Credicorp Ltd

NYSE:BAP

Earnings Call Analysis

Peruvian Economic Challenges Lower ROE Estimate

Amidst a gloomy economic scene in Peru, non-primary sectors have contracted and the mining sector's growth stands out as the lone bright spot. The company has witnessed marginally decreased risk-adjusted net interest margin (NIM), now at 4.45%, due to increased provisions and declining loan quality across multiple sectors. Simultaneously, return on equity (ROE) this quarter fell to 16.2%, with a year-to-date figure at 17.8%. No additional dividends will be distributed this year. The company adjusts to an El Niño phenomenon that's likely to be moderate-to-strong, impacting loan portfolio quality, particularly in regions prone to heavy rains and flooding. Annual cost of risk is projected to lie between 2.6% to 2.9%, influenced by provisions for expected losses from El Niño, leading to a full-year ROE estimate of approximately 15.5%.

Navigating Through Economic Challenges: A Mixed Picture for Peru's Economy

The recent financial results reveal a complex economic landscape. Peru is grappling with weak private investment and sluggish consumption, leading to a contraction in the non-primary sector. However, a shining spot in this challenging environment is the growth in the mining sector, particularly with increased copper production at Quellaveco. Despite this mixed performance, Peru's macroeconomic fundamentals are deemed robust, with low levels of public debt and healthy international reserves.

Coping with El Nino: External Factors Weighing on the Economy

The El Nino Costero weather phenomenon has considerably battered the country’s fishing, agriculture, and textile sectors, leading to the worst anchovy catch in 25 years and significant declines in agricultural and textile production. Peru has responded to easing price pressures and declining inflation expectations with a 50 basis point policy rate cut, which symbolizes a proactive adjustment to the economic headwinds.

BCP's Resilience Amid Economic Volatility

Banco de Credito del Peru (BCP) has navigated through the economic downturn with a 1.5% increase in Net Interest Income (NII) and a strategic shift in loan distribution favoring less risky disbursements. Despite higher provisions due to a challenging economic climate, BCP achieved a Return on Equity (ROE) of 20% for the quarter and 22.2% year-to-date. Growth in retail banking loans underpins these results, marking a strategic pivot away from more vulnerable segments.

Mibanco's Strategic Adaptation in a Variable Economy

Mibanco faces a similar tumultuous environment with social unrest and weather anomalies disrupting client operations leading to higher provisions. Despite this, Net Interest Income grew by 3.2% with disciplined interest rate management aiding to offset increased funding costs. The efficiency ratio worsened slightly, and the recent strategy adaptation aims to restore profitability amidst higher inflation and adverse economic expectations in Colombia.

Grupo Pacifico and Investment Management: Divergent Fortunes

Contrasted performances within the portfolio are evident, with Grupo Pacifico achieving a high ROE of 34.7%, bolstered by strong underwriting results in the life insurance segment and favorable market dynamics for pension products. However, the investment banking and wealth management business was challenged by market volatility, leading to reduced income generation and a strategic decision to lessen exposure to volatile segments.

Loans and Deposits: Reflecting Strategic Banking Shifts

The organization's structural loan measure and average daily balances have modestly grown, with a strategic realignment away from riskier segments. This strategy is demonstrated by a 3.5% expansion of the deposit base, despite a decrease in saving deposits. Year-over-year comparisons reveal slight loan growth and a contraction in total deposit balance, indicating cautious adjustments in the bank's operations.

Core Income and Net Interest Margin: Evidence of Pragmatic Management

Core income demonstrated an increase both quarter-over-quarter and year-over-year, mainly driven by Net Interest Income, which rose due to a more favorable interest-earning asset mix and active interest rate management. Fee income, excluding operations in Bolivia, showed resilience. Overall, the net interest margin improvement by 9 basis points reflects a strategic response to the evolving economic and market conditions.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning, everyone. I would like to welcome all of you to the Credicorp Limited Third Quarter 2023 Conference Call. A slide presentation will accompany today's webcast, which is available in the Investor Section of Credicorp's website. Today's conference call is being recorded. [Operator Instructions]Now, it is my pleasure to turn the conference over to Credicorp's IRO, Milagros Cigüeñas. You may begin.

[Milagros Cigüeñas, executive]

Thank you, and good morning, everyone. For today's call, our Chief Financial Officer, Cesar Rios, will be providing the introductory comments in addition to his usual discussion of the macro environment and financial performance, as our CEO, Gianfranco Ferrari, could not be with us today. In addition, speaking on today's call will be Raimundo Morales, CEO of Yape, who will give us an update on Yape's progress. Finally, participating in the Q&A session will also be Francesca Raffo, Chief Innovation Officer; Reynaldo Llosa, Chief Risk Officer; Cesar Rivera, Head of Insurance; and Pension; and Carlos Sotelo, CFO at Mibanco.Before we proceed, I would like to make the following safe harbor statement. Today's call will contain forward-looking statements, which are based on management's current expectations and beliefs, and are subject to a number of risks and uncertainties. And I refer you to the forward-looking statement section of our earnings release and recent filings with the SEC. We assume no obligation to update or revise any forward-looking statements to reflect new or changed events or circumstances.Cesar, please go ahead.

