Bancolombia - Q1 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen, welcome to Bancolombia's Q1 2023 earnings conference call. My name is Ashia, I'll be your operator for today's call. At this time, all participants are in listen-only mode. Following the prepared remarks, there'll be an opportunity to ask questions. During the question and answer session, if you have a question, please press star then one on your touch tone phone. 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 in this conference call, in future filings, in press releases, or verbally address matters that involve risks and uncertainties.

Consequently, there are factors that 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 describe in our reports filed with the SEC. With us today is Mr. Juan Carlos Mora, Chief Executive Officer, Mr. Mauricio Rosillo, Chief of Corporate Officer, Mr. José Humberto Acosta, Chief Financial Officer, Mr. Rodrigo Prieto, Chief Risk Officer, and Ms. 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 Q1 2023 results conference call. The results for the quarter show an overall good performance. Net income was COP 1.7 trillion, driven by the bank's capacity to generate strong income on the loan and securities portfolios that offsets higher operating costs on the back of thickened inflation, high interest rates, and credit deterioration. As we will further elaborate after posting strong GDP growth in 2022, the countries in which we operate are now facing an economic slowdown. Particularly, Colombia is facing a deceleration in private consumption, adding pressures to an already challenging macro backdrop scenario with falling but still high deficits. The Central Bank in Colombia increased the reference rate up to 13.25% in its effort to control a thickened inflation that reached 13.3% as of March.

Given this macroeconomic scenario and the consequent adjustment in risk appetite in some portfolios, the loan book growth moderated in a quarter, posting a 1% drop on gross loans. The peso appreciated 3.4% during the period, reducing the contribution of US dollar-denominated loans. The loan book moderated its growth pace on a yearly basis to 20%. Deposits were flat quarter-over-quarter and increased 20% year-over-year in line with the loan book performance. NIM was 7.2% with a slight 10% basis points drops quarter-over-quarter, expanding 120 basis points year-over-year as a result of our asset sensitive condition on which we will further elaborate.

Net provisions for credit losses for the quarter were COP 2 trillion, equivalent to a cost of risk of 3.1% for the quarter. This represents an increase of 17.5% quarter-over-quarter, driven mainly by consumer segment deterioration as households' disposable income faces pressure on the back of high interest rates and persisting inflation. As expected, non-performing loans reflect the rollover deterioration with a 2.7% 90 days NPLs ratio. Loan losses coverage remains strong at 218% for 90 days past due, while Basel III core equity Tier 1 ratios stood at 9.8% and total capital ratio at 12%, well above the minimum regulatory capital. OpEx decreased 4.6% quarter-over-quarter and grew 26% year-over-year, driven mainly by increases in wages and effects depreciation.

Efficiency ratio for the quarter was 41%. All in all, higher income generation spinning out of the loan and securities portfolio contributed to offset the broad expense increase, posting an ROE of 17.7% for the quarter. However, as discussed in our previous call, less favorable global and local macro conditions have more regulated Colombia's pace of growth after the strong rebound in the last 2 year after the pandemic. This, coupled with intensified political uncertainty, lead us to believe the economy will grow 0.6% during the year. It is still soon to assess other economic and social impacts arising from the government's ambitious reforms, particularly those related to fiscal imbalances, labor costs, and private consumption, as well as the new cabinet's policy decision-making.

We are following the situation closely as we continue committed to base our decisions under a combined short-term, long-term approach, confident on the strengths of Colombia's financial system and a robust regulatory framework. For further detail on the macro outlook, I will turn the presentation to Laura Clavijo, who was appointed as Bancolombia's Chief Economist after the resignation of Juan Pablo Espinosa. Laura?

Laura Clavijo (Chief Economist)

Colombia experienced an impressive economic rebound following the significant impact of the COVID-19 pandemic. For the period comprising 2021 and 2022, the Colombian economy expanded at an average quarterly growth rate above 8% in real terms, spurred mainly by consumer demand, a dynamic services sector, and thriving activity in manufacturing. During the first months of 2023, economic activity has slowed significantly in response to higher inflation and rising interest rates. According to market forecasts, GDP is expected to grow below 1%, with our forecast set at 0.6% for this end of year. For 2024, a moderate rebound is expected coming from a lower growth phase, with our estimate set at 1.6% of real GDP growth.

High inflation has been a persistent theme in the Colombian economic outlook for the past few years, much aligned with global rising prices. Inflation in Colombia peaked at 13.3% year-over-year during March and fell to 12.8% during this past April, in what is thought to be the beginning of a much anticipated downward trend. On the positive side, food prices increased at a much slower rate, enabling a drop from its 30-year peak of 27.8% in 2022 towards a lower level of 18.5% this past month of April. On the downside, there is an elevated risk of climate-related pressures to food prices for the second half of the year, in addition to sticky prices coming from regulated goods such as fuel and gas.

Consequently, inflation is expected to fall to 9% this year and 4.8% in 2024, moving gradually closer, but still far away from the Central Bank's target range of 2 to 4%. Even though inflation in Colombia remains a concern, subsiding core inflation may serve as a potential backdrop to halt further interest rate hikes. The Central Bank's reference rate saw at the beginning of May, what could be its final rate increase of 25 basis points, reaching 13.25%, thus accumulating a 1,150 basis point increase since late 2021, when rates started to increase. Increasing interest rates have begun to pressure households, and the financial sector's loan portfolio has deteriorated accordingly, especially in the consumer segment.

Considering the economic slowdown, we anticipate the Central Bank will begin its cycle of interest rate cuts in the second semester of this year. On the fiscal side, higher than expected oil revenue and additional tax collection from 2022's budget reforms will help the Central Bank's deficit to fall from the 7 to 8% level of the COVID years to around 4.4% of GDP in 2023, thus enabling the government to meet fiscal rule targets and at the same time increase social spending. Overall, the economic outlook for Colombia remains cautiously stable, with moderating inflation and expected interest rate stability amidst an economic slowdown. Consumer confidence has dwindled to an all-time low amidst these economic challenges, political shifts, and social unrest.

