Banco Bradesco SA

BOVESPA:BBDC4

Earnings Call Transcript 2018-Q2

[Operator]

Good afternoon, ladies and gentlemen. Thank you for waiting. We would like to welcome everyone to Banco Bradesco's second quarter 2018 earnings results conference call.

This call is being broadcasted simultaneously through the Internet on the website banco.bradesco/ir-en. In that address, you can also find the presentation available for download. We inform that all participants will only be able to listen to the conference call during the company's presentation. [Operator Instructions]

Before proceeding, let me mention that forward-looking statements are based on the beliefs and assumptions of Banco Bradesco's management and on information currently available to the company. They involve risks, uncertainties and assumptions because they relate to future events, and therefore depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Banco Bradesco and could cause results to differ materially from those expressed in such forward-looking statements.

Now I'll turn the conference over to Mr. Carlos Firetti, Market Relations Director.

[Carlos Firetti, executive]

Good afternoon, everybody. Welcome to our conference call to discuss our second quarter results. We have today with us our Chief Executive Officer, Mr. Octavio de Lazari; our Executive Vice President, André Cano; our Executive Director and Investor Relations officer, Denise Pavarina; and the CEO of Bradesco Seguros, Vinicius Albernaz.

I turn now the presentation to Denise.

[Denise Pavarina, executive]

Good afternoon, everyone, and thank you for participating in this call. I'll comment on some highlights for the quarter and then Firetti will present the figures in more detail.

We'll start on screen #2. The net income reached BRL 5.2 billion in the second quarter, a growth of 1.2% if we compare to the previous quarter, and 9.7% compared to the second quarter and also to the first half of 2018. The operational results had a very solid growth of more than 25% if we compare annually, and the return on shareholders' equity in the quarter was 18.4%, in the first half, 18.5%. These results reflect in part, the economy improvement but more than that, the adjustments that we made in our operation in spite of the volatility -- the market volatility that we had in the late May and June. The expanded credit portfolio presented a growth of 6% in the quarter and 4.5% in the annual compare, a very good performance in both individual and corporate segments.

In the corporate segment, the growth was 7.5% in the quarter, favored by some specific operations that we added segment of large corporate. In the individual segment, that was very impressive growth in virtually all lines, with emphasis for the mass market portfolios of retail and prime that are growing 9.5% in the year.

As we have already anticipated in previous calls, we highlight the positive evolution that we have in credit quality. Delinquency ratios are decreasing. Ratios are decreasing and we can observe a reduction of 50 bps in the quarter and 100 bps in relation to the same period of last year. As a consequence, the expanded loan loss provision expenses had a further reduction, with a drop of 11.7% in the quarter and 36% if we compare annually. It was worth mentioning that the expenses for both the loan loss provisions and the impairment showed reduction.

The improvement in the last 2 quarters allow us to reduce our guidance for loan loss provision expenses as well as our impairment, that range is now from BRL 13 billion to BRL 16 billion. We believe that at the end of the second half, our delinquency ratios will be back to the precrisis levels.

Operating expenses continued performing well compared to the first half of the previous year despite inflation that we had, the wages increase. And this is mainly a reflection of the adjustments that we made in our operation, our discipline regarding costs. As you know, we are always trying to optimize our operations and seeking for cost reductions, and we have made them mainly through the use of technology. The physical presence of optimization takes into consideration the convenience of our clients and the necessity of each place, each location and then results in adaptation or reduction of our units. We intend to reduce for this year a total of 200 branches.

If you look to the revenues from services fees and commissions represented a growth of 3.7% in the quarter and 6.9% in the 6-month comparison, reflecting the revenue synergies in the system and a great offer of products to our customer base. I think this shows that we had done very important work on expenses in the past and now we can see the synergies on revenues starting to come.

The insurance operation will be commented by Vinicius Albernaz right after my presentation, so I'll leave it to him.

Regarding our capital EBIT, we had a reduction of 100 bps in this quarter due to the volatility of the market, which impacted our shareholders' equity in the mark-to-market of available-for-sale. Firetti will explain in details later.

These are the main topics related to the results and now I would like to take to your attention some of the initiatives we are putting focus on now, and that will boost our customer base in our businesses.

There will be 4 of them. First of all, the individual micro entrepreneur initiative. In this segment, we are providing a new platform to our customers. We just launched a website called MEI which stands for individual micro entrepreneur. In addition to the sales efforts related to Cielo, the machine -- acquired machine that's provided by Cielo.

Next. Next, as you know, our digital bank that focus on customers that seek a full digital and differentiated experience. We are very happy with the results. This quarter Next has reached already 180,000 current accounts and our targets for this year is to reach 400,000 new accounts.

Bradesco POS. We distributed Bradesco POS to our acquired customer with a package that's differentiated, a package of services that merges banking and other services provided by Cielo. Something that's very interesting that we are focusing on is the creation of what we call non-current account holders department. Actually they are clients in many products that we provide but they do not have a cash account with us. So we are giving a different focus to that and this department is going to develop many efforts to explore and to attend better those clients. They have at least 1 of our products of the group as a whole.