[César Ríos, executive]

Thank you, Milagros. Good morning, everyone. Thank you for joining us in our third quarter 2023 conference call. While the macro environment has been more challenging than expected, Credicorp has continued to demonstrate its distinctive resilience in Peru, thanks primarily to our diversified and prudently managed loan portfolio and funding advantage.Strong NII is complemented with an increasing share of the core non-interest income streams, including those from insurance and Yape, which are partially mitigating the impact of the loan portfolio deterioration. While there is still work to be done, we are pleased with the progress in increasing core non-interest income, which is a key part of our strategy of decoupling from the macro.Our strong track record demonstrates our ability to successfully navigate complex environments. We have built a diverse portfolio of businesses, most of them benefiting from robust brand recognition and strong customer loyalty. This privileged position further solidifies our leadership, especially in challenging conditions. We are registering healthy margins even after high provision, supported by long mixed shifts, stricter origination in vulnerable segments, dynamic pass-throughs, and our funding advantage.Our solid capital base represents a strength, particularly within a challenging credit cycle, where the impact of soft macro conditions on payment performance in specific segments is evident.As we have already stated, we believe strongly in the importance of continuing to invest in both the technological transformation of our core businesses and in disruptive initiatives to maintain and enhance our strong competitive modes and future sustainability.Please next slide. By embracing our agile and self-disruptive mindset, we are building a diverse business capturing synergies, maximizing our main profit pools, targeting new client segments, and developing our own disruptors as we seek to retain a healthy and sustainable ROE. Our focus on gaining a deep understanding of both present and upcoming market trends, allows us to meet our customers' challenging needs, solidify our leadership, and increase penetration in new markets.Raimundo will now provide an update on the sustained progress at Yape, which in just over 7 years has become the main payment network in Peru and is the most mature example of our disciplined approach to disruption and innovation as we advance towards our goal of decoupling from the macro.Raimundo, please go ahead.

[Raimundo Morales, executive]

Thanks, Cesar, and good morning, everyone. Yape is an example of our rigorous approach to innovation and our commitment to meeting current and future market needs. Hitting the 10 million mark for Yapero over a year ago was a turning point for us. We initiated our monetization plan by rapidly launching new business lines and functionalities, driving both scale and engagement.At the close of Q3, Yape's had over 9 million monthly active users conducting an average of 29 transactions per month, up over 160% year-on-year. Making interoperability a reality, Yape continues growing at an exponential rate, a clear sign of the benefits this service offers to both clients and the ecosystem in general. Yape is not only the primary payment network in Peru, it is also the digital brand that boasts the highest awareness level in the country.Please turn to the next slide. As the number of active Yapero's continues to grow with each new feature added, the use of individual features also increases, driving gains in market share, attracting even more Yapero's and partners while operating more and more efficiently reinforces our flywheel effect.Top-ups are a clear example of how Yape is helping us decouple our growth from the macro. BCP's top-up market share used to be around 10%, but after launching this functionality through Yape, our market share rose to 46%, which represents 5x growth in just 18 months.Last January, we enabled bill payments through Yape and have seen an upward trend for monthly growth with over 20% of Yapero's now using the service. We are currently at just 5% of our expected TAM for bill payment, so still have an immense opportunity for continued growth.Similarly, the use of our features in each business line, including POS, QR codes in payments, microloans in financial services, and promos within marketplace is still incipient, but quickly growing each month.Rapid adoption of these products is allowing our revenue-generating TPV to grow at a 3x the pace of our total TPV, which has grown from non-existent in early 2022 to around 5% at the end of Q3. Our long-term aspiration is above 20%.Please turn to next slide. Unitary economics continue to move towards an expected break-even in 2024. Revenues are growing and moving closer to cash costs as we incorporate new features. Monthly revenue per active user stands at PEN 2.9 in the quarter, compared to a cash cost per active user of PEN 4.3.Q4 will be key in Yape's evolution towards a super app, with multiple product launches. In Marketplace, Yape Tienda will initially focus on electronics, which typically represents 50% of e-commerce sales. We are also launching other high-engagement products, such as ticketing through our acquisition join us, gaming and gift cards.In financial, we are introducing small multi-installment loans with longer tenures through 100,000 pre-approved leads. In payments, we are completing our portfolio of solutions with FX transactions and remittances, among others. We are also providing collection services for CPG companies.On the functionality front, we are enhancing our UX to include the critical capabilities of a super app. So, as you can see, we are going to remain very busy. Yape continues to progress towards monetization by pursuing its medium-term target of being the main payments network in Peru, being an integral part of Yape's daily life, and addressing their financial requirements. We look forward to updating you again in the future on our continued progress.I'll turn the call back over to Cesar.

[César Ríos, executive]