The left-wing government of Gustavo Petro has proposed significant changes to the status quo economic model through an ambitious agenda including tax, health, pension, and labor market reforms. More recently, a wide cabinet overhaul included the exit of Finance Minister Ocampo. This has set a new political scene in an attempt to advance in the approval of the reform agenda. Incoming Minister Bonilla, a close advisor to Petro, has announced continuity to former Minister Ocampo's agenda of prudent macroeconomic policy and fiscal sustainability. We will continue to closely monitor economic indicators, changing market conditions, and the political environment. Please let me turn back the presentation to Juan Carlos, who will present Bancolombia's quarterly performance.

Juan Carlos Mora (CEO)

Thank you, Laura. Moving to slide number four, I want to call your attention on a set of distinctive capabilities that result from our capacity to generate transactional volume. Which in turn are based on our strong client growth and our digital evolution. Two relevant avenues of growth, of which we shared relevant metrics in our previous call. In this opportunity, I will refer to the merits of this capacity and threefold contribution on: first, deposits and fee income generation. Second, balance sheet structure and NIM performance. Third, cash flow data that fits our risk models. In the following slides, I will further elaborate on each of these elements that allow us to adjust to economic cycles, preserving income generation and balance sheet protection to deliver short and long-term profitability.

In slide number five, you can see the strong growth correlation in terms of number of clients, transactional volume, and size of our deposits. However, the curve of transactions is clearly steeper, outpacing the others. This is not a coincidence, in the last years, we have been investing in developing a broad, robust, and interoperable ecosystem, an engine that engages more clients, increases overall transactional volume and fees, and thus attracts more deposits. In the last years, these efforts have been mainly focused on our digital platforms and products, such that as December 2022, Bancolombia processed around 74% of the market's mobile digital transactions and around 45% of the online banking transactions. As an example, Nequi today has more than 1.4 million active users per day, and close to 10.2 million active users per month.

Moving to slide number six. The most interesting edge of our digital strategy with the evolution of products and channels is that we have been able to attract former unbanked and underbanked individuals that seek for low value transfer and cash out solutions. This in turn results in highly diversified low amount, low cost and sticky deposits that come in mainly through savings accounts. Given as a portion of these deposits have shift towards time deposits in the last quarters seeking for higher rates, savings accounts remain highly relevant due to its scale, representing a 52% stake in the overall funding mix, and thus serving as a one of the key elements for the net interest margin performance. By nature, savings accounts are a stable cash management related deposit tied to fixed rates.

In Colombia, four years ago, they accounted for 25% of the total funding mix, and they have been growing steadily, reaching today at 52%. In the upper left graph, you can see the cost advantage that savings accounts represent to us today due to its significant contribution in terms of volume and low cost relative to the total funding mix. From a balance sheet perspective, this funding structure clearly contrasts with that of the loans, as approximately two-thirds are tied to floating rates, allowing the bank to appreciate a large portion of the portfolio upon interest rates variations. In other words, as we have discussed previously, we have an asset sensitive condition that coupled with a stable low cost funding base, explains the bank's capability to capture a higher margin even as interest expenses goes up, as shown in the bottom left and right graphs.

For us, the contribution of a higher transactional volume that drags along low cost and sticky deposits has been and will be key to deliver NIM performance and long-term profitability. Moving to slide seven. I want to elaborate on the last of the three elements of our competitive advantage based on transactional volume, which is the access to information that we use to feed our risk models. As we evolve in digital products, channels and transactions and generate more deposits and fees, we also capture a by-product which is data on cash flows, and thus a good sight on clients' payments capacity. It has been the key element behind our customer segment growth strategy started back in 2014, as the data input allowed us to anticipate and adjust our appetite on different credit cycles.

In other words, to expand or to contract origination and other measures based on the payment capacity tracker. That's why since mid 2022, we anticipated with several measures based on the cash flows and disposable income assessment of our clients, some of which have been, one, a decrease in risk appetite to individuals without credit history. Second, a gradual adjustment on risk appetite to low-income individuals, and third, further stress in disposable income estimates. As a result, you can see in the chart that the total pre-approved disbursements have dropped constantly since mid-2022, and we will continue to adjust our policies and collection decisions based on these insights. In slide number eight, I want to comment on our ESG strategy.

From a business perspective, I am glad to say that we continue making progress in our loan origination target as we disperse COP 6.5 trillion aligned with our business targets for the quarter, reaching an aggregate of COP 109 trillion since 2020. That is 21% of the 2030 goal. From a strategic perspective, I want to share with you the framework we designed as a roadmap to leverage our purpose of promoting sustainable development to achieve everyone's well-being. In addition to the organization's annual ESG performance measures. We have identified three main ESG goals for which we are generating actions: climate change, biodiversity, and circular economy. Based on this framework, during the Q1, we continued working in our alignment and adherence to Net-Zero Banking Alliance, Net-Zero Banking Managers Initiative, UNEP's Responsible Banking Principles, the Climate Finance Leadership Initiative, and GFANZ.

We also partnered with Ellen MacArthur Foundation to advance in our circular economy strategy. Finally, we are aligning to Taskforce on Nature-related Financial Disclosures, and we have reported our progress in CDP Forests and have signed the Financial Sector Deforestation Action, where we work to reduce deforestation from our investments in lending portfolios by 2025 in the following sectors: palm oil, soybean, cattle for beef and leather, pulp and paper, and rubber. We are very satisfied with the progress made on every one of these initiatives, which serves as a testimony of our commitment to our ESG strategy. As a matter of fact, our ESG performance is permanently assessed and ranks with high scores on the Dow Jones Sustainability Indices, the Carbon Disclosure Project, and MSCI, just to name a few.

