Banco de Credito e Inversiones

SGO:BCI

Earnings Call Transcript 2022-Q2

[Andrés Atala S., executive]

All right. Good morning to everyone, and welcome to our second quarter 2022 conference call. I'm Andrés Atala, from my home, Head of Investor Relations team, and I hope that you and your families, as usual, are doing well and staying safe.

Today, I'm joined by José Luis Ibaibarriaga, Bci CFO; Mr. Jose Marina, CNB CFO; and Sergio Lehmann, our Chief Economist. [Operator Instructions] As usual, this presentation covers the main aspects of the bank for the second quarter, broken down into the topics shown below.

Now I will leave you with our Corporate Chief Economist, Mr. Sergio Lehmann, who will take you through the main macroeconomic figures.

[Sergio Lehmann, executive]

Thank you, Andrés, and good morning, everybody.

Global recession probability has risen in the last month due to significant interest rate hikes in developed economies in order to fight high inflation. This has caused the turmoil in the financial markets and strength in the U.S. dollar. This was added to the already negative perspective as a consequence of the war between Russia and Ukraine and deceleration in China. Given that, the global economy projection were again cut by the IMF.

In the U.S., the economy fell by 0.9% in the second quarter '22, signaling that the U.S. is technically in recession. Consumption is still positive, but fixed investment and private inventories [indiscernible]. Recession probability has increased to 40% for the next year and the IMF forecast 1% GDP growth. Inflation has continued to rise and the Fed will increase the Fed fund rate until 3.5% by the end of the year.

In Chile, the economic growth has been showing some deceleration, but less than expected due to household high liquidity, even though a recession is expected by the second half of this year due to high political uncertainty, decline in private investment and a contraction in household consumption. The political uncertainty will remain high even after the September referendum. Whatever the result, the constitutional process will continue to the next couple of years.

Inflation in Chile was 12.5% year-on-year in June, the largest data in 3 decades. Inflation will go up to around 14% in the coming months but would slowly ease by the end of the year and would go down faster since second quarter '23. In response, the monetary policy rate has been markedly rising and market interest rates move higher. The Chilean Central Bank is nearing the end of the tightening process, at least is our view. The Chilean peso was one of the most depreciated currency in second quarter '22. And Chilean peso volatility reached maximum high since 2008 global crisis, affected by the U.S. dollar appreciation, the fall of copper price and due to domestic risk related to the political environment.

In mid-July, the Central Bank of Chile decided to intervene in the FX market with an amount of $25 billion total until September 30. Chilean peso has not only regained value since then, and -- well, this has been mainly related to the Central Bank Chile intervention.

Let's move to the next slide. On this next slide, we present the main economic figures in the U.S. and Florida. As we mentioned, the U.S. fell by 0.9% in the second quarter of 2022. This is the second fall in a row, so technically speaking, the U.S. economy is in a recession, but the labor market doesn't show the same. The national unemployment rate is at a minimum levels. Payrolls are still improving, but have not reached pre-pandemic levels yet. Florida labor and GDP trends has been even better than the national average during the last 2 years.

Please move to the next slide. Inflation is still the main economic challenge ahead. Inflation pressure recognized higher energy and food prices and supply issues, but core price dynamics are pointing to a decrease in inflation pressures. The Federal Reserve has substantially increased their Federal funds rate to 2.25% to 2.50%. In June, the Fed was expected to increase the rate to 3.5% at the end of this year and continue to do so until [ 3.5% ] at the end of 2024. But the fear of a global recession has led to a decrease in the Fed fund rate expectations. Nowadays, it's expected to reach 3.5% as a maximum level at the end of 2022. And in the first part of 2023, it will start an easing monetary process.

Please move to the next slide. In Chile, economic growth has been starting to show some deceleration. We are forecasting a short recession in the second half of this year, but annual growth will fall for 5 quarters. So in 2023, the economic activity would fall by 1.2% as this scenario. A fall in household consumption and government spending, together with high political uncertainty which would push down investment, are the main causes.

On the next slide, we see Chile's labor market. Figures in general have recovered from the pandemic crisis, but labor force participation still has not reached pre-pandemic levels and the latest trend shows a deceleration in its recovery. Unemployment rate has increased in the latest data and it is stable around 7.8%. Payroll show a negative trend in the last 3 months.

Please move to the next slide. Inflation reached to 12.5% in June '22, the largest figures in 30 years and well above the Central Bank target, which is 3%. Inflation in Chile was mostly determined by local factors in 2021, but recently has started to recognize the impact of higher commodity prices as a consequence of the Russia-Ukraine war. Monetary policy rate has increased rapidly from 0.5% in June last year to 9.75% in July. We expect higher inflation in coming months, near to 14% in the third quarter of this year and then it will slowly decelerate. Monetary policy rate will continue to move higher to 10.25% in September. The Central Bank will keep this level until first quarter '23 when it's expected that the Central Bank will initiate an easing process. Risk over inflation remained elevated and 2 years' inflation expectations are still well above 3% target.

On the next slide, we analyze local financial markets movement. Chilean peso lost significant value between June and the first week of July and FX volatility increased to its highest level since the 2008 financial crisis due to external pressures; increased global probability of recession, which led to an appreciation of the U.S. dollar and a fall in copper prices. But also internal political uncertainty plays a key role.

In order to prevent disruption in the FX market, which could be spread to other financial markets in the Chilean scenario, the Central Bank announced an FX intervention.

