Credicorp Ltd.

The following is a recording for Credit Corp on Thursday, February 7, 2019 at 8.30 a.m. Central Time. Good morning, everyone. I would like to welcome all of you to Credit Corp's LTD Fourth Quarter 2018 Conference Call. We now have our speakers in conference. Please be aware each of your lines is in a listen-only mode. At the conclusion of today's presentation, we will open the floor for questions. At that time, instructions will be given to the procedure to follow if you'd like to ask a question. With us today is Mr. Walter Bailey, Chief Executive Officer, Mr. Alvaro Correa, Deputy Chief Executive Officer, Mr. Gianfranco Ferrari, Deputy Chief Executive Officer, Mr. Cesario, Chief Financial Officer, Mr. Reynaldo Llosa, Chief Risk Officer, and Ms. Francesca Raffo, Head of Transformation at BCP. Now it is my pleasure to turn the conference over to Credit Corp's Chief Financial Officer, Mr. Cesar Rios. Mr. Rios, you may begin.

Thank you. Good morning and welcome to Credit Corp's conference call from our earning results for the fourth quarter of 2018. Before we review Credit Corp's performance in the fourth quarter of 2018, I would like to highlight some important matters that characterize the scenario in which we have operated in the last few months. as tailwinds for our businesses. First, we expected real GDP growth in the last quarter of 2018 to stand close to 5% year-over-year. With these results, the economy will have grown around 4% in 2018, one of the best results in the region. The fishing sector, public investment, and private mining investment were the main drivers of growth in 2018. There were important investment announcements in 2018. One of the most notable was the Keyabeco mining project in Moquegua for $5 billion. Third, the average price of copper stood at $2.96 per pound in 2018, which represented a four-year peak. The price ended at $2.7 per pound, a headwind for our businesses. global economy activity desaccelerated in the last quarter of 2018. Second, through 2018 we observed an escalation of tensions between the U.S. and China. This has implied risk for global economic growth. Third, in 2018 we observed several episodes of financial volatility that impacted our trading-related activities. On the local front, Peru registered a slight decrease in corporate output during the second half of 2018. Lastly, the Lava Jato scandal has had negative effects on economic activity through a paralysis of certain investment projects and political uncertainty. With regard to the political environment, the referendum held on December 9th has no material impact on the business environment. Finally, the most important political event in 2018 was in March 2018 when President Vizcarra took office. Please, let's move to the next page. Here, I would like to discuss the evolution of the local economy in the fourth quarter. In chart number one, you can see that GDP growth peaked in the last quarter in the year, as mentioned in the previous slide. In chart number two, you can see that domestic demand is estimated to have recovered in 2018 and reached a five-year peak. In chart number 3, you can see that local and international interest rates, which affect our funding costs and businesses, decreased in the last quarter of the year. In parallel, the Peruvian central bank reference rate has remained stable at 2.75% since March 2018. In chart number four, the orange line shows that total loans in the Peruvian banking sector expanded 10.2% in 2018, which represents the highest growth rate in three years. Consumer loans expanded 12.6% in 2018, which represents a three-year peak. It is important to highlight that quarter end loan balances of Credit Corp grew 10.3% in 2018. Please, next page. Regarding the full year performance, there are important aspects of our lines of businesses I would like to mention. In the case of Universal Banking, BCP improved its pace of loan growth in all segments after low loan expansion in 2017. The loan needs in the first half of the year put downward pressure but towards the end of the year, retail banking accelerated its pace of loan growth, leading to a subsequent recovery in net interest margins. Moreover, for the fifth consecutive year, the cost of risk dropped, leading to a subsequent increase in credit court risk-adjusted net interest margin. However, although income generation improved, the cost-to-income ratio deteriorated due to acceleration in the pace of growth of operating expenses. which was in turn registered particularly in the last quarter of the year and changed the decreasing trend of deficiency ratio observed in previous quarters. We will explain this topic in detail later on. BCP Bolivia reported a good level of loan growth and a reduction in provisions. However, the funding costs and operating expenses increased and accordingly profitability fell. With regard to microfinance, Nibanco posed a good level of long growth, although long origination slowed down in the third quarter. The cost of risk was relatively stable in comparison to 2017 level, even though it deteriorated in the second and third quarter. Nibanco improved its cost of risk during the last quarter. Moreover, Nibanco has improved its funding structure by increasing retail deposit share of total funding. After significantly improving its operation efficiency in 2017 and 2018, Mivanco has started building capabilities to sustain business growth, which translated in an acceleration of the pace of growth of its operating expenses. Mivanco has started increasing its number of loan officers and