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Banco Latinoamericano de Comercio Exterior SA Bladex (BLX 1.50%)
Q3Â 2018 Earnings Conference Call
Oct. 25, 2018, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Hello everyone, and welcome to Bladex Third Quarter 2018 Conference Call on this 25th day of October 2018. This call is being recorded and is for investors and analysts only. If you're a member of the media, you're invited to listen-only. Bladex has prepared a PowerPoint presentation to accompany their discussion. It is available through the webcast and is on the bank's corporate website at www.bladex.com. Joining us today are Mr. Gabriel Tolchinsky, Chief Executive Officer and Ms. Ana Graciela de Mendez, Chief Financial Officer. Their comments will be based on the earnings release which was issued earlier today and it's available on the corporate website.
The following statement is made pursuant to the safe harbor for forward-looking statements described in the Private Securities Litigation Reform Act of 1995. In these communications, we may make certain statements that are forward-looking such as statements regarding Bladex future results, plans and anticipated trends and the market's effect in its results and financial condition. These forward-looking statements are Bladex's expectations on the day of the initial broadcast of this conference call. And Bladex does not undertake to update these expectations based on subsequent events or knowledge. Various risks, uncertainties and assumptions are detailed in our press releases and filings of the Securities and Exchange Commission. Should one or more of these risk or certainties materialize or should any of our underlying assumptions prove incorrect, actual results may differ significantly from results expressed or implied in this communication.
And with that, I am pleased to turn the call over to Mr. Tolchinsky for his presentation.
Gabriel Tolchinsky -- Chief Executive Officer
Thanks, Jonathan. Good morning everyone. Thank you for joining us today. Before Ana Graciela delves into key aspects of our earnings results for the third quarter, I would like to discuss with you the economic and business environment in Latin America, important developments that took place during the quarter and the impact of these recent developments on our perception of risk and financial results.
First, let's understand the context. During our last quarter conference call, we identified key events that were impacting emerging markets, Latin America and commodity related industries such as sugar. First, was the effect of higher US interest rates and stronger U.S. dollar, often a negative backdrop for emerging markets assets. Second, was the protectionist rhetoric from the US regarding world trade, along with a negative impact of tariffs. Third, was the political and macroeconomic uncertainty and overall lower growth prospects or outright recession for some key countries in Latin America. These trends came to a head in the third quarter. Specifically, a further deterioration in sugar fundamentals during the quarter with prices trading significantly below the marginal cost of production became too much for some -- for many Brazilian producers to bear, even some top quartile low cost producers. This included one of our credits which entered into a restructuring process during the quarter.
With continued weakness in soft commodity prices and in the Brazilian economy, we lowered our recovery assumptions for this Brazilian sugar producer and for other NPLs, 98% of which are in Brazil, impacting our financial results for the quarter. Our view is that we will continue to see macroeconomic uncertainty. Argentina currently depends on the IMF and needs to follow its program to honor its debt obligations now running north of 70% debt to GDP. This will likely lead to a recession and may complicate the political situation for the current Argentine government in the October 2019 elections. Costa Rica is in a very difficult fiscal situation and passage of tax reform is now a month (ph) given that expectations have risen to an almost 8% fiscal deficit for 2019. The Brazilian economy may stabilize in the short term, once the elections are over. But this may prove to be a temporary retrieve given their structural imbalances and the difficulty of getting to a political consensus to fix them. In Mexico we remain cautious and await President elect Lopez Obrador's actions on energy reform and whether he goes ahead with the construction of Mexico City airport as the sign of continuity with established policy directions. In short term, problems past continued to prevail throughout the region. That said, we believe that our credit portfolio is solid and in a good position to withstand volatility.
Let me highlight some of the credit strengths. First, we reduced the potential for volatility in our largest tickets by lowering our exposure to corporates in the top 20 clients category, from 24% in 2016 down to 7%, the third quarter of 2018 while sovereign, quasi-sovereign and financial institutions increased from 76% to 93% in the same time period. Second, our watch list credit category is now down to around $43 million of which $11.2 million is the largest ticket. Like other underperforming credits, the Brazilian sugar producer we mentioned had previously been included in this watch list category before becoming an NPL in the third quarter.