Please move to the next slide. The FX intervention is for $25 billion: $10 billion in the spot market, $10 billion in forward markets and $5 billion in swaps. The amount is higher than the 2019 intervention, but it's timely shorter, just 2 months against 3 months in the previous intervention. And in the last -- or in the first 3 weeks of intervention, the Central Bank has committed more U.S. dollar liquidity than in the whole 2019 intervention. The day after the announcement, the Chilean peso regained value and until now is one of the most appreciated currency in the world. Of course, the external context has helped indeed, which led to an increase in the copper price, principal Chilean peso determinant.

Now I will leave you with José Luis Ibaibarriaga. Please, Jose Luis.

[José Ibaibarriaga Martínez, executive]

Thank you, Sergio. Good morning, everyone. Thank you for participating in this conference call. We will now go over Bci's main second quarter highlights.

Our strategy has had large progress in our constant state of transformation and innovation where we want to highlight the following. Related to ESG, our commitment to sustainability as an organization, we are convinced that companies that get better results in the long term are aware of their role in the society and the communities in which they operate. To such effect, we are very pleased to inform that you -- that in 2022, Bci became the first Chilean company to join the NASDAQ Sustainable Bond Network, in line with our ESG funding strategy that has successfully placed more than USD 300 million in bonds.

Regarding the new Wealth Management division, our aim is to drive a unique strategy, operating onshore and offshore markets, deploying advisory scale, a personalized value offering, an efficient solution based on data analytics by means of our coordinated distribution network with a large digital and regional goals. In this line, we recently entered into a strategic partnership with JPMorgan Asset Management. This agreement will allow us to expand a range of international investment products for Bci clients, including ETFs and alternative funds. Likewise, we continue to drive our international strategy, starting up the operations in Peru.

In terms of consolidated financial results, here are some highlights of this quarter. We closed this quarter with a positive financial results. The highlight was the sound growth of our operational revenue, which was 39.77%, up year-over-year, highlighting a positive performance driven by 26.5% loan growth, positive price management and higher inflation.

I would like especially to mention that City National Bank this quarter reached USD 23 billion in assets and have continued with tremendous momentum, where loan growth combined with deposit growth led to a strong bottom line of USD 74 million, as Jose Marina will outline further in this presentation.

This quarter, the efficiency ratio reached 42.63% below the previous quarter. This improvement, despite that this year, we are implementing our organization of the future will be a basis for executing the strategy of achieving market leadership with a clear digital and international focus. This will mean major investment in talent and technology, focusing on our digital ecosystem and the new Wealth Management division.

Please move to the next slide. Bci now is the largest financial institution in Chile for equity, assets and loans, reaching $83 billion in assets and a 27% increase in loans growth as you can see in the slide. As we have mentioned in past calls, one of our priorities this year is to continue boosting our international presence. We have successfully diversified our operations.

City National Bank and a branch in Miami today account for almost 35% of the bank's total loan portfolio. Furthermore, after receiving regulatory approval, we started our operations on Bci in Peru, a market where we have been present in more -- for more than 20 years through the representative office, with large knowledge of companies and customers. We will focus on Peruvian and Chilean companies with subsidiaries in Peru and multi-Latin companies through a business model with a broad banking offering for the target segments. The products will include different financial options, derivatives, checking account and attraction of deposits that will give us a Chile, Peru, U.S. gateway.

Turning to second quarter 2022, MACH strengthened its value offering to become its client main account. It has maintained its growth of users exceeding 3.4 million customers while developing digital products for daily use, financial products and businesses. Recently, MACH launched Cuenta Futuro, a savings account that allows payments to be scheduled and balances to be withdrawn at any time free of charge and without an associated debit card. As of July 2022, clients can earn interest according to the amount saved. The greater the amount saved, the greater the interest the client receive for them, with 5 different saving tranches.

Now let's go through the main figures of our consolidated operation compared to the results of second quarter 2021. The financial margin surged 63.1%, driven by loan growth, positive price management and higher inflation. This generates an increase in net revenue despite the higher funding cost. Besides the positive transitory effects that positively impacted the net interest margin, there was an effect of the reclassification made to represent better the financial essence of the bank's hedge accounting strategies.

Fees rose 9.7%, with higher fees earned in the local operation, mainly related to credit card fees. Operating expenses rose 15.7%, primarily due to the higher inflation, 11.9% in the last 12 months at Bci in Chile, and greater expenses expanding in international subsidiary mainly explained by the exchange rate effects. Provisions and write-offs, excluding the recovery accounts, increased by nearly 30%. That was in line with the financial system explained by converging to the risk level of the different portfolios, mainly in the consumer loans. This is considering that there were historically low delinquency levels the previous years related to the higher liquidity in 2021.

The tax expenses remained relatively stable this quarter. The main effects were the revaluation of the investment at City National Bank and the price-level restatement of the own capital due to inflation this quarter.

Please move to the next slide. At the local level, the main line items follow the similar trend to the consolidated results in terms of year-on-year changes, as shown here. The next slide further address the main financial indicators to give you more details about local operations. Bci local loans amount to $34.5 billion (sic) [ $34.9 billion ] in the second quarter, increasing 18.5% year-on-year and mainly driven by the growth of commercial and mortgages loan portfolio.

Regarding commercial loan growth, the considerations are the following: the wholesale division continued to have a strong growth as corporate clients switch from funding in terms of corporate loans due to the lower liquidity of the bonds market; appreciation of the dollars currency during this quarter, considering that nearly 28% of the commercial portfolio is in U.S. dollars. Second, in the consumer loans, increased by 12.7% year-over-year, mainly driven by the credit card business at Bci and the Financial Services divisions. Three, in the mortgages, loans continue to have a sound growth of 17% and a significant part of this growth was from the last year's growth, combined with higher inflation. In real terms, we have seen a slowdown in the loan production due to the rise in interest rate, inflation and commercial conditions.