building new channels leveraging its digital capabilities. Regarding the challenges these subsidiaries have faced, it is important to mention that the downward pressure emerges due to competition. With regard to the insurance and pension funds, the insurance business posted an increase in its contribution to critical and an improvement in the... Reposted by the life insurance business and to the good results of health business from the association with Banmedica. All the aforementioned offset the deterioration in the underwriting results of the P&C business, as the increase in net claims and acquisition costs was higher than the increase in net earning premiums. The pension fund business also improved its performance after recovering the profitability of its funds under management and boost of its legal results. However, the tender for new affiliates as was held on December 2018 was not awarded to Prima. in the investment banking and wealth management. In 2018, wealth management income grew in Peru and Chile, offsetting a decrease in income in Colombia. Additionally, total expenses remained stable, although the cost-to-income ratio deteriorated due to a decrease in total income. In the last quarter of 2018, Credit Corp. Capital Chile posted an impairment in Goodwill for 38 million soles, which was mainly due to the adjustment of the discount rate. Finally, the mark-to-mark or proprietary investments deteriorate mainly due to the increase in interest rates. Next slide, please. In this chart, you can see the most important figures of credit course performance in the four quarters. Credit Corp. reported net income of $957 million, which was 5.4% below the third quarter results of the previous quarter and 10% below those registered in the fourth quarter of 2017. The results represent a return on average equity and average assets of 16.3% and 2.2% respectively. The quarter-over-quarter evolution reflects the effect of a significant increase in operating expenses which offset the favorable evolution posted by the net income, core items of non-financial income, and provision for loan losses. The year-over-year drop in net income is attributable to three factors, an acceleration in the pace of growth of operating expenses and an impairment of 38 million soles of Credit Corp's capital shield. Both reported in 2017, and the sale of NL shares in the fourth quarter of 2017, which generated income of $163.7 million. Finally, it is not worth the first, the acceleration in the pace of loan growth and its positive impact in net interest income, which posted the highest quarterly growth rate in 2018, and second, the improvement in cost of risk. Next page, please. In this chart, you can see the full year results. Net income reached a level of 3.9 billion solids, which represented a return on average equity and average assets of 17.5% and 2.3% respectively. These results were 2.6% below those obtained in 2017 due to, first, the gain, or 440.47 million soles from the sale of two long-term equity investments, BCI and NL registered in 2017, and second, but to a lesser extent, increasing operating expenses and impairment at credit card capital shift. However, it is important to highlight the significant improvements in core items such as the acceleration in the pace of loan growth, the significant reduction in cost of risk, and those the recovery of risk-adjusted net interest margins, and expansion of income and gains on FX transactions. Finally, on terms of capital ratio, DCPS and alone, the BIS, P1, and core equity P1 ratios decreased due to a strong growth in risk-weighted assets in line with long expansions. It is important to remember that we keep at credit cost level a reserve fund of approximately 1.5 billion solids, which is invested in liquid low-risk assets. This fund has the effect of reducing credit cost return on average equity by around 100 basis points. Let's review the main figures and indicators in more detail. As you can see in chart number one, first, interest earning assets measured in quarter and balances remain relatively stable quarter over quarter and year over year. Second, there was a change in the composition of interest earning assets in favor of the most profitable assets, loans, which increased their share in total interest earning assets. This trend was observed throughout 2018. Third, as shown in chart number two, Average daily loan balances expanded 9.2% in 2018. Furthermore, in terms of loan mix by business segment, loan expansion was mainly driven by wholesale banking, followed by retail banking and daily banking. It is important to note that loan expansion in retail banking was led by the mortgage loan book. Fourth, in chart number three, you can see that loan growth was fostered in both local and foreign currency. However, the expansion in local currency loans outpaced that of the foreign currency loans. Next page, please. In terms of funding, first, as you can see in chart number one, The report's funding structure shows an increase in deposit shares of total funding, which is more evident in the year-over-year analysis. This was the trend we observed throughout 2018. Second, in chart 2 for deposits by type, you can see that the mixing deposit has also favored funding, given the low-cost deposits, such as savings and demand deposits, increase their share. The 13.8 year-over-year increase in saving deposits is not working and was driven mainly by the initial results posted by saving accounts opened at kiosks, which was the first product launched by BCP's strategic initiative transformation. Third, as