Banco de Chile

SGO:CHILE

Earnings Call Analysis

Bank Posts Strong ROE Despite Economic Headwinds

Despite a challenging macroeconomic backdrop with falling inflation, recession, and increased delinquency, the bank maintained industry-leading results with a noteworthy net income of CLP 1.2 trillion and an ROE of 25.1%. Net income year-on-year was impacted, decreasing by 16.9% mainly due to lower net interest income as inflation declined, and higher operating costs. Operating revenues increased by 7% in Q4 2023 compared to the same quarter the prior year, but saw a 4% decline annually. For 2024, the bank anticipates consumer and residential mortgage loans to drive a forecasted real growth in its loan portfolio of 2% to 2.5%, with an expected rebound in loan demand as economic conditions improve.

Strong Performance Despite Economic Headwinds

Despite a challenging economic backdrop marked by a recession for most of 2023, downward inflation trends, higher unemployment, and raised delinquency, the bank has emerged as an industry leader, showcasing resilience and a proven capacity to generate value for shareholders. Achieving a notable net income of CLP 1.2 trillion and boasting an ROE of 25.1%. These figures are impressive, considering the bank managed to capture 27.2% of the industry's total net income.

Sturdy Capital Adequacy and Asset Quality

The bank leads in capital adequacy, wielding strong indicators that comfortably surpass internal and regulatory thresholds. This robust capital base not only allows the bank to accommodate growth but also provides the flexibility to handle potential economic or specific exposures. Furthermore, the transition to the Basel III regulations in Chile has been effectively managed, solidifying the bank's admirable asset quality, which was demonstrated through the lowest industry delinquency ratios and a core ratio that remained at 2.7 times despite taking additional provisions into account.

Commitment to Environmental, Social, and Governance (ESG) Excellence

The bank's focus on ESG culminated in enhanced external ratings, with the top assessment from Sustainalytics and the successful issue of social bonds under its sustainability financing framework, backing noteworthy initiatives like supporting women-led enterprises.

Economic Context and Outlook

Following a year of no growth in 2023, with the economy burdened by a contraction in domestic consumption and investment, yet supported by net exports, the Chilean economy is anticipated to rebound modestly. The bank expects improved economic conditions to boost loan growth, forecasting a 5% to 6% increase in total loans in 2024, in nominal terms, outpacing the industry-wide projection of 2% to 2.5% growth for consumer and residential mortgage loans.

Anticipated Changes in Net Interest Margin and Operating Income

While operating revenues saw a 7% uptick in Q4 2023 compared to the same period the previous year, overall, the full-year operating income dipped by 4%, primarily influenced by a notable decrease in inflation rates. Notwithstanding, the full-year figures evince the bank's prowess with customer income growing by 11% year-over-year, buoyed by demand and time deposits, as well as an increase in loans and lending spreads. In 2024, the bank’s expected net interest margin (NIM) is projected to be within the range of 3.2% to 3.5% for the industry.

Digital Innovation and Customer Experience

The bank's dedication to digital banking innovation led to the introduction of novel solutions, such as digital onboarding for current accounts in USD and the integration of Apple Pay for contactless payments in Chile, piloting a significant digital ecosystem catering to various customer segments including SMEs and teenagers. The strides made in digital banking have earned the bank accolades for its customer experience.

Strategic Focus on Productivity and Sustainability

The bank adheres to three core strategic pillars: customer centricity, productivity, and sustainability, which have spurred achievements significantly beyond their midterm targets. These successes translate into marked improvements in service delivery and various ESG initiatives, further cementing its standing as a sustainability leader within the industry.

Robust Return on Equity and Future Loan Growth

The bank recorded a robust return on average equity (ROE) of 25.1% for the full year. Its long-term strategy, consistent governance, and decision-making with a focus on core fundamentals during challenging times like the pandemic have manifested in exceptional outcomes. Alongside this, the bank's performance in financial indicators such as net interest margin and fee margin soared above its competitors. As for future developments, the bank is primed to see a comeback of commercial loans and an expansion of retail loans, estimating a rebound in loan demand that aligns with a positive economic shift in 2024.

Earnings Call Transcript 2023-Q4

[Operator]

Good afternoon, everyone, and welcome to Banco de Chile's Fourth Quarter 2023 Results Conference Call. If you need a copy of the management financial review, it is available on the company's website.

With us today, we have Mr. Rodrigo Aravena, Chief Economist and Institutional Relations Officer; Mr. Pablo Mejia, Head of Investor Relations; Daniel Galarce, Head of Financial Control and Capital; and Natalia Villela Investor Relations.

Before we begin, I would like to remind you that this call is being recorded, and the information discussed today may include forward-looking statements regarding the company's financial and operating performance. All projections are subject to risks and uncertainties, and actual results may differ materially. Please refer to the detailed note in the company's press release regarding forward-looking statements.

I will now turn it over to Mr. Rodrigo Aravena. Please go ahead, sir.

[Rodrigo Aravena, executive]

Good afternoon, everyone. Thank you very much for attending this conference call today, where we will present financial results and the main achievements for the fourth quarter and consequently, the full year 2023.

Similar to previous presentations, we will share our analysis of the competitive landscape of the period, followed by the progress in our main strategic initiatives. And we will finally present financial results.

But before moving to this slide, I'd like to highlight the most important achievement of our bank during the year. Please go to Slide #2.

