Bancolombia’s (CIB) CEO Juan Carlos Mora on Q2 2016 Results – Earnings Call Transcript

Bancolombia S.A. (NYSE:CIB)

Q2 2016 Earnings Conference Call

August 18, 2016 9:00 AM ET

Executives

Alejandro Mejia – Investor Relations Manager

Juan Carlos Mora – Chief Executive Officer

Jose Humberto Acosta – Chief Financial Officer

Juan Pablo Espinosa – Chief Economist

Jorge Humberto Hernandez – Chief Accounting Officer;

Analysts

Ernesto Gabilondo – Bank of America Merrill Lynch

Thiago Batista – ITAÚ BBA

Tito Labarta – Deutsche Bank

Nicolas Riva – Citi

Catalina Araya – JPMorgan

Neha Agarwala – HSBC

Sebastian Gallego – Credicorp Capital

Natalia Casas – Ultraserfinco

Operator

Good morning, ladies and gentlemen. And welcome to Bancolombia’s Second Quarter 2016 Earnings Conference Call. My name is Sylvia and I will be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. [Operator Instructions] Please note that this conference call will include forward-looking statements, including statements related to our future performance, capital position, credit-related expenses and credit losses.

All forward-looking statements, whether made in this conference call and future filings and press releases or verbally, address matters that involve risks and uncertainties. Consequently, there are factors that could cause actual results to differ materially from those indicated in such statements, including changes in general economic and business conditions, changes in currency exchange rates and interest rates, introduction of competing products by other companies, lack of acceptance of new products or services by our targeted clients, changes in business strategy and various other factors that we describe in our reports filed with the SEC.

With us today is Mr. Juan Carlos Mora, Chief Executive Officer; Mr. Jose Humberto Acosta, Chief Financial Officer; Mr. Jorge Humberto Hernández, Chief Accounting Officer; Mr. Alejandro Mejia, Investor Relations Manager; and Mr. Juan Pablo Espinosa, Chief Economist.

I would like to turn the call presentation over to Mr. Juan Carlos Mora, CEO, Bancolombia. Please proceed, sir.

Juan Carlos Mora

Good morning, everyone. First, I’ll like to thank you for being with us in Bancolombia’s second quarter conference call. Today, we are going to share with you the recent developments at Bancolombia as well as some strategic goals as we move forward in the second half of the year. First of all, I’d like to highlight that the evolution of the business during the second quarter was very positive. With strong performance of NIMs net long volumes on fee generation. The profit level for the second quarter has put us in line with our financial targets for the year.

During the quarter, we generated COP 733 billion in net income which represents an annualized ROE of 15.2%. In particular, we saw good revenue performance and improved efficiency. During the quarter, we are continuing seeing a moderation in the pace of economic activity in Colombia. Nevertheless, the depreciation of the peso over the last two years has created positive conditions for exporting and for import substitution and today we see a natural adjustment of the economy structure of Colombia. Less dependence on oil and more emphasis on local production.

Going to our business, we saw positive trends in particular in the following items. First, conversion of the growth of the loan portfolio towards the target of 10% for the year 2016. Corporate and mortgages are leading that growth. Construction of residential real estate remains dynamic and the first growth of the 4G projects are started to gain traction. Meanwhile the consumer book is moderating its growth to our projected pace for the year.

The growth in the peso denominator portfolio was 15% year-on-year while the US dollar denominator portfolio decreased 1% when we exclude Banco Agromercantil assets.

Second, as we were expecting NIMs continue to expand and that has allowed us to grow cumulative net interest income of 13% — 33% I am sorry, compared to 2015. At the same time, we maintain our efforts to keep the funding cost as low as possible while extending the average life of the stock of term liability.

Third, we saw moderated formation of new past due loans. This quarter we reached a list of joint agreement with Conalvias and the client stopped being considered past due. Nevertheless, we kept allowance on our balance sheet. Additionally, we experienced very good performance of the dollar denominator portfolio in Panama and El Salvador which also contributed to the growth of the book in the quarter.

We continue making significant provisions in order to keep the coverage ratio at the level that give us comfort and the originations standards and scoring models have been adjusted to include a lower forecasted GDP growth.

Fourth, fees continue growing in a very healthy way. 17% for the first six months of the year in particular banking fees and insurance distribution fees are the leading services. We will continue developing our strategy to enhance fee generation. In the capital front, as we had projected we are operating in the range between 8% to 9% for Tier 1. We saw how the level of the bank ended at 8.5%. This has been a combined effect of moderation in the loan growth and some actions taken to improve the capital consumption. And last, we saw a very positive trend in efficiency front. Our efforts of cost cutting and budgeting in all geographies as well as a very good growth in operation income resulted on an efficiency rate of 48% for the quarter.

