, new past-due loans increased quarter-over-quarter, as shown on the upper left-hand side graph, related to commercial loans in Colombia and Banistmo, personal loans in Banco Agromercantil, and mortgages in Banistmo. Moreover, charge-offs for the quarter were COP 1.5 billion, below the charge-off amount in the last two quarters, as the stock of past-due loans on consumer loans is lower and these typically are written-off faster than commercial loans. In terms of asset quality, past-due loans exceeded our quarterly and annual deterioration in terms of 30-day past-due loans as per the increase in new past-due loans. On the flip side, the 90-day past-due loans ratio remained flat quarter-over-quarter, albeit increasing on a yearly basis as the pace of rollover has subsided, provided by recollections and refinancing agreements. On the other hand, provided the decrease in net provision charges in the quarter, both the 30 and 90-day past-due loans coverage ratio fell to 111% and 170%, respectively, although still proving a strong coverage to the balance sheet. Now from an expected loss perspective, Stage 1 slightly increases provided the growth on loans during the quarter, whereas Stage 2 and Stage 3 remained flat quarter-over-quarter as a net result of less consumer loans reaching 90-day past-due and the transition of some commercial loans from Stage 3 into Stage 2 given their better performance. The combined coverage of Stage 2 and 3 loans increased three basis points to a level of 40%. Going forward, we envision a decrease in loan deterioration on the back of interest rate cuts that alleviate pressure on debtor's cash flows. However, we do expect higher delinquencies on SMEs as construction, manufacturing, and retail continue to perform poorly. Moving to Slide number 13, I will further discuss credit quality in Colombia. As we anticipated, there has been a dividend reduction in loan deterioration in the consumer segment in Colombia, provided all the measures taken to increase collections and adjust credit appetite. As shown on the upper left chart, there was indeed a negative past-due loans delta quarter-over-quarter as new vintages are performing better. When broken down by product, personal loans, which hold a 9.4% share of total loans on Bancolombia's standalone book and 20% of loans in Stage 2 and 3 reduced the most in terms of new past-due loans. On the flip side, auto loans, credit cards, and payroll loans registered a higher past-due loans due to a seasonal effect, as individuals typically have access to extra cash in year-end, allowing them to catch up with their installment. But most importantly, cost of risk fell across all products, except for credit cards given the modern recent interest rate update, which forecasts a descending pact that alleviates debt-to-cash flows coupled with the better performance of the BMDS. In the case of credit cards, the increase in the cost of risk was attributed to the fact that the quarter-end date fell in Holy week, and some collections were recorded days after. Based on the adjustments introduced to the consumer risk model that have resulted in better-performing new vintages in Colombia, we continue to visibly increase the volume of new originations, confident that as rates go down, asset quality metrics will improve. In terms of overall asset quality, we continue performing with the average of 90-day past-due loans amongst the largest peers. Please go to Slide number 14. Operating expenses contracted 8.1% quarter-over-quarter due to a seasonal effect related to year-end additional expenses in IT, advertisement, and cash transportation; consequently, there was a lower VAT provision. Thus, administrative expenses dropped 13%, and the personnel expenses that aggregate salaries, benefits, and the compensation plan remained flat despite the 12.3% average salary increase for employees in Colombia, which was somewhat compensated with lower increases in Central America Bank. Now, from an annual perspective and in line with the lower pace of growth exhibited since the second half of 2023, year-over-year total expenses grew 3.5%, significantly below inflation, driven partly by stringent cost control and second by the 17% peso appreciation during the period. Administrative expenses grew 5.4%, mainly because of non-income taxes and IT-related services devoted mainly to the journey to the cloud and business transformation, whereas personal expenses grew below 1% despite the annual wage increase in Colombia, reaffirming the efficiency gains. Consistently, the cost-to-income ratio for the period fell to 46.2%. Please go to Slide 15. Net income for the quarter was COP 1.7 trillion, equivalent to a 15% increase quarter-over-quarter, driven by the 24% drop in net provisions and an 8% reduction in operating expenses that more than offset the contraction in net interest income. On a yearly basis, however, net income fell 3% year over year on the back of long-held contraction, lower income generation, high credit, and operating expenses. The return on equity for the quarter increased to 17.4%, which if adjusted for goodwill results in a return of tangible equity of 21.8%. This shows strong profitability of the operation isolated from goodwill-related issues. Now, please go to Slide 16 to discuss the evolution of capital generation. Shareholders' equity fell 4.2% quarter-over-quarter due to the COP 3.4 trillion dividend payout approved in our General Assembly in March. Year over year, it contracted 1.2%, driven to some extent by the peso appreciation during the period. On the other hand, the core equity tier 1 ratio ended at a level of 10.4%, implying a 100 basis point reduction, whereas on a yearly basis, it increased 7 basis points on the back of organic capital generation. Consistently, the total capital adequacy ratio was 12.3%, equivalent to a 110 basis point quarter-over-quarter reduction, and a 30 basis point increase year over year. During the remainder of the year, income generation will offset the dividend payout to reach the CET1 target of 11% area for the year-end. With this, I will hand over the presentation to Juan Carlos for some final remarks.