In Brazil, top tier financial institution exposure increased to 65% at the end of the third quarter from 36% in 2016. While our exposure to the sugar industry, net of allowances for ECL has declined from over $200 million to just $36 million at the end of the third quarter. We believe that the actions we have taken on our credit strength enhance our capacity to withstand what we expect will continue to be a challenging environment. Furthermore, Bladex's solid credit underwriting practices facilitate our ability to capitalize on opportunities particularly in these more volatile times. That is why in countries such as Argentina, we focus our origination on companies that generate hard currency on top tier systemically important financial institutions and on quasi-sovereign and top companies in strategically important industries. With these credit and 80% of our portfolio maturing within a year, we believe our Argentine portfolio is solid. Bladex continues to improve its origination with a better mix of medium term to short term loans thereby lengthening the average life of our portfolio and increasing our origination margin.
On the cost side net of restructuring another onetime charges our recurring expenses continue to decline. We believe that our current portfolio of cost structure and allowances for expected credit losses set the base to improve our earnings generation capacity going forward. With allowances for ECL at 2.26% of total commercial loans, we believe we are very well provisioned. With a 17.8% Tier 1 capital ratio, we are very well capitalized. With 75% of our assets maturing in less than one year, our net book value is solid at twenty five dollars a share. That is why our Board of Directors approved to maintain a $0.385 share dividend for the quarter. Against this backdrop, the management of Bladex as well as its Board of Directors is cautiously optimistic for the fourth quarter of 2018 and look forward to an improvement in profitability into 2019.
With these initial and brief comments, I will now turn the call over to our CFO, Ana Graciela to provide you with more color about our financial performance in the third quarter of 2018.
Ana Graciela de Mendez -- Chief Financial Officer
Thank you, Gabby. Good morning and thank you all for joining us in this call. I will now dig into the quarterly result referring to the presentation uploaded in our website. On page four, we summarize and highlight the main drivers for the quarterly result which I will go over in more detail throughout the presentation.
So moving on to page five, let me first elaborate on the evolution of NPL and its impact on credit provisions for the quarter. A $62 million loan in the sugar sector of Brazil significantly deteriorated during the third quarter of 2018 and was classified as NPL. This loan accounted for most of the increase in the allocated reserve for expected loan losses categorized as Stage 3 under IFRS 9. This exposure was a medium term loan originated in 2014 in which the bank participated as part of its syndication. Even though this client is the fifth largest sugar producer in Brazil and among the most efficient in the industry, its capacity to repay its financial obligations which exceed $1 billion has been increasingly affected by a strong deterioration in sugar, International prices which has accelerated in the third quarter as Gabriel mentioned. This led the company to engage in a negotiation process to restructure its obligations during the third quarter.
Given the prospects for continued low prices in the international sugar futures market and the risk involved in this recent restructuring process, the bank estimates that the probability of collection was cyclically diminished during the third quarter as reflected in our increased level of individually allocated allowances for expected loan losses. Total NPLs amounted to $119 million at September 30, 2018 representing 2.08% of total loan portfolio with a reserve coverage of 1.2 times. 98% of the bank's NPLs are in Brazil as Gabriel mentioned.
As shown in page six, Stage 3 credit allowances related to the non-performing portfolio went up by $63 million during the quarter. Stage 2 allowances went down by $11 million, part of it as a result of reclassification into Stage 3 along with a reduction of exposures in the underperforming category which has been decreasing over time. Stage 1 credit allowances which relate to the performing portfolio increased by $3 million on good quality, higher origination during the quarter denoting an increasing quarterly trend. The net effect was a $55 million increase in total allowances for expected credit losses for the third quarter.