In a nutshell, we feel that these results show the robustness of our operation and considering these projects that we just mentioned, we expect a very interesting future as the economy puts the crisis period behind.

So now I would change to Firetti to provide detailed information on the figures.

[Carlos Firetti, executive]

Thank you, Denise. Starting on Slide #3, the adjustments on our recurring net earnings, basically the main adjustment as in the previous quarter was the goodwill amortization. We amortized BRL 613 million. Our expectation for the year is BRL 2 billion. Therefore we expect a reduction in the level of amortization in the second half.

In Slide 4, only a few comments on this slide. We'll go into details on the lines on the following slide. Basically return on equity of 18.4%. In the quarter our operating income show a strong growth of 25.7%. Recurring earnings grew 9.7%. Basically as you can see, we have a higher tax rate this quarter. This is related to the creation of tax credit due to the tax variation. This reduced our ability to consume tax credit for previously constituted at 40% and had this impact on the tax rate. We can discuss that more in details in the Q&A, if you wish.

Going to Slide #5. The -- our net earnings as a group, 9.7%, 32% of the results in the first half came from insurance.

In the Slide 6, we have some details on our net interest income. Our net interest income in the first half had a reduction of 3.8%. In the quarter, we had a reduction of 3.3%. We have a nice increase in credit intermediation already reflecting the increase in volumes in our loan book and also that overall favorable mix mostly coming from loans in the retail operations that have better margin.

In the insurance, we had -- margin, we had a reduction, the NII from insurance, mostly due to the differential of indexation ratios in our assets and liability management for the insurance company. Basically, we have a very high wholesale inflation that corrects our liabilities while our assets have mostly bonds indexed to retail inflations. This differential represents a higher cost for us that reduced the margin for insurance. We can say this is a temporary impact, provided that the -- as normally is the case, retail inflation comes higher than wholesale. Basically the -- we don't have this impact that is normally the case.

In the asset liability management and others line, basically we had the impact from results in the bond portfolio. I will talk a little bit more about mark-to-market when I talk about capital. We had this quarter -- looking to the quarter, isolatedly, I call it in the credit margin, basically as I said, reflecting both the better mix.

On Slide 7, we have our loan book. Focus on the bottom parts of this slide, the extended loan book by segment. You can see that we are growing above 9% in the retail portfolio, so basically retail and prime. While we had a pick-up in growth for corporate. This is, as Denise mentioned, mostly due to FX. It's small -- a small part of this. It mostly due to some specific operations in the corporate segment we originated this quarter and helped grow. We didn't change our view that corporate probably will not grow that much in the short term, mostly because companies still didn't start an investment cycle, so we remain with the same view. We believe retail should do better than corporate loans going forward. We had the first quarterly growth in the middle market portfolio for some time this quarter. So basically, we had a net increase of 6% in our extended loan book in the quarter, 4.5% year-on-year.

On the Slide 8, we have our expanded loan book where we can see there, the lines that are growing more continue to be payroll loans where we have a big strength coming from the origination of payroll loans in our own branches and also getting stronger in private sector payroll loans and real estate financing, car loans. So we had mostly this quarter, an increase in all individual lines in the portfolio.

In Slide 9, we have the origination per business day. Our origination per business day grew 23% in the quarter in the annual comparison. For companies, we had an increase of 35.6%.

In Slide 10, we have our delinquency ratios. It is one of the big highlights of the quarter and has been one of the highlights for the previous year. The delinquency ratio of 90 days dropped almost 40 bps this quarter. We have improvement in SMEs that, despite the big improvement, still remains above the bottoms we have seen in the past. We believe we may see still a gradual improvement there. Individuals, we are getting closer to historical bottoms but remember that we changed the mix, so it's possible to see some improvements there. In corporate loans, despite the improvements, it is still high. Probably it will take a little bit more time to see the delinquency ratio there going back to the bottoms that historically were around 0.5%, mostly because the segment tends to be impacted by specific cases or a few specific cases, even though most of the portfolio is in a much better shape.

On Slide 11, we have our gross provisions without considering impairments and recoveries compared to the NPL formation. We -- our provisions -- new provisions represented 112% of the NPL formation, denoting the consistence in our provision. In the lower parts of this slide, we have our expanded loan book in relation to the portfolio. We reached the ratio of 2.7%. It's a very low level. And it's basically, in our view, the hidden expenses will remain very well behaved.

In Slide 12, the NPL creation per segment. The total NPLs creation continued reducing. This quarter, we have reductions in corporate NPL creation, SMEs. For individuals it remained stable this quarter.

In the Slide 13, we have our coverage ratio. We reached 230% coverage over the 90-days NPL, a very healthy level. We believe this coverage will go down when we grow -- with growth in our portfolio. We don't intend to revert additional provisions we have constituted in the past at this moment.