Thank you, Raimundo. I will share now the key financial highlights of the quarter, focusing primarily on quarter-over-quarter evolution to emphasize the recent shifting trends. Both structural loans and low-cost deposits positively quarter-over-quarter. Growth in structural loans, measuring average daily balances, stood at 1%, fueled primarily by retail banking at BCP. Meanwhile, low-cost deposits grew 1.2% and accounted for 50.9% of our funding base at quarter-end. Similarly, most of our income streams registered relevant sequential increases. NII grew 1.6%, driven by asset-mix dynamics, which were partially offset by a higher cost of funding for bank deposits.Fees also grew 1.6% off the back of positive dynamics in revenues from debit cards, collection services, and bill payments. Insurance and write-on results rose 11.6% as earnings in the live business continued to trend upwards. We navigated asset-quality headwinds as Peru's credit cycle continued to deteriorate.As such, the cost of REITs edged up to 2.5% percent. Structural NPLs' ratio stood at 5.6% percent, given that weak economic performance took a toll on payment performance in specific segments. All-in-all, we delivered resilient results despite negative GDP growth and have maintained solid capital levels at our subsidiaries.Having said that, a note of caution is in order, since, as we'll elaborate later, the recent change in macro and climate perspective will more than likely weigh significantly in our profitability for the rest of the year.Next slide, please. In the third quarter, the Peruvian economy is expected to have registered a third consecutive quarter decline year-over-year. Accordingly, annual GDP growth will be lower than expected and stand around zero or slightly below.Several factors, both expected and unexpected, have driven weak performance. First, the social protests at the beginning of the year, which were prolonged in the country's south. Second, climatic events, namely Cyclone Yaku and El Niño Costero, which heavily impacted agricultural, fishing, and manufacturing sectors. I will go into more detail on El Niño topic on the next slide. Third, very weak private investment and sluggish consumption led to non-primary sectors to contract. Four, the government's efforts to stimulate the economy have been insufficient.It's important to note that growth in the mining sector, mainly to increase copper production at Quellaveco has remained a bright spot. The confluence of these factors has led the country to register its lowest print for economic performance in 25 years, excluding the pandemic. Despite this disappointing performance, Peru's macroeconomic fundamentals remain robust, with low levels of public debt and high international reserves.Additionally, there is a significant package of public and private projects that, impacted by political intent and deployed quickly, could generate growth down the road. Regarding inflation, price pressures have eased in Peru and inflation expectation has fallen. Additionally, the policy rate has been cut by 50 basis points.Next slide, please. The El Niño Costero weather phenomenon that has directly affected Peru this year is associated with a sustained rise in sea surface temperature aboard certain thresholds along the northern central coast of Peru. El Niño Costero has battered the fishing, agriculture, and textile sectors in particular in the first 8 months of the year. The fishing sector is set to record its worst anchovy catch in 25 years after the fishing season was cancelled. Agricultural production in turn is expected to register its worst performance in 31 years, while textile production has a record small market decline in 28 years, excluding the pandemic and the global financial crisis. Given that, there was no winter season this year in the coastal region.Weak performance in these key sectors of the economy has exercised a multiplier effect and exacerbated contraction in the non-primary sectors. Given this context, we continue to closely monitor the evolution of El Niño and its impact in our businesses. I will look at the expected evolution of El Niño through the summer of 2024 and its potential impacts later.Next slide, please. BCP results were impacted by economic downturn described early. This has pressured provisions outward and impacted loan growth. Analyzing key quarter-over-quarter dynamics, the 1.5% increase in NII was driven by several dynamics. On the mixed side, wholesale loans registered a contraction due to low private investments, while SME-Pyme, loans reported an upswing in disbursements that entailed less risk. These dynamics helped mitigate an increase in the funding cost, which was pressured by a more expensive deposit mix.It is important to note that, migration from low-cost time deposits has decelerated in recent months. This quarter, BCP's fee income was bolstered by an uptick in fees from debit cards, collection services of business clients, and bill payment services provided through Yape.Provisions remain high in a prolonged recessive high inflation environment that has affected payment capacity of vulnerable segments in individuals and higher-risk segments in SME-Pyme. In individuals, growth was driven mainly by consumer loans and credit cards, followed by mortgages. This uptick was partially offset by an un-reversal of provisions in wholesale banking.On a year-over-year basis, a 16% increase in NII was driven by rising interest rates and by a 1.2% increase in structural loans, which was primarily attributable to an 8.1% uptick in retail banking loans. Loan loss provisions increased 87.6% due to the same quarter-over-quarter dynamics.On a year-to-day basis, operating expenses grew 6.1%, which primarily reflects growth in core business IT expenses due to an increase in digital transactions and to significant investment in new capabilities and investment in disruptive initiatives. In this context, BCP's efficiency ratio stood at 37.8%. Finally, ROE stood at 20% in this quarter and 22.2% on a year-to-day basis.Next slide, please. After a difficult first semester where social and climate events, as well as ongoing deceleration, have hit clients hard, MiBanco registered a decrease in loan origination in risk assessments and higher provisions on a quarter-over-quarter basis.Net interest income rose 3.2% despite lower loan growth. These favorable results reflect disciplined interest rate management, which helped offset the uptick in the funding costs. In this context, NIM increased 80 basis points and stood at 13.5%.Provisions remained high this quarter, given that social protests and weather anomalies continue to impact our customers' payment capacities. Other income fell 3.5%, fueled by a drop in bancassurance fees followed by a reduction in disbursements.From a year-over-year perspective, NII rose 1.9% is fueled by an increase in structural loans and interest rate pass-throughs, which mitigated the impact of rising funding costs. Mibanco's provisions rose due to the same dynamics mentioned earlier.On a year-to-day basis, operating expenses rose 5.8%, reflecting an increase in IT-related costs. Income in turn, grew at a slower pace, which led to efficiency ratio to rise to 52.6%. Finally, ROE stood at 8.3% this quarter and 7% on a year-to-day basis.Mibanco Colombia is facing high inflation, high funding costs, lower interest rate ceilings, and a deterioration in economic expectations. We have adapted our strategy to record profitability.Next slide, please. ROE at Grupo Pacifico was high this quarter and stood at 34.7%, as we continue to capitalize in transitory tailwinds in the life insurance business on top of a strong underlying business. On quarter-over-quarter terms, net income rose 19%. Growth was primarily boosted by an uptick in insurance underwriting results in the Life business after claims fell, primarily by Credit Life and Individual Life products. An increase in the net gains from exchange difference also contributed to the positive evolution this quarter. These developments were partially offset by a decrease in net financial income.Year-over-year profitability was up 37%, primarily driven by positive dynamics for insurance and the ROE results in the Life business. Pension products reported an uptick in income, which was attributable to better prices and more favorable dynamics, while Credit Life and Personal Accident products registered a decrease in service expenses.Next slide, please. ROE for the investment banking and wealth management line of business stood at 8.2%, impacted by a drop in income generation at our more volatile businesses. Income from our capital market business decreased 5.9% quarter-over-quarter, pressured by market dynamics that negatively impacted our proprietary fixed income portfolios.Market volatility also impacted our asset management business, where income decreased by 0.8%, impacted by losses in the market value of seed capital in the funds we manage. Despite market headwinds, our assets under management remained relatively flat, growing by 2% -- 2.4% quarter-over-quarter in the asset management unit and contracted by 1% quarter-over-quarter in the wealth management unit.As we shared with you on our Investor Day, we took the strategic decision to reduce exposure to the most volatile business of this line of business. We have made progress in this front, but it's important to emphasize that the process is gradual.Next slide, please. Now we will look at credit cards consolidating dynamics. On a