Bancolombia - Q2 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen, welcome to Bancolombia's Second Quarter 2023 Earnings Conference Call. My name is Alan. 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. During the question-and-answer session, if you have a question, please press Star, then One on your touchtone 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 uncertainty.

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 Corporate Officer, Mr. José Humberto Acosta, Chief Financial Officer, Mr. Rodrigo Prieto, Chief Risk Officer, Mrs. Catalina Tobón, 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, welcome to Bancolombia's second quarter results conference call. To begin, please go to slide two. The results for the quarter reflect the less favorable macro conditions under which the bank is currently operating. In Colombia, in particular, the circumstances have become more challenging due to the economic slowdown, driven by lower internal consumption, lower trade flows, and less dynamic foreign direct investment, with an underlying high inflation that has kept interest rates high, as we will further elaborate. These circumstances have discouraged credit, harmed asset quality, and elevated operational costs, driving a moderation on the loan book and income growth, resulting in a net income for the quarter of COP 1.5 trillion.

It is worth to highlight the stronger contribution that the Central American operations is delivering, as all three banks in the region continue making progress on income generation, cost control, and profitability. Partially compensating the current slower growth of the Colombian operation and providing the merits of our di- diversification strategy. Due to the Colombian peso appreciation on the quarter that reduced the contribution of the US dollar-denominated loans, the consolidated loan book contracted, contracted quarter-over-quarter, albeit still growing at a much moderated rate year-over-year on the back of lower credit demand. Similarly, deposits also fell during the quarter due to FX appreciation and slowed its pace of growth on a yearly basis. Furthermore, as interest rates remained high, the shift from savings to dep-- to time deposits continues, exerting more pressure on the funding cost.

NIM remained high, hosting a 6.7% for the quarter, driven by the lending margin as per our asset-sensitive condition. We recorded COP 2.1 trillion in net provisions, equivalent to a cost of risk of 3.1% for the period. It is showing a descending pace of growth, suggesting a better forecast in terms of deterioration, as we will further elaborate. The coverage ratio of the 90-day NPLs is 207%. Basel III Common Equity Tier 1 ratio increased to 10.4%, well above the minimum regulatory levels, reflecting the capacity to generate organic capital. OPEX increased mainly as a matter of inflation and higher taxes, and efficiency ratio reached 44%.

All things considered, strong NIM and other operating income performance of set higher costs and expenses, which, coupled with smaller, smaller loan book, result in a ROE of 15.7% for the quarter. Going forward, even as the government's ability to pass through its ambitious reform agenda has lost some ground, it is still soon to assess the potential economic and social impacts that this or other set of initiatives may have, particularly due to fiscal imbalances, labor cost, and deterioration on country risk sentiment. We continue committed on our long-term strategy, confident on, on the robustness of Colombian institutions and the regulatory framework. For further detail on the macro outlook, I will turn the presentation to Laura Clavijo, our Chief Economist. Laura?

Laura Clavijo (Chief Economist)

Thank you, Juan Carlos. Indeed, our updated economic forecast for Colombia pose a more promising scenario for 2023 than previously expected. Nonetheless, modest growth for 2024. Despite the resilient performance of the Colombian economy with 3% GDP growth in the first quarter, we anticipate a further slowdown in economic activity during the second half of the year. For 2023, we have doubled our growth forecast to 1.2% from April's scenario of 0.6%, driven mainly by the statistical carryover effect from solid first quarter growth, and we expect moderate GDP growth of 0.9% for 2024. In fact, weakening economic activity is already evident in monthly leading indicators that reflect a meager 0.5% growth as of May.

Private consumption and investment have been pressured by high inflation, rising interest rates, and declining consumer confidence, impacting performance of key productive sectors such as retail, transportation, construction, mining, and manufacturing. On the positive side, inflation has consistently fallen over the course of the past few months. After peaking at 13.3% in March, CPI has decreased to 12.1% year-over-year as of June, driven by declining food prices. However, inflationary pressures to core inflation persist. Fuel price adjustments, indexation of service fees, particularly in housing, as well as increases in electricity and gas tariffs, will remain stubbornly high. Consequently, we maintain our 2023 inflation forecast of 9% end of year, but foresee potential pressures to regulated goods and food prices in 2024, resulting from indexation and climate-led effects from the phenomenon of El Niño.

Only in early 2026 should inflation return to the central bank's target. Receding inflation, labor market resilience, and overall stability in the financial sector has enabled the central bank to halt interest rate hikes and keep rates stable at 13.25% during the past few months. If given the conditions, we expect the central bank to begin cutting rates as early as October and up to 75 basis points before year-end. Expectations of an ending tightening cycle, both globally and locally, have contributed to easing market conditions and improving terms of trade. Finally, in comparison to a year ago, there are notable corrections in Colombia's macroeconomic imbalances, which have improved our country risk position, reflect better financing conditions, and reduced vulnerability to external shocks.