Let's move to the next slide. The local increase in NIM was mainly driven by local growth and higher inflation, which generated greater interest income and indexation, offset by higher funding cost expenses. In addition to the positive effects of inflation, 12.5% year-over-year, that has a positive impact on the NIM. There was an effect associated with the reclassification to represent better the financial period of the bank's accounting hedging strategies, which previously generated [ asymmetry ] between equity and income, which financially, [ better as a risk ] reflect the effect of this hedge on income and as a consequence on equity.

Meanwhile, net fees rose 4%. This positive result is explained by higher fees in the retail business, mainly driven by card-related fees.

In terms of OpEx, we managed to maintain OpEx growth below annual inflation in Chile. The bank ended this quarter with an efficiency ratio of 40.98%. The OpEx growth consider large investment in technology, data analytics capabilities and in our strategic vehicles like digital ecosystems, wealth management, and the distribution and service model in branches, among others. The positive results of the net income were reflected in the return on equity and the return on assets, as you can see in this chart below. As of June, the consolidated return on equity was 15.8%.

On the left side of this slide, we show the evolution of our funding mix. Our deposit base grew 21.2% year-over-year, where we have seen a shift from demand deposits to time deposits as rates have continued to rise. As you can see in this slide, this reflects in the noninterest bearing deposit decreased by 1.7%, while time deposits increased by 52.3% year-over-year.

With regard to Basel III implementation, so far, we have complied with 100% of the schedule associated with the delivery of the new regulatory reports for credit, market and operational risk, ending this quarter with a 9.31% CET1 ratio under Basel III, as you can see in the top right chart, well above the regulatory minimum. The decrease in CET1 ratio was mainly driven by the effect of capital account due to higher Chile and U.S. rates, greater expectation on inflation and a solid and profitable growth observed during the first part of this year.

Our local loan portfolio is well diversified by customers, business lines and economic sectors, as you can see in this slide. On the left side of the slide, we present as usual the loan distribution among the different business segments, while in the right side, the chart shows our commercial loan portfolio diversification among different sectors and industries. Exposure to the entertainment, hotel, health and restaurant sectors, where we were hardly impacted during the pandemic, remains below 5%.

As our total loan volumes, growth has been led by commercial loans, followed by mortgages loans. This is the second quarter in a row where we are observing the nonperforming loans ratio trending upwards, still at very moderate levels and significantly below pre-pandemic levels yet. But apparently, evidencing a trend that we're likely to continue seeing in the upcoming quarters. We believe this trend is explained by the return to the normal -- new normal where individuals and companies are less disrupted by COVID infection and quarantines and government support programs that injected a significant level of liquidity into the market start to be gradually eliminated. Hence, enabling to create a portfolio to manifest in a more normal way and heading towards pre-pandemic levels or around them.

As the portfolio did not manifest the expected performance during this period where the government injected liquidity to the market, Bci built up significantly voluntary loan loss provisions which are evidenced in the dotted line, which represents the ratio of the total loan loss provisions, including voluntary provision to total loans, which is over 1.5x the ratio excluding voluntary provision and 1.3x the level of this ratio before the pandemic hit us.

As the government liquidity support initiatives approach the end and individuals and companies returned to the new normal, we believe it is reasonable to assume that our trade portfolio performance should return to a pre-pandemic level and eventually worse. However, we continue to believe that some support initiative has been so strong that they may have helped many borrowers to improve structurally and not only temporarily so the net effect may be better than originally expected on this side.

Commercial loans continued to lead the growth in the loan book, with demand for new good quality loans recovering since mid last year, more than offsetting the scheduled payment of the government guaranteed loans granted mostly during 2020 and the first half of 2021. As nonperforming loans ratio, it has been trending upwards, both in the first and second quarter, but it is still far below pre-pandemic levels. The ratio of LLPs to total commercial loans remain relatively flat, which is due to the fact that unlike other portfolios where LLP are primarily led by PDOs, in the commercial loans books, nearly 90% of the exposure is individually risk classified. So the risk is captured away before borrowers become past due.

The other 10% is primarily represented by SME commercial loan portfolio, which was hardly hit by the pandemic. However, SMEs were the segment that was most supported by both banks and by government guaranteed lending programs. So borrowers had the ability to refinance their debt and/or to borrow new money under extraordinary lending terms, which helped many to survive. The SME portfolio is evidencing an increase in PDOs and NPLs ratio, but still below the levels we had before the pandemic hit the economy. So we are confident that the support measure helped many SMEs to cross the other side.

So far, the residential mortgages portfolio has maintained its resilience in the current scenario, with the portfolio size increasing by NPL ratio still performing well below the pre-pandemic levels. After a decline of the portfolio side in 2020 due to the greater liquidity and more restrictive risk appetite, we have started to gradually see a recovery in volumes since the second half of last year, partly due to consumers recovering the demand for trade and partly due to the gradual flexibilization of credit terms which were triggered during the most of the pandemic.

As to NPLs, after reaching bottom levels by the end of 2021, we are now seeing a trend back towards pre-pandemic levels, slightly slower in Bci and faster in Servicios Financieros, which is more concentrated in the lower income segment of Bci. Voluntary provision were built for this portfolio in order to recognize the risk while levels of PDO were artificially low because the extraordinary liquidity coming from the various government support programs were in place.

Now I will leave you with Jose Marina, City National Bank's CFO.