Page 14, we have our renegotiated portfolio. We have an increase in the total renegotiated portfolio by BRL 700 million this quarter. This is more like a, not a one-off, but it's driven mostly by the renegotiation of some -- a few corporate loans, and it's not a trend. These loans already had provisions. So basically it doesn't impact at all the dynamics for the expanded provision expenses in our portfolio, not -- also it doesn't change the trends for NPL.

On Slide 15, we have our fees and commissions. Our fees grew on a year-on-year basis in the second quarter at a rate of 8.3%. Good performance from checking accounts, asset management, from brokerage and also investment bank. That is clearly one of the bigger highlights in the quarter. The checking accounts -- the performance growing 8% in the first half shows we have been able to capture more synergies from our acquisition, especially in the current account fees.

Slide 16. Our cost -- our total costs grew in the quarter year-on-year 0.6%; for the first half, 0.1%. We had a slight higher increase in administrative expenses mostly related to the concentration of marketing expenses in the quarter but also some impact from third-party services. And also, we had this quarter, an increase -- a reduction year-on-year in personal expenses, 0.8. But actually, the structural part of the personal expenses dropped 4.1, while the nonstructural grew 13.9. The main reason behind that are the very high levels of provisions for labor lawsuits. This has been high because of the higher numbers of lawsuits filed against us due to the reduction in the number of employees we have recently. Also, the average provision we have been making for each case is still on a higher level. We already see a lower flow of new lawsuits, and we believe as time goes by, since the provisions are made on a moving average, also the provision for lawsuits will be lower. So we believe in the second half, the provisions for labor lawsuits can be materially lower, and that should help the personal expenses.

We continue, in terms of branch network, we had a small reduction of 8 branches. We continue with our target of closing around 200 branches in 2018. The efficiency ratio, 40.80% this quarter. The coverage ratios, that is basically fee revenues divided by cost, reached 80.3%. This is the best level we have for many quarters.

Now I turn the presentation to Vinicius to comment on insurance.

[Vinicius Albernaz, executive]

Thank you, Firetti, and good afternoon, everyone. The first half of 2018 figures show that the Brazilian insurance market is still feeling the effect of the general economic environment, with growth well below its potential. Despite this challenging scenario, the main performance indicators of Bradesco Seguros in the first half were positive. Our claims ratio showed an improvement of 70 basis points in the first half of the year in comparison to the same period last year, reaching 74.4%. In a similar manner, our commissions ratio improved by 100 basis points, reaching 8.9%.

Our efficiency index, which completed its ninth consecutive quarter around 4%, has remained at the best of the market among the large issuers in Brazil, reflecting a strict control of our direct costs. As a result, our combined ratio has also shown an evolution of 100 basis points, reaching 85%. In the same direction and despite a lower Selic rate and increasing market volatility, our first half financial results exceeded approximately 5%, the one observed in the same period of 2017. The strong operational performance has allowed insurance group's net income, which totaled BRL 3.145 billion in the first half, to grow by 19% in comparison with the same period last year. The adjusted retail on shareholders' equity was 19.6%.

Our technical provisions exceeded BRL 252 billion corresponding to about -- to around 27% of the Brazilian insurance market -- of total provisions of the Brazilian insurance market, with total financial assets reaching BRL 280 billion. The total amount paid in benefits reached BRL 29 billion, corresponding to more than BRL 230 million per working day. These figures translate the strength of Bradesco Seguros, whose revenue has maintained our market share around 25%.

We understand that the insurance market is undergoing major changes, both in Brazil and the rest of the world. Changes that range from the demographic profile of the population to the introduction of new technologies, new forms of relationship with the clients, in addition to the rise of a hyper-connected generation with very specific perspectives. We have been working with special focus in improving our internal processes aiming not only at the development of new products but also the continuous improvement of our pricing models, acceptance in management of claims among other key aspects are essential to the insurers' activity.

Therefore, in spite of the challenges, we still have the confidence we had at the beginning of the year. If, on the one hand, the reduction of the Selic rate challenges our market concerning financial results, which is an integral part of the insurance business. On the other hand, the moderate recovery of the economy shown in the first half tends to create favorable conditions to support operating results going forward.

We will continue to pursue gains of scale, administrative efficiency while maintaining the excellence in our services. And also promote the continuous evolution of our multiproduct distribution channels, our ambition is to have a strong presence in all channels ensuring complete insurance solutions to all our generations of clients throughout their lifetime and professional needs.

Thank you very much.

[Carlos Firetti, executive]

Thank you, Vinicius. So jumping to Slide 19, we have our Basel ratio. We have this quarter a variation in our capital by 100 bps. Basically as you can see, the main sources -- the main drivers for the variations for the mark-to-market in our available for sale securities portfolio that are mostly secured from our asset liability management, and prudential adjustments that means basically tax credits that we generated this quarter. For mark-to-market, only I remark here basically the duration of our positions in this asset liability management for the bank are very short. Basically, they are limited to the horizon of the monetary policy. Our focus here is to earn the accrual of interest from the positions. So basically, as we get closer to the maturities of those securities and considering that Selic didn't change, we continue with a positive accrual and actually the mark-to-market naturally reduces for the securities.