Indeed, we've seen a process of adjustment in the current account deficit, which has improved from a 6.2% of GDP deficit in 2022 to an expected 3.6% deficit this year. Unfortunately, driven by a significant slowdown of both imports and exports. On the fiscal side, the central government's deficit is expected to adjust to 4.3% of GDP in 2023, which signals a significant improvement from the 7% level deficit of 2021. Nonetheless, the government relies on uncertain sources for additional income, such as litigation and tax collection efficiencies, amidst increasing social spending goals and decreasing global oil prices. In sum, 2023 began with an overall negative outlook regarding global growth and Colombia's expected economic performance.

Even though this year will be in fact characterized by an economic slowdown, this is now expected to occur in a far more positive scenario, driven by receding inflation and expectations of an ending tightening cycle. 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. Now we move to slide four. This opportunity, I want to introduce these five value-driven pillars that are framed within our purpose, and therefore, are the foundation for our current and future results, and for which we will continuously comment going forward. First, a client-centric approach to design and deliver integrated solutions. Second, an evolving, interoperable, and multi-channel platform. Third, our corporate structure and governance model, our financial management, and our risk and capital controls as fruits to our performance. Last, our culture of efficiency and productivity as a catalyst for profitability. Moving to slide five, I want to share a snapshot of the main initiatives we are working on the pillar 1: seeking integrated solutions leveraged on information, analytics, and technology....

First, our eco-ecosystem model under which we are orchestrating experiences in our own channels and allowing third parties to develop financial services under their own brand. Second, we are transforming our value proposition for agribusiness, productive supply chain, and social and environmental projects. A good example is the origination of loans for small farmers through our digital wallet, Bancolombia A la Mano. Third, we are continuously evolving our analytics-based models to further enhance our pre-approved loans accuracy, our ratings models, and the collection process to estimate clients' payments capacity and anticipate to credit deterioration. Moving to slide six, sorry. Now, I will refer to the main initiatives we are working under pillar 2, that are essential to further enhance our transactional capabilities. Over time, we have built a robust multi-channel platform, as we deem each channel has an essential vocation.

Going forward, we will pursue further capillarity and interoperability, hand in hand with our digital evolution. As of June, we have more than 8 million digital active clients in our app, Bancolombia, and Nequi has reached more than 17 million customers. Furthermore, we are developing our Super App and Super Web models, providing several financial and non-financial services that connect demand and supply in one place, such as banking services, transportation, home services, amongst others, thus accelerating digitalization and enhancing customer experience. After this general strategic overview, I want to turn now the presentation to Jose Humberto Acosta, who will further elaborate on our second quarter 2023 results. Jose?

José Humberto Acosta (CFO)

Thank you, Juan Carlos. Please go to slide seven, in which I will elaborate on our regional operation and its contribution. The Colombian loan book represents almost 70% of the total portfolio, whereas the Central American operation accounts for roughly 27%, providing a good source of diversification in growing economies with different market dynamics. Banco Agrícola stands out given its higher net income generation, coupled with a very low cost of risk that drives profitability, posting an above average return on equity of 20.6% for the quarter. Going forward, we expect the bank to continue delivering very positive results in a more promising economy and political environment seem to be underway. It's worth highlighting BAM and Banistmo positive yearly evolution are reflecting in their higher NIMs and return on equities, and well-suited to pursue growth opportunities on the back of their better-performing economies.

Nonetheless, we remain cautious of the inherent political and economic uncertainties in these geographies, and thus, we are working with a risk-adjusted return approach and enhancing control initiatives to boost profitability. Please go to slide eight, in which I will elaborate on our strong and well-diversified loan portfolio, in which commercial loans represent almost 64%, consumer 22%, and mortgages 14%. The overall loan growth during the quarter was affected by a 3.4% on average peso appreciation on the quarter. The consolidated loan book decreased 2.4% quarter-over-quarter by the sharper deceleration of consumer segment, as high interest rates have harmed credit demand and risk appetite has been adjusted. Commercial loans decreased the least during the period, explained by a couple of large corporate loans disbursed in June.

On a yearly basis, the pace of growth has significantly decelerated to a 7.4% rate as of second quarter, consistent with the credit cycle described previously. Net of effects, the loan book would have been grown 1.3% quarter-over-quarter, albeit still reflecting the significant moderation in terms of growth. Breaking down into segments, as shown on the bottom graphs, we want to comment not only on the positive evolution in terms of clients and loan growth in each, but also to highlight the growth and value potential that the SME segment represent, provided that the growth in clients has outpaced that of loans, leaving enough room to further grow leverage on client-centric integrated solutions. Please go to slide number 5.

Consistent with the loan book performance, total deposits fell 3% quarter-over-quarter, with a higher-than-the-average contraction in savings and current accounts, and a modest 1% growth in time deposits. Year-over-year, deposits grew 9.5%, slightly above loan growth, and mainly explained by time deposits with a 48% increase, whereas savings accounts recorded a drop of almost 5%. As expected, time deposits increased its share on the total deposit mix, reaching at 35%, albeit growing at a slower pace on a quarterly and yearly basis. On the other hand, savings account kept its share at 38% of the total funding mix, whereas checking and other funding sources yielded to time deposits.