[Jose Marina, executive]

Thank you, José Luis, for the opportunity to join you on this quarterly earnings call to review City National Bank's performance over the past months. Good morning, everyone. My name is Jose Marina, and I am City National Bank's CFO.

I'm excited to be here with you this morning to discuss our second quarter results. We started 2022 with a strong first quarter and continued that tremendous momentum into the second quarter. Our total assets increased by $1.1 billion quarter-over-quarter, surpassing the $23 billion mark. As of June 30, we have $23.2 billion in total assets, representing $2.9 billion or 14.5% of year-over-year growth.

City National Bank has a long track record of outstanding organic loan growth. The combination of our organic growth engine with the strong macroeconomic conditions in Florida resulted in new loan commitments of $1.8 billion for the second quarter of 2022, which was $463 million higher than the second quarter of 2021. This resulted in $1 billion of net loan growth, excluding PPP, which is significantly higher than the industry growth rate. We grew significantly while preserving our strong asset quality.

We continue to grow our deposits, which increased by $177 million. As you will see, this deposit growth was generated at a time when the banking system as a whole is shrinking their deposit base. Our significant loan and deposit growth translated to strong results as well. In fact, our core net interest income, which excludes the impact of PPP, increased by $18 million quarter-over-quarter and $36 million from the same quarter in 2021. Overall, year-to-date net income of $138 million is 22% higher year-over-year.

We will conclude our comments this morning by discussing the fundamentals that are in place that have positioned us to continue our success in 2022. But first, let's review our second quarter financial achievements and results with you.

On this slide, you can see our assets increased by $1.1 billion for the quarter, reaching $23.2 billion. This represents a year-over-year growth of nearly $3 billion or 14.5%. Our asset growth was purely organic as we have not closed any acquisitions recently. Our loan-to-deposit ratio remains very low at 77% due to the impact of our deposit growth over the past couple of years, which we will discuss shortly. It is key to emphasize that we have deployed excess liquidity throughout the year via loan growth to still have a low loan-to-deposit ratio.

The significant loan growth has resulted in a reduction of our cash position, which represented 8.6% of our total assets a year ago versus about 3% as of June 30. Our investment portfolio increased quarter-over-quarter and still represents around 28% of our assets. Our investment yield increased 21 basis points over the prior quarter as our new purchases have come at higher coupons due to the increase in overall market rates.

We have increased our deposits by $2.3 billion year-over-year or 13.7%, including $177 million of quarter-over-quarter growth. We continue to focus on cross-selling deposits on all of our new loans as well as during the loan renewal process. A substantial amount of our growth is in noninterest-bearing deposits, which now account for 42% of our deposit base. Our noninterest-bearing deposits increased by $363 million over the prior quarter.

Our spot cost of client deposits slightly increased 13 basis points quarter-over-quarter and remains very low, especially considering that as of June 30, the Federal Reserve had raised the target Fed funds rate from 25 basis points to 175 in the past 3 to 4 months. On the right-hand side of this slide, you can see how our deposit growth rates quarter-over-quarter, year-to-date and year-over-year compared to the banking industry as a whole. City National Bank's deposit growth rates significantly exceed those of the industry in all these periods, demonstrating that our cross-sell efforts have paid significant dividends. As a result, we have ample liquidity to continue funding our strong loan demand.

The combination of our long proven loan production capabilities, combined with the strength of the Florida market, resulted in $971 million of loan growth, excluding PPP, in the most recent quarter. This represents an increase of 7% over the prior quarter or 29% annualized growth rate, excluding PPP. On the right-hand side of this slide, you can see that our loan growth rates for the quarter, year-to-date and year-over-year are significantly greater than the banking industry as a whole. I should also mention that our loan growth rates when compared to the banking industry include the impact of declining PPP balances.

On this slide, you can see that our outstanding loan portfolio is very well diversified, with only 43% of our portfolio classified as commercial real estate. You can also see on the right-hand side of the slide that there is ample diversification within the commercial real estate category with only 2 segments slightly exceeding the 20% mark.

It is also important to note that the real estate secured loan categories have a very low weighted average loan-to-value of only 56%. In fact, CRE, owner-occupied CRE and residential all have weighted average LTVs of 60% or below, indicating that our loan portfolio has been assembled in a very conservative manner. Finally, you can see that our CRE concentration ratio, which measures our CRE exposure over our regulatory capital, is about 272%, well below the 300% guidance threshold established by regulatory authorities.

On this slide, you can see the evolution of our PPP loans and fees. We funded over $1.8 billion of loans in 2020 with $57 million in fees. During 2021, we originated an additional $790 million of loans under PPP 2.0 with almost $30 million of fees. We also proceeded to forgive $1.7 billion of PPP loans, recognizing $45 million in fees last year. In the first half of this year, we have seen $444 million in PPP forgiveness which resulted in $14 million in fees being recognized. As of June 30, we have $260 million of PPP loans outstanding with just over $4 million in fees yet to be recognized. As a result, PPP fees will have a limited impact on our results moving forward.

Now I'd like to discuss our asset quality trends. You can see that our loan deferments are minimal. They have declined all the way down to $3 million, decreasing from $21 million in December. You can also notice on the bottom left-hand side of the slide that all remaining deferments are residential mortgages. It is very important to note that the weighted average LTV of the residential loans on deferment is a very conservative 58%.

Our NPLs have also declined significantly during the course of the year from 96 basis points as of December 31, 2020 to 21 basis points as of June -- this past June 30. Similarly, past dues are at low levels, representing only 0.53% of total loans as of June 30. Finally, due to our outstanding organic loan growth, we recorded $6 million of loan loss provisions in the first semester of 2022.