To summarize the operational performance is very positive and we estimate that the second half of the year we will continue down this path.

In addition to the financial performance I’d like to share with you some aspects of our strategy regarding innovation and client experience. This part of our business plan focuses on addressing the challenges that the financial services industry is facing. First, we announced strategic agreement with First Data, a global leader in commercial enabling technology to integrate and strengthen our technology platforms in order to improve and diversify services for business owners in Colombia. We will focus on building commerce technology solutions for merchants and facilitating access to the banking system, offering advanced technology and secured efficient transactions. As a result, we expect that the acquiring fees will grow faster as more of our clients will be able to pay with card.

Second, we are making a lot of progress in the operational efficiency of our processes. As an example, we have simplified retail consumer engagement. We will make the process of opening new account faster, cheaper and more convenient for our clients. And lastly, we continue making progress in our digital banking strategy. Our platform Nekee [ph] is fully operational. The idea behind Yakee is to provide home bank retail clients with an easy to use platform to manage their cash transfer and transfer it to relatives and friends at no cost whatsoever and with nominal balance requirements.

Our financial results for the year are the backbone of achieving superior ROEs and I will reiterate the bank’s focus and commitment to generate sustainable higher levels of profitability. I’d like to emphasize that lifting profitability in all geographies added to the boosting efficiency will be the two fundamental driver going forward to reach our performance goals. Having said these, I’d like to continue with the detail presentation of Bancolombia’s financial results for the second quarter of 2016.

Now I’ll turn the presentation over to Humberto Acosta will elaborate on the main topics that impacted our business in this period. Acosta?

Jose Humberto Acosta

Thank you, Juan. Slide 3 shows the profitability of the bank. As you can see the second quarter show so much improved bottom line thanks to the good performance of the bank revenue. In particular, net interest income coupled with a lower effective tax rate and lower tax charge off are seen in the first quarter. Profit before tax continues to demonstrate strong 23% year-over-year. Also, provision has been increasing this year due to the trepid economic environment and this understandable put a track on the net income growth. Regarding taxes, we forecast an effected tax rate of approximately 38% for the year. Assuming a year end FX rate similar to the current one, 3,000 pesos per dollar. Nevertheless, as we have previously mentioned a tax rate for the year will be subject to any variation in exchange rate. We will only know that tax payable at the very last date of the year. All included, we are very satisfied with this results because they show the strength of Bancolombia. The ability to fund a bank at the lowest cost in the market where we operate. The capacity to transfer interest rates to the asset side and the ability to generate capital in our organic manner. Moreover, we take advantage of a strong distribution network more than 7 million customers in Colombia along with our bank’s strong local capital market position.

Now we’ll like to continue with the brief discussion about the economic environment. For this purpose we have

Juan Pablo Espinosa, Bancolombia’s Chief Economist who will elaborate more on this market. Go ahead Pablo.

Juan Pablo Espinosa

Thank you, Humberto. Now I’ll ask you to go to slide number 4 in the presentation. During the past few years Latin America has been experiencing a period of poor economic growth due to the combination of global headwinds, internal borrow mix and limited policy support. However, beyond this general trend there are significant differences across countries. While some economies will still be stuck in recession, others will grow below the overall trend and a last group will manage to expand above the average of the past decade.

In Central America, several countries are benefiting from low commodity prices and a stable growth in the US. As a result, we forecast that this year Guatemala and El Salvador will expand by 3.6% and 2.3% respectively. In the case of Panama, we expect that growth will continue to converge to its potential rate with an estimate variation by 5.7% this year. Moreover, over the medium term we expect these countries to accelerate further and this would allow credit to grow at consistent pace. For Colombia, leading indicator suggest that the moderation in activity intensify during the second quarter. In fact, we’ve recently revised our full year 2016 growth forecast from 2.6% to 2.4%. We think that growth will be affected by contractive monetary and fiscal policy, which will coincide with a lackluster performance of private investment and a less solid internal consumption. Furthermore, due to lack of significant short-term growth catalyst and the uncertainties surrounding the discussion of that tax reform which will be possibly submitted to Congress next October, we think that risk to our baseline scenario are biased to the downside. In a less rosy scenario GDP growth would moderate to 1.8%. Due to the pro cyclical nature of credit markets, we expect that these deceleration of economic activity in Colombia will translate to a less dynamic growth of loans particularly in the commercial, consumer and mortgage segment which are more sensitive to changes in interest rate and in confidence level.