We are very proud of our successful year. We let the industry and result in several aspects of the business, confirming our proven capacity to continuously add economic value to our shareholders. On this slide, we present a summary of some of the main achievements of the bank during the year.

On the financial front, we led the industry once again with a net income of CLP 1.2 trillion, equivalent to an ROE of 25.1%, allowing us to increase the [ gap ] with our main payers. In fact, in 2023, we represented 27.2% of the total net income posted by the industry.

It's worth mentioning that these impressive results were achieved despite the existence of headwinds faced in 2023, such as the recession for most of the year, the downward trend in inflation, higher unemployment and increased delinquency, among others.

We also led the industry in capital adequacy by holding strong indicators and positive gaps, in relation to internal and regulatory thresholds that enable us to be confident to face business as usual growth, while dealing with potential stressing situations attributable either to the economic cycles or idiosyncratic exposures.

Likewise, our capital base enable us to address increased regulatory requirements established as part of the implementation of Basel III regulation in Chile. In addition, we posted the best asset quality indicators, while maintaining the quarter core ratio of the industry of 2.7x, when taking additional provisions into consideration. Similarly, we lead the industry in terms of efficiency and maintain the best customer service in the country.

On ESG, we achieved further improvements in external ratings, attaining the best evaluation according to Sustainalytics, and we issued social bonds under the sustainability financing framework.

In the rest of this presentation, we will present the basis behind these achievements. Let me start with the macro economic environment where we operate. Please move to Slide #4.

The Chilean economy began to show signs of improvement after 3 quarters of negative year-on-year growth rate. As you can see in the chart on the left, 0.6% year-on-year in the third quarter and a value informations from the fourth quarter suggests a modest recovery of 0.2% year-on-year. Given this result, the economy probably didn't grow in 2023. From a demand perspective, two opposite forces explain this result, a negative contribution from the domestic demand, given the fall in private consumption and gross investment. In contrast, the rise in net export due to the [indiscernible] decline in imports contributed to the opposite direction. Nevertheless, there are some important factors to consider behind this outcome. First, the recession between late 2022 and mid-2023 resulted from a normalization of the economy after the substantial rise of local spending in the previous year. Specifically, the absence of measures implemented during the pandemic, such as pension fund withdrawal, the adjustment of the fiscal spending in 2022 and 2023 and the contractionary monetary policy led to an important adjustment, especially in domestic consumption. The chart on the other right, shows the decline in commerce, where services have gradually been offsetting this decline. Secondly, it's important to be aware that this adjustment, apart from being temporary, has also contributed to reducing the macroeconomic imbalances. Notably, the current account deficit measured as the accumulated figures of the last 12 months declined from a peak of 10% of the GDP in 2022 to 3.5% in the third quarter, which is the last available figure. As we will see in the next slide, the narrow win in the external deficit an output gap has been reflected in a normalization of several economic figures. Please turn to Slide #5.

As mentioned, the substantial decline in domestic spending was a key driver for the downward trend in local inflation at the chart on the other left displays. In 2023, the annual inflation rate went down to 3.9%, after posting a yearly rise of 12.7% 1 year ago and a peak of 14% in August of 2022, returning to the tolerance range set by the Central Bank, which is 3% plus or minus 1% for the first time since 2021. All the core measures have been declining, reflecting lower pressures in the economy.

Apart from its impact on local inflation, the sluggish activity has also affected the evolution of the labor market. The chart in the other right shows the unemployment rate has slightly been increasing. In the fourth quarter, it rose to 8.5%, which is 60 basis points higher than the figure posted 1 year ago. While in 2023, it was 8.7%, being 80 points higher than the unemployment rate of 2022.

Even though higher unemployment is consistent with a weak environment, it is worth mentioning that this trend has mainly been explained by the acceleration of the labor force, rather than a full unemployment.

In fact, as seen in the chart, on the bottom right, label participation has been recovering the lost ground during the pandemic, suggesting that the higher unemployment is a consequence of the greater labor supply, rather than weaker employment.

In this scenario, marked by lower growth and more normalized inflation, the Central Bank began an [ nuisance ] cycle in the monetary policy in July of last year, when it reduced the rate by 100 basis points to 10.25%. This decision was followed by further reduction during the fourth quarter that led to the reference rate to 8.25% at the end of the last year, with a clear expansionary bias anticipating further cut during this year.

I'd like to share our best scenario for this year. Please go to the next slide, #6.

We have a more constructive view of the economy for this year. We expect the economy to retain positive growth rate, probably towards 1.5%, after the [ new ] expansion in 2023.

As seen in the table, we foresee a recovery in domestic demand, mainly in consumption on the ground of both lower inflation and decreasing interest rates. Nevertheless, we expect an expansion still below the long-term capacity of the economy, which is estimated at nearly 2%, due to the lack of investment.

In prices, the CPI should continue falling from 3.9% in 2023 to 3% this year. In fact, the year-on-year inflation will likely reach the Central Bank target of 3% before midyear. Based on this trend and in line with the guidance provided by the Central Bank in its December monetary policy report, we see room for further rate cuts to 4.5% by the end of this year.

The chart on the right shows our quarterly rate and CPI expectations for the following periods. We acknowledge the existing of risk, that could potentially affect the macro scenario. From the center front, the evolution of its main three partners of Chile, such as China and the United States are worth paying attention to.