Juan Carlos Mora, CEO

Thank you, Jose Humberto. Please proceed to slide 17 to review the evolution of our sustainability strategy. In Q1, we increased disbursements under a business with purpose strategy by COP 10.2 trillion, bringing the total to COP 151 trillion since 2020. These loans support small-scale agribusiness ventures, green buildings, and mobility projects, decarbonization plans, and gender-related initiatives. Over the past year, as part of the Climate Finance Leadership Initiative, we have been actively engaging in meetings with representatives from both the private and public sectors. These discussions have focused on our collective contributions to climate action and clean energy transition strategies. The culmination of this work will be formally presented at the upcoming COP 16 conference. We are also pleased to announce that we have been voted as the company with the highest ESG responsibility for the fifth consecutive year. This recognition is based on the findings of a survey conducted among 80,000 respondents, encompassing ethical conduct, transparency, corporate governance practices, and environmental commitment. Finally, in the area of social impact, we are pleased to introduce La Casa de la Plata, an innovative online platform designed to foster financial well-being among our valued customers. This comprehensive platform provides a wealth of financial education resources and interactive tools, empowering individuals to make informed and responsible financial decisions. Last, on Slide 18, I will share our guidance for the end of 2024 based on the current data and our updated macroeconomic forecast, as shown on the left-hand side, for which I want to highlight the variation in terms of the exchange rate as it imposes changes to dollar-denominated accounts when expressed in pesos. We expect a total loan growth of 8%, broken down into 4.1% growth on peso-denominated loans and 8.5% in dollar-denominated loans. We keep our 6.8% guidance with regards to net interest margin, adjust our cost of risk from 2.4% to 2.6% as vintages continue performing better, adjusted efficiency ratio to 15% area, and maintain our ROE forecast around 14% and core equity Tier 1 ratio of 11% area. With this, we conclude the review of our first quarter results. We will be happy to address any questions you may have. Thank you.

Operator, Operator

Thank you. We will now begin a question-and-answer session. Our first questions come from the line of Ernesto Gabilondo with Bank of America.

Ernesto Gabilondo, Analyst

Thank you. Good morning, Juan Carlos and Jose Humberto, and good morning everyone. I appreciate the opportunity to ask questions. I have three inquiries. First, regarding NIMs, you mentioned adjustments to your balance sheet. What is your current sensitivity in Colombian pesos and basis points for a 100 basis point change in interest rates, and what NIM pressure should we expect this year? Additionally, what normalized levels do you foresee for NIMs? My second question pertains to market-related revenues. We observed some pressure in this area during the quarter. How do you anticipate this to perform in the upcoming quarters? Lastly, on NEC, we've begun to see increased fee income generation and a growing number of active clients. Can you share if you have specific targets for NEC concerning the number of clients, revenues, or profitability within Bancolombia?

