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Bladex (NYSE:BLX)
Q2 2018 Earnings Conference Call
Jul. 20, 2018 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, everyone, and welcome to Bladex second-quarter 2018 conference call on this 20th day of July 2018. This call is being recorded and is for investors and analysts only. If you are a member of the media, you are invited to listen only. Bladex has prepared a PowerPoint presentation to accompany their discussion. It is available through the webcast and on the bank's corporate website at www.bladex.com.

Joining us today are Mr. Gabriel Tolchinsky, chief executive officer, and Mrs. Ana Graciela de Mendez, chief financial officer. Their comments will be based on the earnings release which was issued today.

A copy of the long version is available on the corporate website.

Any comments made by the executive officers today may include forward-looking statements. These are defined by the Private Securities Litigation Reform Act of 1995. They are based on information and data that is currently available. However, the actual performance may differ due to various factors, which are cited on the safe harbor statement in the press release.

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 and thank you for joining us today.

Before Ana Graciela delves into key aspects of our earnings results for the second quarter, I would like to discuss some of the important developments that took place during the quarter and our expectations for the remainder of 2018 for the Latin American economic and business environment, and how this may impact our perception of risk and financial results.

The second quarter was actually a tale of two quarters. During the first half of the quarter, expectations for economic growth and trade in the region were optimistic. Low perception of credit risk, tight lending spreads, resulting primarily from abundant liquidity in key markets were the norm and a relatively benign environment prevailed.

In early May, the IMF issued a report declaring that growth in Latin America and the Caribbean is picking up, thanks to stronger demand at home and a favorable global environment, helped also by rebounding commodity prices. Furthermore, they predicted that growth in South America, led by the end of the recession in Argentina, Brazil, and Ecuador, higher commodity prices and a moderation of inflation has provided space for monetary easing. And in the near term, Mexico, Central America, and parts of the Caribbean are benefiting from stronger growth in the United States. They did, however, caution that heightened economic risk externally notably has shifted toward more protectionist policies, and a sudden tightening of global financial conditions could weigh heavily on growth prospects.

The IMF report had good reason to urge caution.

In May, the Argentine currency started depreciating, leading to a $50 billion IMF rescue package. On May 21, a truckers strike in Brazil protesting rising petrol prices brought the resignation of Petrobras CEO Pedro Parente by June 1. In Mexico, presidential candidate Andres Manuel Lopez Obrador, who was not viewed as pro-business, was the clear favorite for the July 1 Mexican election. These developments set the stage for what was going to become a more uncertain second half of the quarter.

Parallel to these developments in Latin America, the U.S. was setting its targets for tariffs in an ever-expanding trade battle with China, its NAFTA partners, and the EU. After announcing tariffs on a limited number of Chinese goods and exempting Mexico and Canada from steel and aluminum tariffs in early April, by May 23, the U.S. administration announced tariffs on vehicles and car parts, vastly expanding the scope of a potential trade conflict by adding up to $359 billion in goods.

And then, on June 1, Mexico and Canada got included in the list of countries for steel and aluminum tariffs. All in all, by the end of the quarter, $582 billion worth of goods were subject to new tariffs. Today, $874 billion of goods are subject to U.S. tariffs.

On July 16, the IMF issued a revised report for world growth, titled, Less Even Expansion, Rising Trade Tensions, and downgraded its 2018 economic growth prospects for Latin America from 2% to 1.6%. Furthermore, the IMF put Argentina, Brazil, and Mexico on review for possible downward revisions to growth due to recent developments.

Furthermore, when we speak of higher commodity prices, we miss specific situations like sugar that affect producers in Brazil which fell in the international market. Sugar has been in a protracted bear market, trading significantly below the marginal cost of production for many Brazilian producers. Uncertainty and tighter lending conditions in our region ultimately benefit Bladex through higher lending margins. For example, our short-term origination margins in May and June were 14 and 11 basis points above margins of maturing, short-term loans.

These were the first two consecutive monthly increases in over a year but, our assessment in that lower growth prospect in key markets also increases credit risk for our performing loan portfolio and can impact recoveries for problem loans. That said, we expect our top line to continue to improve. We're working hard to increase the average tenor of our origination in the second quarter. For example, our average origination tenor more than doubled from 101 days in the first quarter of 2018 to 227 days in the second quarter.

And as you'll hear from Ana Graciela, we're making progress in fee income generation and getting new clients.