Internally, some aspects related to the discussion of some reforms, including taxes, the pension system and the health care system that could affect the economy or the financial condition of certain sectors.

As we mentioned in previous conference calls, banks are a good reflection of the economy. Having said that, I'd like to move to the next slide, #7.

To analyze how the economy impacted results in the financial industry in the fourth quarter and over the year 2023.

Last year, the local banking business was marked by declining loan growth due to weakened economic environment. As you can see in the chart on the other right, commercial and consumer loans suffered the largest decline, while mortgage loans decreased partially due to lower inflation, as this product is indexed to CBI. As a result, the industry total loans grew by 3.2% in nominal terms, but contracted by 1.5% in real terms on an annual basis as of December 2023.

In this context, the industry reported a net income for the full quarter of CLP 1.2 trillion and CLP 4.6 trillion for the full year in 2023, equal to an ROE of 15.9% and 15.4%, respectively.

When compared to the prior year, full year net income fell by 16.9%. This decrease was primarily attributes to lower NII as inflation came down, higher operating expenses and temporary behavior of effective credit losses that was a combination of an important rise in core credit charges that was offset by decreasing the establishment of additional provisions.

Looking ahead to 2024, we anticipate several key developments. We paid more dynamism in terms of loan growth, driven by improved economic conditions, particularly due to increased consumption that would be partially counterbalanced by a slight contraction in private investment.

Accordingly, we forecast real growth for the industry loan portfolio within the range of 2% to 2.5%, led by consumer and residential mortgage loans.

From a funding perspective, we anticipate a more normal behavior of demand deposits in 2024, where real and expansion aligned with the GDP growth. At the same time, due to decrease in interest rate and lower inflation compensation for customers, we foresee a potential buyers towards long-term funding that should increase in line with loan growth rather than short-term time deposits, resulting in marginal declines in the latter.

In terms of net income, we consider sale factors influencing net interest margin, with expectation of NIM falling within the range of 3.2% to 3.5% for the industry in 2024, depending on the balance sheet structure of each bank.

Credit risk management will remain in the spotlight, with an improved but still constrained economic outlook and implementation of [indiscernible] provisioning methodology for consumer loans.

Now I'd like to pass the call to Pablo, who will go into more detail about Banco de Chile's strategy and financial performance.

[Pablo Ricci, executive]

Thank you, Rodrigo. I would like to begin with advances in our main strategic focus. Please go to Slide #9. The solid track record of results that we have consistently achieved has resulted from our permanent focus on 3 strategic pillars: customer centricity, productivity and sustainability. By focusing on these areas and implementing our core initiatives, we have exceeded our midterm targets as shown on the right of the slide.

On the next page, we'll look closer at our main accomplishments in digital transformation, productivity and sustainability. Let me start with digital banking. Please move to the next Slide #10.

To be the best bank for our customers, during 2023, we continued focusing on developing innovative solutions and creating a comprehensive digital ecosystem to provide the best experience to our customers. Some of our initiatives were launching a digital onboarding current account in U.S. dollars for individuals and companies and integrating the contactless mobile payment functionality through Apple Pay wallet as soon as it was available in Chile.

In addition, we have offered digital accounts for diverse segments, including SMEs and teenagers that registered 1.4 million accounts. Our initiatives were recognized by Praxis Xperience Index, which awarded us -- the bank with the best customer experience in the country.

On the efficiency and productivity front, we continued implementing diverse initiatives to build a fast, timely, secure and digital bank.

A significant achievement has been the comprehensive review of our physical infrastructure, identifying areas for space rationalization and unlocking potential savings while ensuring our infrastructure remains efficient.

Additionally, we enhanced our investment planning process to ensure that our strategic initiatives were in line with our long-term goals, and introduced a new corporate procurement model to optimize resource allocation.

Furthermore, we conducted a reengineering of our branch service processes, resulting in an improved service time and customer experience.

At the same time, we continued to strengthen our ESG initiatives. Among many actions we have implemented towards sustainability, we'd like to highlight the issuance of our social bonds under the ESG framework to finance enterprises led by women, driving economic empowerment and gender equality.

In line with our commitment to promote entrepreneurship, we continued implementing diverse national contest aimed at SMEs and students as well as several volunteering initiatives.

Our actions on sustainability led us to be the top performer in the local industry in Sustainalytics ESG Risk Rating, and to be recognized by several institutions, both locally and abroad.

Please turn to Slide 12 to go into detail about Banco de Chile's financial performance. 2023 has proven to be another exceptional year of productivity for us, as evidenced on the chart to the left. Every quarter this year, we surpassed our long-term sustainable ROE estimates, and we posted an outstanding 30.2% return on average equity in the fourth quarter. When compared to our peers, our bottom line almost doubled that of our closest competitor.

In terms of return on average equity, we posted a strong 25.1% level for the full year. Our competitive advantages, consistent long-term strategy and solid governance practices have enabled us to achieve this positive outcome.

We acted consistently during the pandemic by maintaining a long-term view on business decisions that were focused on our core fundamentals. In the end, the strategy translated into the outstanding results that we are seeing today, despite the environment of normalization and the economic factors such as inflation, interest rates and liquidity.

Let's move on to Slide 13 on operating revenues, where we'll dig deeper into our figures. Operating revenues increased 7% when we look at the fourth quarter of 2023 versus the same quarter of the prior year, thanks to improved income from loans, enhanced results from financial instruments and higher margins from deposits.