quarter-over-quarter basis, our structural loan measured in average daily balances grew 1% or 0.3% with FX neutral. Growth in BCP Retail Banking, which has shifted away from the most vulnerable segment, was offset by a contraction in Wholesale banking at BCP and Mibanco.Our deposit base expanded 3.5%, or 1.3% with FX neutral. This evolution was driven by an uptick in time deposits and demand deposits, which was partially offset by a drop in saving deposits. Additionally, the migration of funding and solids from low cost to time deposits decelerated.On a year-over-year basis, structural loans increase 1.2%, measuring in average daily balances, fueled primarily by Retail Banking at BCP and Mibanco. Deposit balance dropped 2.8% or 0.5% with FX neutral. Low-cost deposits have fallen system-wide and currently represent 63.7% of our total deposits. Our market share in low-cost deposits by the end of August stands at 40.3%.Next slide, please. Now let me explain core income dynamics. On a quarter-over-quarter basis, core income rose 1.4% on the back of NII, which rose 1.6%. Growth was attributable for more favorable interest earning asset mix and to our interest rate management. When analyzing the results for fee income and FX transactions, it is important to note that both lines have been affected by our operation in BCP Bolivia, where we charge fees to FX clients to offset losses on buy-sell FX transactions.Excluding BCP Bolivia, fee income rose 2.9% quarter-over-quarter driven by an uptick in transactional levels from debit cards, collection services, and bill payments at BCP. And gains in FX operations diminished 2.6% quarter-over-quarter due to a drop in FX transaction volumes at BCP.On a year-over-year basis, core income increased 8.8% on the back of NII, which rose 12.9% due to an uptick in structural loan volumes and our active interest rate management. Excluding BCP Bolivia, fee income diminished by 1.9% on the back of lower fees. At Prima AFP an adjustment in the fee framework applicable to a significant share of affiliates at Credicorp Capital, primarily due to lower assets under management in the third-party fund distribution business. These dynamics were partially offset by gains in FX transactions, which grew 1.4%.In terms of margins, net interest margin rose 9 basis points quarter-over-quarter to stand at 6.11%. Risk-adjusted NIM fell marginally over the same period due to an increase in provisions and stood at 4.45%.Next slide, please. Let's look at the dynamics of structural non-performing loans. As indicated earlier, adverse events in 2023 and weak economic performance continued to impact client impairment performance and consequently portfolio quality. In this scenario, on a quarter-over-quarter basis, growth in structural non-performing loans was driven by wholesale banking, where specific clients in the hospitality and commercial real estate sectors became delinquent.Individuals where the debt service capacity of clients continued to face challenges due to over-indebtedness and unsustainable employment. SME-Pyme, where low-ticket subsegments had poor payment performance. At Mibanco, where the increase in delinquency was concentrated in over-indebted clients, clients impacted by social conflicts at the beginning of the year or those affected by climatic anomalies.On a year-over-year basis, the structural non-performing loan volumes increased due to an uptick in refinanced loans from wholesale banking. The evolution of non-performing loans in retail banking and Mibanco was driven by the same factors as in the quarterly analysis.In this context, the structural coverage ratio stood at 101.4%. The NPL coverage ratio fell quarter-over-quarter and year-over-year, driven by wholesale banking clients, which represented deterioration that has been previously provisioned and have high levels of collateral. Please refer to Appendix 2 for more details.Next slide, please. Moving on to provisions, the cost of risk has risen once again and stands at 2.5%, while the structural cost of risk stands at 2.6%. This reflects the fact that client payment capacity has deteriorated alongside ongoing macroeconomic contraction. Provisions for the Individual segment at BCP have risen since. As I just explained, payment performance has been impacted mainly to consumer and credit cards. Additionally, in individuals, provision for mortgage increases to reflect increased expected losses on lending to clients who have reported an uptick in delinquencies in consumer products or in other entities. Provisions at SME-Pyme, BCP and Mibanco are also up driven by the downturn in payment performance that I just described.The aforementioned was partially offset by reversals in wholesale banking after some clients in the corporate segment registered improvements in the credit ratings or cancelled obligations.Next slide, please. We will review the evolution of efficiency on an accumulated basis to isolate the impact of seasonal effects. Operational expenses grew 11% in the first 9 months of the year, driven primarily by core business at BCP and disruptive initiatives at the Credicorp level.At BCP, core business fuel grow in expenses through an uptick in IT expenses related to increased use of cloud as clients record more digital investments to enhance digital capabilities and improve cybersecurity, and move to attract more specialized digital talent. Marketing expenses mainly driven by advertising to boost deposits and digital sales. Expenses for disruptive initiatives at Credicorp level increased 64.3% as some of these initiatives have scaled up. Operating leverage remained strong at BCP. At Mibanco, operating expenses remained under control, but operating income is still challenged. In this context, our efficiency ratio stood at 45.1% for the first 6 months of the year, down 160 basis points year-over-year, driven by positive operating leverage at BCP and Pacifico.Next slide, please. This quarter profitability was sustained by solid results in our Universal Banking and Insurance business. ROE this quarter decreased to a stand at 16.2%. Meanwhile, ROE for the first 9 months of the year was 17.8%. All-in-all, these results are a testament to our resilience and ability to adapt to challenging circumstances.To exercise caution, we have decided that no additional dividends will be distributed this year. Now, before commenting on our perspective for the rest of the year, I would like to briefly discuss current expectations on the magnitude for El Niño phenomenon for coming months.Next slide, please. At the time of our last conference call, our outlook contemplated an El Niño phenomenon that was either weak or moderate in intensity. The combined probability of these 2 scenarios was 75%. Currently, projections from expected experts indicate that the 2 most likely scenarios entail an El Niño that is either moderate or strong in intensity. The combined probability of these 2 scenarios stands at 96%.Furthermore, the probability of a strong El Niño over the summer has grown by more than fourfold and currently stands at 49%. It is important to consider that the levels of risk and exposure associated with this phenomenon vary by region, but are concentrated in specific areas that experience heavy rains and flooding.The share of Credicorp's loan portfolio located in impacted geographies areas stand at 6.2%, which is comprises of 10% of retail banking portfolio at BCP and 18% of Mibanco's portfolio. The levels of impact will vary across areas and clients. We have rolled out multiple measures to mitigate the adverse effects of El Niño on our clients, businesses, and the country in general. In a coordinated effort with Pacifico, BCP, and Mibanco, we have proactively developed a communication plan to educate our clients and the population about taking specific predictive measures to mitigate potential damage to homes or businesses.Additionally, we have adjusted our underwriting policies for the most exposed clients in Retail Banking at BCP and Mibanco. We have also leveraged our extensive network of relationship managers who are working with clients in advance to serve potential financial needs and help them to be better prepared. The El Niño underway is expected to generate impact that are strong, not catastrophic, such as that seen in 1982, for example. We are rolling out preventions and response plans with anticipation to reduce impacts and support clients.Next slide, please. Significantly weaker-than-expected economic performance for Peru, coupled with a material change in the outlook for El Niño over the coming summer has triggered changes in the perspective for our business, particularly for cost of risk and consequently ROE. Our new estimates are in line with the scenario of a moderate to strong El Niño.As previously mentioned, our updated macro scenario for 2023 now reflects a GDP growth estimates close to 0% with a downward risk. Structural loan growth measured in average daily balances remain in line with guidance. NIM, in turn, remains resilient and such is expected to sit within guidance.We now expect the full year cost of risk to stand between 2.6% and 2.9%, impacted substantially by provisions related to expected losses caused by El Niño. We still expect a consolidated efficiency ratio between 45% and 47%, as BCP and Mibanco continue to demonstrate positive operating leverage. Given the aforementioned dynamics, ROE is not likely to stand at around 15.5% for the full year.With these comments, I would like to start the Q&A session.