We continue to make improvements in productivity and efficiency as we examine and improve our workflow processes. In that effort, we are identifying systems and applications that have become obsolete under the revised workflow, and we're riding these off accordingly. Against this backdrop, the management of Bladex, as well as its board of directors, is cautious about the outlook for the third quarter but we look for an improvement in profitability toward the end of 2018 and into 2019.

With these initial and brief comments, I will now turn over the call to our CFO, Ana Graciela, to provide you with more color about our financial performance in the second quarter of 2018.

Ana Graciela de Mendez -- Chief Financial Officer

Thank you, Gabi. Good morning and thank you all for your participation and interest in our company.

I will now refer to the quarterly earnings results presentation uploaded in our website. On Page 3, we summarize and highlight the main drivers for the quarterly results, which I will go over in more detail throughout the presentation.

So, let's move on to Page 4. During the quarter, the bank increased its loan origination by 21% to $4.3 billion of which $538 million, or 12.5%, represented medium-term loan disbursement, with an average tenor of about 2.5 years and net lending spreads exceeding 135 basis points those of short-term origination. We should see the benefits of longer tenor portfolio growth translating to improved net interest margins in the coming quarters. Moreover, we continue to have a solid pipeline of medium-term transactions with our traditional client base of top financial institutions, exporting corporations, and what we call multi-Latina, which are companies that operate throughout the region.

Short-term origination remained strong during the quarter at $3.7 billion, the majority of which was trade finance and which exceeded $3.6 billion of maturing short-term loans. All of these factors led to a 6% quarter on quarter and 4% year-on-year increase in our commercial portfolio to $6.1 billion at June 30, 2018.

On Page 5, we present the trends in net interest income and margins. During the second quarter of 2018, the bank reversed the recent quarterly declining trend in net interest margin, achieving a 13-basis-point quarter-on-quarter increase to 1.81%, a similar level than a year ago. Net interest income of $27.9 million increased by 5% quarter on quarter on the account of higher net interest margin as the bank benefited from increasing market interest rate, given its narrow interest rate gap structure, which allowed us to pass along LIBOR-based rate increases in funding to our asset base. Year-to-date, net interest income of $54.5 million and net interest margin of 1.75% still remained at lower levels from a year ago due to narrower net lending spreads as a result of the bank's focus on short-term originations throughout 2017 and during the first quarter of 2018, and also due to higher U.S.

dollar liquidity in the region.

Now, moving on to Page 6. Fees and other income increased to $5.6 million in the second quarter of 2018, more than doubling the preceding quarter's results, mainly due to the closing of two syndicated loan transactions for a total of $268 million to two financial groups, namely Promerica and Banco Aliado. The bank continues to see a solid syndications pipeline for the remaining of the year where we are already working on two mandates to be executed shortly. Income from letters of credit and contingencies remained very consistent and relatively stable quarter on quarter, with an increasing trend year on year.

Slide No. 7 shows operating expenses and efficiency, which reflect an overall quarterly declining trend. The quarter-on-quarter decrease is salaries and other employee expenses mostly relate to the annual variable compensation expense incurred in the first quarter of this year. The Bank continues its effort on cost control and increased productivity in order to achieve improved levels of efficiency.

On Page 8, we present the commercial portfolio, including loans, letters of credit and other contingencies. Brazil remains our main exposure at 17% of the total portfolio, a relatively stable level since a year ago. Fifty-four percent is trade-related, 61% is with financial institutions, and it is predominantly short-term, with an average remaining tenor of around 3.5 months. Other significant country exposures are Mexico with 15%, followed by Colombia at 12% while Argentina's exposure was increased to 9% during the quarter, 81% of which is related to trade, and with an overall average remaining tenor of 10 months.

Total portfolio exposure remains well-diversified in terms of countries and industry with an increasing and predominant exposure in the financial institutions sector, the Bank's traditional client base representing 50% of the total commercial portfolio at June 30, 2018, followed by the overall oil and gas sector that is integrated, downstream, and upstream, which represented 17% of total exposure, and sugar was 5%. The remaining exposure is well-diversified among several industry sectors, none of which exceeded 4% of total exposure. Total portfolio continued to be mostly short-term, with an average remaining tenor of 9.5 months and 81% maturing in the next 12 months.

As presented on Page 9, NPL balances stood at $54.3 million at quarter-end, or 0.98% of the total loan portfolio, with a reserve coverage of 1.6 times. The $4.5 million quarter-over-quarter reductions in NPL balances reflected a write-off against individually allocated reserves, which were established in prior years. In addition, the bank registered a loss of $1.1 million on investment properties at fair value and an impairment loss on other assets for $1.7 million, both of which related to the deterioration of assets acquired by the bank as a result of a distressed workout situation. Allowances for expected loan losses increased by $3 million due to loan loss provisions of $7.5 million from higher end-of-period loan balances net of loan write-off of $4.5 million.