For the full year, operating income decreased by 4% year-on-year, which was mainly due to the normalization of economic factors. Specifically, the drop was due to non-customer income, driven by a sharp reduction of inflation that went from 13.3% in 2022 to 4.8% in 2023, as measured by the variation of the UF. This was, to a great extent, offset by customer income that grew strongly by 11% year-on-year, boosted by a higher contribution of demand deposits and time deposits, as well as a greater income from loans driven both by growth and improved lending spreads in most of our lending products.

Additionally, fee income also contributed to compensating this drop in revenues. The annual expansion of fees was supported by rise in insurance brokerage premiums and transactional services, primarily associated to greater credit card transactions and increased fees related to loans.

When compared to our peers, we outperformed them in the main financial indicators such as net interest margin, fee margin and total operating margin as shown on the chart to the right.

On the next slide, we'll take a closer look at how our assets and liabilities have advanced. Please turn to Slide 14.

Total loans grew by 2.5% year-on-year and 2.3% on a sequential basis. Like what occurred at the industry level, this modest growth has been the result of 4 years of subdued economic activity in an environment still marked by uncertainty and higher levels of interest rates and particularly in 2023, the delinquency indicators are returning to normal levels as expected. All these factors have affected supply and demand for loans in Chile.

Mortgage loans and consumer loans have posted positive growth, but expanding at slower pace than in prepandemic years. Residential mortgage loans grew 7.8% year-on-year in nominal terms. It's important to highlight that mortgages are primarily indexed inflation. So in real terms, growth was around 3% in 2023.

As for consumer loans, we have seen slightly lower dynamism versus 2002 (sic) [ 2022 ], as some economic factors that benefit consumer lending, such as the reduction in liquidity levels from the pension fund withdrawal and the end of the COVID lockdowns in Chile have ended.

In 2023, demand for consumer loans was more in line with long-term levels, especially when taking into consideration a weak labor market, consumer confidence and sluggish economy.

Nevertheless, we managed to grow faster than the market, gaining 70 basis points in market share by deploying targeted campaigns based on both business and risk intelligence models that pursuit to accurately promote installment loans among targeted personal banking segments, and the expansion of the use of credit cards by reinforcing promotions and loyalty programs tailored to our middle and upper segments of the retail customer banking area.

As per commercial loans, these continued weakening, dropping 1.5% year-on-year, but recovering 1.9% on a sequential basis.

Still higher than normal interest rates, reduced private investment and business uncertainty have significantly reduced the demand from the Wholesale Banking segment. Additionally, SMEs during the pandemic were heavily supported through the government guarantee program, which reduced the room to continue penetrating the segment with new originations in 2023.

In 2024, we expect that demand for loans to pick up in line with an improved environment. Total loans for us should grow in the range of 5% to 6% in nominal terms, in line with expectations for the long term loan growth to GDP elasticity of around 1.3x plus inflation.

In this baseline scenario, we are anticipating a recovery of commercial loans from negative territory to around 5% and retail loans should expand around 6%. This should permit us to pick up market share in their key strategic areas. Please turn to Slide 15.

Over the last 4 years, there have been significant changes in our asset and liability structure. Financial instruments have grown substantially, now accounting for almost 20% of our total assets when compared to just 9% in 2019. This increase can be attributed to the significant surge in liquidity within the Chilean economy that resulted in abnormal inflow of demand deposits, as evident in the demand deposit to total loan ratio shown on the table, the right of this slide.

Additionally, the Chilean Central Bank introduced the FCIC program as a finance facility for banks to promote lending during the pandemic, which expires between March 30 and July 1, 2024.

Both these factors contributed to high levels of liquidity. Due to the important amount of available financing, specifically from total deposits together with a weak lending activity, we increased the volume of financial instruments on our balance sheet.

The rise in current account deposits reached 68% in 2021, as shown on the chart to the right. This growth in demand deposits allowed us to promptly benefit from the hikes in interest rates, given the contribution of noninterest-bearing deposits to the funding cost. However, as rates and inflation rose, demand deposits gradually normalize, as customers pursued to generate income from these funds.

Today, demand deposits as a percentage of total deposits and as a percentage of total loans have returned to levels similar to those we had before these events unfolded.

Consequently, the reductions in the monetary policy rate have reverted to the norm and their cost of funds is decreasing swiftly on the grounds of the repricing of time deposits that became the main source of funding on the balance sheet.

The downward evolution in our core funding cost is expected to continue in 2024 as long as interest rates decline, which, in conjunction with improved lending spreads and a more positively sloped yield curve, will allow us to partially offset the decline in net interest income coming from the reduction in financial instruments. This is due to the fact that our excess liquidity will begin to gradually decrease in 2024, and we will have to move our fund from financial instruments to fund our loan portfolio.

Despite this lower liquidity level, we will remain well above the regulatory limit, ensuring financial stability and the soundness of our bank, as shown on the chart on the bottom left.

Regarding our exposure to inflation, our net asset exposure stands at CLP 8 trillion as of December 2023. The increase in the UF GAP has been mainly driven by our assessment of inflationary pressures in the short term, all the while maintaining a balanced risk return profile.

It's worth noting that approximately CLP 5 trillion of this UF GAP is structural, as it is linked to long-term assets in which we invest our shareholders' equity to keep it hedged from inflation while earning interest rates.