This larger portion of time deposits and the rise in interest rate expenses paid on loans and loans due to higher interest rates increased the cost of funding during the period to 5.5%. It is also worth to highlight that 62% of our outstanding fixed-rate time deposits mature in less than a year, providing some margin protection upon interest rate cuts. Due to the lows in lending dynamic in the market, we do not foresee funding pressures affecting our cost of funds for the remainder of the year, nor our ability to maintain comfortable Liquidity Coverage and Net Stable Funding ratios. Please go to slide number 10. Interest income decreased 3.3% quarter-over-quarter, attributed to a fall in interest income and valuations on the investment portfolio in the period.

This drop on the investment portfolio income is compensated by income on derivatives recorded under other operating income. On a yearly basis, interest income grew 52% due to the repricing dynamic as per our asset-sensitive condition, and because new loans are disbursed at the higher interest rates. On the flip side, interest expenses grew 2.9% during the quarter, despite the drop on deposits, mainly explained by the change in funding mix. Year-over-year, it grew 152% as it continues to capture the rise in interest rates. NII fell almost 8% quarter-over-quarter, but increased 14% on a yearly basis. On the other hand, when analyzing the NIM by components, the lending NIM was 7.9%. That is 3 basis points higher compared to the last quarter and 86 basis points year-over-year.

The investment NIM fell by 458 basis points quarter-over-quarter, driving the overall NIM to 6.7%. Please go to slide 11. Net income is slightly decreased, minus 0.36% quarter-over-quarter, yet increased 13.5% year-over-year, despite fee expenses growth outpacing that of fee income on the back of higher costs related to the third-party providers and processing charges. The income ratio was 19.6% for the quarter. It's worth mentioning that the fee income generation is well-diversified in terms of sources. I want to highlight the good result and positive evolution of income related to the fleet leasing operation, which was a driver to other income's performance that reached 13% growth quarter-over-quarter and 127% year-over-year.

Please go to slide 12, in which we present our provision expenses as support to a strong coverage. Net provision expenses for credit losses for the quarter were COP 2.1 trillion, equivalent to a cost of risk of 3.1% for the period. This represents an increase of 1.8% quarter-over-quarter, driven by new non-performing loans and rollovers, mainly on the consumer segment in Colombia, as high inflation and high interest rates kept harming individual payment capacity during the period. As a matter of fact, there was a COP 158 billion increase quarter-over-quarter in provision expenses on the consumer segment in Colombia, to which we will refer to further on.

On the other hand, even as the economic backdrop has become more challenging, commercial loans are performing well, despite of some isolated cases in the corporate segment that do not represent systemic risk. Also, except for Colombia, where provisioning expenses grew 7% quarter-over-quarter, the rest of the countries in which we operate, provision expense decreased, denoting better-than-expected asset performance, driven by more favorable macro perspectives and credit payment behavior. The 90-day past-due loan ratio for the quarter increased to 3%, up from 2.7% in the first quarter, reflecting higher past-due rollovers in consumer and a couple of specific commercial loans. Nevertheless, our allowances as a percentage of past-due loans remains strong and represents 207% coverage of 90-day past-due loans. From an expected loss perspective, 87% of our total loan book remains currently in Stage 1.

The 13.9% remaining balance is composed of Stage 2 and 3 loans, which represent the current and potential NPLs, all of which have a coverage of 41.7%. Although Stage 3 increases due to the rollovers, Stage 2 balance remains controlled because of the several actions taken to cut back deterioration. Moving to slide number 13, I will elaborate some further insights on credit quality for Colombia, where the loan deterioration focus has been. Same as in the previous quarter, deterioration occurred mainly in consumer segment, which holds at 16.4% balance in Stage 2 and 3, a 90-day past due loans ratio of at around 4.8%, and consequently, cost of risk of 13.3% remaining as a outlier.

Personal loans that represents 54% of consumer loans, accounted for most of the deterioration with a 6% 90-day past due loan ratio and 16% cost of risk. Whereas credit card is well contained, running with a 90-day past due loan ratio of 3.9%, below the overall segments metric. As discussed in our previous call, this deterioration phase is consistent with our consumer segment penetration strategy based on pre-approval loans, which in our view, has been successful from a risk-adjusted return perspective. However, aware of the potential risk to asset quality, the strategy came to a halt for lower income segments, and thus we have reduced our pre-approved loans to individuals in almost 28% year-over-year, and 17.6% quarter-over-quarter.

Consequently, the pace of deterioration for consumer segment in Colombia has started to subside, as observed in the lower left chart as of May. Also, in the bottom right chart, you can see the 90-day past due loans for the Colombian financial system as of April 2023. Although far from ideal, the explanation for our better-than-the-average system performance is twofold. First, is due to our well-articulated sectoral risk assessment that provide us tools for an in-depth understanding of each industry, and those allow us to properly diversify, anticipate, and support our customers with solutions, and to adjust quickly to credit cycles. Second, it is also the result of our enhanced collection process based on analytics, which has increased client contact effectiveness, allowing us to move ahead earlier, preventing further deterioration. Please go to slide number 14, where I will discuss upon efficiency and our productivity initiatives.