This increase in the allowance for loan losses was offset by a $5.7 million relief in allowances for expected credit losses on off-balance sheet items, mainly due to improved mix in the letters of credit exposure. The net effect in quarterly results was a net credit loss provision charge of $1.8 million, compared to $2 million in the first quarter of 2018 and $4 million in the second quarter of 2017.

On Page 10, we describe the composition of the Bank's funding sources. Deposits from Latin American central banks, our Class A shareholders continue to be a reliable and cost-effective source of financing, accounting for 73% of total deposit. The Bank's solid funding structure also derived from geographic tenor and product diversification. The increase in funding costs relates to higher market rate while the Bank has been able to decrease its funding spreads.

Page 11 shows Bladex's stock price evolution, which has recently been trading below book value. Today, the bank announced its quarterly dividend of $0.385, unchanged for more than three years.

Now, going back to Page 3, I would like to summarize the key takeaways of this quarterly result characterized by solid commercial portfolio growth, driven by the continued short-term trade loan originations, coupled with increased medium-term lending to our top-quality client base; reversal of a downward trend in financial margin; enhanced quarterly top-line income; improved efficiency, reflecting the Bank's continued focus on increasing productivity throughout the organization; and close monitoring and proactive management of troubled credit exposure in a continually defiant economic and political environment in the major Latin American markets.

I will now turn the call back to Gabriel to open the Q&A session. Thank you.

Gabriel Tolchinsky -- Chief Executive Officer

Thank you, Ana Graciela, and I leave it up to you, Jonathan, to open it for the Q&A.

Questions and Answers:

Operator

Thank you. At this time we'll open the floor for questions. [Operator instructions]. We'll take our first question from Yuri Fernandes with J.P.Morgan.

Yuri Fernandes -- J.P.Morgan -- Analyst

Thank you, Ana Graciela, Gabriel, for an opportunity of taking questions. I have the first questions on impairments. My question is, how recurring are those items? My understanding is, this is related probably from past vintage that was like some recoveries of loans, things like this. So, I am not sure if we should continue to see such high impairments going on.

So, that's my first question, the recurrence of those items. And my second question is about volumes in Argentina. We saw it was a great quarter for Argentina, it was one of the main drivers of the growth but, given the crisis in Argentina today, how do you see the prospect of growth there? I understand that maybe, given the higher efficiency in Argentina that may be actually good for you for exporting in the country but, just to have a better glance on how that may be, I don't know, challenging for future growth for Bladex. Thank you.

Gabriel Tolchinsky -- Chief Executive Officer

Thank you, Yuri. Thank you for your question. Let me start addressing first the impairments question. I think that we are cognizant that the environment has turned, the context has turned a bit more challenging overall in Latin America.

And as such, we want to monitor our credit risk exposure and make sure that the exposure we have goes along with the context and it's able to withstand what could be a little bit stronger negative when coming out of the three major economies, meaning Mexico, Brazil, and to some extent Argentina as well. I think that your comment about these impairments being related to previous restructurings or problem loan positions, that comment is correct. Now, we want to be cognizant of the fact that this is the more challenging environment. So, we will be monitoring our exposure and correcting things accordingly.

With respect to your question about Argentina, it's important to understand that transactions get worked over a period of time. And some of these transactions we've been working on that for quite some time. These are very good names, all with U.S. dollar generators.

And as you correctly pointed out, when the waters get a bit more turbulent, that turns into an opportunity for us. We focus on what we consider very good credit names and U.S. dollar hard currency generators, and we're comfortable with the exposure that we've gotten and the growth that we had so far.

Yuri Fernandes -- J.P.Morgan -- Analyst

OK. So, just a follow-up on the first point, on let's say the cost of risk sustainability. So, it's fair to assume some worsening going on, maybe as the Graciela was talking about, maybe share gain, or you may see maybe the cost of risk running at higher levels than the first and the second quarter, right?

Gabriel Tolchinsky -- Chief Executive Officer

I think it's a question for how long we will experience this environment. If it persists, if the Brazilian economy because of political uncertainties gets into a more protracted downward trend, that will increase our perception of credit. I think Brazil is a good example in terms of the prevailing framework that we were working with, a little bit of a decoupling between the political side and the economic side. We started seeing the Brazilian economy truly recovering at the beginning of the year.