Overall, the deferment trend is strong. The remaining deferments are minimal and well secured and our already strong asset quality indicators continue to improve.

Moving to our results for the quarter. Our net income totaled $74 million, an increase of $10 million or 16% over the first quarter of 2022. Year-to-date, our net income totaled $138 million, representing an increase of $25 million or 22% over the prior year. This improvement was mainly driven by increasing our core net interest income, excluding PPP, as you will see on the next slide. We have also increased our noninterest income by $10 million or 27%, as we will detail later. Additionally, our expenses have increased by only 5%.

You can also see in this chart at the bottom that our ROA, ROE (sic) [ ROAA and ROAE ] for the year are both strong at 1.25% and 13%, respectively. Our efficiency ratio is also strong at 42%. In summary, we are generating strong results in 2022, and our core earnings trend is very favorable.

On this slide, you can see the year-over-year evolution of our pretax preprovision earnings, which increased by 33% year-over-year. The main driver of the improvement was a $60 million increase in our core net interest income, which excludes the impact of PPP and MSLP fees. This increase reflects the impact of our 32% loan growth and our 14% deposit growth over the last year. Noninterest income increased by $10 million year-over-year, which we will further discuss shortly, while noninterest expenses increased by $8 million over the prior year, which is less than 6% as we continue to attract new talent and invest in technology.

On the left side, you can see the evolution of our net interest income compared to the most recent quarter and the second quarter of 2021. The dark green part of the bar represents our net interest income, excluding the impact of PPP and MSLP fees. You can note that our core net interest income increased by over $18 million or 13% over the last quarter and by $36 million or 30% over the same quarter of 2021. Our significant growth in earning assets has driven our net interest income growth, excluding PPP and MSLP. PPP fees totaled $7 million in the second quarter, remaining flat as compared to the first quarter.

On the right-hand slide, you can see our net interest margin evolution as well. Our core NIM, excluding the impact of PPP and MSLP, increased by 24 basis points over the prior quarter to 2.96%. Our overall NIM for the quarter was 3.06%, including the impact of PPP, which increased our NIM by 10 basis points. In conclusion, our net interest margin has increased as we have benefited from our loan growth and the rising rate environment and the net interest income trend is also very favorable.

On this slide, you can see the pretty aggressive pace of Fed rate hikes over the past couple of months. During the first semester, the Federal Reserve increased its target rate by 150 basis points. Consequently, the average fed funds rate significantly increased by 64 basis points quarter-over-quarter from an average of about 12 basis points in the first quarter to 76 basis points in the second quarter. On the other hand, our cost of funds has remained virtually unchanged, slightly increasing from 21 basis points to 27 basis points in the second quarter, contributing to the NIM expansion that we just saw in the previous slide. We have been very strategic about deposit rate increases and are appropriately adjusting rates on a case-by-case basis, always with a focus on relationship banking.

Noninterest income has increased by 27% year-over-year or $10 million, as we previously pointed out. Our deposit service charges continue to grow as a result of our cross-sell and deposit gathering efforts. We have also generated higher swap fees as our back-to-back swap program regains traction as an excellent way to generate fee income to provide clients with competitive rates for longer-term loans.

As we just discussed, the hawkish tone from the Fed has translated into a 150 basis point increase through June, with the market expecting another [ 7 or so -- ] the remaining part of the year, including the 75 basis point hike that just occurred last week. It is therefore important to mention that our balance sheet is asset-sensitive and that we are well positioned for increases in short-term rates. Again, our positioning contributed to the NIM expansion that we are experiencing this year.

As you see on this slide, 40% of our loan portfolio reprices within 1 year. 42% of our deposits are also noninterest-bearing deposits, which also serves to provide great value in a rising rate environment. It is also important to mention that City National Bank entered into $325 million of forward starting swaps over borrowings during 2020 when rates were at historically low levels. These forward starting swaps have a duration of about 6 years and started to fund this past June, and will continue to fund through 2023 at an average cost of 55 basis points, providing significant value as rates increase. In short, our balance sheet is well positioned and will benefit from the rising rate environment.

As you saw during this morning's presentation, we closed our first semester in an extremely strong fashion, and the bank is well positioned to keep this performance in the second half of the year. As we carry this momentum into the second semester of 2022, there are 5 distinguishing factors that provide City National Bank with a strong opportunity to continue outperforming our peers.

First, despite uncertainty around the economic outlook for the remainder of the year, we are operating in a state with one of the best economic environments in the U.S. Affluent individuals and sizable businesses are relocating from the Northeast and other parts of the U.S. to Florida on a daily basis. We have the scale, products and market expertise to continue benefiting from these favorable economic conditions.

Second, City National Bank has unparalleled talent throughout the organization. We are focused on continually augmenting our talent base with the best talent in the markets that we serve and also offering a work environment and culture that maximizes employee retention. To that end, City National Bank was named this year as the best company for career growth by Comparably. Our results are a direct reflection of our people.

Third, we continue to invest in technology and our digital transformation initiative and continue to build upon our recent digital investments that enabled many of our key accomplishments during the recent year. Over the last 2 years, we have deployed Salesforce and the nCino loan origination system in our institution, and we are currently rolling out our new loan pricing system as well, PrecisionLender, which integrates with both Salesforce and nCino.

Fourth, we are in one of the best markets in the nation with tremendous potential for growth outside of our core Miami market. Specifically, we have relatively limited market share in Palm Beach, Fort Lauderdale, Orlando and Tampa. And that offers tremendous opportunity for us to increase market share in those attractive and growing markets.