The remaining part of the UF GAP is related to the directional positions taken by treasury area, to capitalize on short-term shifts in market expectations related to funding rates and inflation.

Based on this view, our structural UF GAP has a strong business fundamental that has permitted us to profit from long-term asset exposures and reinforce our capital base.

Please turn to Slide 16 to discuss our strong capital. We ended the year with a Basel Ratio of 17.5%. Our capital path of our CET1 over the past few years has also clearly outperformed both of our main competitors, as displayed on the chart on the bottom left. This has positioned us as the leading bank to meet and adapt to new regulatory requirements.

As shown throughout this presentation, we have a unique position of high returns, high net income and high CET1. We have achieved this by focusing on customers' needs and finding the right balance between risk and return. This has enabled us to grow our portfolio and bottom line in a sustainable way.

Moreover, we have been able to keep offering a compelling dividend without compromising this leadership position, while keeping the largest margin of capital above the regulatory limits to comply with Basel III regulations.

It's also worth mentioning that in January 2023, the Chilean regulator released a reference rate for additional capital associated with Pillar 2 for 9 local banks, including us. The reference charge is imposed to us was 0.5% of our risk-weighted assets, which should gradually be fulfilled over a period of 4 years, at a 25% rate per year beginning to June 30, 2024.

This charge is derived from our exposure to long-term interest rate risk in the banking book as measured with the CMF standard model. It is important to note that our long-term interest rate risk in the banking book is primarily driven by a structural UF GAP, as mentioned earlier, has a robust business fundamental in the long run and has allowed us to benefit from economic dynamics.

I would like to highlight that we currently have a significant gap over the internal and regulatory thresholds to meet this additional requirement, a countercyclical buffer set by the Central Bank in May 2023 and the increasing limits scheduled as part of the implementation of Basel III. The current limits and the evolution over the next years are presented in the table on the right.

Also, it's important to take into consideration that as part of the guidelines set by our Board on capital [indiscernible], we managed internal buffers that reasonably overcome both countercyclical buffer and the Pillar 2 charge, so we feel very confident this doesn't represent a significant issue that could restrict our organic growth in the coming years. Please turn to Slide 17.

Core expected credit losses are in the process of normalization. This quarter, credit losses reached CLP 128 billion, CLP 5 billion above 1 year ago, without establishing additional provisions in the fourth quarter of 2023.

For the full year, we posted CLP 361 billion of credit expenses, down 17% from a year ago. However, when we exclude additional provisions, the normalization of our portfolio is very clear when compared to the low levels of core provisions in 2022, attributable to a period of high liquidity that maintain risk indicators unsustainably low.

Specifically, this rise has mostly been related to the lower payment capacity among retail banking customers and some specific wholesale banking clients for which we have seen a worsened financial condition. Nevertheless, the increase in credit risk expenses was significantly lower than those posted by our main peers, thanks to our superior credit risk management and a higher quality portfolio.

The charts on this slide show how our portfolio and our risk management culture stands out from their peers. We have the best portfolio quality, the highest coverage ratio of 2.7x, when taking into account additional provisions that totaled CLP 700 billion, as the charts to the right show. This puts us in a better position than our peers, if the economy does not keep improving.

Finally, we need to emphasize how important our risk management practices are for our profitability. This is a crucial area where we have outperformed our competitors in the past, as you can see in the chart on the bottom right. And we expect to continue doing so in the future.

We have increased our leadership over our peers since 2021, even though we have a much higher coverage ratio, showing our outstanding ability to run our business.

Also, I would like to stress that noncredit-related risks, we are very consistent with no material exposures or volatile behavior and managing exposures to derivatives or debt securities in the trading or in the banking book. Likewise, we are one of the soundest banks in terms of liquidity management. Please turn to Slide 18.

Our expenses increased 12% year-on-year. This increase is mainly due to the high inflation that we experienced in 2022 of 13% and still high inflation of 4.8% in 2023, affecting our cost base. It's important to highlight that most of the expense line items, including salaries are tied to CPI.

We also incurred greater severance payments and higher costs related to the acceleration of deferred costs associated with the former collective bargain agreements, due to the negotiation of a new agreement before the expiration of the prior one. As for the rest, the greater expenses are mainly tied to a rise in IT expenses related to software licensing, data processing services and the amortization of intangible assets.

In addition, we incurred higher expenses resulting from the relocation of part of our ATM network as we entered into a new alliance with a local retailer, which coupled with higher expenses that stemmed up from the implementation o VAT in services starting January 23, according to the last tax reform.

In terms of efficiencies, we reached a cost-to-income ratio of 37% in the fourth quarter when compared to our peers. We continue to lead and have widened the gap in efficiency, as shown on the chart to the right. Our strong emphasis on enhancing cost controls, increasing productivity and applying technology to improve our business management should keep enabling us to achieve excellent results in terms of efficiency.

However, we acknowledge that our present level of efficiency has largely been influenced by the impact of market factors that temporarily boosted our top line. Nonetheless, we are confident that we will maintain sustainable levels below 42% in the medium term. And for 2024, we expect a cost-to-income ratio of around 40%. Please turn to Slide 19.

The Chilean economy is poised for a rebound in 2024, moving out of a period of stagnation in to one of growth. With an expected growth of 1.5% alongside a projected stabilization of the CPI and interest rates at 3% and 4.5%, respectively.