After this general business update, I want to turn now the presentation to José Humberto Acosta, who will further elaborate on our Q1 results. José Humberto.

José Humberto Acosta Martín (CFO)

Thank you, Juan Carlos. Moving to slide number nine, you can see the evolution of loans and deposits per segment during the period. The consolidated loan book dropped almost 1% quarter-over-quarter, consistent with the drop in all segments, mainly in commercial, which went down 1.2%, affected by less originations in Colombia and some prepayments in Banistmo. Consumer loans also fell 0.8%, reflecting the consequences of the economic cycle and risk appetite adjustments discussed earlier. The result for this quarter was also affected by a 3.4% peso appreciation. Net of the effects, the loan book was flat quarter-over-quarter. However, on a year-over-year basis, the aggregate loan book still expanded at 20%, as was the case for all segments, except for consumer, that expanded slightly below at a level of 19%.

Compared to the last quarter, yearly expansion of 22%, this pace of growth reflects some moderation due to the lower demand and less risk appetite. On the other hand, total deposits performance during the quarter was aligned to that of loans. That is, they were flat on the quarter. However, time deposits grew almost 12%, gaining share on the total deposit mix as savings dropped 6.2%. This is due to the higher interest rates environment and thus we expect further shifting towards time deposits in the following quarters. Moving to slide 10, we present a brief snapshot of the Central America operation performance. As of March of 2023, Banistmo, Banco Agrícola, and BAM represented 29% of the total loan portfolio, in line with the past quarter.

Despite all metrics are affected by effects on each period, in general terms, most banks have increased their share at a consolidated level and show similar trends as to Colombia in the last quarters in terms of loans and deposits growth. The income generation, good NIM performance, and efficiency gains. A good example of this positive evolution is BAM, which has been growing steadily in a higher risk-adjusted returns in consumer segment on the back of Guatemala's better economic performance. We continue working on tapping growth opportunities and implementing cost control initiatives to boost profitability in all geographies. Moving to slide 11, I will elaborate on liquidity. The total funding mix changed again during the quarter as saving and checking accounts kept yielding to time deposits that grew 12% consistent with the preference towards higher interest-bearing deposits.

As a result, time deposits reached a 34% in the total deposit mix, whereas savings to 38% and checking accounts 13%. Overall, deposits still represent an 85% share of the total funding mix, in line with the last quarter. As a result of the larger portion of time deposits, the cost of funding grew by the 5.27% remains significantly below the 13% prevailing reference rate during the quarter. This certainly reflects our cost advantage based on the strength in saving accounts. Even when interest rates have risen significantly since the third quarter of 2021, our overall cost of funding has increased substantially less.

Going forward, we do not foresee funding pressures, and we are running comfortably in our short- and long-term regulatory liquidity ratios, as reflected on the Liquidity Coverage Ratio and Net Stable Funding Ratio on the bottom left graph. Finally, I want to take this opportunity to comment on our investment portfolio structure and its composition. As of March, our investment representing roughly 9% of our total assets and had a duration of at around 14 months, reflecting our nature of a commercial bank, whereby our securities portfolio is composed of mandatory investments and high-quality assets for liquidity management purposes. Therefore, 21% are debt securities issued by the Colombian government and 49% of foreign governments, of which U.S. Treasury bills represent at around 30% of the total portfolio.

With from an accounting perspective, 46% of the portfolio is registered as a tradable securities changed through PNL, and the remaining 54% is made up of mandatory investments and corporate bonds, out of which 27% is registered as available for sale, changed to through other comprehensive income and 26% as a held to maturity. In slide number 12, we provide a snapshot of fees. In the Q1, net fee income decreased almost 2% compared to the Q4 explained mainly by lower credit and debit cards usage and bank assurance sales due to the seasonal effects. Consequently, fee expenses also decreased 12% in the period and thus fee income ratio increased to almost 20%. Year-over-year, net fee income increased 9%, of which Colombia provided the largest contribution driven by higher volume of transactions coupled with growth in clients.

Going forward, we expect net fee income to grow at around 9% in 2023. Moving into slide 13, I will walk you through NII and NIM performance. Despite the slight reduction in the loan book during the quarter, interest income grew 10% and 90% year-over-year, whereas interest expenses grew 26% during the quarter and an impressive 224% year-over-year, driven by the significant increase in interest rates as per the contractionary monetary policy. As per its asset sensitive condition, NII still grew 0.1% quarter-over-quarter and almost 45% year-over-year. NIM slightly dropped to 7.2% down 10 basis points quarter-over-quarter, but expanded 120 basis points year-over-year, explained mainly by the bank's capacity to capture more interest income as the rates rise.

Going forward, we have been preparing our balance sheet against cuts in interest rates. As an example, 60% of our time deposits mature in the next 12 months while provide us some margin protection. Moving into slide number 14, we present the evolution of provisions and asset quality. As discussed before, the combination of high inflation and interest rate has harmed household disposable income and payment capacity, mainly in lower income population, a segment now posting higher NPLs. Going forward, higher unemployment can also add to the deterioration. Hence, net provision for credit losses for the quarter were COP 2 trillion, equivalent to a cost of risk of 3.1%. This represents an increase of 17.5% quarter-over-quarter, mainly driven by an increase of COP 470 billion in consumer segment, for which we will provide more details on the next slide.

There were also provision charges for specific commercial loans, mainly for two non-sector related clients in Colombia, increasing provisions in COP 123 billion compared to Q4. Other than that, corporates and SMEs are performing well in general in all geographies. As a matter of fact, Banistmo reduced its provision expense in 52% as it had anticipated charge in the past last quarter. The 90-days past due loan ratio for the quarter was 2.7%, up from 2.2% in the Q4, reflecting higher past due rollovers in consumer and a specific real estate corporate client in Banistmo that became due in January, reaching the 90-day past due. Bear in mind that as per last quarter provisioning plus the collateral in place, this loan is 100% covered.