shown in chart number three, credit card funding costs have remained relatively stable despite the upward trend in international rates, mainly due to a more favorable funding mix both by currency and by funding source. Next page, please. Net interest income grew 4.9% quarter over quarter, 8.6% year over year, and 5.2% in 2018, which represents an improvement compared to the results posted in the previous quarter and in 2017. This performance shows, first, the positive effect of loan growth on interest income, where all segments of BCP and MiBanco expanded their portfolios. Second, the moderate increase in interest expenses, which was attributed to a more favorable funding structure than in previous years, as we explained earlier. Next page, please. With regard to risk quality, in chart number one, you can see the quarter-over-quarter evolution of the total cost of risk, which decreased 20 basis points due to, first, the decrease in the provisions required at BCP due to the improvement of the risk quality of the portfolio and the revulsion of provisions due to reduction in the exposure to clients related to the Lava Jato case. The decrease in the provision required at Mibango after the adjustments made at the end of the second quarter of 2018 to recover risk quality. The analysis of two-year results are shown in chart number two. The contraction of 40 basis points in the total cost of risk is not working and due mainly to, first, the reduction of BCP's provision requirement due to the improvement in the risk quality of the portfolio, in particular in the consumer and credit card segments, and to the reversal of provisions from Lavajato case claims. And second, the effect of 2017 of the provisions requirements for the El Niño phenomenon and the Lavajato case. It is important to remember that on January 1st, 2018, Credit Corp adopted the requirements of IFRS 9 for loan provisions whose first effect was a one-off increase of 320 million loans and off-balance sheet exposures due to methodology changes. Next page, please. As we discussed in previous slides, Credit Corp's net interest margin was relatively stable in 2018, reaching a level of 5.26%. Furthermore, for the fourth consecutive year, the cost of risk improved and reached a level of 1.38%, 44 points below the level posted in 2012. As a result, Credit Corp's risk-adjusted net interest margin increased 20 basis points and reached a level of 4.31%, the highest in six years. These results represent clear evidence of the efforts and resources that we have been rolled out to strengthen our capabilities as well as project strategies. After challenging years in terms of risk quality and long-term risk-adjusted means, we have reached a healthy level. Next page, please. On this page, we will discuss the evolution of non-financial income. As you can see in chart number one, non-financial income expanded 6% quarter over quarter due to good performance for core items, free income, net gains in foreign exchange transactions, and the net gain from associates, which refers to the health business from association with Bank Medica. On a full year basis, as you can see in chart number two, the core items of non-financial income that we mentioned before also post-dual performance. However, total non-financial income contracted 5.9% compared to the level in 2017. This was mainly attributable to, first, the income of $444.7 million generated in 2017 from the sale of equity investments DCI, and ML, and so on, in a lesser extent, the effect of market volatility throughout the year that resulted in a decrease in the net gain in sales of securities and net gain in derivatives. Next page, please. In the year-over-year analysis of operating efficiency, which eliminates seasonality And in the full year analysis, you can see that the cost-to-income ratio deteriorated due to an acceleration in the pace of growth of operating expenses. This was mainly due to an increase in salary and employee benefits, administrative and general expenses, and acquisition costs of the insurance business. In 2018, approximately 50% of the increase in operating expenses was registered in BCP stand-alone. 30% in Pacifico and 10% in Mibanco. If we start with Mibanco, the expansion in operating expenses was mainly due to the developing of new capabilities to support the growth of our traditional businesses, international expansion, and the creation of digital products. In the case of Pacifico, Approximately 60% of this increase was mainly related to the expansion of sales in life insurance businesses, and the remaining 40% was mainly due to a change in the accounting of property and casualty of underwriting fees that previously were booked up front and from 2018 and on are accrued over the lack of insurance policy. In the case of DCP standalone, a third of the increase is due to the strategic initiative transformation, whose budget execution was accelerated at the end of the year. The remaining two-thirds were mainly due to three different drivers. First, expansion of transactional activity. Second, the increase in incentive for productivity and variable compensation, which were mainly explained due to sales volume above target, and the outperformance in another KPIs such as customer satisfaction. And third, a BCP stand-alone net income surpassed budget, so we provisioned an additional profit sharing for employees. Now, I would like to hand over this call to Francesca Raffo, Head of Transformation at BCP, who will talk about the strategic initiative transformation that we are executing at BCP.