Juan Carlos Mora, CEO

Thank you, Ernesto. I am going to start addressing your third question, and I'm going to ask Jose Humberto to give you some insight into the first two questions. I’m also going to ask Laura to provide her perspective on how the interest rates are expected to behave according to our view. So we can have the framework to address your question about the NIM. Let me start with your NEC question. NEC continues to develop its business plan. It's continuing to grow in terms of the number of clients and active customers. We currently have close to 9 million customers, of which around 13.5%, or 5 million customers, are active, meaning that they interact with NEC at least once a month by conducting a monetary transaction. So we have the client base, and the activity of those clients continues to increase, and fee generation of NEC continues to perform very well. Regarding our customer target, we are expecting to continue the same pace of growth. We have a target of around 22 million customers by 2025. But with 19 million, we have a big enough customer base to achieve the revenues that we expect. We continue, as I said, with new products. We launched a platform to receive remittances this year. So fee generation in Nequi continues to increase. We are pleased with the performance of Nequi and how the clients are using the platform. However, we still need to wait for Nequi to reach profitability, which we expect to happen by the end of 2025. With this, I'm going to ask Laura to provide her view on interest rates, and then Jose Humberto will address your questions regarding sensitivity and the market-related revenue.

Laura Clavijo, Chief Economist

Thank you, Juan Carlos. Yes, indeed our revised forecast suggests for the Central Bank policy rate, we revised giving an additional space of an additional 50 basis points during this year. We've seen how during March and April the Central Bank cut 50 basis points, and we expect it may accelerate to the levels of 75 basis points somewhere early in the third quarter. This aligns with how we're observing inflation declining. The most recent number for inflation in April shows another decline, still with a little bit of pressure on food prices, but we believe the climatic impact of the El Nino phenomenon will start to lessen its effects on inflation in April and May. Therefore, we anticipate continued declines in inflation, leading to a much more comfortable level that enables additional rate cuts. However, it is important to consider the upside risks in inflation; we still have announcements from the government regarding a diesel hike. We see some uncertainty regarding their ability to implement the necessary price hikes, especially in gasoline, which have been pressured by international oil prices and the resulting deficits. Thus, we foresee a cautionary approach from the Central Bank towards monetary easing due to the risks still present in stabilizing inflation. I believe we have seen loan portfolio interest rates declining since nearly 12 months ago, reinforcing our outlook on rates and their impacts on loan performance.

Jose Humberto Acosta, CFO

Ernesto, regarding your first two questions, I would say that the sensitivity right now is between 20 basis points to 30 basis points for every 100 that the Central Bank interest rates move. Remember that our structural balance sheet has almost 70% of our loan book floating. Meanwhile, on the deposit base, we have more than 50% floating as well. The other point that I want to highlight is the fact that we have been very aggressive in reducing interest rates on time deposits by around 200 basis points in the last three months. Meanwhile, interest rates from the central bank have reduced by 100. So we have been prepared for the second half. What is going to happen next is that we might feel some pressure on NIM in the second half again, because our expectations are for interest rates from the Central Bank to be at a level of 8.75 at the end of the year. Summarizing, that means the compression of the NIM by around 20 basis points. Regarding the market, specifically with our securities portfolio, we forecast a structural NIM of around 2% due to the investment portfolio. Thus, we expect normalization of that NIM during the second half of the year.

Ernesto Gabilondo, Analyst

Super helpful. Thank you very much, Juan Carlos, Jose Humberto, and Laura.

Operator, Operator

Thank you. Our next questions come from the line of Yuri Fernandes with JPMorgan. Please proceed with your question.