So basically, this should very soon go back to equities. Also, I remind you, our strong capacity of generating capital organically from our retained earnings. So that is enough to really offset even strong growth in risk-weighted assets as we had this quarter. So basically, we feel very comfortable with capital.

And finally, in Slide 20 we have our guidance. We revised the guidance for 2 lines. Insurance premiums, we reduced the range from 4% to 8% to 2% to 6%, basically reflecting the fact that the market had underperformed in terms of growth and premiums. But we feel we are in a better position to meet this guidance now. And also we revised the guidance for the expanded provision expenses from BRL 16 billion to BRL 19 billion to a range of BRL 13 billion to BRL 16 billion. We target here the middle. If you analyze the first half, we would have BRL 14.6 million in provisions so we are very comfortable on that.

On the other lines, for the expanded loan book growth, we target the middle. For NII, we are comfortable with the middle, the minus 2 in this range, 0 to minus 4. Fees and commissions, also the middle. And operating expenses, we believe we can be on the mid to lower portion of the guidance for full year '18.

With that, I close my comments on the presentation and open for Q&A.

[Operator]

[Operator Instructions] Our first question is coming from Mr. Carlos Macedo with Goldman Sachs.

[Carlos Macedo, analyst]

I have a couple of questions. First question, thank you for updating the guidance. I want to talk a little about the margin growth guidance that you put where you didn't change 0 to minus 4%, minus 3.8%. I think it's 2 questions around that. First is on the loan growth. You're moving to the upper side of the range here on your loan growth guidance. And from everything that we can tell from the origination, your retail book is starting to grow, probably accelerate through the second half of the year. Do you think there's upside to this growth on the retail side? And could that have an impact on your margins given that you had a negative effect on insurance this quarter and that you're going to have a better mix in the second half of the year? Do you think that something that could offset some of the headwinds you faced earlier in 2018?

[Carlos Firetti, executive]

We totally agree. We believe the mix can really help us. I think it has started to help. When you look on the quarterly variation, we already have an increase in the credit margin this quarter. So credit margin can improve. And basically insurance, we don't call this one-offs, but the differential between wholesale and retail inflation shouldn't repeat. So basically, the insurance results should normalize. And also the ALM others also have room for normalize. So yes, we think mix can help. The growth in corporates this quarter is kind of, as I've said, based on specific opportunities, we hope we have those same opportunities during the rest of the year. But most likely, we go back to the same path in terms of growth for corporate as we had before or maybe better more to the end of the year. While these strength in retail probably will remain. We always point that we should be able to grow high single digits for these retail portfolios and we are there.

[Operator]

Our next question is coming from Mr. Jorge Kuri of Morgan Stanley.

[Jorge Kuri, analyst]

2 questions, if I may. On your guidance for provisions that you reduce considerably, you are seeing such a growth in consumer loans for the second half, as you mentioned. When you initially set the guidance, I think the expectation for GDP growth, which was earlier this year, was around 2.5% to 3%, consensus is probably around 1.5% now. So the economy's growing less, unemployment is having improved this margin expected early on. So it does seem that the macro environment is a bit worse than what you set your guidance on and you're actually growing faster. And we did see that debt formation pick up quite meaningfully this quarter; we calculate 25% quarter-on-quarter. So just wanted to understand why -- what's allowing you to grow more, provision less in an environment where NPLs, debt formation is picking up and the economy is growing much less than you expected early on this year. That's question one. And -- go ahead, Firetti.

[Carlos Firetti, executive]

Yes. First, let's start with your comments on bad debt formation. I understand you include renegotiations in your bad debt formation calculation. That is the only difference to our calculation. That is basically the variation of NPLs plus write-offs. Basically, as I pointed, the bad debt -- the increasing renegotiations this quarter is due to very few companies renegotiated for which we mostly have provisions. So basically these renegotiations don't even impact the provisions, despite the fact that yes, the renegotiated loans leave the NPL. So basically, in the retail and SMEs, actually there's no impact in -- from renegotiations. And the trend you see there, in terms of NPL creation, NPL is a real one. So systemically, I would say we are doing very, very well in credit quality.

Your point about GDP is fair. We started the year expecting something as 2.5% growth. We are seeing 1.5%. But it's interesting, we saw very strong months in April, May and June in terms of origination. Very good quality -- the vintages we originated were very good. So we didn't reduce our credit standards. So basically, we still see demand. Maybe we have some impact going forward, some slowdowns in the origination. We haven't seen that so far. But it may happen. But we continue optimistic that actually considering we are now very close to a very important event. And after that, we believe we may see a real acceleration in the economy. So eventually, we don't see a material deceleration in loan growth.