On page seven, commercial portfolio including loans, letters of credit and other contingencies remains well diversified across countries and industries. Financial institutions, the bank's traditional client base accounted for a predominant 52% of total exposure denoting an increasing trend. Total portfolio continued to be mostly short term with an average remaining tenor of close to 11 months and with 75% maturing in the next 12 months. Integrated oil and gas sector exposure accounted for 11% of total portfolio as of September 30, 2018 and is mainly concentrated in quasi-sovereign entity.
In the sugar sector, the bank has reduced its exposure by 42% since 2015 to $272 million as of September 30, 2018 representing 4% of total portfolio. This reduction in the sugar sector took place mainly in Brazil with a 62% reduction since 2015 to the current level of $86 million including the NPL exposure for $62 million alluded to before. Apart from Brazil, the bank's remaining exposure in the sugar sector is with top tier clients with solid financial indicators in Mexico, Colombia, Peru and Guatemala mainly, most of which are not significantly exposed to international sugar prices. The remaining overall exposure is well diversified among several industry sectors none of which exceeded 4% of total exposure as of September 30, 2018.
Moving onto page eight, in terms of country distribution, Brazil remains our largest exposure at 19% of total portfolio, a relatively stable level in the last couple of years. Since 2015 and as a result of the country's political and economic deterioration, the bank has continuously refocused its origination efforts into Tier 1 and state-owned financial institutions and quasi-sovereign entities all of which currently represent 77% of total exposure in Brazil. 64% of the portfolio in Brazil matures within the next year with an average remaining 10 tenor or 15 months. Other significant country exposures are Mexico, with 14% followed by Colombia at 12%, Panama at 10% and Argentina at a stable quarter-on-quarter level of 9%.
As shown in page nine, portfolio in Argentina is mostly short term, with 80% maturing within the next 12 months and an average remaining tenor of 10 months. 63% of Argentine exposure is with export incorporation that are hard currency that is U.S. dollar generators, while 22% is top tier banks mostly international. Bladex benefits from preferred creditor status in the country with preferential access to U.S. dollar convertibility because it is recognized as a foreign trade entity by the Central Bank.
Moving on to page 10. Our exposure in Costa Rica stands at 6% of total portfolio and is mainly of short term nature with 84% maturing within the next 12 months. 61% is with financial institutions and the remaining 39% is with corporations most of which are U.S. dollar generators or multi-Latinas with presence in several other countries in the region.
Let's now continue on to page 11. During the quarter, the bank originated $3.3 billion in loans, exceeding maturities at $170 million. The bank continued to perform well on its short term origination capacity with a total of $2.8 billion in loans disbursed most of which were trade related. Medium term origination reached $491 million as the bank continued to deploy longer tenor transactions with our traditional client base of top quality financial institutions, export incorporations and multi-Latinas. The average tenor of medium term origination during the quarter was about 2.5 years. Overall, as a result of this robust origination, our commercial portfolio increased by 4% on a quarter-on-quarter basis and 10% year-on-year to $6.3 billion as of September 30, 2018.
Net interest income for the third quarter of 2018 shown on page 12, decreased 2% quarter-on-quarter to $27.3 million as a result of a 7 basis points decline in net interest margin to 1.74%, mostly attributable to the reversal of accrued interest on NPL reclassification. In addition, strong short tenor origination with financial institutions and high quality corporate clients continue to pressure net lending spread. These were partly offset by higher average lending volumes which increased 2% during the quarter along with the net positive effects of the bank's assets and liabilities repricing in an increasing interest rate environment. Given the bank's narrow interest rate gap structure, we are able to pass along LIBOR based rate increases in funding to our asset base. Year-to-date, net interest income decreased by 11% to $81.8 million and net interest margin of 1.74% with 13 basis points lower than a year ago, due to overall narrower net lending spreads on shorter tenor and higher quality loan portfolio exposure.
Moving on to page 13, fees and commissions were flat year-on-year at $11.8 million for the first nine months of 2018. Fee income from letters of credit and contingencies remain relatively stable quarter-on-quarter at close to $3 million with an increasing trend year-on-year. Quarterly fees from syndication and which totaled $0.9 million in the third quarter of 2018, denote the transaction based uneven nature of this business. The bank remains as a relevant player in originating syndicated transactions across the region and continues to work on a good syndication pipeline for the remainder of the year.