[Operator]

Our first question comes from Tito Labarta with Goldman Sachs.

[Tito Labarta, analyst]

I guess my question, if I look at the revised guidance of 15.5% ROE or roughly for the full year, just given where you're coming from, rough math here, that would imply about $700 million in earnings in 4Q, which would be around a 9% ROE, and I assume that's all because of much higher provisions. Just to -- I guess, I wonder if you can -- does that math sound correct? Is that what we should expect more or less for 4Q?

[Reynaldo Llosa Barber, executive]

I will say that roughly you are more or less in line, when we talk about 15.5% around, specifically this is around. But you are correct that the main driver for the decreased profitability of the quarter is the increased provisions due to expected losses by El Niño, and if you compare the fourth quarter with the third quarter, the other thing relevant is the seasonal increase in expenses at BCP that happens all four quarters.

[Tito Labarta, analyst]

Okay. No, that's very clear. Thanks for clarifying. So I guess my follow-up question would be on the provisioning. How much of this is -- you mentioned due to expected losses, but you think a lot of it will be in anticipation. Does that mean cost of risk should normalize next year? If so, what would be a normalized level of cost of risk for 2024? And if there's further impacts from El Niño, could there be additional provisions in next year as well?

[César Ríos, executive]

That will depend on the severity of the El Niño. Today we have estimated an impact on the fourth quarter that is very relevant and explains the increase in the cost of risk projected for the whole year.Having said that, we have a strong El Niño, we will probably see an impact in provisions during the first semester of next year. And then we -- based on all what we've done in managing the portfolios, both in the SME and consumer market, we should expect a much more stable cost of risk during the second semester of 2024.So we see this as a peak that will depend on the impact of El Niño that, as you know, carries a lot of uncertainty or degree of the impact that this could have on the economic side of the country in general, and specific in the northern side of Peru.

[Tito Labarta, analyst]

Okay. No, that's helpful. And one, I guess, more weather-related, I guess, but how long could El Niño go on for? Is there a time frame where you would then feel comfortable that, okay, you're past the worst? Just any thoughts on that?

[Reynaldo Llosa Barber, executive]

Yes, usually El Niño occurs during December, January, and February, can extend a little bit more or less than that.

[Operator]

The next question is from Ernesto Gabilondo with Bank of America.

[Ernesto María Gabilondo Márquez, analyst]

My question would be on your ROE expectations for next year. I understand you're still running numbers, but considering that you will create an important number of provisions anticipating to this medium to strong El Niño, how should we think about the ROE for next year? Can we expect it to be higher when compared to 2023 levels?

[César Ríos, executive]

As you know, we are going to provide a guidance for 2024 in the next call, but directionally, I would say that '24, if the impact of El Niño is according to our current expectation, should be relative better than this one.Even say that, as Reynaldo has explained previously, we need to really assess the impact at the beginning of the year. So we should expect a probably more cautious credit loan origination at the beginning of 2024.

[Ernesto María Gabilondo Márquez, analyst]

Okay, no, excellent. So just for my second question, you have said in the past that management has been doing a lot of important efforts to invest in technology and in the digital transformation. However, if at some point we get it into a medium to strong El Niño, probably you will be thinking maybe to delay some of these investments to protect the profitability and maybe to return to those investments after getting away from El Niño. Are you still thinking about this or you will continue the investment phase?

[César Ríos, executive]

I would say that what we did in the past probably is a good reflection of our general strategy. At the beginning of the year, then the expectations of the GDP growth were starting to deteriorate, we adjust the general expenses trend to better adjust to the income generation capacity without forgetting investment in the transformation of the business. So we are going to manage prudently, but we are committed to long-term profitability to build capabilities for the future. So we are going to manage prudently, but we are not contemplating stopping, developing new capabilities, investing in the initiatives that are creating a new business for the future.

[Operator]

The next question comes from Geoffrey Elliott with Autonomous.