[Denise Pavarina, executive]

But just to add something, Jorge. What we see is that the team is much more prepared. We do have systems that we put in front of the managers, the offers they should do to each client in each moment. And the credit can be contracted out, so in the -- via mobile, via ATM, Internet banking. So we are creating conditions to the client to access the credit easier and also for the managers to offer more effectively, more efficiently. So adding to what Firetti said, I think the 2 things together, and there are specific lines where we are growing faster, like the real estate, the auto financing and the salary-related loans. So those are very focused by the managers to offer to our clients.

[Jorge Kuri, analyst]

Great. And my second question is on net interest margins. I understood from your comments that you expect a better performance in the second half from an improvement in your lending mix and normalization of the insurance product. Could I ask what is the duration of your overall loan book? Because if yours looks similar to the overall industry, which is somewhere around 12 to 18 months, that means that credits that are going to come due in the second half of the year were issued with a level of SELIC rate that was closer to 10% versus 6.5% now. So your back book, front book repricing seems a bit challenging to expect a normalization in margins. Could you talk about that, please?

[Carlos Firetti, executive]

You are right. Our loan book is about 1.5 years, mostly. And we -- you are right, there's a repricing of the portfolio and spreads, really when you look line by line, in some case, went down. The key thing here is the mix. Actually, we are growing more in retail loans and less in corporate, apart for this quarter that was, as I said, due to some specific operation. So this -- and we are growing -- in retail, we are growing small companies and individuals. So basically, small companies have pretty good margins. So basically, this is the point: they're substituting corporate loans for retail loans even though you are true -- you are right, there is effects of reprices help margins, together with a pick up in volume. Sorry, that helps NII.

[Operator]

Our next question comes from Mr. Jason Mollin with Scotiabank.

[Jason Mollin, analyst]

My first question is on loan growth and origination. You do show, on Slide 9 of your presentation, the origination by business day for individuals and companies. I think for individuals, it's pretty easy to understand. Can you help us follow what happens for companies because of the devaluation -- 17%, devaluation Q-on-Q in the quarter? You do provide some details on foreign currency loans that we've looked at. But specifically, what would the origination be like if we exclude the impact on FX?

[Carlos Firetti, executive]

I don't have that information, Jason. I guess, on origination, probably the effect is not really material. We can try to do something. If there's an impact from FX in the overall portfolio growth, that I can give you. Basically, we grew, in nominal terms, 4.5%. Without the FX impact it would be 3.2%.

[Jason Mollin, analyst]

That's helpful. I mean, I get it. I guess just comparing year-on-year, as you would if you're comparing, I guess, in the quarter. I'm wondering if part of this origination. Clearly, I think part of the year-on-year is probably just looking at it on a bunch of different levels.

[Carlos Firetti, executive]

Yes. It's fair to assume that. Probably it would still be growing anyway. But it's fair to assume that it may have this impact.

[Jason Mollin, analyst]

My second question is on -- and you mentioned the book value evolution or negative impact of the mark-to-market. And you said that the duration of the securities book is very short and that as these bonds mature, you could actually have the losses reversed. Maybe you could give us some more color, what's the big hit in the quarter? We didn't see book value grow even after the BRL 5 billion in recurring earnings after we look at this mark-to-market. And I guess we had this impact of Prudential measures that we saw that also you show impacting the capital. If you can give us some color there as well. And should we expect therefore -- I mean, we don't know what's going to happen with volatility, but if you were to sell these securities available-for-sale, they would obviously -- you would realize the loss.

[Carlos Firetti, executive]

So yes, you are right. The duration of that, as I said, it's not really long. It's -- we -- for strategic reasons, we do not give the duration. But we can say it's a match in the -- it matches the horizon of the monetary policy. We -- since those securities are really a part of our liabilities management policies, how we vet, especially, we hedge at this rate, some liabilities, we should take it to mature it first. The accrual on that position is it's too positive despite the fact we had a negative mark-to-market, given that, actually [ CDC didn't move ]. Then, basically, as you get closer to maturity, the mark-to-market, even if prices remained, rates remain the same level, actually, the mark-to-market reduces. But the tax credit doesn't -- it didn't impact equity. It impacts the referential capital for BIS purpose, but it doesn't impact, actually, shareholders' equity. It's only the mark-to-market.

[Jason Mollin, analyst]

So where was that booked then? So where was that booked -- that was booked in that -- we have that line, that referential -- that Prudential reserve or provision.

[Carlos Firetti, executive]

But it is -- you have that in the capital calculation. In the table, we showed the calculation of the capital for BIS. But tax credits go on the balance sheet. It's there; not in the equity. Actually, it's reflected in the equity somehow, but it does not impact shareholders' equity. And -- but mark-to-market, yes, is one of the shareholders' equity components.

[Operator]

Our next question comes from Mr. Marcelo Telles with Crédit Suisse.