Regarding inflation, Colombia is the exception in a tendency of low price pressures. In fact, the latest 12 months inflation trend is almost 9%, the highest since the inflation targeting redeem was introduced in 2000. But as the second half passes and the economy cools off, we expect that price pressure loose steam. We foresee that inflation will close this year at 6.5% and that it will converge to the ceiling of the target range in late 2017.With these prospects of moderating inflation and higher risk to grow our monetary policy call is that the

Central Bank will remain on hold for the rest of the year. Given that the transformation of monetary policy actions to interest rate has been traditionally is low and lengthy process. We expect that during the next month the market will continue to absorb the tightening in cycle that has taken place so far. In turn, this should lead to a stable behavior of net interest margin in the Colombian financial sector. In Guatemala, we expect that inflation will close this year at 3.8% and that 25 basis points hike in the reference rate is likely in order to keep inflation expectations under control.

Finally, in the dollars economies of Panama and El Salvador inflation and the interest will remain low in line with the trend in the US.

Let me conclude this section by saying that the difference macro trend across the countries in which group of Bancolombia operate will be evident during the rest of this year and this should bring in important diversification benefits going forward. After this overview of the economic environment let me turn to presentation back to Humberto who will discuss the bank’s results.

Jose Humberto Acosta

Thank you, Juan Pablo. On Slide 5, we see the evolution of assets and their composition. Some important facts about Bancolombia’s assets and loan portfolio. Today peso denominated assets represents 59% of the total assets of Bancolombia. And is organically growing at a pace of 12% while dollar denominated represents 41%. Also the Colombia peso appreciates 2.7% against the US dollar during the second quarter. Loans outside Colombia represent 38% of the total loan book. Our loan portfolio in US dollar decreased 1% during the year-over-year. All the products are growing in line with our expectations. Total assets grew 19% year-over-year in line with our organic target rate of 10% growth for the year. The incarnation of Banco Agromercantil assets six months ago along with the peso the depreciation of 12% explains this growth momentum.

Loan portfolio growth is primarily driven by commercial loans which continue to exhibit sustainable growth around 10% for the year. The average yield to maturity for the revenue portfolio 7.3% and we continue to maintain a total debt portfolio primarily for liquidity management. Also, the duration of the securities portfolio continues to remain low at a level of 18.5 months which minimizes risk in a very volatile environment.

We continue originating loans with a straight underwriting standard in order to maintain the high credit quality of the loan portfolio especially in the consumer and SME segments. The loan portfolio in US dollars decreased during the quarter affected by the FX rate we just mentioned and by the moderation in credit demand. The loan portfolios growing list that we saw last year in 2015 which is perfectly fine and in line with our risk and credit standards. Since the Colombian economy will be growing around 2.4% for this year and 2.7% for next year.

Nevertheless, we are starting to perceive opportunities in some sectors of the economy such as manufacturing, tourist and infrastructure. Many of these sectors have been positively impacted by the weak peso. That is why we are slightly increasing our growth forecast for 2016 to the level of 10% growth. We will still focus our growth in the less risky products as we want to maintain a very healthy balance sheet. It is also important to mention that Bancolombia’s balance sheet is match in terms of currency which reduced the effects of FX variations on the shareholders equity.

Last but not least, we want to highlight this fact that is very important to understand our view on capital. That is a high regulatory consumption for all our asset. The proportion of risk weighted assets plus market risk to total assets today is 88%, a ratio that is very high but also give us comfort because the risk weightings are very conservative in the Colombia regulatory framework.

Now on Slide 6, we present a snapshot of credit quality at the end of the quarter. In general, we saw deterioration in the quality of the consumer loan portfolio and the coverage ratio for C, D and E loans. The consumer book was impacted by three key elements. The truck drivers’ strike in Colombia. The end of the quarter usually known for their past due loan formation and deterioration of credit card business specifically in Banistmo. The overall coverage ratio improves however because of their risk of turning of Conalvias which has a significant impact.

The 30-day past due loans to total loans came at a level of 3.1% below the 3.3% we had in the previous quarter. Also the coverage ratio increased to 121% from the last quarter levels of 106%. Last quarter, we finished the provisioning of Conalvias making a small COP 30 billion dent in our P&L. We forecast to have a 30 day coverage ratio ranging from 110% to 120% in the medium term which we believe is more than enough to absorb potential credit losses. Similarly, 30 -day past due loans loan should represent between 3% and 3.2% of gross loans. This forecast includes any foreseeable deterioration of corporate client.

At the bottom of the table, we compare 30-day past due loans, which is the Colombian standard and 90-day past due loans, which is a better indicator of credit quality as we have significant portion of our assets in countries that use that standard.