[Geoffrey Elliott, analyst]

It's another one on the cost of risk outlook. Could you just quantify for us how much of the additional provisioning that you're expecting in Q4 relates to El Niño Nino looking like it's going to be worse than you were expecting back in August? Just trying to isolate that impact from the impact of the broader macro weakness.

[Reynaldo Llosa Barber, executive]

Yes. It explains almost all of that change between our guidance on the previous quarter. And basically, it has 2 impacts. It has an impact in a specific region, which is -- which could be severe if we have a strong El Niño. And it also has an impact on the overall economy of the country, because there's an important level of sales that are channeled through the northern businesses.So, it has a double impact, as I explained. So, I would say, it's -- I cannot give you a specific number of the amount of the difference between both numbers, but it's basically explained by those 2 effects.

[Geoffrey Elliott, analyst]

And if I could just squeeze another one in more a clarification that nothing's changed. But on the sensitivity to lower rates, if you could just quickly give U.S. dollar rates and peso rate sensitivity to 100 basis point cap?

[César Ríos, executive]

Yes. This topic has been reviewed carefully internally. And now we think it's below that we previously communicated, below 20 basis points or 100 basis points instantaneous adjustment. So, the composition of our portfolio is flexible enough to allow us to converge to a sustainable NIM, assuming that we can counter the effect of reduction rates with a shift in the portfolio mix.

[Operator]

The next question is from Thiago Batista with UBS.

[Thiago Bovolenta Batista, analyst]

My question is about Yape. When you look in a couple of years for Yape, what do you believe will be the main source of revenues of Yape? And among the 10 million monthly active users of Yape, how much of those guys were already BCP or credit card clients?

[César Ríos, executive]

Excuse me. Could you repeat the first part of your question? Because I having in some interference.

[Thiago Bovolenta Batista, analyst]

Yes. Not sure if the line is better now. But when you look in a couple of years, what do you believe will be the main source of revenues of Yape? And among the 10 million clients of Yape, how much of those guys are -- were already BCP or credit card clients?

[César Ríos, executive]

Okay. So, in your first question, we currently expect payments to continue growing as our number one line of revenue. But definitely, we expect in 2 or 3 years lending to become much more relevant. So, I would say that around 40% to 50% will continue to be payments revenue, then a third around the lending, and the rest will become from the retail or marketplace. That's more or less where we're aiming to and what we expect. Of course, that might change a bit.Regarding the second part of the 10 million clients, it's a tough question because there were a lot of -- so, there's like 2, 2.5 million of those clients that are Yape with [ DNE ], that they opened exclusively in account without being BCP clients. But of the ones that were BCP clients, there's a big group that opened the BCP account to have Yape in the history. So, really it's a mixed number. Definitely, a lot of those clients are much more active in Yape than at BCP. So, I don't know if it's half and half of the 10 million, I would say that you could attribute to Yape.

[Operator]

The next question comes from Yuri Fernandes with JPMorgan.

[Yuri Fernandes, analyst]

I have a question on revenues. So far, so good, right? You have margin expanding, so your NII is still pretty healthy. But what is the outlook for 2024? Because you already mentioned that credit originations should be like last year, given like a more cautious outlook and makes total sense. You have lower rates, right? That should be bad for your sensitivity on margins. And on the fee side, I guess, it's a weak economy, right?So, my question is, what should we expect for revenues, NII for the next year? Should we be a little bit more cautious on these also? Like, what is the -- I know you don't have a guidance, but just on a trend, what should be the outlook here for revenues?

[César Ríos, executive]

I think if we have the impact of El Niño as we expect, we should expect a slight increase in revenues. That is the combination of a managed NII and increasing volumes starting probably in the second quarter of the year.In terms of fees, we still expect an increase in fees driven by the transactional activity that we are developing and increasing through our traditional channels and Yape in particular.

[Yuri Fernandes, analyst]

But you think like low should accelerate in 2024 versus 2023? Or should remain at those low single digits? Just as a more concern outlook

[César Ríos, executive]

I would think in single digits. We still expect next year's GDP to be around 2%, not a booming year.

[Yuri Fernandes, analyst]

No, perfect. Super clear. And if I may, just asset quality, just to see if I got it correctly. This quarter, the third Q, you had a very high new unit formation, higher charge-offs. So, this was basically the client's payment behavior we're seeing, right? The provisions, everything we saw now. And for the fourth Q, the increase you should see on the guidance, this is the El Niño. This is more or less, the delta should be mostly the El Niño, right? So, this quarter, basically, bad macro. And for the next quarter, a little bit of bad macro, but also the El Niño, right? Is this correct? Like misunderstanding on n asset quality?

[César Ríos, executive]

Totally correct.

[Reynaldo Llosa Barber, executive]

Yes, that's 100% correct. We are ending up that the digestion of the bad portfolio we had during the year, but the most impact is explained by El Niño, as you have mentioned.

[Operator]

The next question is from Sergey Dubin with HL.

[Sergey Dubin, analyst]

All of my questions would be on asset quality and cost of risk. I'm very surprised to see this significant jump in Q3, especially on wholesale loans, or wholesale NPLs, I should say. Could you comment what do you mean by 22% of Credicorp NPL volumes, which were refinanced loans? What are these loans?

[César Ríos, executive]

Well, basically, what we have done is there have been 2 specific cases in the tourism sector and then real estate, commercial real estate, which have fallen in default, which are recognized in the NPLs. But also, now that the activity is starting to recover in some of those businesses, and we are able to project a cash flow for those businesses, we are refinancing those loans. And that portfolio is included on the NPL ratio. So that's basically why this number has been growing during the year.

[Sergey Dubin, analyst]

So, are you saying that these loans, or these borrowers have hit problems and you basically refinance the loans so that they're going to be performing again? I don't quite understand. Are these borrowers in trouble? Or is that just an issue of having you extended and maybe soften some terms so that they can pay on a different schedule? How should I think about the underlying credit quality of these borrowers?