Yuri Fernandes, Analyst

Hi, thank you for the opportunity to ask a question and congratulations on the quarter. I have a follow-up regarding asset quality and provisions. Jose Humberto discussed this in the presentation. When we look at the provisions, they were significantly lower mainly due to updates in the expected loss models. Despite the lower write-offs this quarter, we still observe a high rate of new past-due loans, particularly those that are 30 days past due. It appears that there is a lower signal compared to other lines in this category. I would like to know if you view this as a typical first quarter situation, where seasonality might improve the 30-day figures. Are you comfortable with the lower coverage ratio on these loans? I recognize that your 90-day coverage is higher than for the 30 days, but I want to understand more about short-term delinquency in relation to your guidance on lower cost of risk versus the worsening posture in the 30-day category. That's my first question. Regarding your projections, I see that your ROEs remain steady at 14% despite a lower cost of risk. I believe this is due to a higher efficiency ratio. Could you elaborate on this? Why aren't ROEs expected to be higher for the full year considering you achieved nearly 18% ROE in the first quarter? Is there potential for upside risk regarding the 14% guidance for the full year? Thank you.

Jose Humberto Acosta, CFO

Thank you, Yuri, for your questions. Let me add to your first point regarding the cost of risk and asset quality. The quarter was indeed good regarding asset quality and provides positive surprises on the downside. However, we need to read that quarter carefully. As you mentioned, past-due loans, specifically 30-day past-due loans, ended higher. That's something we need to take into consideration, but it's controllable in the context that the last day of the month was Sunday at the end of Easter week. So, many individuals didn't pay their loans that week but did pay the following week. But we need to be careful about what is going to happen in April. All in all, it was a better quarter than expected in terms of cost of risk that could lead to a better year. However, I want to highlight that this is a year with high volatility in which we need to be careful regarding how the Colombian economy, particularly, will behave. Regarding the consumer side, we see good performance; provisions are lower than we had anticipated. This is because we started adjusting our origination process at the end of 2022. During all of 2023, we had tighter consumer loan origination standards. What we need to be careful of is how SMEs are going to perform during this year. We are examining very closely how that particular segment will behave. Overall, we think we can achieve higher than initially expected costs of risk, which we had initially set at 2.6%. That's why we say we can potentially move to 2.4%, but there is a lot of uncertainty regarding that. Expenses, the quarter was very good, mainly because of some of the measures we took. But also due to the revaluation of the peso which helped us positively this quarter. In previous quarters, the devaluation adversely affected us; this quarter, the opposite was true. In terms of ROE, we believe we could possibly be slightly above 14%, close to 15%. There is a lot of uncertainty, which is why we prefer to stay near 14% as guidance while we keep an eye on how the year develops.

Yuri Fernandes, Analyst

So quickly, if I may, just a follow-up on asset quality. The impression I have is that the situation is still a little bit uncertain on the credit cycle in Colombia. For sure it's improving, but maybe it's improving faster for you than other peers. Do you agree with that statement, given these moving parts?

Juan Carlos Mora, CEO

Completely. Completely. The economic environment is uncertain. GDP growth in Colombia is projected to be close to 1%, which is low. So there is a lot of uncertainty, as you mentioned, and I agree with your statement, Yuri.

Yuri Fernandes, Analyst

Okay. No, perfect. Thanks very much.

Juan Carlos Mora, CEO

Thank you.

Operator, Operator

Thank you. Our next questions come from the line of Julian Ausique with Davivienda Corredores. Please proceed with your questions.

Julian Ausique, Analyst

Hi, everyone, and thank you for taking my question. I have two questions, and the first one is regarding efficiency. I know you already explained this, but I couldn't quite understand. So I would like to understand why you're expecting a deterioration from the efficiency rate from the first 14% or 45% as you report to 50%. My other question is regarding the NIM. I would like to understand why the widening of the loans deteriorated a little bit even with the better performance of the cost of funding. What are you seeing in terms of collecting or the income firmed loans? And the third question is regarding the ROE. I would like to know, I know your guidance is 14%, but I think that I've heard the 14% is like the base case scenario. What would be the best-case and worst-case scenario in terms of the ROE? Thank you.