Our allowances as a percentage of loans remains strong and represents 219% coverage on a 90-day past due loans. Moving to slide number 15, I would like to share some further detail on credit quality for Colombia, where the loan deterioration focus has been. It's important to mention that today 87% of our total loan book is currently in Stage one. That is 1.3 percentage point higher than one year ago. The 13% remaining balance is composed of Stage two and Stage three loans, which represent the current and potential NPLs, all of which have a coverage of almost 40%.

Deterioration during the quarter has occurred mainly in consumer segment, which holds a 15% balance in Stage two and three, a 90-day past due loans ratio of at around 4%, and consequently a cost of risk of 13%, notably an outlier compared to commercial and mortgage that are performing well. Within consumer segment, personal loans show the highest deterioration amongst all other products with a 4.7% 90-day past due loans ratio and 15% cost of risk. As opposite to this, credit card represent a 90-day NPL ratio of 3.1% below the overall segments metric. All in all, we consider the recent deterioration as part of the pre-approved loans strategy implemented several years ago to penetrate consumer segment for which we feel comfortable considering our balance sheet coverage and our credit policy.

Moving to slide number 16, we present operating expenses and efficiency ratio. Operating expenses grew 26% year-over-year. In addition to inflation and effects, the main contributors to this growth were, first, higher taxes related to transactions and deposits as per last year's fiscal reform. Second, higher IT expenses as function of a higher volume of transactions. Third, higher personal expenses which were impacted by the annual wage increase. Net of effects, the annual growth would have been around 20%. The cost income ratio was 41% as a result of the income performance and the cost control initiatives in which we continue making progress. A good example is our journey to cloud, with which we are shifting from fixed to variable cost. In the long term, we expect a more sustainable ratio of 45% on the back of normalized income generation.

On slide 17, you can see our profitability metrics. Net income for the quarter was COP 1.7 trillion, up 4.5% compared to last quarter on the back of a strong income generation and cost dilution. Return on equity was 17.7%, which, if adjusted for goodwill, results in a return of tangible equity of 23.3%. The effective tax rate for the quarter was 25%, and we forecast a tax rate of 32% for the year as per last year's fiscal reform. Finally, on slide 18, we present a snapshot of the bank's capital. Shareholders' equity grew 22% year-over-year. Meanwhile, assets grew 20%, thus reflecting the bank's capacity to generate capital to foster growth whilst preserving a sound balance sheet.

Moreover, Basel III total capital adequacy ratio stood at 12.1% on a consolidated basis for the quarter, with a CET1 of 9.8%. Year-over-year, there was a CET1 generation of 262 basis points and a total of 351 basis points reduction, mainly associated with a strong organic growth and significant peso depreciation that increased the value in pesos of dollars denominated loans and the goodwill. During the remainder of the year, income generation will offset the COP 3.4 trillion dividend payout. Our CET1 target remains in 11% area for the year end. Now, I will hand over the presentation back to Juan Carlos for some final remarks. Juan.

Juan Carlos Mora (CEO)

Thank you, José Humberto. As we discussed in our past call, 2023 is proving to be a complex year with an evident economic slowdown, persistent fundamental imbalances, and political uncertainty. However, we are confident that our balance sheet's strength and a well-articulated set of competitive advantages equip us to handle these complexities and pursue on our long-term strategy. We will remain very close to our clients, providing proactive solutions to alleviate their cash flows and offset further loan deterioration. Given the current context for year-end, we forecast a loan growth of around 5%. Cost of risk between 2.2% and 2.4%, NIM of around 6.5%, core equity tier one of 11%, and ROE of 18%. In the midterm, we expect NIM of around 5.5% and a ROE of 15%.

With this, we conclude our Q1 results conference call. We now invite you to ask any questions you may have.

Operator (participant)

Thank you. We will now begin the question-and-answer session. If you have a question, please press Star-Then-One on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press Star-Then-One on your touchtone phone. The first question comes from Ernesto Gabilondo with Bank of America. Please go ahead. I'm sorry. The first question comes from Yuri Fernandes with JPMorgan. Please go ahead.

Yuri Fernandes (Executive Director and Senior Equity Research Analyst)

Hi, guys. Thank you for the opportunity of asking question. I have a question regarding your ROE guidance. I guess you moved it up. I think it was around 16, 17, and now if I, if I heard correctly, I think you are calling for 18%. You increased your cost of risky guidance, right? My question is, what will help you to keep ROEs at those good levels? It's basically NIM expansion, top line, or other income, right? Other income was very strong this quarter. If you may also comment how sustainable will be this line during this year. Should we continue to see other income running at those levels? Should it lose a little bit of momentum? What should we see for you to deliver the 18% ROE? Thank you very much.

Juan Carlos Mora (CEO)

Thank you, Yuri. Yeah. You heard correctly. Our guidance for the year of ROE, it's between 17% and 18%, which is similar with the ROE that we had during the Q1. Let me elaborate a little bit on how we see the development of the quarter, because your question allowed me to have a very big picture of the different variables that we will see. In our past conference call with the one for the last quarter of last year, we gave you a guidance of the cost of risk of around 1.92. Definitely the cost of risk for this year is gonna be higher.

We are expecting a cost of risk between 2.2 to 2.4%. The deterioration that we are seeing is higher than the one we expected because the economy is not performing as we expected as well. It is going to be a slower growth during this year. How are we going to get the 17 to 18%? It's because we will continue having a very strong income, and that's because the volume that we acquire, the loan portfolio, is growing 20% year-over-year. The margin will continue to be high, right, yeah, higher than the average margin for the bank on the long term.