Thank you. I'd like to show a slide with the purpose and BGP's North Star. We have established two North Star goals for 2021. One of them being number one in customer experience in Peru and the next one having the best efficiency ratio in the region. To describe how those look like in more concrete terms, we have set six key results for 2021. And we have really challenged ourselves significantly to define them, and we know we might not achieve all of them. But the purpose is to inspire and give size to our ambition and to move the organization towards this goal. The key results are a cost-to-income ratio around mid-30s, to duplicate the cross-sell ratio for our customers, to be able to pre-approach 50% of the economically active population, to be number one in employee experience, to serve 70% of our sales digitally, and also a non-disclosed net income goal. The next slide shows the way we approach the transformation. We started some years ago and we describe it as we are on board of a large spaceship on our way to planet XF, the planet of experience and efficiency. Our program is currently organized in 10 fronts. These we refer to as engines of the transformation, and I will briefly comment on some of them. The first one was digital learning. This is focused on improving a customer experience through digital innovation. We have a structural project which has been in the market and it has grown significantly, reaching 450,000 users. Strap-it is a key piece in our digital strategy as we are focused on increasing its use. It helps us to build customer loyalty, reduce the use of cash, increase deposits, and allow us to obtain more customer data to serve them better. We have also built five digital MVPs and are beginning to see the results in different parts of the system. Digital risk. We focus on transforming the risk process within the bank so that we are more prepared for a digital world. The end of 2018, We have managed to achieve credit for 25% of the economically active population and a principal increase from 16% in 2017. Data and analytics are the challenge to enable a self-driven organization. We have a few different layers of three of our two data signatures, the data lake, We have also experienced that data scientists start to write to data analytics. Key highlights to the analytics is that we use data analytics to manage to increase cost in a portion exchange basis. Another entry is the situation model and focusing on redefining the situation model for lacking to our customers and to our customers' needs. In 2018, 25 branches were supported by the Board. In this slide, you can see the first resource. Number one, we see our customers. Number two, we have the resource. By the end of 2018, 31% of our customers are now digital customers, going from 21% two years ago. Consumers' customer base has grown 3% in the same period, which means that the number of digital customers has grown more than 90% in the last two years. In terms of construction, The percentage of transactions performed through digital channels continues to increase as a percentage of total transactions done at branches and end-to-end, and as a result, it continues to increase. In December 2018, 58% were done via digital channels, and that number turns into 59% when we include zero-waste transactions, and only 4% of the transactions were executed at the branches. The next slide is digital sales. Regarding digital sales in 2018, 6% of our digital sales in usage were served digitally, and 33% were served via digital and self-service channels. And if you look at December alone, those numbers are 8.3 and 34.6 respectively. So we're going to... Start again looking at the Q results. Slide number 16. So our main achievement for 2018 is as follows. Looking at our digital results, by the end of 2018, 31% of our customers are digital customers, growing from 21 two years ago. Considering our customer base has grown 30% in the same period, it means that the number of digital customers has grown more than 90% in the last two years. In terms of transactions, the transactions performed as a percentage of digital channels continues to grow, and the percentage done at branches decreases. In December 2018, 48 of our transactions were done via digital channels. That number turns into 59 when we include POS transactions. And only 4% of the transactions are executed through branches. Next slide is digital sales. Regarding digital sales, in 2018, 3% of our sales in units were served digitally, and 33% were served by digital and third service channels. In December alone, both numbers are 8.3 and 34.6, respectively. We have six products being sold via digital channels and expect our digital sales to continue to increase as the offering continues to grow. We introduced the savings account opening on digital channels in December 2019, and in the first month of operation, 2% of all the account openings were done via this channel. An additional 39% of accounts were opened via our self-service key. Starting at 90%, 21% of them are now sold digitally. Finally, regarding the loan portfolio, we launched credit card applications via web in December of 2018, and in the first month also, it has contributed 2% of the total credit card sold. Regarding our several advanced products, one-third of them are served digitally. We continue to work on delivering new products via digital as we are convinced this brings both better experience for our customers and more efficiency. The cost of opening a savings account is nine times lower than compared to that of physical channels. The next slide, we look at satisfaction. Finally, in terms of customer satisfaction, we remain at the market leader in our private banking and other affluent small mid-sized business and middle market corporate banking and institutional segments. And we have achieved to grow from fourth to third place in our consumer segment market, which is the biggest market in terms of number of customers.