Juan Carlos Mora, CEO

Thank you, Julian. Sound quality was poor, so I'm going to try to address your questions as best I understand them. I'll start with your last question regarding ROE. Consistent with what we shared earlier, there is a lot of uncertainty regarding the performance of the economy, particularly in Colombia, and how interest rates will behave. This is why we prefer to provide guidance of 14%, which is our base case. There may be potential upside, and we could reach 15% ROE. However, due to the uncertainty on the Colombian economy, we would prefer to stay cautious at 14%. Regarding NIM, we have elaborated on how we expect interest rates to behave. We are managing our cost of funds effectively. However, the Central Bank is likely to reduce the reference rate by around 300 basis points, but we may not see the full effect of these reductions until 2025, with perhaps some part of the effect felt in Q4 of this year. Thus, we expect a reduction to 6.8% for the net interest margin, with the full effect of reductions mostly in 2025. On efficiency, we still expect inflation in Colombia, which is currently around 7%. That means our costs will continue to increase, particularly labor costs. Managing these costs remains a priority for us, and we expect the efficiency ratio to be closer to 50%. I will ask Jose Humberto to add to these comments.

Jose Humberto Acosta, CFO

Thank you, Juan. Just to highlight the part regarding your second question, why did it compress a little bit in the first quarter? There is a combination of two factors at play. First, the reduction in savings accounts because people are shifting from savings accounts to time deposits. Consequently, we increased our reliance on time deposits a bit more. The good news is that 67% of the time deposits are due within a year. Thus, we anticipate the repricing of liabilities will occur at the same pace as assets repricing. That's the main reason you see more contraction in NIM this first quarter.

Operator, Operator

Thank you. Our next questions come from the line of Andres Soto with Santander. Please proceed with your question.

Andres Soto, Analyst

Good morning, Jose Humberto and Juan Carlos. Thank you so much for the presentation. My first question is related to expenses. Juan Carlos, you were mentioning about this plan with medium-term targets for efficiency improvement. I understand this is going to be a challenging year, but looking ahead, what can we expect in terms of expenses and efficiency? You are currently running at a cost to assets of 4.4%. Do you have any number in mind of what could be attainable over the medium-term based on this plan?

Juan Carlos Mora, CEO

Thank you, Andres. As you mentioned, 2024 is a challenging year regarding expenses. Yet, we still maintain our mid-term target of a 45% efficiency ratio. I believe that’s attainable. In the first quarter and last year, the improved results were supported via net interest income because of higher interest rates and better margin growth. However, now that interest rates are decreasing, we need to focus on managing expenses. So, there is significant pressure on the efficiency ratio indicator. Nevertheless, I still believe that our efficiency ratio of 45% is achievable next year. Our inflation forecast for the end of the year is 5.7%, but we project an average inflation rate closer to 7%. There is pressure, specifically with regards to labor costs, which have seen significant increases in the last three years. We are bearing that burden throughout this year. This means we need to focus on operational efficiency in 2024 to realize desired results during 2025.

Andres Soto, Analyst

Thank you, Juan Carlos. My second question is regarding these mandatory loans that the government is proposing as part of the package to stimulate the economy. You mentioned previously that Bancolombia aims to provide around COP 500 trillion in loans with sustainable or ESG factors. How do you see those discussions evolving? Do you believe your loan portfolio will be sufficient for what the government wants to accomplish in terms of mandatory investments? Or do you expect any additional pressure from the government in terms of requirements for where you need to provide funding?