[César Ríos, executive]

Yes, I mean, two things about your comment. Those were loans that we were managing in the short-term, because we were unable to project a cash flow in the long-term. Once we extend structurally the final term of the loans, we mark them as refinanced loans. And then we include them in the NPL ratio.And having said that, these are loans that have significant collateral, mostly over 150%, because they are basically hotels and real estate projects, which have guarantees that support extensively the amount of our exposition with those clients.

[Sergey Dubin, analyst]

Okay. So, at the moment, these borrowers are paying, right? They're not in default, they're paying as you refinance, they continue to pay interest and principal. Is that correct?

[Reynaldo Llosa Barber, executive]

Yes. Basically, before they were paying only interest, now they are starting to pay principal as well.

[Sergey Dubin, analyst]

Okay. All right. And then, also on a consumer book, my impression, my very distinct impression from the last call was that you guys, which you communicated actually, was that you tightened the credit standards in the consumer book. You obviously foresaw this macro pain, so to speak. So, you tighten the credit standards. I was under the impression that that should help in terms of assets quality, but it doesn't look like that was really what transpired. So, can you explain why your reduced risk appetite didn't translate into better credit quality on the consumer book side?

[Reynaldo Llosa Barber, executive]

Yes. What we're doing is refocusing on our appetite on those clients that we know better. And that's basically what explains why we are growing in the consumer portfolios. Basically, in times like this, when we don't have GDP growth, we obviously become more conservative in our approach to those clients that we know better. We still do some pilots with a specific segment, but relatively with a much less proportion than what we have done in the previous years. That's basically what explains our strategy today.

[César Ríos, executive]

Yes. Probably, may I add something? I think I understand what you are heading to. Of course, we adjust our credit origination policy and the new vintages are being originated and actually are coming with lower risk profiles. But the already booked loans are sour, as is expected. So, we have a combination of old books that are already deteriorating at a higher rate, and new vintages that are smaller in size, higher quality. And the result that you are going to see during the next quarter is a combination of these 2 dynamics.

[Sergey Dubin, analyst]

Okay. And then, is there any way to -- so, I'm going to put El Niño aside because that's completely unpredictable phenomenon that depends on nature. It's not up to you. I understand all that. But if you looked at your underlying borrower health, so to speak, and kind of a cost of risk trends, NPL trends, again, putting El Niño aside for a moment. Are you seeing that we're sort of at the bottom of this cycle or there's more pain? And if it's later, how much more pain are we going to see in the year?

[César Ríos, executive]

Yes. Our expectations, putting El Niño aside, as you mentioned, is that we would reach the higher cost of risk of those portfolios during this year. And during 2024, we would have seen a decline. Having said that, El Niño is around the corner, so we have to consider that on our projections.

[Sergey Dubin, analyst]

Okay. So, ex-El Niño, you should see decline in cost of risk in 2024 relative to 2023?

[César Ríos, executive]

For specific portfolios, I also want to emphasize that we are shifting gradually the portfolio towards a more retail. So, the cost of risk for specific portfolios are going to decline, but the long-term trend is to shift the portfolio towards a more retail one that entails higher cost of risk. That's important to consider.

[Sergey Dubin, analyst]

Yes, yes. No, that's a longer trend, but like in the shorter term, you're going to, it's like, maybe that's a question, actually, like in the shorter term, are you going to maybe pull back on retail a little bit and really -- manage risk? Because I think that's where a lot of pain is, in fact, right?

[César Ríos, executive]

No, there is no change in the strategy. What is an adjustment to react to the current macroeconomic conditions? It's an adjustment in a specific sector that are more vulnerable, but the long-term strategy remains the same, I would say, in general terms.

[Sergey Dubin, analyst]

Okay. And that last question, because it's also related. So, as of, I believe, as of Q3, right, you had 3.1% of your loan portfolio, which is these Reactiva loans, right? So, they're very -- they're only -- they're very thinly covered, right? It's only 17%, I think, NPL coverage on that specific segment, because obviously the government backed. So, if you -- let's assume you're going to, all of that will be paid down by the end of the year. When you grow your retail book, from year-on-year, that you originate as loans in retail, that would have to be covered, up from 17% to probably, I don't know, let's assume 100%. So, wouldn't that, how much, if that's the -- if I'm describing this dynamic correctly, what would be the incremental delta and the cost of risk that you would see from that specific point?

[César Ríos, executive]

I will give you some general comments, and after Reynaldo can complement me. First, the Reactiva loan at this point is around PEN 4 billion only. It's not going to be entirely paid down at the end of the year. The leverage of coverage is significant, and the wholesale part is 84%, 91% in retail BCP, and 97% at MiBanco. So, the risk associated with this is substantially covered by the government, and this portfolio is going to be paid down substantially over the next year, but not at the end of this year. The payment of this year could be around $900 million out of the $4 billion.

[Reynaldo Llosa Barber, executive]

Having said that, I mean, your assumption that this will require higher provisions is true, but also we will provide a much higher margin, because remember that in the Reactiva loans, there were very low government-funded interest rates that almost only covered operating costs. Back to normal, they will provide a much higher yield on those loans as well. That will compensate the higher provisions you mentioned.

[Sergey Dubin, analyst]

Okay. So, by the end of the year, only $100 million will be paid down, and they will be paid down gradually over the next 13 or 16 months or whatever. I know that your strategy is to grow retail book longer term, but again, given the macroeconomic pain and then this El Niño coming up, do you think it would be prudent to perhaps emphasize wholesale book more in this next 12 months to 16 months, or are you still going to emphasize retail as well? I'm just trying to see how you think about growth in this challenging environment.

[Reynaldo Llosa Barber, executive]

Well, we review this permanently. Today, we see it proper to adjust our underwriting policies on the specific segments that could be affected on the northern side of Peru and those specific industries like fish mill and agriculture that could be affected, but that's in permanent revisions. I mean, we will see how the El Niño evolves, and then we will adjust either further or relax a little bit our underwriting policies as well. It's a permanent process, as you know. Today, we are providing with the best information we have at hand.