[Marcelo Telles, analyst]

I have 2 questions, if I may. The first one, I'd like to dig a little bit deeper on the insurance margin for the quarter. Now as you mentioned, the margin was negatively affected by the mismatch between IGPM and IPCA. I'm just trying to quantify that impact. Looking at your financials, I just want to confirm with you if the part that is -- if this mismatch is the BRL 22 billion of NTNs in your -- that are held to maturity -- booked as a -- held to maturity in the insurance business. Because if that was the case, this 2% differential pretty much represents close to, like, BRL 440 million of NII in the quarter, which is quite meaningful when -- if you have those IGPM and IPCA aligning down the road, you could have a very significant pick up in NII down the road. Do these calculations make sense to you? Or I'm looking at something incorrect here? And the second question is your insurance operation, when you look at the operational result -- at your insurance result and excluding it, of course, in the financial result, there was a very significant improvement in the quarter. As you mentioned, claims ratio improved, and it seems that a lot had to do in health insurance. So going forward, do you think there is room for you to improve further? Where do you think you are in terms of a claims ratio vis-à-vis what you see as kind of the more recurring level?

[Carlos Firetti, executive]

Okay. I will start the answer. I'll tell you, the mismatch in the insurance is really, in terms of IGPM-IPCA, it's much, much smaller than that. For strategic reasons, we don't disclose, but the mismatch is more on the range of a couple of billion than actually the numbers we've said. When you look to the positioning in inflation-linked bonds, you actually see that, look, the management of reserves and also the capital of the insurance company, not really only the management but the actuarial mismatch has found its way on the pensions business. So basically -- but you are right. As -- this is only to explain the nature of this negative impact from this mismatch even though I'm now saying the magnitude is not the one you mentioned. Basically, we have liabilities in the insurance company, mostly related to traditional pensions. And we have assets covering this liability for part of the portfolio, is IGPM plus something. And we hedge that with bonds, and basically, some of these bonds are IPCA, retail inflation plus something. We have part of the liability covered by matching, actually, but there is a gap. But basically, when IGPM is higher, we have expense that is higher than the revenues from the inflation-linked bonds. This is the source of this mismatch.

[Vinicius Albernaz, executive]

Firetti, if I -- Marcelo Vinicius here. If I may add and, of course, the government no longer issues government bonds linked -- inflation linked to IGPM. In the past, we used to have most of our liabilities covered by -- fully by government bonds, inflation linked to IGPM, which they have a natural schedule of redemptions. We had a big redemption back last year. So that mismatch is a part of our life. It's become a no longer issue that. And of course, I mean, we are, at this point, with this current mismatch, losing on the margins, but we have to remember that for a couple of years, the opposite happened. So I mean, this is something that, over the long term, tends to converge. But there may be some periods of impact. And also, as Firetti said, part of the portfolio of inflation linked bonds to IPCA, we also covered other liabilities. We have liabilities linked to general inflation index as well, as well as long-term liabilities that they help, for instance, that they warrant some sort of asset linked to inflation. And as for your question on the operating results, I think that it's not only auto. I mean, auto is an important part of that. As I mentioned, underlying underwriting discipline and the -- more improvement in the mix of auto and P&C in general, are looking for better results and better returns in that portfolio. But also I have to say that we had a significant improvement in the claims ratio of the health business. This is a trend that we believe continues the trend of the first quarter. And this is very, very positive, and it's caused by an improvement in employment in the current environment situation but also is the result of several measures that were undertaken by the company in the last year or so in order to control losses, to control claims. It reflects a lot of those operational gains that we believe will be fruitful going forward.

[Operator]

Our next question comes from Mr. Thiago Batista with Itaú BBA.

[Thiago Bovolenta Batista, analyst]

I have just one question about the insurance results, but this time in the operations side of the insurance results. The results of insurance improved a lot this quarter, and [ not to be wrong, ] this was the best quarter ever for the operating insurance results. Do you believe this level is, let's say, recurring? We can see the level of insurance results in coming quarters similar to this one? And also if there is any one-off impact that explains these very strong insurance results?

[Carlos Firetti, executive]

There are some trends that, as Vinicius mentioned, are, in our view, stable. The improvement in health, basically, we did a lot of homework to really control costs. There's the stability of the unemployment ratio. Remember, we always had that and the increasing of unemployment, basically we had an increase in frequency due to this, and even though unemployment is not going down, actually, it's more stable. So we have benefits on insurance -- on health insurance. We also have improvement in claims in the auto line. And also, we've had some improvements, or at least we have been keeping our administrative efficiency ratios.

[Vinicius Albernaz, executive]

Yes, I think, Thiago, it's important to mention that this is coming also from lower commercial ratios, expense ratios, commercial expense to commissions ratios, lower administrative costs. And also, I mean, you have to remember that this is the counterpart of the financial side. I mean, when the insurance business, when financial results go down, given lower interest rates and different scenarios, it's natural that you have an improved operating results. Also, I think you should take into account the 2 quarters combined and compare it to last year, the first half of 2018 compared to 2017. And of course, going forward, we believe that these improvements in processes that we have undertaken and as well as controlling of risks and our disciplined underwriting policies will continue to allow us to have better operational results. But of course, we also are in Brazil, and we also are linked to the general environment, and that has a big impact. So we are, I think, in a very good position to capture continuing improvements in the general economic environment should it happen. But this is a risky business, of course, to be sure. This is not something that we can predict 100%.