On page 14, quarterly operating expenses of $10.9 million showed a quarter-on-quarter declining trend. Year-to-date, operating expenses were, 8% above last year levels, mainly due to severance and other onetime expense charges associated with our effort of optimizing our personnel processes and technology infrastructure, along with higher variable compensation during 2018. Efficiency ratio stood at 37% for the third quarter and 40% year-to-date. Excluding severance and onetime expenses alluded to before, the run rate of operating expense base totaled $9.8 million for the third quarter of 2018 resulting in an adjusted efficiency level of 33%. The equivalent amount for year-to-date expenses was $33.7 million and an adjusted efficiency of 37%. In addition, the bank disposed off technology related assets for a total of $4.1 million, $2.7 million of which is presented in the income statement line item of loss on the recognition of intangible assets and the remaining $1.4 million is presented as impairment loss on other assets.
On page 15, we present a detail of funding sources and capitalization. Deposits from Latin American Central Banks, our Class A shareholders continue to be a reliable and cost effective source of financing accounting for 74% of total deposit. The bank maintains a solid funding structure with wide geographic diversification. During the third quarter of 2018 the bank successfully closed a $175 million syndicated transaction and overall increased its medium term funding by $254 million with bilateral loans in tenors up to five years. The increase in funding cost relate to higher market rates, while funding spreads decreased year-on-year. Tier 1 Basel III capitalization of 17.8% remains above the bank's historical level. It was reduced from 20% in the previous quarter on higher level of risk-weighted assets, resulting from commercial portfolio growth, coupled with lower equity levels on the quarterly loss.
Now going back to page four, I would like to summarize the main drivers for third quarter 2018 results. A $55 million credit provision charge mainly associated with increased level of NPLs to $119 million led to a quarterly loss of $40.7 million and a year-to-date loss of $9.6 million. Aside from the two related credit already identified as NPLs, the bank continues to improve the quality of its portfolio with a predominant exposure in the financial institutions sector, quasi-severance entities and U.S. dollar generating corporations across a diversified country and industry mix. Sustainable loan origination led to a 4% quarter-on-quarter and 10% year-on-year commercial portfolio growth.
Decrease in quarterly topline revenues by 6% were mainly affected by the reversal of accrued interest due to the reclassification of NPL and by lower fees as a result of the uneven nature of syndications business. Run rate base of operating expense level led to quarterly adjusted efficiency ratio of 33%. We continue our efforts to optimize our personnel, processes and technology infrastructure which led to onetime expenses, cope up with the disposal of technology related assets. Capitalization remains robust at 17.8% Tier I Base lII capital ratio.
I will now turn the call back to Gabriel to open the Q&A session. Thank you very much.
Gabriel Tolchinsky -- Chief Executive Officer
Thank you, Annie. Jonathan, I guess we -- it's time to open it for Q&A.
Questions and Answers:
Operator
Thank you. Ladies and gentlemen, at this time, we will open the floor for questions. (Operator Instructions) We'll take our first question from Yuri Fernandes with JPMorgan.
Yuri Fernandes -- JPMorgan -- Analyst
Thank you, Ana Graciela and Gabriel for the opportunity of making questions. I had a follow up on the asset quality. I guess that was the main issue this quarter. And I would like to have your views going on especially for the fourth Q. Looking to the breakdown of the sugar industry, (inaudible) to some exposure assuming other clients also became bad loans. So what do you think about that? And also regarding other countries, your tone was optimistic with Argentina. But what about other things from major (ph) countries? How are you seeing Costa Rica and Honduras? Do you think those can be -- can add some pressures for your cost of risk in the coming quarters? Thank you.
Gabriel Tolchinsky -- Chief Executive Officer
Thank you, Yuri. Thank you for your question. Let me start by addressing our exposure to the sugar industry. Obviously, one needs to make decisions based on the information we have available up to the date. And based on what we see and the credit within the sugar exposure are part of the portfolio. We believe that we are very well provisioned on a go-forward basis and really have very small exposure to overall international prices for sugar. Many of the companies in which we have lent money to, are companies that are not exposed to international prices, they sell within their designated markets, at already established prices, have low levels of overall leverage. They are -- in other words, in very good financial and credit shape.