The cost-to-income ratio for the quarter reached 44%, as our operating expenses grew 3.2% quarter-over-quarter, and 25.8% year-over-year, mainly driven by, first, higher taxes related to transactions and deposits as per last year's fiscal reform. Second, higher personal expenses due to the annual wage increase and higher actuarial valuations on certain employees benefits resulting in higher APV. Third, higher IT expenses related to a business transformation and journey to the cloud. Net of effects, the annual growth would have been 21.3%. We continue executing ambitious transformational projects and cost control initiatives that cover a wide range of areas, confident that it will boost productivity going forward. Please go to slide 15 to further elaborate on our profitability metrics.

As we had anticipated in our previous call, lower loan growth and net income generation, coupled with the higher provision expenses and overall cost, has impacted our profitability. Net income for the quarter was COP 1.5 trillion, a 15% contraction quarter-over-quarter, and 18% year-over-year, and consequently, return on equity decreased, though it remains high at a level of 15.7%, which, if adjusted for goodwill results in a return on tangible equity, it would be 20.9%. Finally, on slide 16, we present the evolution of capital generation. Shareholders equity grew almost 10% year-over-year. Meanwhile, assets grew 8% respectively, reflecting the bank's capacity to generate capital to foster growth whilst preserving a sound balance sheet.

On the other hand, Basel III total capacity adequacy ratio increased to 12.5% on a consolidated basis for the quarter, with a CET1 of 10.4%, as net income generation in the quarter helped to offset the dividend payout declared in the previous quarter, and the FX appreciation reduced some risk-weighted assets capital consumption. Consequently, quarter-over-quarter, there was a CET1 generation of 70 basis points. Now, I will hand over the presentation back to Juan Carlos for some final remarks. Juan?

Juan Carlos Mora (CEO)

Thank you, José Humberto. Please go to slide 17, in which I will comment on the progress made on our sustainability strategy. As a part of our business with purpose strategy, we have disbursed almost COP 20 trillion during the year, reaching an aggregated of COP 123 trillion since 2020. Also, last week, we closed a $100 million sustainability link credit with Wells Fargo Bank, our third of this type, to secure financing for our sustainability loan growth. Regarding sustainability framework, we made progress on the following three initiatives. First, we published our TCFD 2022 report, containing our climate change strategy, risk management, and metrics, as well as our sustainability governance model, by which we declare that our commitment is embedded in our corporate decision-making process, fostering its execution.

Second, we are moving ahead with the pilot program for Colombian for Colombia, under the Climate Finance Leadership Initiative, which aims to engage the private financial sector in supported climate action, mainly focused on energy, transportation, and infrastructure sectors. Last, we declare our diversity, equity, and inclusion strategy, a set of initiatives that path the way so that by year 2025, at least 50% of the leadership positions in the bank are held by women. Please go to slide 18, in which I will provide our guidance for year-end 2023, given the current macro environment. We expect a loan growth of around 2% in peso-denominated loans and 3.5% on dollar-denominated loans, that the consolidated results will depend on FX.

A NIM of around 7% as the average rate of the central bank that determines reference rate will remain high during the year versus last year. In the long term, NIM should be around 5.5% area. In terms of cost of risk, we forecast an annual, annual cost of risk between 2.4% and 2.6%, as we expect further moderation in the economic activity, coupled with still high rates and a slow downward inflation. We expect an efficiency ratio of 46% and an ROE of 16% area, as we expect our asset sensitivity condition to keep above average margins. For the long term, we expect an ROE of around 15%.

Last, provided our net income expected performance and effects forecast, our Core Equity Tier 1 target remains in 11% area for year-end. Last, in slide 19, I would like to share our investment thesis, a summary of our most distinctive drivers of future growth. We deliver integrated solutions under a client-centric approach that nourishes preferences and loyalty on a rapid growing client base. Second, our interoperable multi-channel platform and digital evolution creates a competitive advantage, positioning us first in the market and fostering customer experience, efficiency, and growth. Third, our continuous investment in leading-edge technology and innovative operational capabilities support our business evolution and unlocks profitability. Fourth, we are a leading regional banking platform with access to broad funding sources, sound earnings generation, and best-in-class risk and corporate governance. With this, we conclude our second quarter results conference call.

We now invite you to our Q&A session.

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 touch tone 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 touch tone phone. We will pause momentarily to assemble our roster. Our first question comes from Tito Labarta of Goldman Sachs. Go ahead.