I made a mistake because at the end of my opening remarks, I mentioned 6.7% of NIM. NIM is going to be by the end of the year close to 7%, could be even higher. What we are seeing now it's a reduction already in the cost of funds, even though we are moving to time deposits. The cost of those deposits is reducing because there is more liquidity in the Colombian market. We are seeing a strong performance of the income or interest income. If we combine. We are also going to work on expenses.

If we combine, all of those variables that I just mentioned, even with a cost of risk, in the range that I mentioned, we will be able to reach the 17 to 18% cost of risk, Yuri.

Yuri Fernandes (Executive Director and Senior Equity Research Analyst)

No, that's quicker-

Juan Carlos Mora (CEO)

I'm sorry. ROE 17% or 18% ROE. Sorry, go ahead. Go ahead, Yuri.

Yuri Fernandes (Executive Director and Senior Equity Research Analyst)

No, I said it's quicker. Basically, top line kind of offsetting this cost of risk. I guess that's the summary. If I may, just on the cost of risk, the 2.2 to 2.4% cost of risk guidance, you had a 2% cost of risk this quarter, right? If you do like a just a simple average for you to be in the midpoint, 2.3%, right? The midpoint from the 2.2 to 2.4%, we should see the cost of risk in the coming quarters running around 2.1%, right? You reach the midpoint of your guidance. My question is that what you have in mind?

Like, are you gonna see, like, in the second Q, another high level of cost of risk, let's say, I don't know, 3%, 2.5, whatever, and then by the second half this moves below 2%? Like, what is the curve of this cost of risk for you to reach the 2.2 to 2.4%? Because it implies a big improvement versus the first Q in the coming quarters. I would like to understand a little bit the path for that improvement.

Juan Carlos Mora (CEO)

You are completely right, Yuri Fernandes. The Q1, we saw a very high cost of risk. What we expect is that the cost of risk will be lower in the coming quarters. Why is that? Because we changed our cost appetite in the second half of last year. What we have now is the vintages that were originated with a different risk appetite. What is coming are vintages originated with a different risk appetite, with a different policy risk. What we expect is that the cost of risk will be going down.

That we will see, as you mentioned, a lower cost of risk during the second half of the year to average that 2.2 to 2.4% cost of risk for the whole year.

Yuri Fernandes (Executive Director and Senior Equity Research Analyst)

Perfect. Thank you very much.

Juan Carlos Mora (CEO)

Thank you, Yuri.

Operator (participant)

The next question comes from Ernesto Gabilondo with Bank of America. Please go ahead.

Ernesto Gabilondo (Senior Equity Research Analyst)

Thank you. Hi, good morning, Juan Carlos and José Humberto, and good morning, everyone. Thanks for the opportunity to take questions. My first question will be on potential regulation. Just wanted to see if you have heard something in terms of potential caps on fees or any other type of regulation that could be against the banking sector. On the other hand, I would like to hear your opinion on the recent increase in the minimum salary of public workers. Just wanted to hear if that could be a threat for the fiscal balance of the country. My second question is on OpEx growth. We saw an important jump due to the salary increases, the higher technology costs, higher expenses associated to the depreciation of the Colombian peso.

I remember the guidance in OpEx growth was around 13% for the year. After this impact, how should we think about the OpEx growth for this next year? Thank you.

Juan Carlos Mora (CEO)

Thank you, Ernesto. Let me give general comments and particularly answer your first question, and general comments on your second and third. I am going to pass your second question to Laura, and the third question to Jose Humberto, the one related to OpEx potential regulation. As you know, and we mentioned on our opening remarks, the Minister of Finance, in the change of the cabinet there is a new Minister of Finance.

The initial, the public announcement of the minister has been very positive in terms of that he will comply with the fiscal rule, that he doesn't see any intervention on the interest rates, that the interest rates should be determined by market conditions. Initial, the public announcements has been in line with what we expect this to be, to continue in the same line that Mr. Ocampo was following. In that regard, we don't foresee any changes or any intervention either on interest rates or on fees, and that's according to the announcements that he has made.

In those terms, we don't see any trends, any threats, so far, Ernesto. Regarding your second question, I will pass that to Laura, the increases on public servants' wages. Laura, go ahead, please.

Laura Clavijo (Chief Economist)

Hi. Yes. Regarding the recently approved increase to public workers, if we look at it even though it's pretty high compared to other years, in real terms, it was actually a bit lower than the past year when President Duque was approving those increases. In real terms, it's not as high as other opportunities, but of course, we do have 13% inflation still. That shouldn't be a particular stress to the public, the central government deficit. It's something that is in line, let's say, with regular yearly increases. The fiscal deficit we're projecting for this year is still around 5.3%...

I'm sorry, 4.4% of fiscal deficit in terms of GDP. It should be going gradually down, thanks to sort of oil revenues and new tax collection, as we mentioned. We continue to monitor, especially, how oil prices will be reflected in the Central Government's budget, which is being discussed according to declarations from Minister Bonilla.

Juan Carlos Mora (CEO)

Thank you, Laura. José Humberto, could you address Ernesto's third question regarding OpEx, please?

José Humberto Acosta Martín (CFO)

Yes. Ernesto, yes, this Q1, you see on annual basis that the OpEx growth of 26%. You have to consider several elements. The first one is FX. With the new number, it would be 20% if you deduct the FX situation, and the evaluation of 15% during the year. There are another elements this year that explains that 20%, which is the labor cost. Remember, the wage increase 16% in Colombia. The second element is IT. We are increasing our IT because our level of transactionality. There are another element, which is taxation. Because of the tax reform also, we have been affected because of that. Regarding 2024, we have two key drivers of OpEx for next year. The first one will be inflation.