[César Ríos, executive]

Yes. I think it's worthwhile to remember that this is a cyclical event. We have experienced different levels of El Niño. Each 5, 7-years has been several severe El Niño in the past, and we have developed the capacity to manage that. The whole country is not paralyzed by El Niño. During the presentation, we shared some figures relating to the level of direct exposure of our portfolio in the northern part. It's around 6% directly exposed, and so the rest of the country has spillover effects, but it's still working, and we expect a modest but a rebounding economic growth next year.

[Operator]

The next question comes from Carlos Gomez with HSBC.

[Carlos Gomez-Lopez, analyst]

I want to ask you again about expenses. At the beginning of the year, you mentioned that your budget for transformation was equivalent to 1.5% of ROE, which we calculated to around $175 million. Has that changed, and what is your expectation going into next year?

[César Ríos, executive]

I think this is more than a budget. This is an appetite and a boundary. We adjust that according to the dynamics of the underlying business and the specific disruption initiatives. I would say that this is a rough number that is a guide for us. It's a boundary, but I wouldn't qualify that as a budget.

[Carlos Gomez-Lopez, analyst]

Okay. Should we understand that you have been adjusting it during the year, and should we expect more or less in 2024?

[César Ríos, executive]

As I mentioned, this is -- I would say, an upper limit, and we are going to be operating under this upper limit.

[Operator]

The next question is from Andres Soto with Santander.

[Andres Soto, analyst]

My question is regarding your macro assumptions for 2024. I believe, Cesar mentioned, you have in your numbers 2% GDP growth. Is that what you have, the implicit for the cost of risk that you are guiding to this year? It already incorporates this assumption for 2% growth next year. When I look at the weather pattern that you show in your presentation on Slide #10, which is quite interesting, it looks like it's turning increasingly similar to the 1997 event. Based on that experience, is that the type of growth that you may expect? I remember back then, the economy was growing the year before El Niño, the economy was growing 7%, and -- to a decrease of 1%, so a dramatic slowdown. Are you still expecting -- it makes sense to expect a recovery next year, considering that this sort of El Niño can materialize?

[César Ríos, executive]

I think it's a very relevant question. We still have an expectation of a 2% GDP growth for 2024 that it considers an impact of El Niño. El Niño, considering this GDP growth, is moderate to strong, already considered. Still, we are considering that the year of reference as El Niño is 2017. It's also good to remember that at the end of the century, in 1998, we have a combination of El Niño and the debt crisis, an international debt crisis. So, this significant drop in GDP that we mentioned is a combination of probably a stronger El Niño that is now expected, and an international monetary crisis.

[Andres Soto, analyst]

That's very helpful, Cesar. Regarding monetary policy, now that Peru is officially in a recession, do you see additional space for this? Actually, inflation is printing pretty well. Do you see additional space for the central bank to cut rates more aggressively than it has done? Or do you believe that the carry trade will prevent a more aggressive move?

[César Ríos, executive]

I think the carry trade is a factor, but another very important one is the Fed funds. Looking only to internal factors, probably the central bank will be more aggressive cutting rates. But a combination of El Niño, that usually has inflationary effects in the short term, and the higher for longer guidance from the Fed suggests that the central bank has only limited room to decrease rates until the middle of next year.

[Operator]

It appears there are no further questions at this time. I will now turn the call back over to Chief Financial Officer Mr. Cesar Rios for his closing remarks.

[César Ríos, executive]

Thank you all for your questions. As discussed, challenging circumstances persist in Peru. Given weak economic performance and higher probability of El Niño, a scenario worsening to moderate strong in the upcoming 2024 summer season, nevertheless, we are confident that the preemptive measures that we are taking, together with our flexibility to adapt to changing conditions rapidly, will allow us to effectively navigate these near-term challenges. It's important to keep in mind that El Niño is a transitory shock, and historically, we have seen the economy rebound after prior El Niño events. We expect to see the same trend again.Prior to closing today's call, I would like to leave you with these 4 key messages. First, Credicorp is resilient and has the ability to adapt to challenging circumstances. We delivered health-risk-adjusted margins this quarter. Even as we increased provisions for specific customer segments, we weakened payment capacity, giving a prolonged, regressive, and inflationary environment in Peru.Second, we have increased our efforts across different fronts to mitigate the negative impacts of El Niño on the population, our customers, and our businesses. Pacifico, BCP, and MiBanco are promoting preemptive actions to limit damage to homes and businesses through various educational programs.In addition, we have modified our underwriting policies for the most exposed retail segments at BCP and MiBanco. Only about 6% of our portfolio is in the areas expected to be directly impacted. Our teams are working closely with clients in these areas to anticipate the likely financial requirements. Beyond the private sector, the government's capacity to unlock and execute projects will be key to jumpstart growth. There is a significant package of projects that will be key to jumpstart growth. There are a lot of projects in the pipeline. The global long-term trend to transition to a green economy favors copper consumption. As a leading global copper producer, with the lowest production costs and the highest copper reserves, Peru stands to benefit from this trend. Thus, it is imperative to accelerate the execution of mining projects.Third, the strength of our balance sheet, prudent management, and leading franchise built upon top-notch transactional capabilities provide a solid foundation for us to weather short-term challenges.Lastly, we continue to invest into the future. We remain focused on executing our mid-term strategy, the revolt of decoupling from the macro and securing a healthy long-term ROE. We are committed to continue to develop our disruptors to strengthen our competitive modes, while further enhancing the efficiency of our core businesses through technological transformation.In closing, we thank you for your continued support and are committed to delivering on our value creation strategy. Thank you for joining us in this call. Goodbye.

[Operator]

Thank you, ladies and gentlemen. This concludes today's presentation. You may now disconnect.