Based on that, we believe we're very well provisioned for continued volatility. And in fact, if you see the level of provisioning that we have for our NPL or our recent addition to NPL in which we are covered based on a -- only a 25% recovery assumption, it already bakes in a significant amount of volatility for the industry and we are really in a position where we can say that even if sugar prices were to decline from the levels they are today, and continue to exhibit the volatility that they've been exhibiting, that we feel comfortable with the remaining exposure that we have.
Now moving on to the other question, was with respect to our exposure to other Central American countries. We are, as Ana Graciela described, very comfortable with our exposure in Costa Rica to financial institution, dollar generators and top-tier multi-Latinas in Honduras, where 81% of our portfolio matures within a year. We also are very well positioned 72% in top tier financial institutions. So it's from our perspective a solid credit picture in terms of our portfolio on a go-forward basis.
Yuri Fernandes -- JPMorgan -- Analyst
Okay. Thank you. I have a second question on capital and dividends. Your Q1 is super solid, I don't think it's an issue. But assuming the ROEs does not improve as much as your pace of loan growth you are growing, as you said 10%, your commercial book, so this is well above the level of ROEs we have been seeing in the last years. And with this level of dividends, you will continue consuming capital. So my point is what is your comfortable level for Tier 1 and how you see the dividend policy evolving in the coming years?
Gabriel Tolchinsky -- Chief Executive Officer
Okay. Let me just answer by saying that I don't completely agree with the assessment of the bank continuing to deplete capital without any continued growth in our origination. We believe that at our current dividend rate even without growth assumption, we will continue to accumulate retained earnings and our capital base will improve. I think that the scenario by which our capital goes down is let's call it the good scenario. The good scenario meaning growth and increase in our overall risk weighted asset. And needless to say we are very comfortable with our credit underwriting process and intend to continue to grow in credits and in industries where we feel comfortable with the underlying risks.
So it should be commensurate with our capacity to generate further earnings, any decline that you will see in Tier 1 capital ratio. So I don't know if this fully answers your question but I would say that given our business model, a 15% Tier 1 capital ratio under a growth scenario for a portfolio -- our portfolio is something we would feel very comfortable with.
Yuri Fernandes -- JPMorgan -- Analyst
Okay. So 50% is a number you feel comfortable for Tier 1? I guess it is like even if your ROE -- even if your ROE improves, let's say, to 10% if you have like a 70% dividend payout, that implies that your equity will be growing like 3%, but your risk weighted assets are going -- probably to grow in line with your loans, so like 10%. So we are going to give leverage. That, as I said, is a good problem like if you are able to deliver those level of ROEs, level of loan growth, that's a good problem. But my point was more to understand how do you see the payout versus the capital growth.
Gabriel Tolchinsky -- Chief Executive Officer
Annie, would you like to address that?
Ana Graciela de Mendez -- Chief Financial Officer
Yeah. I mean in terms of the payout, the payout, it's related precisely to our ability to deploy our leverage to balance sheet. We think that with the current payout level or what -- I mean what the board has done is to maintain the dividend independently from the payout ratio because obviously we have increased it substantially. But going forward what we see in our model is that even with a 50% payout ratio which has been pretty much the guideline in the past and a continued growth to leverage the balance sheet with the 15% -- it should give us around 15% Tier 1 ratio and we should be able to deliver it, two digit ROEs with that model.
Yuri Fernandes -- JPMorgan -- Analyst
Great, great. Congrats Ana and Gabriel. Thanks for the question -- for the answers.
Gabriel Tolchinsky -- Chief Executive Officer
Sure. Thank you, Yuri.
Operator
Thank you. (Operator Instructions). We'll take our next question from Michael Holm (ph) with -- he's Individual.