Finally, we have a strong brand in Florida that has been developed and earned since we started operating in Miami over 75 years ago. As a result, we are excited not only about delivering strong results in 2022, but also in the years to come.

In conclusion, we achieved tremendous growth that is translating to strong earnings. Our deposit and loan growth, both for the quarter and year-over-year, far exceeded the banking industry. Our asset quality metrics, which are already strong, continue to improve and we are generating significant earnings growth. This strong loan growth that we are generating now and will continue to generate will ensure that our strong results will be sustainable even in a potential economic downturn.

With that said, let's turn the call back over to the Bci team for some additional thoughts. Thank you.

[José Ibaibarriaga Martínez, executive]

Thank you very much, Jose, for your presentation.

Let's move to the next slide, please. In terms of environmental, social and governance, ESG criteria, we have made significant progress with the execution of our strategy. After an evaluation process analysis, the bank's sustainability policy commitment and processes, Bci has become the first Chilean company to join the NASDAQ Sustainability Bond Network (sic) [ NASDAQ Sustainable Bond Network ] becoming a transparency partner and the first Chilean bank to join the IDB.

In the SME segment, we promoted 2 initiatives this quarter: Sustainable Chile and Spark Challenge of SME value. At Sustainable Chile, this initiative aims to ensure that there are more and more SMEs that measure and manage their social and environmental impact for free and online. Spark, agile collaboration modeled between start-ups and companies in Latin America.

Regarding our suppliers, we have developed the Bci Suppliers Program and Sustainability Accelerator for Suppliers, encouraging suppliers to move forward to become economically, social and environmentally responsible.

I would like to address our updated 2022 guidelines for Bci, considering the macro variables forecasted by Bci Research and shared by Sergio early in this presentation. As you can see in the slide, local loan growth will be boosted by inflation and the FX movement. In the case of expenses, it will grow in line with inflation where we continue to invest heavily in the key initiatives we recently mentioned. Considering this scenario, net income should grow between 40% to 50% year-over-year compared to 2021.

Today, we found ourselves celebrating 85 years as a bank, years during which we have had to face different political, economic and social changes, which grow more constant every day. Throughout our history, we have been faithful to our distinguished company culture and mission, consistently placing people at the center of decision with the conviction that our performance has a significant effect on the community in which we operate. It is not only a responsibility to create economic value, but also to contribute to the construction of further and more developed communities.

With this philosophy in mind, the bank has developed a clear business strategy and a transformation process and now more active than ever. With this, the digital economy, development of ecosystem and our international strategy will continue to be decisive drivers of our growth. All of this has enabled us to position ourselves as one of the 10 most important banks in Latin America and the second Florida-based bank and be a reference of innovation in the industry by seeking to develop the first digital bank with MACH.

Using these principles, we aim to be much more than a bank for peoples, companies and communities. We want to promote well-being and progress, investing with great conviction in the country to support the clients and community where we work.

With this, we finish this part of the conference call. Thank you very much for participating. If you have any questions, we will be more than glad to answer them.

[Andrés Atala S., executive]

Thank you, José Luis, Jose and Sergio. From this point, as José Luis mentioned, the room is open for your questions.

[Andrés Atala S., executive]

The first one is coming from Florencia Stefani from LarrainVial.

[Florencia Stefani, analyst]

I have a question. I want to understand how much of your NII generation in the last quarter is related to peso depreciation as a result of the consolidation of the CNB operation?

[José Ibaibarriaga Martínez, executive]

Florencia, let me repeat your question to be sure that I understood. How much of the NIM evolution is related to City National Bank?

[Florencia Stefani, analyst]

Yes. I see that, for example, you have higher results related with the commercial portfolio in interest in your NII generation. And I want to understand how much of this is related to the depreciation.

[José Ibaibarriaga Martínez, executive]

Okay. Florencia, basically, what's going on with -- I will answer your specific question but basically, what's going on with the NIM is that there are several moving part that we have to take into consideration. On one hand, this year, as Sergio mentioned, we have a higher inflation than expected. That is positively affecting this indicator. Likewise, in terms of loan growth we are already seeing an upturn in consumer loans and increasing prices.

On the other hand, we are already seeing an effect on the monetary policy rates where there has been a migration from noninterest-bearing deposit to time deposits which will generate higher cost of fund. And answering directly your question, in the case of City National Bank, there are [ nonrequiring effect ] in 2021 associated with the income from the PPP program that Jose explained in detail that will not impact ourselves during the second [ semester ] as important as it was in the last couple of years.

So the main effect that we are seeing this year in NIM is related basically to inflation, price increases in Chile. And regarding City National Bank NIM impact, maybe Jose, you can give us more color in that sense, please.

[Jose Marina, executive]

Of course, José Luis. So our NIM has been growing for a couple of reasons. As I just indicated, our core NIM increased by about $18 million quarter over quarter from about $136 million to nearly $154 million. And that's driven by a couple of reasons. Number one, our significant loan growth, which we're growing at an annualized rate of about 30%, excluding the impact of the PPP forgiveness. And the second reason being the fact that our NIM has been expanding, as I just indicated, our NIM expanded from 2.81% to 3.06%, so a 25 basis point increase in our NIM quarter-over-quarter.

We have the growth and then we have the growth of the balance sheet and our loans and then the fact that our NIM is expanding as a result of our ability to reprice our loans higher, which I indicated about 40% of our loans reprice within 1 year, about 34% in the immediate short term. And the other factor being that we've been able to control our cost of funds. And as I indicated earlier, an increase of our cost of funds are quarter-over-quarter from 21 to 27 basis points. So that's been the main factors there.