In this context, the Chilean financial sector has a promising outlook of business and consumer confidence rebound, thanks to lower risks.

With respect to Banco de Chile, we have successfully addressed these challenging times, not just maintaining their leadership position, but by also excelling across key metrics such as profitability, operating revenues, asset quality, efficiency and capitalization. Our robust risk management and our commitment to ESG have also distinguished us in the [ Lion ] American banking landscape.

Looking ahead to 2024 and beyond, Banco de Chile is well positioned to capitalize on the economic upturn, especially with our superior capital position. We aim to further enhance our operational efficiencies and to seize new opportunities that align with our strategic goals.

With a focus on sustainable growth, we are aiming for a long-term ROE of approximately 18%, reflecting the confidence in our continued success and leadership in the industry.

Thank you for listening. And if you have any questions, we would be happy to answer them.

[Operator]

Thank you very much for the presentation. I will now be moving to the Q&A part of the call. [Operator Instructions] Our first question comes from Mr. Tito Labarta from Goldman Sachs.

[Daer Labarta, analyst]

Pablo, Rodrigo, I guess, on the long-term ROE of 18%, just given the capital that you have, does that assume that the capital ratio will remain around the current levels? Do you see room to pay additional dividends from here? Just what's the right level of capital to consider with that 18% ROE?

[Pablo Ricci, executive]

Thanks, Tito. Well, the ROE, as we've mentioned in the past, we think is around -- in the baseline scenario for the economy of 3% inflation rates at the long-term level of around 3.75%, so it's the Central Bank and Chile growing at around the 1.5% to 2% level.

In the long term should generate a good level or a decent level of growth of loans. And this should all translate into a bottom line of around 18%, we believe. Some years, it could be a little bit higher, others it could be lower depending on market factors in the economy, but we think with this level of capital, we're comfortable and we can have achieved this level of 18% ROE.

[Operator]

Next question comes from Mr. Ernesto Gabilondo from Bank of America.

[Ernesto María Gabilondo Márquez, analyst]

Rodrigo and Pablo, my first question is on loan growth. So given that the economy is gradually recovering, and we are starting to see the possibility for the consumer lending activity to start picking up, we're seeing lower rates, lower inflation, no longer having excess of liquidity. So just wondering if there could be upside risk for loan growth and especially for the consumer segment?

My second question is on your dividend payout ratio. So we saw that you are proposing a dividend payout ratio of 66%. So we continue to see that Banco de Chile has a very strong capital ratio. So just wondering why you didn't pay again the 80% as of last year? I don't know if it was to be conservative because of the new capital buffer. Any insight will be very helpful.

And for my last question is on the payment of the FDIC credit line. How should we think about the impact after paying the credit line? I think this could imply a lower investment yield by the reduction of the securities. And also, how should we think about this impact taking place? Should it be on net interest income or in financial results? Any insight also will be very helpful.

[Pablo Ricci, executive]

Thanks, Ernesto. In terms of your first question, in 2023, as you know, we grew around 2.5% year-on-year, and this was driven mainly by the retail sector, right? Our retail segments, consumer loans growing a little bit above 7%, mortgage loans, almost 8%. But the commercial loan area growing below minus 1.5% around there.

So it really depends for the next 2 years or the next year, the confidence from consumers and businesses and how this level of growth will be. What we've seen is a weak demand today from our customers, and that's translated into this weaker loan growth, especially in commercial loans.

If we look at what we're expecting in our baseline scenario, we see Chile growing around the 1.5% for next year -- sorry, for this year, 2024. And in terms of growth, it's around the 5%, 6% level for us in nominal terms. And what's driving that loan growth, we're seeing the areas of, again, the retail segments, which are growing closer to that 6% level, while the commercial loan segment is growing probably below the 5% level, with the recovery in SME lending, which has been very penetrated in the recent period because of all of these government guaranteed loans.

So there's an upside risk that this could improve. It will really depend on the cycle of economic situation, if there's any surprises in terms of better job creation, economic activity, investment, FDI, that could be a possibility. But those are our numbers in their baseline scenario.

For the FCIC and basically NIM, what we see is that the NIM, there's different positive and negative pressures for us. For 2023, we ended the year at almost 4.5%. What drove that was obviously a higher level of liquidity, especially from different types of funding deposits, this FCIC funding. And because we had this higher level of liquidity that we couldn't lend out because what I mentioned about the demand, the extra deposits that we had on hand, was invested in financial instruments.

So in 2024, when this comes due, the lending from the Central Bank, we have to figure out a way on how to pay that, and that way will be with the reduction of our financial instruments to pay or to fund -- the low-end of the FCIC was funding.

So this will have a negative impact in terms of -- this is a negative factor in terms of NIM, but this is -- it's more important to mention the positive factors that are occurring in 2024, which is an improvement in the lending spreads of the bank as well as an improvement in the reduction of the cost of funds of time deposits as well as a continued good activity in terms of demand deposits, which are funding our loans.

So net-net, what we're seeing for the net interest margin for 2024 is something around 10 basis point drop year-on-year because we have all these other positive factors. And not to mention that we also have the positive factors that financial instruments are coming due, and these are being repriced at a higher level as well.

And for the capital, I'll hand it over to Daniel Galarce.