As Laura mentioned at the beginning, we are expecting an inflation targeting at around 5% area at the end of 2024. FX, potentially FX will have a less volatility, but you don't know exactly, but less volatility. Assuming these two key drivers, we are expecting to maintain an OpEx growth next year between 10 to 15%. Why? Because we are still investing in technology, and we are still having related costs to transactional increase in the operation. Most important, Ernesto, is our guidance for efficiency is to maintain a level of 45% area in the next coming years. That's the best way to maintain the return on equity that Juan mentioned at the beginning of the presentation.

Ernesto Gabilondo (Senior Equity Research Analyst)

Thank you very much, Juan Carlos, Laura, and José Humberto. Just a couple of follow-ups. After your new expectations on cost of risk and OpEx, which both are going higher, how should we expect about earnings this year? Would it be reasonable to be flat? The other one is on your medium-term ROE of 15% versus 18% today. Just wanted to understand what will be the lines that would be declining in the next years, moving the ROE from 18 to 15%.

Juan Carlos Mora (CEO)

Ernesto, a couple of comments regarding those two topics. Doing the numbers, and I am sure you will do them, we are confident that we can reach the 17 to 18% ROE. Doing the math, that will give you the how the net income will compare versus the net income of 2023. It's not a big increase. Increase is pretty much flat. There is no... Could you remind me your second point that I forgot? I'm sorry.

Ernesto Gabilondo (Senior Equity Research Analyst)

Yes. Yes. My second thing, point is on your medium-term ROE.

Juan Carlos Mora (CEO)

Okay. Okay.

Ernesto Gabilondo (Senior Equity Research Analyst)

... because today you have 18, and you're expecting medium term to be 15. I understand that one of the elements was, potentially, NIM normalization, but I don't know if there could be another line that could be declining in the next years, and that's why you are moving from 18 to 15.

Juan Carlos Mora (CEO)

What we have now, Ernesto, is an abnormal NIM, which is above average. That is what causing that we will offset the higher cost of risk that we will have this year. But the NIM is going to be abnormally high. NIM should return to a range between 5.5%, 5.7%. And also cost of risk that we think in the long, in the near term is going to be between around, or between 1.8% and 1.9%. With those variables, with a lower NIM, because of lower interest rates. Cost of risk normalized in the midterm trend that will give us a result, ROE of 15%.

We will continue working on efficiency, trying to improve that number. With the numbers that we have now, that's what we expect.

Ernesto Gabilondo (Senior Equity Research Analyst)

Perfect. Super helpful. Thank you very much.

Juan Carlos Mora (CEO)

Thank you, Ernesto.

Operator (participant)

The next question comes from Carlos Gomez with HSBC. Please go ahead. The next question comes from Julián Ausique with Davivienda Corredores. Please go ahead.

Julián Ausique (Senior Equity Research Analyst)

Hi, everyone, thank you for having my question. I would like to ask you two questions. The first one is related with the Central American operation, 'cause we saw a good performance in the Panamanian, in El Salvador operation, the earnings increased related to fourth quarter of 2022, very well. Guatemala operation had only decrease in the net income. I would like to understand why was that, and if you can give us more color about the operation and how are the long growth and the cost of risk in those regions. Also, I would like to understand the performance of the other incomes that we saw and a huge increase in those lines quarter-over-quarter.

I would like to understand why was that and if we will see this performance or this behavior during the next quarters. Thank you.

Juan Carlos Mora (CEO)

Thank you, Julián. Let me take your first question regarding Central American operations, and I will pass your second question to José Humberto for comments. As you mentioned, our Central American operations had a very good performance during the Q1, contributing more to the net income of on a consolidated basis. Panama performed well. We anticipated some of the provisions last year. Also, the loan book is growing well. The same thing in El Salvador. In general, those economies are performing well in general terms, including Guatemala that you mentioned particularly, why BAM had not as good quarter as the last quarter of last year.

The answer is, we grew very aggressively in Guatemala on consumer credit because the combination of the mix of the balance sheet of Guatemala was very heavy towards commercial loans. We wanted to add more consumer loans. Those loans, since we grew aggressively last year, are bringing some additional cost of risk. Overall, we are very happy with the performance of Bancomercante due to the combination that higher income and cost of risk or the return on adjusted or the returns adjusted by risk are higher. The performance of the economy of Guatemala will be good during this year.

What we expect for the next of the year is to continue in the same trend, that the Central American operations are going to contribute a little bit more of what we had during the past years on the overall results of Bancolombia on consolidated basis. José Humberto, could you address the second question of Julián, please?

José Humberto Acosta Martín (CFO)

Yes. Julián, other income has two main elements, that explains why the number is so positive. The first one is, it is a reflection of our security portfolio that we are having. Most of them is because of our clients and the other parties because of our liquidity. As a counterpart, we have our derivatives, the performance of the derivatives have been very positive. This is the first reason why other income moves in the direction that you ask. The second element is as a result of the operated leasing. We have been growing at a very good pace in our renting business, that explains the other positive number of other income.

Julián Ausique (Senior Equity Research Analyst)

Okay. Just as a follow-up, are you expecting the same performance for the rest of this year, or you are expecting a moderating performance through the next quarters?

José Humberto Acosta Martín (CFO)

You know, Julián, that is correlated with the level of the volatility. Just to give you an idea, we in our forecast, we are forecasting a NIM of the security portfolio 1%. In this quarter was 2.4%, that is basically because of the volatility. We are just expecting a flat performance of 1% of NIM of that security portfolio. The rest will be a consequence of the volatility of the FX and the volatility of interest rates.

Julián Ausique (Senior Equity Research Analyst)

Okay, thank you.

Juan Carlos Mora (CEO)

Thank you. Thank you, Julián.

Operator (participant)

The next question comes from Carlos Gomez with HSBC. Please go ahead.

Carlos Gomez (Managing Director and Head of Latin American Financials Research)

Yes. Hello? Hello, can you hear me?