Juan Carlos Mora, CEO

Andres, the president mentioned mandatory investments for financial institutions. However, we do not have sufficient details to provide a comprehensive analysis at this time. We are engaging in discussions with government officials through the Banking Association to obtain more specifics on what the government expects concerning these mandatory investments. Let me say, we have already participated in mandatory investments in Colombia and past experiences have yielded subpar results. This underscores the conversations we are currently having with the government to gain additional clarity on their projections and plans concerning these mandatory investments. Regarding our ESG strategy, we are dedicated to these loans because we firmly believe this is the right direction to take, allocating resources toward clean energy, renewable energy, mobility, and green construction. These are lines of credit we are implementing, and we are committed to tackling climate change. Ideally, these initiatives align with what the government is envisioning and allows us to provide significant attention to agriculture and supporting small producers. However, we still do not have enough information to determine whether those investments will be forces or not.

Andres Soto, Analyst

Understood. Thank you, Juan Carlos, and congratulations on the results.

Juan Carlos Mora, CEO

Thank you very much, Andres.

Operator, Operator

Thank you. Our next questions come from the line of Nicolas Riva with Bank of America. Please proceed with your questions.

Nicolas Riva, Analyst

Thanks very much, and I think it's important that both equity analysts and fixed income analysts can ask questions during the earnings call. So I hope that moving forward, fixed income analysts can have the chance to ask questions as well. With that, I have a few questions on your capital. If you can talk a bit about the call option you can exercise on the 2029 Tier 2 bonds in December. If I look at capital on a consolidated basis, your total capital is at 12.3%. That's only 80 basis points above the minimum requirements. Given that the 2029 Tier 2s will start losing capital treatment if not called, my view is that sooner or later, you will need to raise more Tier 2 capital. So, again, if you can discuss your thoughts regarding the call option that you have on the 2029 Tier 2s in December. You can also confirm that even if you do not exercise the call option, you can still execute a tender offer for the 2029s or even the 2027s, assuming that you get approval from the bank regulator to take out some of the 2027s and/or the 2029s. In that case, could you even consider doing a larger Tier 2 issue and then calling the 2029s in December while also doing a tender offer for the 2027s? Finally, clearly, there was a drop of roughly 100 basis points in this quarter. I assume this was due to the dividend payment you declared this quarter. I want to check if the entire dividend declared in the quarter, the COP 873 million, was fully deducted from your CET1 in this quarter?

Juan Carlos Mora, CEO

Thank you, Nicolas. I will pass your question to Jose Humberto.

Jose Humberto Acosta, CFO

Thank you, Nicolas. Regarding your first question regarding the Tier 2 treatment, we are evaluating the 2029 call option. Next year, the Tier 2 will begin to lose capital treatment at the level of 60%, starting to lose 20%. Our calculations suggest that we will close the year at a level of about 1.7%, and maybe next year that will reduce to 1.2%. Our target for Tier 2 is to maintain healthy leverage between 1% to 2%, and it all depends on market conditions. You mentioned that our BIS is at a low level of 12.3% at the end of this quarter, but this is mainly due to our dividend payout of COP 3.4 billion, which has impacted our capital. However, we project that due to net income and loan growth that will be below 10%, we will close the year at least at 11% in Tier 1 and around 13% in total capital. From this standpoint, it is primarily the dividend impacting our capital. To address your third question: yes, we can initiate a tender offer, but all of this will depend on market conditions. You mentioned that the market is currently active, but again, this is an opportunistic strategy that we will continuously assess over the next few months, depending on conditions. You also asked about the dividend; yes, the dividend declared was fully deducted from the calculation of CET1.

Nicolas Riva, Analyst

Thanks very much. I assume that you're guiding for a CET1 of roughly 11% at the end of this year. You also mentioned that you want to have between 100 and 200 basis points in Tier 2 capital. This means your CET1 is basically guiding for 12% to 13% as a sustainable level, which places you between 50 and 150 basis points over the minimum requirements. Would you feel comfortable with that kind of buffer above the minimum requirements?

Jose Humberto Acosta, CFO

The answer is yes, in this context with the growth expectations we have. We are projecting loan growth to be below two digits in 2024 and 2025. If you maintain growth below 10%, our target remains sustainable.

Nicolas Riva, Analyst

Okay. Understood. Thanks very much, Jose Humberto.