Michael Holm -- -- Analyst
Good morning, guys. I've been a shareholder of Bladex in the past. I have a number of questions, so I'll just put them out there and you can address them as you see fit. The first question I had was I thought that in 2018 as LIBOR would go up that your spreads would also increase and that has not happened. I like to understand why maybe I was wrong. Second, you have a number of severance one-off expenses, when do you think those will come to an end?
The third question I'm interested to know if you think that an ROE above 10% is achievable for next year, if that's realistic or not, but I'm curious to know if you think that you can do an ROE above 10% next year. And then the last question is you've kept your dividend at the same level. I like to understand why you think the dividend is sustainable. Thank you.
Gabriel Tolchinsky -- Chief Executive Officer
Sure. Thank you, Michael. Those are four very relevant and good questions. Let me start with the spreads. And I think that what's been happening in 2018 in an increasing interest rate environment, U.S. interest rate environment, is that economic activity for Latin America and consequently demand for credit has been pretty stagnant in the region. And as such, banks which are still with quite a bit of liquidity, banks that operate in the region both international banks and local banks, basically compete to deploy that liquidity in an environment in which demand for credit is essentially going nowhere.
So, of course, I'm painting everything with a very broad brush, but that essentially has been the situation. That tends to end at some point because U.S. a higher US interest rate, tend to create a capital withdrawal from emerging markets in general, and Latin America in particular. And then it leads to an environment in which liquidity subsides and it becomes a more interesting environment for us to be able to make loans that at better levels and focus on the type of credits we'd like to focus on. So that is the very big picture story on spreads.
As far as the severance, we've announced a restructuring in 2000 -- in the first quarter of 2018 and we believe that the bulk of that is behind us. We are very much in the mindset of optimizing the business and making it efficient, that means that obsolete resources whether it's of the human kind or whether are we're talking about our technology or the operating infrastructure, we will continue to see points and areas in which we can lower costs. And sometimes in order to lower cost and get a lower base, you need to spend some money. We don't want to be shy about it and we want to really position the bank, not for the next quarter, but for the next year, two years, five years and more. Bladex, we believe is very relevant to its shareholders, to Latin America as a whole, we believe we have a role to play and it is our job as a management and for the Board of Directors to position the bank accordingly for the long run.
Now with respect to ROE, as you've probably heard us mentioning before, we don't provide forward guidance. We are very cognizant that our cost of equity is below the ROE -- it's above the ROE, the bank has been delivering. And we intend to do our best both from the improvement on cost side as well as our capacity to originate more business, to get us to our cost of capital, without making any promises as to whether that's going to happen the next quarter, in the next two quarters or the next year. But that is our goal. And it's with that in mind that we are doing what we're doing with a long term vision in mind.
As far as the dividend, we are very comfortable that we can deliver earnings to be able to maintain our dividend and maintain very solid capitalization. So with that in mind is that the Board of Directors determined to maintain our dividend. And as long as we believe that we can maintain our solid capitalization and not be depleting it over time and maintaining capitalization through solid earnings, we will continue to pay our dividend.
Michael Holm -- -- Analyst
Okay, thank you very much. Appreciate the commentary.
Gabriel Tolchinsky -- Chief Executive Officer
Thank you, Michael.
Operator
Thank you. (Operator Instructions) At this time, I'm showing no further questions in the queue. I would like to turn the call back over to Gabriel Tolchinsky for closing remarks.
Gabriel Tolchinsky -- Chief Executive Officer
Thank you, Jonathan, and thanks everybody once again for joining us. We look forward to talking to you guys again at the end of the fourth quarter for our fourth quarter results and yearly results. And with that in mind, as you know, both Ana Graciela's office and mine are open to talk to you and communicate with any questions, any follow up questions you may have. Thank you very much for joining us, and everybody have a good day. Thank you.
Operator
Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.
Duration: 44 minutes
Call participants:
Gabriel Tolchinsky -- Chief Executive Officer
Ana Graciela de Mendez -- Chief Financial Officer
Yuri Fernandes -- JPMorgan -- Analyst
Michael Holm -- -- Analyst
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