[Florencia Stefani, analyst]

Okay. That's -- when you translate the CNB results in U.S. to Chilean pesos, do you reflect a positive impact in NII results due to the peso depreciation?

[José Ibaibarriaga Martínez, executive]

Well, Florencia, the answer is yes as we have had the depreciation that you already know and the financial statement in Chile is reflected in Chilean peso, we do have an impact. That impact is not a significant impact if you take into consideration that City National Bank represents around 30% of our margin, and I think that what is impacting the most in the NIM in Chile today is related to the price increase that City National Bank is doing, inflation in Chile and price increases in Chile. I would believe that, that is the 80-20. And yes, the exchange rate do have some marginal impact. It's not that significant.

[Andrés Atala S., executive]

Thank you, Florencia, for your question. The next one is coming from Tito Labarta from Goldman Sachs.

[Daer Labarta, analyst]

A couple of questions, I guess. Maybe one following up on Florencia on the margin. Just going forward, to think, just -- what are your expectations for inflation and interest rates in Chile for the rest of this year and for next year? And how do you see those 2 variables impacting your margins from here? So just to get some more color on that going forward.

And then my second question, in terms of asset quality NPLs, holding up well. You said maybe gradual normalization there. Cost of risk, also doing well. How do you think of maybe asset quality, maybe going into next year even? Do you expect any further deterioration? Or when can you see a bigger increase in NPLs? And what would that mean for cost of risk sort of longer term into next year?

[José Ibaibarriaga Martínez, executive]

Thank you, Tito. Sergio, can you give us some color about inflation interest rate? And then I'll answer the asset quality question.

[Sergio Lehmann, executive]

Yes. Thank you, Tito. With respect to inflation, we are expecting that it will remain high this year. We're expecting that it's going to be close to 14% in the coming months in normal base. And then closing the year in a level close to 13%, 12.7%. And then some decrease in next year, probably more rapidly in the second part of this year and then converging to 4.5% inflation rate at the end of 2023.

In terms of interest rates, we're expecting that the Central Bank of Chile is going to raise again the monetary policy rate by 50 basis points to 10.25%. And then it's going to remain at that level at the beginning of next year. We're expecting, as a difference with the market, a more rapid decrease in the monetary policy rate by the Central Bank, closing by 6% at the end of the next year. And this is going to be mainly because we're expecting this decrease in inflation during the second part of next year, which is going to be more or less rapidly compared with the expectation of the market.

And because we are expecting that the Chilean economy is going to be in a recession in the second part of this year and also for the next year, we are expecting some decrease in GDP by 1.2%. So given that we expect that the Central Bank is going to decrease the monetary policy rate, as I said, faster than the market expect, basically because they're going to have this space because we're expecting that the inflation expectation we will be converging gradually to the target of 3% of the Central Bank.

[José Ibaibarriaga Martínez, executive]

Thank you, Sergio. Tito, in our local loan portfolio is very well diversified by customers, business line, economic sectors, both in U.S., as Jose mentioned and in Chile. The loan distribution among the different business segment that we show in the chart in the presentation, shows our commercial loan portfolio among these different sectors. And going to your specific question, we believe that as time passes, most loan portfolio should tend to perform closer to pre-pandemic levels.

In addition to that, we are seeing entire macroeconomic outlook as described before which should have some impact on the quality of the loan portfolios. It is essential to remember too, Tito, that during the last 2 years, we have built important voluntary provisions intended to be used as a bridge in the event that the portfolios in the next couple of years outperformed worse than what is expected.

We have -- we believe, and this is the view that we have that in the commercial side, we are not seeing any specific issue. We have a strong due diligence of our loan portfolio. In the mortgages loans, we are not seeing any deterioration. And where we are seeing and we expect to see a deterioration is in the consumer portfolio, where we are already seeing a deterioration that we have not yet arrived to the pre-pandemic levels yet.

But we expect that we will arrive there, which is a normal situation. If your question is that we are seeing some situation worse than this pre-pandemic levels on the risk area, we are not seeing that yet. And in the event that it happened, we are very well prepared with all the voluntary provisions that we have built in the last couple of years.

[Daer Labarta, analyst]

Great. Just one follow-up. Can you give -- what is your sensitivity -- what is the sensitivity of your margins to the movements in inflation and interest rates? Just given those 2 moving parts, can you remind us for 100 bps move in inflation, what does that mean for margin? Same thing on interest rates?

[José Ibaibarriaga Martínez, executive]

So can you give some information, Jose, what is the situation in City National Bank to the movement of the interest rate, and then I will tell you interest rate and inflation in Chile.

[Jose Marina, executive]

Of course, José Luis. So I mean, we are -- I mean we try to maintain a balanced position. We're -- right now, we're talking about rising interest rates. But when you look at the Fed funds futures, we're going to be -- we're talking about rates coming down at the beginning part of next year. So we've been able to -- we're a little bit more asset sensitive than liability sensitive, but we're fairly [ nimble ]. And that's why we've been able to expand our NIM by about 25 basis points quarter-over-quarter.

I do think with the 75 basis point increase that we saw in June, at the end of -- or mid-June and the 75 basis point increase that occurred last week, I think the cost of funds is going to start going up at a faster pace, and we'll be able to maintain our NIM, but I don't think we're going to see the same NIM expansion that we've had, 25 basis points, in this next quarter as well given the pace of the rate increases. I hope that answers your questions.