Operator, Operator

Thank you. Our next questions come from the line of Carlos Gomez with HSBC. Please proceed with your questions.

Carlos Gomez, Analyst

Hello. Good morning, and congratulations, and thank you very much for taking the question. I wanted to ask you first about the tax rate? I know that we update this every quarter. I wanted to know where you are now, what do you expect for this year and for the coming year? And second, you mentioned that Bancolombia represents now so much of the earnings of the Colombian banking system, which is great for Bancolombia. Maybe it's not that great for Colombia itself. Are you concerned about the situation in which the rest of the system is? Are you perhaps a bit more careful now when you take counterparty risk with any of the other institutions in the system? Thank you so much.

Juan Carlos Mora, CEO

Thank you, Carlos. Regarding taxes, we are expecting our effective tax rate on a consolidated basis to be around 26% to 27%. Remember, we have income from different geographies with different tax treatments. So, on a consolidated basis, we have an income tax rate in Colombia of about 40%. Combining income from the different jurisdictions gives a tax rate of around 26% to 27% as mentioned. Regarding your second question, I want to be clear that we are not concerned about the situation of the financial institutions in Colombia. All of them are solid with good levels of capital. The condition you observe is more in relation to market circumstances that transpired throughout last year and the beginning of this year. But as stated, we are not concerned about systemic risk in Colombia because, as I mentioned, all the institutions have good capital levels and are taking the needed measures.

Carlos Gomez, Analyst

Okay. That's clear. Thank you so much.

Juan Carlos Mora, CEO

Thank you, Carlos.

Operator, Operator

Thank you. Our next questions come from the line of Tito Labarta with Goldman Sachs. Please proceed with your questions.

Tito Labarta, Analyst

Hi. Good morning. Thank you for the call and for taking my question. I’m sorry some of this may repeat; I joined a little bit late. But just you maintained your ROE guidance of 14% for the year despite a pretty good quarter. I know there's still some headwinds, but what do you think is going to drive ROE lower from here? Is it mostly a function of interest rates? As rates come down, do you see pressure on margins? Are you concerned about asset quality getting worse? I know provisions were lower, but could that increase from here? And also, in terms of loan growth, which is still somewhat muted, any concerns on that? Thinking a little beyond 2024, if the economy begins improving in 2025, do you think that 14% ROE is sustainable beyond 2024? How could it evolve, particularly if rates continue to fall in 2025? Just some color on the path from current ROE, which is very strong, to that 14% you expect for the full year. Thank you.

Juan Carlos Mora, CEO

Thank you, Tito. I'll answer your question clearly. The variables you mentioned will influence our performance and ROE. However, the most crucial factor for us this year remains cost of risk. We see considerable uncertainty there, and we believe ROE is achievable, and we think we can reach that level, identifying that as our base case. I will state that we do have possibilities of upside that could result in higher ROE. However, the key factor I keep repeating is the cost of risk. Regarding NIM and loan growth: We have clear expectations here, and we believe we have the elements needed to manage margin effectively. Loan growth may remain slow due to economic performance, but we have the tools to handle that. There is significant uncertainty about cost of risk, and we'll monitor that closely as we take steps to manage it. As mentioned earlier, our focus on SMEs is vital. We must also stay observant on consumer loans which are performing better than expected but still warrant attention. Overall, we feel confident we can secure the targeted ROE during 2024 becase of efficient cost management.

Operator, Operator

Thank you. We have reached the end of our question-and-answer session. I would now like to turn the call back over to Juan Carlos Mora for final remarks.

Juan Carlos Mora, CEO

We would like to thank you for attending our first quarter 2024 conference call. As we highlighted during the call, it was a good quarter, and we are very happy with the results. Uncertainty remains an important factor in determining our results for 2024, so we expect to see you at our second-quarter conference call to discuss the development of Bancolombia. Thank you very much, and have a good day.

Operator, Operator

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.