Tito Labarta (VP and Senior Equity Analyst)

Hi, good morning, Juan Carlos, Humberto. Thank you all for the call and taking my question. I just wanna speak a little bit about the, the, the outlook for profitability from here. I know you gave the long-term guidance of, of ROE of 15% and, and the revised guidance for this year. Maybe thinking, you know, a little bit into next year, right? You lowered your loan growth guidance for this year. You increased the cost of risk a bit. You have, been decelerating GDP growth into next year, unemployment picking up a little bit. Could there be, you know, just additional downward pressures on profitability, thinking about, you know, 2024? You know, w- will loan growth, decelerate a bit more? You know, when do you think asset quality would peak?

I mean, your revised guidance sort of implies that maybe the worst risk provisions might be behind us, but just to think a little bit about that. Your margin should fall, as you mentioned, as interest rates come down, particularly more in, in next year. You know, is that 15% you, you think doable in 2024? Could there be some downside risk to that, just given some of the headwinds from, from the economic outlook, that you're seeing? Thank you.

Juan Carlos Mora (CEO)

Good morning, Tito, and thank you for your question. Regarding the outlook for 2024, what we see is that the economic dynamics for 2024 will be better than for 2023, meaning that the GDP growth for the year should be around 2%-2.5%. The global environment also will be better. Probably the fight against inflation, the global fight against inflation, will be in the final phases and interest rates will start to go down globally.

In Colombia, what we expect is that interest rates remain high, meaning that the rates going down will start at the end of the year, but during 2024, still, we will have interest rates that are not going to be probably the rates for the long term. Meaning that our margin, our loan book margin will continue being high when if we compare it with the long term NIM. Regarding risk, which is, which is key, we are expecting that the risk peaks this year, and we expect probably that that peak is in this quarter that we are, we are discussing.

Loan growth won't be very, very dynamic. With all of this, to answer your question, if we believe that we can achieve the 15% ROE, we think that all in all combined, we are able to achieve that 15% ROE in 2024. We will be challenges regarding risk, we are very focused on how we originate the new loans now, that are the loans that will be performing next year. In that, we are very, very careful on origination, meaning that our focus is not on growing the loan book, it's in quality. To summarize, margins will go down, but not as fast as we thought some months ago.

That will also give us some room from the, from the income side. Margins will, will remain, as a consequence, margins will remain high compared with the, with the long-term average. The cost of risk should go looking for, for the long-term guidance, even though it could be a little bit higher during 2024, but we don't expect a big deterioration. Loan book w- won't be very dynamic, but with all, again, we think that we can achieve that 15% ROE for 2024, Tito.

Tito Labarta (VP and Senior Equity Analyst)

Okay, great. No, that's helpful, Juan Carlos. I think, yeah, I guess some, some mixed trends. Just on the, on the loan growth, to clarify, I know you said it, it won't be dynamic, but it sounds like, you know, perhaps that could accelerate a bit, compared to the guidance that you've given for this year, because I guess lower inflation, lower interest rates, maybe the, and the new origination seems to be in a little bit of a better place, so maybe that accelerates a little bit versus this year, and cost and risk coming down, so those should be the drivers, it sounds like?

Juan Carlos Mora (CEO)

You are, you are completely correct, Tito. That's a good read of the situation. We are expecting the loan book to accelerate its growth. When I mean not being very dynamic, meaning it will be better than the loan growth that we have in this year, 2023.

Tito Labarta (VP and Senior Equity Analyst)

Okay, perfect. Thanks so much, Juan Carlos.

Juan Carlos Mora (CEO)

Thanks, Tito.

Operator (participant)

Our next question comes from Yuri Fernandes of JP Morgan. Please go ahead.

Yuri Fernandes (Executive Director)

Hi, Juan Carlos, José Humberto Acosta, Catalina Tobón, everybody. I have a follow-up on, on top line, and also for 2024. I would like to start with your margin sensitivity for rates, because I totally agree, right? Rates remain high. You had, like, some market lower security gains this quarter. So maybe for 2023, we will continue to see, you know, a very sound top line. But my concern here is the sensitivity, right? Because, although rates will remain higher than historical in 2024, you, you are forecasting about 400-500 basis points, right? Going from 13.25% today to maybe 8.5%. I think this is what you have in your presentation.

My question is: What is your rate sensitivity on, on, on every 100 basis points, a decrease on, on, on rates? And how quickly this translates into your margins? Because if your average rates go down by 200-250 basis points, maybe we're talking here, based on past quarters, like 60-70 basis points, right? I remember it was 30 basis points, 35 basis points, every 100 basis points, you should say. Again, just checking, mean sensitivity and how quickly this will hurt your margins in 2024. Thank you.

Juan Carlos Mora (CEO)

Thank you, Yuri. Let me, let me give you some general comments, and I will ask Laura to give us more color about how we are seeing the development of the reference rates that we are gathering information every week and every month with the new data that is coming in. Laura will give us some color regarding how we see the path of the of the rates, the reference rates. I am going to ask Humberto about the sensitivity, but my general comments are as follow. You, you mentioned, we need to analyze the margin, and if we take as a this quarter as a base, the loan book margin remains stable, high, 7.9%.