90-day past due loans have been very stable over the last two years. However, they were slightly improved during this quarter, not surprisingly because of the restructuring of Conalvias. They represent 1.9% of gross loans as of June of this year with the coverage ratio of 194%.

Slide number 7 shows the provision charges, which were COP 6.28 billion during the quarter. They represent 1.7% of average gross loans when annualized.

In the shaded row of the table at the bottom, we present the amount of loans that became 30-day past due during the quarter, which is impacted by seasonal factors. The COP 24 billion new past due loans is very low specifically due to restructuring of Conalvias, which means incorporation of COP 260 billion that was now considering past due. Furthermore, total PDL was COP 4.3 billion.

As we have talked about it in recent months, the central bank continues to hike rate. And we have now at all time high which translates positively into better margin but does have a negative effect over the broader economy. Delinquencies are on the rise and the bank must decide in growing list or otherwise taking on more risk. We believe we have a sufficient amount of risk appetite and have not made a change to our initial strategy from the beginning of the year. We will continue monitoring the performance of the portfolio and making sure that the new vintages are disbursed under more stringent underwriting standard.

Moving on to slide number 8, we see the evolution of the net interest income and funding cost along with funding composition. This is the most positive trend in our business because over the last 12 months we have been able to grow NII much faster than the volumes of loans and as a result the operating income of the bank has grown steadily as well. This is a combined effort of two fronts. First, optimizing the funding terms in order to keep cost as low as possible; and second, pricing loans at higher spread.

NII for this quarter was COP 2.4 trillion, 37% greater than the same quarter of the previous year, driven by first higher loan volumes, which grew 20% over the last year. Second, higher spread of new loan originations, third, depreciation of the Colombian pesos versus U.S. dollar which was 12% in the last 12 months, the 265 basis points increase in DTF, which is the benchmark rate that we use to price a significant portion of our loans, specifically in Colombia and as a result an improvement in NIM.

Bancolombia’s funding cost was slightly pressured upwards, mainly by higher cost on long-term debt and also by the Central Bank interest rate hikes and a relatively tighter liquidity environment has increased funding competition among banks. The total funding cost increased by 27 basis points during the quarter, while the Central Bank’s reference rate increased 125 basis points and the DTS [ph] increased 50 basis points. These increases exemplified one of the Bancolombia’s competitive advantages, which is a fact that about half of our deposits in our operation in Colombia are not sensitive to the interest rate. And therefore, our funding costs grow significantly less than the Central Bank’s rate. On the other hand, a large proportion of our loans were priced with higher rates, and the NII and NIM grow as a result of this dynamic.

During this year, we have focused our efforts not only keeping the funding cost as low as possible but also on increasing the average time to maturity of the stock of liabilities, in particular, time deposits and long-term debt. On a positive note, we feel we were competitive in the funding market during the second quarter. Although, there were some pressures on the time deposits and we have to recognize a higher interest on the new CDs, as you can see with cost of deposits rising 36 basis points over the quarter. The trend in interest rate hike, increasing funding cost and NIM expansion that we have seen in recent months should stabilize in the second half of this year, as we believe that we have captured a significant portion of the benefits already this first half of the year.

Our goal is to keep funding cost as low as possible, which have been able to achieve over the past months while maintaining a conservative approach to liquidity risk management, in an effort to defend our expand a NIM and grow of NII. We have in our favor, the before mentioned, asset sensitive condition of our balance sheet, which is beneficial for margins.

Turning to page on slide number 9, we show the net interest margin. During this quarter, we saw an upside in the reported net interest margin at the level of 6.1%, 44 basis points above last quarter, explained by the loans net interest margin basically. In particular, there are three main factors positively impacted the NIM during the quarter. First, the appreciation of the Colombia treasury or TES, and some other securities, even though the investment portfolio is only 7% of total assets; second, investment flows, mainly from international players entering the Colombia fixed income market; and third, more clients demanding structural projects for hedging purposes such as FX swaps options.

In the lending business, we have to link the stronger names to the asset sensitive condition of the balance sheet and to the higher spreads of new originations. Also briefly Colombia shows the strongest NIM because their repeated rate hikes during the quarter. While NIMs in Central America are significantly lower. At the end of the quarter, we had unconsolidated NIM for Colombia of 7.1% compared with the 3.8% of NIM, 6.4% in Bancolombia which is a very positive number and 4.7% in Guatemala for Banco Agromercantil operations. Despite a lower numbers in Panama and Guatemala specifically we did benefit substantially for the higher rate environment in Colombia.