We had growth expectations north of 2%, somewhere between 2% and 2.4%. And I think that trucker strike clearly showed us that politics and economics in Brazil have not completely decoupled. We're entering the final stretch of the election. We see the kind of the two extremes of choices being at the top of the list, both on the right and the left.

So, it's important to be cognizant of that context and understand that if the Brazilian economy is not able to recover, that will naturally flow through into higher cost for credit in Brazil, same with the election of AMLO, Andres Manuel Lopez Obrador, in Mexico. We are very open to hear and see what he is going to do, how NAFTA negotiations are going to move forward with his election. These are all kind of too early to tell situations. And as they evolve, we will act accordingly.

Operator

Thank you. Our next question comes from Greg Eisen with Singular Research.

Greg Eisen -- Singular Research -- Analyst

I want to go back to Argentina, if I may, and ask, could you tell us what the average tenor of the loan book that you have in Argentina at quarter-end was, what was the average tenor then?

Ana Graciela de Mendez -- Chief Financial Officer

It was 10 months. That's the average tenor of the portfolio.

Greg Eisen -- Singular Research -- Analyst

And I was going to ask if the loans themselves are dollar-based loans as opposed to being repaid in Argentinean currency, generally speaking.

Ana Graciela de Mendez -- Chief Financial Officer

Yes.

Greg Eisen -- Singular Research -- Analyst

You said that the companies, the lenders, borrowers are dollar generators but are the loans themselves dollar-based?

Ana Graciela de Mendez -- Chief Financial Officer

Yes. All of our credit exposure is U.S.-dollar-based or most of it or either ... and it is the same as our funding. Our book is basically dollar based.

Gabriel Tolchinsky -- Chief Executive Officer

We have small exposure in Mexican pesos but no exposure whatsoever to the Argentinean peso.

Ana Graciela de Mendez -- Chief Financial Officer

Or any other Latin American currency.

Greg Eisen -- Singular Research -- Analyst

Right, OK but just moving on, given the stress on the local economy in Argentina of the devaluation, can you talk about how you view the risk to your outstanding loans there and then just the risk of developing any new business there, given this devaluation? How do you see it playing out with your customers? Are you more worried than you were before because of this?

Gabriel Tolchinsky -- Chief Executive Officer

Well, first of all, thank you for your questions, Greg. And I think that we actually feel very good about it. Argentina is a very interesting place in terms of how devaluation is going to flow through to the cost structure of corporations and how they flow through the economy in general. I believe Argentina is one of the countries that for not being dollarized, the flows through to inflation is around 0.7, so meaning for every dollar equivalent of the devaluation of the currency $0.70 will flow through to the inflation.

So, it has a very quick impact. That being said, the fact that the cost structure of these exporters that we focus on have been in pesos, and they sell in the dollar. The credit profile of our average Argentine borrower actually improves under depreciation of the currency environment. So, we feel very good about it.

Let me just say one more thing that I neglected to say with respect to our Mexican peso exposure. Whatever we do in Mexican peso is much funded also in Mexican pesos or hedged. So, the resulting net exposure is dollar exposure. So, for all intents and purposes, the Bank has no foreign currency exposure in its book.

Greg Eisen -- Singular Research -- Analyst

That's great news. I appreciate you telling us that. If I could ask another question, could be unrelated to that, regarding the syndication business. You had a good quarter in syndication revenue in the fee income line.

Could you talk about the size of the pipeline in terms of the dollar value size of potential syndications? Are we looking at under $100 million in the pipeline or $100 million to $200 million, or give us a range so we have some idea if there is going to be some kind of continued fee income in the next couple of quarters from this syndication side of the business?

Ana Graciela de Mendez -- Chief Financial Officer

Sure, Greg. Thank you, again for your question. Yes. The pipeline, as you saw this last quarter, we closed two transactions and in total, they represented $268 million in assets.

So, as I mentioned, we already have two more being executed at the time. And the range usually is ... are similar levels. We would say, it's between a 150 million to $700 million in the pipeline that transactions that we're looking, not necessarily these ones that we're working on right now. I cannot disclose the exact amount but I can give you a range.

The size of the transactions that we usually do is between a $100 and a $150 transaction and we have already two in the process and we look forward to a strong pipeline of several transactions being negotiated at the time.

Operator

Thank you. [Operator instructions]. Mr. Tolchinsky, at this time, I am showing ... My apologies, there's one question from Arthur Byrnes with Deltec Asset Management.