What we had this quarter was a negative effect on the investments, margin, mainly due to some particular issues regarding effects. As you know, the peso appreciated during this quarter significantly. We need to... Or we, with that consideration, we took our positions on US dollars, and we reorganized them. That's an effect that was during the quarter, but for the long term or if we look the average for the investment margin, we still believe that it's going to be between 1% and 1.5%.

The loan book, the margin on loans, will have some pressure probably, and from the cost side, and because of the rates will start to decline by the end of the year, as Laura will tell us later. So we expect the loan margin to be around 7.7%. As for 2024, it will be some pressure, but still the margin will be high, and the average for the year should be around 6.7%. I'm talking about the loan, the loan margin. So that's a healthy margin that give us room to maneuver. The other key aspects for 2024 will be the cost of risk and how the loan book performs, as I commented before to Tito Labarta's question.

With this, I am going to give, to, to ask Laura that, tell us, how we see the path of, of the, of the reference rates, in Colombia. Laura?

Laura Clavijo (Chief Economist)

Thank you, Juan Carlos. Indeed, the outlook for interest rates, central bank interest rates, will be very dependent on what we've been seeing for inflation in the past few months. We've had 4 consecutive months of declining inflation. The latest figure was not so positive on the core inflation, nevertheless, coming down as well. Inflation has been driven mainly by receding food prices. We do see some potential pressures for core inflation coming from fuel prices, some regulated goods such as housing tariffs and other types of public service tariffs. We do have a 9% inflation forecast for 2023, perhaps with an upside risk, giving these potential pressures that I'm mentioning. Also, climate risk coming from phenomenal El Niño.

In all, inflation is in fact receding, and at least from the point of view of the central bank, this is being well received and closely monitored. In that sense, we foresee the possibility of having a central bank rate cuts before year end. We're anticipating a first 25 basis point reduction somewhere in the last quarter of this year. Again, very dependent on what happens with inflation and how economic activity continues in our market. We are seeing that possibility towards the end of the year.

In line with what I'm mentioning from inflation pressures, nonetheless, we see that interest rate cuts will be gradual and very driven by what happens with inflation and how it continues to come down. We're still very far away from the central bank target. In that sense, for at least 2024 as well, we see gradual rate cuts in that sense, from the central bank.

Juan Carlos Mora (CEO)

Thank you, Laura. Now, José, regarding sensitivity that Yuri asked.

José Humberto Acosta (CFO)

Okay, Yuri, good morning. Regarding your question, how quickly the margins will compress, we will be able to manage the reduction of interest rates next year because of three factors. The first one is we today, in our time deposits, more than 60% of, of that time deposits will, they are less than a year, which means that the repricing of those time deposits will be faster. The second element is we still have a very good composition of funding in terms of saving accounts. That will be today's 38%, and roughly, we are going to maintain the same mix, and the checking accounts.

Because of these three factors, the compression of the NIM next year will be less than or at around 50 basis points, and our sensitivities for every 100 basis points, our NIM will change 30 basis points.

Juan Recalde (Research Analyst)

30 basis. Perfect. Thank you, José Humberto Acosta, Juan Carlos Mora, and everybody. Thank you very much, guys.

Juan Carlos Mora (CEO)

Thank you, Yuri.

José Humberto Acosta (CFO)

Thank you, Yuri.

Operator (participant)

Our next question comes from Carlos Gomez of HSBC. Go ahead.

Carlos Gomez (Analyst)

Hello, good morning. I have 2 questions. The first one is on capital. If you can reiterate, I believe your target to be at 11% by the end of this year. I have, I guess, two further questions around there. First, is that 11% enough? You mentioned a much more uncertain scenario, a slower economy, would you feel more comfortable operating with a higher level of capital? Second, when I look at the chart of your capital adequacy, you have a comfortable position in Tier 1, almost 300 basis points above the minimum, but you are only less than 1% above total capital. It would seem like you need more Tier 2. Is that so, and how do you intend to address it? Thank you so much.

Juan Carlos Mora (CEO)

Thank you, Carlos. As for your question regarding if we feel comfortable around 11% Core Equity Tier 1, the answer is yes. With 11%, we feel that we can manage the risk that we are facing. At 11%, and I think it's very, very achievable for this year that 11%, we feel comfortable. Regarding your second question about adequacy and total capital around 12.5%, and just being 1.5 above the Core Equity Tier 1, we feel comfortable.

We always are looking for opportunities to manage capital, but with that 12.5%, with 11% Core Equity Tier 1, and with the perspective that we have regarding loan book growth and, and, and the risk, we feel comfortable on on those levels. I don't know, José Humberto Acosta, if you have additional comments on on this regard?

José Humberto Acosta (CFO)

Yes, I want to complement that the fact, Carlos, that we are having 11 Tier 1, but also we are having a very strong coverage ratio of 90-day past due loans that give us some protection. If you double-check the numbers, we are above the line of 200 basis points of coverage of 90-day past due loans, which help us to maintain a very solid Tier 1 ratio as well.