Juan Carlos Mora (CEO)

Yes. Yes, Carlos, go ahead.

Carlos Gomez (Managing Director and Head of Latin American Financials Research)

Hi. Apologies for before. Thank you for taking my question. I had two brief ones. The first one is on capital. You mentioned that your capital at the end of the year is 11%. I mean, you are pretty far away, maybe that's a decimal point that we're not considering. Where exactly do you expect the capital to be at the end of the year? Where do you expect it to be next year, and what is your target? Can you confirm you are still going for the 11.5% you have mentioned in the past? Second, if you could give us an update on the process to get to monetization of Nequi. Thank you.

Juan Carlos Mora (CEO)

Thank you, Carlos. Let me comment on your two questions, and I will ask José Humberto if he has any additional comments on the capital front. As we mentioned, Core Equity Tier 1 ended the quarter on 9.8%. That's the lower point of the year due to the dividends that we declared in the past shareholders meeting. What we expect for the next or for the end of the year is the Core Equity Tier 1 to be in our target of 11%, which we consider comfortable, and that's because loan book growth is going to be lower as we mentioned. It's going to be around 5%.

With the other numbers that we are discussing in this call, the net income is going to add to the equity number that would allow us to be around 11%. Regarding the separation of Nequi, we are in the process of separating Nequi. As you know, we already have the authorization of the Finance Superintendency to separate. What we are doing is we are working on the operational readiness of Nequi to be a separate entity. That's going well. That could take probably a little bit more than we expected. When we are ready, the operations are ready to be separate or a separate entity, we will ask for the final approval of the Superintendency.

What we expect is going to be by the second half of this year. Could be a little bit late than that. After that, Nequi will operate as a separate entity. We will see any opportunities and we will evaluate the market condition. Let me add that Nequi is performing very well. Nequi it's continued growing. It has almost 16 million customers, of which close to 11% are what we consider active customers, meaning that they do at least one monetary transaction a month. Additionally, one day customers that interact with Nequi are close to 1.5 million. Clients are using Nequi, and that's our path to monetization.

It's what we expect. We continue growing. We are adding different services and products in which we are charging fees. The number of clients that are using the platform and are generating fees is increasing. It's on the path that we are that we were expecting in general. José Humberto, I don't know if you have any comments regarding the first question that Carlos first question regarding capital.

José Humberto Acosta Martín (CFO)

Thank you, Juan Carlos. Yes, Carlos, as you mentioned, our cap target of tier one at the end of the year is 11%, probably because of the cost of risk of the deviation could be around 10.8% or 10.9%. Our view for medium term, in terms of capital, that will be influenced basically because of loan growth and in our forecast, as Laura mentioned at the beginning of the presentation, that the expectation of GDP growth next year also will be below 2% at around 1.6%. The second element is FX also is contributing to consume solvency ratio, but we are neither expecting a big devaluation next year.

Because of that, we are still thinking that our guidance will be to maintain a capital ratio of 11% at the end of the year, and potentially 10.5%, 10.6% on average. This is for 2023 and 2024.

Carlos Gomez (Managing Director and Head of Latin American Financials Research)

All right. You would go to 11. Again, as discussed, some other times, you may have mentioned 11 and a half as a long-term target, but that's not the way you expect to be in the next two years.

José Humberto Acosta Martín (CFO)

Correct.

Juan Carlos Mora (CEO)

You are correct, Carlos.

Carlos Gomez (Managing Director and Head of Latin American Financials Research)

Thank you very much.

Juan Carlos Mora (CEO)

Thank you, Carlos.

José Humberto Acosta Martín (CFO)

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

Tito Labarta (VP and Senior Equity Research Analyst)

Hi, good morning. Thank you for the call and taking my questions. A couple of follow-ups, I guess. First on the asset quality and, you know, just to understand how you get comfort that the cost of risk will come down in the second half of the year. I mean, there was, you know, a big increase in NPL this quarter. Inflation is still high. You know, economy, you know, really slowing, has slowed down quite a bit. Yeah, just how do you get comfort that, you know, things will begin to improve, I guess, from an asset quality perspective in the second half of the year, to bring down the cost of risk? Then second question, just to understand on the margin evolution and how quickly it should come down.

I mean, I guess first remind us the sensitivity of the margin to reduction in rates and how you expect, I guess, the interest rates to evolve from here, given, I mean, we still have relatively high inflation. I mean, I see your forecast here. We expect rates around 7% level by the end of next year. How likely is that given the level of inflation today? Does that mean that your margin should fall significantly next year to get to that 5.5%? Or how soon do you get to that 5.5% margin given your expectations for rates? Thank you.

Juan Carlos Mora (CEO)

Thank you, Tito. first, asset quality and then margin evolution. I will ask José Humberto Acosta if he has any additional comments. Asset quality. Why we are comfortable that the cost of risk will evolve positively. Definitely what we saw, in our view, was a peak during the Q1. Asset quality will continue to evolve. As I mentioned before, we changed our risk appetite half in the second half of last year. What we are doing is we are anticipating to the deterioration of the assets. We are also working very closely with our clients on restructuring the loans that need to be restructured.

Now we have in place actions that would allow us to handle the current situation. It's pretty much focused now on consumer loans. Commercial loans are performing well. We are confident that remember that

the provisions that we are recording are looking forward, so are anticipating the deterioration of that book. That's why we are confident that we can reach at the end of the year a cost of risk between 2.2% and 2.4%. Regarding margin evolution. Margin at this moment is 7.6%. As I mentioned, it's above normal.

Your question is very important and it's going to be an important variable on the results of 2023 results because how fast or the speed in which the margin contracts is going to be key. As we mentioned, we believe that inflation will start to decrease. On top of that, interest rates will start to follow and decreasing also. What we expect now, the reference rate, the repo rate in Colombia, it's 13.25%. The expectation is that they start to go down by second half, and they will be probably between 12% and 12.5%.