Arthur Byrnes -- Deltec Asset Management -- Analyst

I am sorry to being so late on this but, can you tell me going forward, is the focus still on trade finance or are you doing things that are longer term and less trade finance-oriented? And if so, what's the breakdown of the portfolio, the way you would like to see it?

Gabriel Tolchinsky -- Chief Executive Officer

Understood. Thank you, and very, very good question. We see Bladex's mission as going in two directions. One is trading for Latin America and the other one is regional integration in Latin America.

And those are two of our main focus for origination, both on our short-term as well as our medium-term exposure. We really have almost no long-term exposure in the book. We very often function as let's call it the reference bank for a Colombian corporation that wants to do business in Mexico but does not have established banking relationships there and we know them and have been doing business with them in Colombia. We understand their business and are able to be there for them as the bank of reference when they start their operation in Mexico.

So, view us in that context.

In terms of portfolio allocation, the trade will always represent somewhere between 54%, 55%, and let's call it 65% of our book. That's what it's been historically, and you should expect that to continue to be the case. The remaining part of the portfolio, which is more with what we call multi-Latinas that are entities that have business interests and exposures throughout the region and represents the remainder of that exposure.

Arthur Byrnes -- Deltec Asset Management -- Analyst

And what type is that loan for? Is it a construction loan to open a factory somewhere else and therefore longer term, or what is the other 40% meant to look like in terms of the type of loan? I know it's multi-Latino and all that but, what really is it?

Gabriel Tolchinsky -- Chief Executive Officer

It's generally related to lending to eventually get them to have production capacity for export-related businesses and also expansions that financial institutions do in Latin America. We have significant exposure to banks mostly and other forms of financial institutions but very often they expand beyond their borders, and we're often there for them.

Arthur Byrnes -- Deltec Asset Management -- Analyst

And the tenor of that kind of loan is average?

Gabriel Tolchinsky -- Chief Executive Officer

On average it's about three years and I would say three to five years. Three years should be the kind of average.

Arthur Byrnes -- Deltec Asset Management -- Analyst

Adjustable rate?

Gabriel Tolchinsky -- Chief Executive Officer

Absolutely.

Arthur Byrnes -- Deltec Asset Management -- Analyst

Very good. I appreciate your answer. Good luck.

Gabriel Tolchinsky -- Chief Executive Officer

Thank you.

Operator

Thank you. [Operator instructions]. We'll take a follow-up question from Greg Eisen with Singular Research.

Greg Eisen -- Singular Research -- Analyst

I just had a question about your capital ratios. And specifically, given that the company's earning what we call it mid-single-digit return on equity right now, most stock analysts would describe your balance sheet as probably having excess capital at this time. Given your current outlook and the board's attitude to the situation, is the company and the board predisposed to reducing the capital to improve returns, or do you want to hold on to the existing excess capital in order to, No. 1, fund future growth which you think the future will be a lot better than the recent past; and No.

2, provide a cushion for the inevitable rainy day when the next recession comes?

Gabriel Tolchinsky -- Chief Executive Officer

Greg, thank you very much for your question. That is a very good question. I would say that the answer is both. We view our strong capitalization as a solution for what is a turbulent region, and we're very happy that we have that.

At the same time, that turbulence is what creates an opportunity for us. While local players get thrown off by the changing environment in the countries every time that crisis ensues and the big financial players, international players shy away from emerging markets and the region whenever there is these type of uncertainties, Bladex is always there and can spot the opportunity and act accordingly. So, having the strong capitalization enables us to both weather the storm or the bad weather, in whatever form it comes, and it also allows us to capitalize on the opportunity that is created from a higher-margin, lower-liquidity environment. And that is what should ultimately fuel our growth and our capacity to deliver significantly higher earnings.

Operator

[Operator instructions]. At this time, I'm showing no further questions in the queue. I would like to turn the floor back over to Mr. Tolchinsky for closing remarks.

Gabriel Tolchinsky -- Chief Executive Officer

Thank you, Jonathan, and thanks, everyone, for participating in this call. And thank you for your support of Bladex and the name of the board of directors, the employees of Bladex and my name. I look forward to talking to you on our next quarter conference call. And we're always open to dialogue with whoever would like to contact us and talk to us in the meantime.

Thank you.

Operator

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

Duration: 41 minutes

Call Participants:

Gabriel Tolchinsky -- Chief Executive Officer

Ana Graciela de Mendez -- Chief Financial Officer

Yuri Fernandes -- J.P.Morgan -- Analyst

Greg Eisen -- Singular Research -- Analyst

Arthur Byrnes -- Deltec Asset Management -- Analyst

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