[Daniel Ignacio Galarce Toro, executive]

Yes. Regarding dividend payout ratios, the effective dividend payout that is proposed to the shareholders' meeting or to ordinary shareholders in March, is actually 66%. We have to consider that Basel III is still being implemented. There are some room or gap regarding how the models for measuring diverse risk will be implemented and will be accepted by the CMF. So basically, it is a kind of buffer that we can have in the future in order to continue bolstering our capital base.

[Operator]

Our next question comes from Mr. Yuri Fernandes from JPMorgan.

[Yuri Fernandes, analyst]

I had a question regarding operating expenses. It was a little bit high this quarter, right? Up 20% year-over-over. And you mentioned like some collective agreements, some severance package. Can you provide more color on this and how this should track? Because the impression I had is that you are potentially, I don't know, front-loading some expenses in '23. So this may -- these are tailwind for '24. So just would like to hear more details on expenses.

[Pablo Ricci, executive]

Thanks. So in terms of expenses for 2023, what we've seen is an expense growth, which grew in the full year around 12%, a little bit higher than 12%, and this was largely due to some key factors, which was inflation and IT expenses.

In the fourth quarter, there were some additional expenses like the agreement with the unions to agree before the end of this contract. So what was left had the pass-through income because this is accrued on a monthly basis with the length of the contract. So this was an additional expense. We had some additional bonuses and some other items there.

But if we look more so on the medium term, what's happening in our view is inflation, which is very important for our cost base. The high inflation of 2022, the still high level of 2023 affected 2023, but this is normalized in 2024. So this shouldn't be such an important impact for next year as well.

We have many different projects in the pipeline, which we're improving in terms of productivity efficiency. So the incremental improvement of all these projects should continue to bear fruit and maintain our cost base under control. And what we're seeing is for 2024, an efficiency ratio of 40%, costs growing more or less in line with inflation. And in the long term, what we expect with a normalized operating income and normalized level of cost, an efficiency ratio that should be less than 42%.

[Yuri Fernandes, analyst]

Pablo, so basically cost in '24 inflation like? And just the first Q, coming back to this, because I think you mentioned CLP 22 billion on one-off kind of like onetime events. Isn't this like anticipating expenses for '23? Sorry, '24 and '23?

[Pablo Ricci, executive]

Well, for example, the expenses for the contract, the bonus for the unions, it's accrued on a monthly basis. So if we sign off on earlier, we have to pass that through income, all the months have to come due. So it's -- for example, that would be something that's not accrued. It would be a double accrual.

[Operator]

Our next question comes from Ms. Neha Agarwala from HSBC.

[Neha Agarwala, analyst]

Congratulations on the results. A quick question on the impact from the interchange cap for '24 and '25. I'm not sure if you mentioned that and apologies if I missed it. So if you could reiterate that.

And my second question would be on -- we recently had one of the Chilean banks, the AT1 issuance, is that something on the radar for the Banco de Chile? Could we see that in the coming months?

And lastly, on asset quality, is there any trend that you would like to highlight in terms of asset quality performance for 2024?

[Pablo Ricci, executive]

In terms of the fee growth and the interchange related to the fee growth. In 2023, we had fees, if we were to adjust for reclassifications on the balance sheet. Fees grew around 6% year-on-year. In terms of the drivers of this, we have insurance, transactional product services, including credit cards, which grew substantially. We had a strong improvement in credit cards despite a slight reduction in the interchange fee at the end of the year, because of a rise in transactions of 14% because of individuals changing their preferences to paying with cash to use more digital and noncash payment methods.

So this is very important when looking at the interchange, because not only is there is a reduction in the fees coming up or already implemented one more at the end of the year. But at the same time, what we're seeing is a strong growth in terms of transactions, which that will partially offset the reduction in the fees.

So an update on the fees. Debit cards go from 0.6%, in October, they went down to 0.5% interchange fees, and in October of 2024, they dropped to 0.35%. In credit cards, it grows from 1.48% to 1.14% in October 2023, and in October 2024 to 0.8%.

So this has an impact in terms of fees. But what is important to mention that these are partially offset by an improvement of our growth in the number of transactions. And at the same time, adjustments on another expenses related to loyalty programs, et cetera, that reduces the net cost of this change.

The other question in terms of asset quality is -- what we're seeing in terms of asset quality is a normalization from the very low rates that we've had in the past few years. So if we look at this 2023 versus 2022, and we exclude additional provisions, we see a normalization, reaching a cost of risk of almost 1% and NPLs of 1.4%, which is very good considering the cycle and the high inflation that we've had during the period, which has affected the purchasing power of consumers and also of businesses areas that we're looking at, and we're monitoring is obviously the typical ones. That's a green in Chile. We have the construction area, the real estate, not really the construction, more of the real estate. We have also SMEs, which is always an area that's a little bit more cyclical, and individuals, especially those in the middle and the more susceptible to inflation.

What we've seen is nothing that we're too concerned of. We think that we're in a level more or less -- this level of 1.4% is reasonable, move up or down a little bit in the next months. We have to see how the economy evolves. And in terms of the guidance for the for this year of around reaching at most around 1.2%, it could be lower depending on the evolution of the economy of the baseline scenario unemployment, how this year will evolve. And in the long term, with a similar mix of loan portfolio that we had prior to the pandemic level of around 1.2% to reasonable.

And the third question, I don't remember what it was.