That will allow us to maintain a margin above normal during this year, and as I mentioned, could be around 7%, it could be even higher. We'll start going to the midterm target, which is between 5.5% and 5.7%, which will happen more towards the end of 2024 or even 2025. That will allow us to have some margin on the income side to performance the ROE that we are expecting. I don't know, José Humberto, you have any additional comments on Tito's question?

José Humberto Acosta Martín (CFO)

Yes, Juan, on the medium-term, Tito. You know, the key difference right now is our structure of funding. You know that 85% of our funding comes from the deposit base from our clients. On the long term, as Juan mentioned, 5.5 is achievable. There is basically because we have right now 70% of our loans are floating, and today almost 50% of our deposit base also are floating.

Juan Carlos Mora (CEO)

60% of our time deposits are less than a year. Next year, as Juan mentioned, if the interest rate is coming down, we will be able to reprice also the liability at the same pace that the repricing on the loan portfolio. That's the reason why we are confident to sustain the 7% NIM this year and to maintain the long-term view, the 5.5, because the way we structure our funding, which is because of the granularity, because of the clients, we are able to maintain that 85% of deposit coming from clients.

Tito Labarta (VP and Senior Equity Research Analyst)

Okay. Thanks, Juan Carlos and José Humberto Acosta. That's helpful. Is it fair then to think that, you know, that 15% long-term ROE target is probably after 2024, right? I mean, if, you know, rates are still kinda coming down next year, the margin shouldn't necessarily fall immediately to that 5.5%. You know, if you're right on the asset quality and cost of risk coming down a bit, you know, that could also help. It doesn't mean that you have to be at a 15% ROE in 2024. Maybe there's still a little bit of upside for next year.

Juan Carlos Mora (CEO)

Yeah, that's fair enough, Tito. I think just as you just mentioned.

Tito Labarta (VP and Senior Equity Research Analyst)

Okay, great. Thanks, Juan Carlos.

Juan Carlos Mora (CEO)

Thank you, Tito.

Operator (participant)

Once again, if you have a question, please press star then one. The next question comes from Andres Soto with Santander. Please go ahead.

Andres Soto (Executive Director and the Head of Andean Equity Research)

Good morning to all. Thank you for your presentation. My question is regarding the asset quality evolution, and asking about the very short term, based on, you know, the fact that just in February, you were guiding for a cost of risk of 1.8%, and now you have a cost of risk of 3%, and it's based on the consumer deterioration. I will suspect that most of the deterioration actually occur towards the end of the quarter.

I would like to confirm if that was the case, and based on this and the recent trends that you have seen, if we can expect some much more deterioration in the Q2, and what will be the peak, and when we will see the peak of asset quality for Bancolombia?

Juan Carlos Mora (CEO)

Thank you, Andres. Yeah, the deterioration was higher than we expected. As we mentioned, on our conference call for the last quarter last year, we were expecting a deterioration but not as fast as it occurred. As you point, the deterioration increased in February and March. What we expected is that the Q2 will have, still, a cost of risk that could be higher than...

Due to how we are dealing with the clients that have some difficulties in terms of cash flow, and due to as I mentioned, the different or the risk appetite that we implemented during the second half of last year, that will start to come down to end the year in the range that we already mentioned between 2 and 2.2 and 2.4%. This quarter, the... I mean the Q2 of this year is going to be key to really assess how the evolution of cost of risk will be. We are confident that what we are seeing so far will be in line of what we are expecting, Andres.

Andres Soto (Executive Director and the Head of Andean Equity Research)

Thank you, Juan Carlos. Any expectation of, at what level asset quality will peak and when?

Juan Carlos Mora (CEO)

We expect that these first two quarters of the year will be the peak. We will see how the Q2 will perform. After these two quarters, we expect the cost of risk to go down.

Andres Soto (Executive Director and the Head of Andean Equity Research)

Thank you. My second question is related to expenses. In a previous answer, you mentioned, you expect expenses to still grow significantly above inflation, next year. It's clear, you know, that there are some pressures from several fronts. My question is, what can you do on your own to improve efficiency? Is there any opportunity to shut down branches in a context of which you are not expecting to see much loan growth over the next three quarters?

Juan Carlos Mora (CEO)

Andres, what we can manage. I mean, we have pressure from inflation, we have pressure from the devaluation of the peso as we already mentioned. In the front of branches, we don't see much opportunity. Due to the amount of customers and the growth in the number of on the customer base, we are having customer going to branches. On the near term, we don't see the space to reduce to have a reduction that is significant on branches.

Cost cutting on that front doesn't seem very, very possible. What we are implementing, it's, we are, probably, analyzing the expenses that we have on the front of technology digital transformations to see if we can delay some of them without affecting the income of the bank. Also on the headcount front, we are not expecting to have a reduction on the headcount, but not growth, not growth on headcount. Those will be the probably the main drivers to manage expenses in the coming year, Andres.

Tito Labarta (VP and Senior Equity Research Analyst)

Understood. Thank you, Juan Carlos.

Juan Carlos Mora (CEO)

Thank you, Andres.

Operator (participant)

Once again, if you have a question, please press star then one. We have no further questions at this time. I would like to hand the call over to Mr. Juan Carlos Mora for closing remarks. Please go ahead.

Juan Carlos Mora (CEO)

Thank you everybody for participating in the presentation of Bancolombia's results for the Q1 2023. As we mentioned, this is a challenging year in terms of economic performance of Colombia, mainly. The other countries in which we operate look good in terms of performance. Asset quality will be the focus of our actions. We know that the results of the bank will depend very much on that front. We will see the evolution, and we hope to see you on our conference call for the Q2 2023. Thank you very much, everybody, and have a good day.

Operator (participant)

This concludes today's conference call. Thank you for participating. You may disconnect.