[Operator]

Our next question comes from Mr. Mario Pierry with Bank of America.

[Mario Pierry, analyst]

Two questions here. The first one is related to your new guidance for provisions. The midpoint of your guidance is BRL 14.5 billion. However, if I consider that you had already done BRL 7.3 billion in the first half, and you're running at BRL 3.4 billion per quarter now, it implies that you would be reaching closer to BRL 14 billion. So just wondering how conservative are you being on your guidance for provisions? And does it reflect maybe just being conservative because something could come up? Or should we be working with a figure, then, closer to the bottom of your guidance rather than the midpoint of your guidance? The second question is related to your headcounts and branch counts. As you've shown on your presentation, they are down about 7% year-on-year, but it seems like they have stabilized. At the same time, when we look at your efficiency ratio, on Page 17, your efficiency ratio is stable for the last 5 quarters, at 41%. Part of that, I think, reflects the weak NII growth or the NII contraction that you're showing. But I wanted to get a sense from you, is there more room for you to improve your costs? And at what level do you think, or do you want, your efficiency ratio to get to, let's say, by next year?

[Carlos Firetti, executive]

Okay. First, on your question, I think we, overall, would prefer to say that our target is the middle of the range. I think there are still a lot of things going on. I think there is some uncertainty. I think this BRL 14.5 billion is already a very strong reduction. We think the trend overall in terms of credit quality is a very positive one. But really, we prefer to commit only to the BRL 14.5 billion that is actually already very, very, very good. In terms of efficiency, you are right. We did a lot but this quarter, specifically, I wouldn't say one-off, but margin-wise impacted by some effects that reduced the NII. Probably we have a recovery soon on those specific lines. And part of the benefit improving efficiency has to come from revenues. We did a lot in terms of reducing costs. And basically, the fact we didn't improve more was because the revenue scenario for a while was very hard. So we expect revenues will, from now on, start to help more. But we continue with our focus on costs. I think for this year, we expect to close more 200 branches. Probably, the reduction in the number of people will be lower, but it cannot -- it should still happen. And there is also other fronts here in terms of trying to control expenses. We don't -- for this year probably, as I said, the expenses should be either mid-lower portion of the guidance, 0 to minus 2%. So there's improvement in -- or accounting in personnel expenses only by having better labor lawsuits or lower labor lawsuits that should happen in the second quarter. So we still see benefits on the cost front and we expect to start to see better numbers also on the revenue fronts as we've started to capture more synergies.

[Denise Pavarina, executive]

Just to add, when I mentioned the adaptation of the branches, I think when I see that a place doesn't need to necessarily to have a branch, what we do, we just change to a post of attendance where we don't have to have the security guards so the costs -- and it's this is a big space that we're using. So the costs reduces an average of 5% of the branch that was previously chooses adaptation. What happens with that is that it will come on time. We don't see it at first, but it usually come on time. And that we continue to evaluate, as I said, all the points we have and considering the business model we have of a national presence, this adaptation has to be done according to the needs of the place and the results that, that place can bring to us. So this is something that we are very carefully looking at.

[Operator]

Our next question comes from Mr. Felipe Salomao with Citibank.

[Felipe Salomao, analyst]

I have a question about Cielo, to be more precise. So recent months have been challenging for Cielo. Competition has intensified, important executives have left the company and results are deteriorating despite the market recovery. Look, I'm sorry, for asking a broad question. But how the bank, as one of the controllers of Cielo, is seeing the future of the company in the short to mid-term? Should results continue to be under pressure? Or are they expected to improve given that the SME loan portfolio growth is accelerating? And can you please also comment if the distribution of POS devices at branches has been accelerating since the launch of the Stelo brand?

[Carlos Firetti, executive]

Okay. Thank you, Felipe. We have to be careful here in terms of talking about Cielo. But overall, our view, for sure, you are totally right in your reading that there is a change in the competitive environment in the acquiring business. Cielo had some advantages in the past that are not there anymore. There's been a strong increase in the number of competitors. But Cielo remains a great company. It's our partner for our initiatives in the acquiring business. We do with them the -- our POS machine, a cobranded POS machine. We have been growing there in terms of number of POSs. Their POS is our vehicle for playing in the individual entrepreneur business. That is a business that makes a lot of sense for us. We have been investing and positioning ourselves to be the most relevant player there. We already have a big number of clients in that segment as clients of Bradesco, considering we have a lot of clients also in the bottom of the pyramid. And we are really improving our offer to be even more competitive in that segment, offering the tools for attracting and providing the better services for -- the best service for the client. We are selling quite actively the Stelo POS, the Bradesco cobranded POS, as well helping them in other situations. So basically, it's -- we are comfortable and think they will -- their sales overcome this pressure in revenues in terms of mark. We have sold, so far, considering both, Cielo, the cobranded and Stelo machines, about 110,000 POSs. So we are quite active. We have just started on that.