Carlos Gomez (Analyst)

Okay, no, I guess the Tier 1, I mean, in your chart, you only have 200 basis points, and it is a total adequacy, which is. I mean, if I, if I read it correctly, the minimum is 11.5, we are at 12.45. I mean, that, I mean, it, it doesn't look like, like a lot more. One would think that perhaps you want to have more Tier 2 in the future, or perhaps it is too expensive to have it now.

José Humberto Acosta (CFO)

Yes, Carlos. Obviously, all depends of, of loan growth, and we are expecting the loan growth next year, 2024, 1 single digit. Again, we have an opportunity to touch the market with the Tier 2 structure, for sure, next year or in the next coming years. We have availability to do that.

Carlos Gomez (Analyst)

Okay. One final comment, if I can abuse you a little bit more. Again, given the situation in capital, this year you paid 50% of earnings of the previous year. It seems like things are a bit tighter going into next year. Where do you think your dividend may come out on the 2023 earnings?

José Humberto Acosta (CFO)

Carlos, you know that dividend is depending on the amount of capital that we want to grab next year, assuming loan growth and assuming macro conditions. We don't have today a clear picture about what is going to be the dividend policy, but we are going to do the calculations to maintain the 11%, but based on the conditions that will be presented for 2024.

Carlos Gomez (Analyst)

Thank you so much.

Juan Carlos Mora (CEO)

Yeah, Carlos. Mm-hmm. Thank you, Carlos.

Operator (participant)

Our next question comes from Juan Recalde of Scotiabank. Please go ahead.

Juan Recalde (Research Analyst)

Hi, good morning. Thank you for the opportunity to ask questions. My questions are related to the digital initiatives, Nequi and Bancolombia A la Mano. We've seen increasing engagement in terms of number of transactions by clients and deposit growth. However, the loans are shrinking in both Nequi and Bancolombia A la Mano. I was wondering, first, if this is a result of competition, lower demand, or a decision from yourselves, coming from yourselves? Two, if you can provide us any color in terms of the asset quality trends of the loans originated at Nequi and Bancolombia A la Mano. Thank you.

Juan Carlos Mora (CEO)

Thank you, Juan. As you mentioned, the dynamic of Nequi and Bancolombia A la Mano, it's very positive. I mean, we keep growing in the number of clients, in the number of transactions. Usage from our customers, it's growing in Nequi, close to 70% of our users are active users, and the number of transactions is growing. Same thing in Bancolombia, in Bancolombia A la Mano. Regarding your point of the loan book on those digital banks, and to your question, it was our decision to slow down the new originations. Those two initiatives are focused mainly on middle to low-income individuals, and we are providing them a banking solution according to their needs.

What we are doing is learning more from them, in, in a sense that we need to originate loans that are in the range of our risk appetite. That's why we are not growing as fast as we were growing before. Asset quality in, in those two platforms, was a little above of what we were expecting. That's why we decided to take a break and, and originate, in, differently. Those are, as I mentioned, groups that are new to the banking system mainly. We need to be careful in how we originate, what are digital process are, sometimes new for them, and how to manage the, those interactions with, with these platforms need, need time.

This to say that we will we will continue advancing in new ways and with the information that we are gathering from the transactions that they are doing in the platforms to continue growing. Our path to monetization, to profitability, definitely go past for the loan book. We are expecting for the second quarter start originating in a different way with different models. We now, we now have a new calibrated scoring model that we are going to use to originate during the second quarter.

Also we need to have in consideration the economic situation that is tougher now than it was in the past, at the beginning of the year or last year, when we started originating in this platform. To summarize, we slow down the origination, we calibrate the models, we gather new information, we will restart with a new strategy, originating loans. We will be monitoring how they are going to behave, and then, depending on that behavior and the economic condition, we will accelerate further the next year. Juan. Perfect. Thank you for the comments. Thank You, Juan.

Operator (participant)

Our next question comes from Andres Soto of Santander. Go ahead.

Andres Soto (Analyst)

Good morning to all, thank you for the presentation. Juan Carlos, I, I, I would like to, to help us understand a little bit about your pillars number three and number four, regarding your new strategy. What exactly you, you think you can do in terms of corporate structure or efficiency, and how investors can expect that being reflected in long-term results for Bancolombia?

Juan Carlos Mora (CEO)

Thank you, Andres. As I, as I mentioned, we, we have four pillars, and, and we have the purpose to promote sustainable development to achieve everyone's well-being. You mentioned the third and the fourth pillar. We, we are, we have a very strong corporate, corporate structure and, and governance. We have been working on, on that corporate governance for, for a long time. As, as you know, and, and we have mentioned this during this call, but also in the past, we, we are very focused on, on, on profitability. That corporate structure, meaning our presence in the different countries in which we operate, how are we organized?