[Neha Agarwala, analyst]

AT1.

[Pablo Ricci, executive]

I'll pass that to Daniel Galarce.

[Daniel Ignacio Galarce Toro, executive]

Yes. Well, we haven't issued any AT1 instrument yet. Basically, we are seeing some possibilities here in Chile and also abroad but, to be honest, given our very strong CET1, we don't believe it's necessary yet. And in addition, we have a lot of room with respect to regulatory limits. So we are not yet considering an specific issuance even in Chile or overseas.

[Operator]

Our final question comes from Mr. Andres Soto from Santander.

[Andres Soto, analyst]

My question is related to the consumer lending outlook. When we look at Chile, over the past few years, this has been an area where we have seen continued weakness in terms of loan growth. And now with lower interest rates, lower inflation, you will have imagined the [ issue ] have translated into a pickup in consumer loans, but your guidance is still relatively timid. So I would like to understand what prevents you from having a more aggressive guidance in terms of consumer lending?

[Pablo Ricci, executive]

Well, in terms of consumer lending, our retail lending as a whole, still we have a variety of areas that is affecting loan growth. So we have unemployment level, which still is relatively high. We don't think that there is a drop destruction, but the creation is weak. We see also investment in Chile is weaker, so that's affecting retail lending as well because of the job creation. And we have a more normalized -- a normalized level of inflation, which has also obviously had an impact in the prior years, especially in terms of mortgage loans, which made those products more costly.

So in general, households have less room to continue getting into that, and that's affected the demand for growth, plus the weak environment and confidence from the consumer is affecting the demand.

So it's more of a demand issue than a supply issue. I would say. And what could be a driver for the future to see an improvement there and improved level of the economy, reductions of the interest rate as well, is very important, which has affected loan growth as a whole. And I would say, more or less an overall better outlook in the economy will drive the consumer loan growth.

[Rodrigo Aravena, executive]

Andres, this is Rodrigo Aravena . Just let me add just a couple of things. It's very important to be aware that this recession in Chile in 2023 was a bit different compared to other crisis that we have in the country. Because this time, we had a very strong decline in domestic demand, particularly in durable consumption and other consumption areas.

For this year, particularly in this quarter, we are expecting like a turning point in the economic cycle, since, as I said before in the presentation, today, we have a more constructive view, a much more positive view on the economy. Since we're expecting different positive factors affecting the private consumption, including, of course, the positive impact and the potential positive impact in consumer loans.

It's very important to remember, for example, that we are expecting a positive growth for GDP for this year and also low inflation rates, an important decline in the automate rate, higher growth and then probably a normalization as well in terms of the labor market.

Because when we analyze today, during the last quarters, for example, the Chilean economy had an inflation rate above the long-term level, still contractionary interest rates below trend economic growth. So that's why the main reason behind the turning point of the economics related with consumption, especially with the private consumption, we are not very optimistic about private investment. So I think that it's very important to highlight that one of the key drivers for the potential, the cyclical recovery in Chile this year is related with the total consumption, the private consumption. So that's why or where this is one of our main basis of that's why we are more positive for the year in terms of consumer loans as well.

[Andres Soto, analyst]

Rodrigo, that's very helpful. And an additional question that I had was related to the additional reserves that you guys still have in the balance sheet. How should investors think about those at some point they are going to become part of your capital? Or are you still considering the possibility that they could be returned to shareholders? And under which circumstances that will be the possibility for those reserves to be an extraordinary dividend?

[Pablo Ricci, executive]

Thanks. Well, we have -- as you know, during the pandemic, we accumulated up to CLP 700 billion in additional provisions. So with a coverage ratio of about 2.7x. Today, we still have these additional provisions on the balance sheet. We did implement any of dividend provision, any more additional provisions in 2023.

Now there's no direct time line or trigger that we can mention of releasing these provisions, but what's been mentioned in the past, and it's true today is that if we don't need to do traditional provisions, a portion of these may be reversed and may be used for different purposes, but there's no clear guideline on when this will occur or the factors that would have to be occurred?

Rodrigo?

[Rodrigo Aravena, executive]

Yes. So important to be aware of the still existence of source -- of uncertainty that we have in Chile today. We have different uncertainties from the rest of the world. We will know that [ kind ], for example, is our main 3 partner, there are some uncertainties related to the economic growth for this country for this next year.

Internally, we have different discussions in Chile. Probably, there's going to be discussions about taxes, pension funds. This year also there will be elections for municipal elections as well. So even though the improvement in the economic cycle, in the private consumption, in the GDP, still we have some uncertainty. So it's very important to have more visibility on that uncertainty, the potential impact in the long term of the key long-term figures that affect the banking system, in order to have a more specific time line for the potential decision to reverse some additional provisions.

So today, we have a lot of uncertainty that we have to pay attention to. The main thing where we have more visibility today is that there's going to be an important improvement in the economic cycle for this year, but still with important uncertainties.

[Andres Soto, analyst]

Absolutely. Congratulations on the results.

[Operator]

Okay. Thank you very much. We see no further questions at this point. I'll pass the line back to Banco de Chile team to conclude the call.

[Pablo Ricci, executive]

Well, thank you for joining our conference call, and we're looking forward to speaking with you for the first quarter results of 2024. Bye.

[Operator]

Thank you very much. This concludes today's conference call. We'll now be closing all the lines. Thank you, and goodbye.