[Operator]

Our next question comes from Mrs. Natalia Corfield with JPMorgan.

[Natalia De Melo Corfield, analyst]

With regards to your capitalization. You saw this decline of 100 basis points quarter-over-quarter. And I want to know first if you -- what you expect for the second half of the year. And do you think there is a chance that we will continue to go down? Secondly, if you're comfortable with the level that you currently have, and if you're not, which would be the comfortable level of capitalization for you? Those are my questions.

[Carlos Firetti, executive]

Yes. Okay, Natalia. Thank you for the questions. Basically, we are comfortable with this level, but you -- we understand and I think everybody understands that, actually, we generate a lot of capital. We organically, through retained earnings, that should continue. This quarter, we have, especially in the corporate business and also due to FX, an acceleration in loan growth part of it. It's due to these specific issues. Even though we believe loan growth should continue, probably these effects are more like one-offs. It's based, as I mentioned in the presentation, part of the impact -- or most of the impacts comes from mark-to-market in our securities portfolio. And as most of these securities are short term, and as we converge to maturities and considering that basically we believe that we recover this mark-to-market through our capital. Also, consumption of tax credits generated, that also impacts it. Just let some quarters go, and we should consume a big part of it. So basically, we think our capital will naturally expand over the coming quarters. We have said that we believe a -- some sort of comfortable level would be something around 13.5 Tier 1, probably 12 kind of principal capital plus the perpetual bonds. And we think we may -- we should get there in -- not that long considering all the trends, capital accumulation and actually recovering this mark-to-market, that should naturally flow through to our balance sheet.

[Natalia De Melo Corfield, analyst]

Okay. And what about the core equity? Like that's at 10.6% level. Is that something that you had in your mind? Or you think that, gradually, based on what you said, the maximum -- the extended effects of the mark-to-market fade, this should gradually improve?

[Carlos Firetti, executive]

Yes, that's -- as I said, basically, we naturally improve with this natural evolution plus earnings retention. But we continue generating capital organically through earnings retentions.

[Natalia De Melo Corfield, analyst]

Okay. And to reach your -- the comfortable level of Tier 1, do you think about issuance of 81?

[Carlos Firetti, executive]

Are you saying perpetual bonds?

[Natalia De Melo Corfield, analyst]

Yes.

[Carlos Firetti, executive]

We have. We always are attentive to this market, but we don't have any plans at this moment for any issuing, but we are always looking.

[Denise Pavarina, executive]

We have space if we wish.

[Carlos Firetti, executive]

Yes, if we wish, we could issue up to 70 bps more. We already have 80 bps in an issuance made here in Brazil.

[Operator]

Our next question comes from Mr. Carlos Gomez with HSBC.

[Carlos Gomez-Lopez, analyst]

The line is poor and if you have trouble understanding these questions, I apologize for that. The first one is about the Prudential adjustment that we see on Page 19, 0.3% decline. I remember that this related to the Basel III implementation but that should have come in the first quarter, so can you explain why you have another Prudential adjustment in this quarter and if we should expect more in the coming quarters? And the second one was just a... [indiscernible]

[Carlos Firetti, executive]

Carlos, let me -- the line is very poor. Let me answer your questions one by one. That is going to make it easier, okay?

[Carlos Gomez-Lopez, analyst]

Sure.

[Carlos Firetti, executive]

Yes. So basically this Prudential adjustment, basically it's something that adds to the Prudential adjustment. Basically, I mentioned in the call the Prudential adjustment basically is the increase in the stock of tax credits, mostly related to FX variation on our hedging of external FX exposure. So basically, this quarter, given the level of the held depreciation, we had these tax credits that are deducted from our equity. That's it. And basically, as -- we basically should consume that over time.

[Carlos Gomez-Lopez, analyst]

Okay. So, let me understand. You have nothing from the currency. You have, because of your hedges, an increase in the tax credit and therefore credits will be smaller?

[Carlos Firetti, executive]

Yes, I don't have any FX exposure. The only impact is really the fact that there's duration of tax credit.

[Carlos Gomez-Lopez, analyst]

Yes. And my next question was actually the tax rate itself. And I guess that was also related to the mix in the currency?

[Carlos Firetti, executive]

Carlos, would you mind to call me after the call? I'm really having trouble to understand. We -- maybe we can discuss that.

[Operator]

Excuse me, ladies and gentlemen, since there are no further questions, I would like to invite the speakers for their closing remarks.

[Denise Pavarina, executive]

I would like to thank you, everyone, for participating on this call. And as Firetti just mentioned to Carlos, we will be available for further questions later on. Thank you. Have a very nice day.

[Operator]

That does conclude Banco Bradesco's conference call for today. Thank you very much for your participation. Have a good day.