[José Ibaibarriaga Martínez, executive]

Thank you, Jose. Regarding Chile, Tito, we make a short-term sensitivity measurement called [ STEP ]. This measure is a shock [ parallel in ] the short-term rate group. In this case, we assume that the monetary policy rate impacts only the items of the banks denominated in pesos or UFs. And we estimate that amounting around CLP 10 billion. And in the rate and inflation, we currently -- the balance sheet gap on UFs is around CLP 3.4 billion, which generated a 100 basis point -- will impact in around CLP 33 billion in the income statement, assuming that the rest of the relevant variables remain unchanged. And the total effect of the income state will depend on the combined effect of the changes in the inflation rates, movement in the temporary interest rate structure and the sensitivity of the balance sheet to those movements. So that is the two situations in Chile.

[Andrés Atala S., executive]

Thank you, Tito. We have, again, Florencia Stefani from LarrainVial.

[Florencia Stefani, analyst]

I have -- the last question. Regarding the consumer loan growth, you're expecting to decelerate this -- the trend that we have seen during the last month or you are expecting to continue with the trend in terms of growth for the coming quarters?

[José Ibaibarriaga Martínez, executive]

Florencia, we are expecting a decrease in the demand on the consumer loans. In consumer quotas, in quotes, clearly it's a decrease, and we are not expecting the loan portfolio to be increased in the next 6 months. We are seeing an increase in the demand is in the credit card area. This is in the consumer family. And especially, there is some seasonality at the end of the year, which we expect that it will increase in November and December, specifically the credit card demand. Overall, if you put all together the consumer family, the growth expectation for the second semester is marginal, and you should expect that the loan portfolio that we have today is basically what we are going to finish by the end of this year.

[Florencia Stefani, analyst]

Okay. Perfect. And what is -- what are your expectations for the consumer loan growth for the next year?

[José Ibaibarriaga Martínez, executive]

Excuse me, Florencia? I didn't hear you well.

[Florencia Stefani, analyst]

The consumer loan growth expectation for the next year.

[José Ibaibarriaga Martínez, executive]

Well, as -- we're expecting, as Sergio has mentioned, that next year, we will have some construction in the GDP of Chile. We are in the process of building the budget for next year. So we do not have a specific number of guidelines for the loan portfolio nor the consumer portfolio for next year yet. Expectation is that if we have a negative GDP or close to 0, the growth will be very low.

[Florencia Stefani, analyst]

Okay. And regarding the commercial portfolio, do you have seen any risk related with some sectors like real estate or construction during the last weeks or during the last months?

[José Ibaibarriaga Martínez, executive]

If we have seen a decreasing demand, Florencia?

[Florencia Stefani, analyst]

Or increasing in risk in those sectors.

[José Ibaibarriaga Martínez, executive]

Not necessarily. No. I think that what we are seeing in the commercial side is a demand to have some liquidity. We are not seeing an extreme demand for new projects. So investment in infrastructure or the building or houses for those type of companies, we are not seeing a special demand there. And neither we have increased prices, different than the spread that you obvious -- so we have not increased spread. That is a better answer.

We regularly have -- this is a very, very, very detailed answer, but we regularly monitor industry and segments of different customers in our portfolio, which could become potentially impacted by the contingency events by more structural or permanent ones. As such, we are giving a special [ venture ] to customers or groups of customers in the loan portfolio. And obviously, you have the -- all the discussions of the constitutions that could be affected in some areas. And obviously, we are looking to that. But still, the due diligence that we do have, we are very confident that we have a very good quality of our loan portfolio.

[Andrés Atala S., executive]

Thank you, Florencia. And the last one is coming from Jorge Perez from Itau.

[Jorge Pérez Araya, analyst]

Just one question on my side. So do you have any specific concern about the mortgage loans because of the high inflation level that we are seeing in Chile? And in the same topic, do you know or an estimate of what percentage of your clients have their salaries indexed to inflation to the UF?

[José Ibaibarriaga Martínez, executive]

Jorge, that's a very, very, very good question. The -- as you know, mortgages in Chile and houses in Chile are very important for families as -- such that the families pay special attention to pay their mortgages. And the nonperforming loans in these sectors is really marginal, not today, but always. And the expectation is that we are not seeing -- we do not expect to see a significant deterioration in the nonperforming mortgages loan portfolio.

Regarding the -- your question, if or how much of the customers that do have mortgages, their salary is adjusted to inflation. What -- it's going on in Chile and maybe Sergio, I don't know if you have some dates (sic) [ data ] on how many of the families in Chile have their salary adapted to inflation. I don't have the specific number of how many customers -- that specific relation to inflation. Do you have some information about that?

[Sergio Lehmann, executive]

Not really, but most of the salaries are indeed indexed to inflation to UF. But anyway, given the lack of that, we have seen some decrease in real salaries in the last months. So anyway, we have seen this deterioration in terms of salary and power of purchases or from salary side, from family side, but we don't have a specific data related to that.

[Andrés Atala S., executive]

Thank you, Jorge. And now we finished the -- this conference call for this quarter. So José Luis, maybe you can -- wanted to say some words.

[José Ibaibarriaga Martínez, executive]

Just to thank you very much for participating in the call. As always, the Investor Relations team is always more than happy to receive all your questions, and we will be more than glad to answer it. Thank you, Jose, for participating, and thank you to all the teams that make this conference call possible. Thank you, Sergio, for being here again. Thank you, and have a nice day.

[Sergio Lehmann, executive]

Thank you. Bye.

[Andrés Atala S., executive]

Thank you very much.