The corporate governance that, that we have are focused on getting that profitability, that, that we are talking about on, on a, on an environment of, of risk control. Regarding the pillar four, we are very clear that efficiency and productivity are key. At, at the beginning, Sito and Yuri were asking about 2024, and we have very clear that one of the key aspects on top of the other others that I mentioned, it's how we manage the efficiency and the productivity of the bank. We have had some pressures from the from inflation, from some competition issues that, that we need to, to tackle.

We have clear that that focus on efficiency is key during 2024, and we will be a part of, of how we achieve the results that we were talking before, Andres.

Andres Soto (Analyst)

Thank you, Juan Carlos. If I may follow up, when I look at your efficiency evolution, I see the Central American operations, the one that appear significantly above what you have at the consolidated level. What exactly can you do in those operations? It's just a matter of operating leverage and is growth what is going to drive improve efficiency, or are there any specific measures that you can implement in order to accelerate the efficiency improvement?

Juan Carlos Mora (CEO)

As you said, we have the ratios in our Central American operations are higher than the one we have in Colombia. Volume is very important to dilute some fixed costs in those operations, so that's key, and you mentioned it. Also we are investing in new technologies that are allowing us to work on that, on that efficiency. For example, in Banistmo in Panama, we are investing in a new core bank system that now it's driving expenses high, but will produce results in the future, making us more productive and more efficient. Like that, we are also investing in El Salvador and in Guatemala.

It's mainly through volume, but also digitalization and new platforms that we are implementing in the different countries that we will achieve that improvement on the efficiency on the different countries. Saying this, it's important to take into account that what drives mainly the group efficiency, it's Colombia. You know that around 70% of our operations are in Colombia, 70%-75%. The main driver at the end on the consolidated basis of the efficiency of Bancolombia, it's Colombia. Of course, the efficiency of the other operations impact the overall ratio, but Colombia is key on that ratio, Andres.

Andres Soto (Analyst)

Of course. Thank you, Juan Carlos.

Juan Carlos Mora (CEO)

Thank you.

Operator (participant)

Our next question comes from Julian Ausique of Davivienda. Go ahead.

Julian Ausique (Analyst)

Hi. Hi, everyone. Thank you for having my question. I would like to ask you, and it's a little bit of follow-up on the cost of funds, 'cause as we saw in the presentation, we saw an increase in the funding costs in Colombia, and I think it's due to the restriction of liquidity that we are having in the financial sector. I would like you to ask you, how are you seeing these pressures in the liquidity in Colombia, and what are your expectation for the next quarters in the cost of fundings and also in the NIM of Colombia? Thank you.

Juan Carlos Mora (CEO)

Thank you, Julian. Bancolombia it's in a very good position in the Colombian market, as we have a franchise that is very well known. We have a branch network, digital channels that allow us to reach many retail customers, and also we have access to corporate funding. As you mentioned, there have been some pressure from liquidity pressures on the Colombian market. What had happened in our case is that we or some funds were moving from savings accounts, and they were moving to CDs, mainly one-year CDs, maximum one, one-year CDs. That means that we have to pay some additional interest rates for those fixed deposits.

I think that Bancolombia, in the Colombian market is, as I said, very well positioned in the market. We capture many opportunities regarding the liquidity that is in the market. Those pressures and the, and the level of the, or levels of the, of the interest rates that we have in the market that we discussed before, also drive that the cost of funds increases. With this, I will ask Jose Umberto if he has any additional comments regarding liquidity. Jose Umberto?

José Humberto Acosta (CFO)

Thank you. Julian, let me put it in two different ways. The first one is, in terms of the bank, as we mentioned previously, we have an strength, and if you check the numbers, 50% of our funding comes from checking and savings accounts, which give us certain level of comfort in terms of liquidity, and only we have 35% in time deposits. We are expecting a kind of plateau in terms of cost of funding for time deposits at least the next two or three months, waiting for the strong signal from the central bank reducing interest rates. Meanwhile, we are not seeing any particular change, neither going up or going down, those costs of risk, which means time deposits.

From the general perspective, the industry, obviously, because of the Net Stable Funding Ratio, all of us, all the banking industry, are colliding with time deposits. In our case, we have the strength that we have a different source of funding and not only time deposits. Again, as we mentioned previously, we are expecting to sustain the NIM, at least for these next two quarters, and next year we are obviously expecting a compression of the NIM because of change of interest rates of Central Bank.

Operator (participant)

This concludes-

José Humberto Acosta (CFO)

Thank you, Julian.

Operator (participant)

- the question and answer session. I would like now to hand the conference back over to Mr. Juan Carlos Mora for any closing remarks.

Juan Carlos Mora (CEO)

Thank you, everybody, for participating in this third quarter results conference call. As, as we discussed during the call, the environment has some challenges, but we are confident that in Bancolombia we are very well prepared to tackle or to manage those, those challenges that we, that we are facing. For the, for the second semester of the year, we will see a dynamic that will, will continue in, in the trend that we are seeing, but we think that in terms of how we, we will manage them, will lead us to achieve those targets that we mentioned during this call. With this, I, I conclude this conference call, and I hope to see you on our third quarter results. Have a good day, and thank you very much.