A breakdown analysis of fees is presented on the slide number 10. Fees are another front where we continue to be successful as can be seen in recent results. During the second quarter, net fees increased by 6% compared to the last quarter despite an expected set back in transaction volume momentum. Banco Agromercantil assets contributed with 2.6% of the fee growth. Net fees grew 12% year-over-year and 18% on a gross level. Electronic services and ATM debit and credit card fees were a key driver of fees during the quarter. We are experiencing sustaining growth in cards and users in Colombia due to rising wages and also to the promotion of this method of payment.

We continue to see more credit and debit card transactions, as a result of our commitment to promote the use of cards for in-store transactions. In addition, we are tapping into new business segments when it comes to promoting and introducing numerous benefits and customer reward initiatives. Today, Bancolombia has 20% number of cards outstandings in the market and 33% in debit card market. Also the bank has 26% of market share of billings in credit cards and 44% in debt cards. This creates an enormous opportunity because the plastic usage is not only fee generator but also is a source of efficiency. Banking services and asset management was also a major contributor for fee growth during the quarter as well as an asset management. In addition, we saw a sustained performance of insurance distribution fees, which generated COP 91 billion during the second quarter and grew 35% year-over-year. Fees represented 17% of the second quarter operated income, which is a good share since these are transactions does not require a significant amount of capital. Our non-banking corresponding channel is steadily growing as we find new, cheaper ways to bring banking to Colombia’s most under penetrated geographies and client segments. Today, we have more than 6,000 of them.

In slide 11, we present evolution of expenses. Total operating expenses grew 21% year-over-year or COP 287 billion. When analyzing this growth in marginal terms, we find that the Banco Agromercantil at the end of this quarter represent 29% of the increase. In other words, excluding BAM, Banco Agromercantil, and the year-over-year growth would have been at 15%, which is also affected by the depreciation of the Colombian peso against the U.S. dollar over the last year. The cost of income ratio improved significantly quarter-over-quarter because of ongoing cost controlling initiatives and a strong NII growth. And was 48% for this quarter. Our target is to get these numbers under or at around 50% level of this year in the short term.

Operating expenses consist primarily of personnel expenses and administrative expenses, which have been kept under control in their respective currencies. As we have stated last quarter, Bancolombia is committed to developing low cost channels based on technological innovation and optimal customer segmentation, as we try to grow expenses in line with nominal GDP. Our guidance for this year is an increase of expenses ranging from 8% to 10% on an organic level, which we believe will be the key in obtaining strong profitability levels.

Moving to slide 12, we see the evolution of the net loans to deposit ratio, which ended the quarter at a level of 116%, slightly above the level shown last quarter. This ratio has become relatively stable over the last year and is a level where we feel comfortable. The proportion of loans that we do not fund with deposits is funded with long-term debt in order to have a similar duration of both sides of the balance sheet. This strategy reduces the volatility in the net income and shareholders’ equity. It makes more sense to us to fund long-term loans with long-term liabilities and that’s why the 116% is a level that gives us comfort about the liquidity position of the bank.

Regarding capital, on the bottom right hand side, we show the capital adequacy ratio. The Tier 1 ended at the level of 8.5%, 400 basis points above the regulatory minimum level of 4.5%. This is a very good ratio and most importantly their continuous growth in the metric leads us to reaffirm our estimation for this year will be a year of capital accumulation. Now that we talk about capital we wanted to make a reference of the rating agency action taken yesterday by Fitch. Considering the recent reviews of the sovereign rating of Colombia influenced by current account and fiscal deficit, as well as the impact of the depreciation of the Colombian peso on Bancolombia tier 1 ratio. Fitch decided to reduce the rating of Bancolombia from BBB plus to BBB. With this rating Bancolombia is at the same level of the sovereign rating and despite it is a downgrade it is still an investment grade. We continue our conversation with the rating agencies to share with them the evolution of the business and in particular our capital accumulation process. Nevertheless, as we have shared with you in the past calls, the capital levels that Bancolombia present today are optimal for the business plan that we have designed in particular we identify four factors to support our peso. First, the Colombian regulation is very conservative and the risk weightings of assets are very high. Nevertheless, Bancolombia is well above the regulatory levels and the fact gives us comfort.

Secondly, the simple leverage of Bancolombia is very low. Third, when we run our model to estimate economic capital required to operate a bank, we find that the requirement is to have a Tier 1 of 4.4%, which is very similar to the regulatory requirements. Four, 22% of our equity is in dollars which mitigate the impact of the deprecation of the Colombian peso on risk weighted assets.

And finally, given the business cycle that we are going through today, we do not see the need to have more capital. The credit growth forecast for this year is very moderate and we will organically generate the capital to achieve that growth.

As we have said before, we look to operate the bank at optimal Tier 1 ranging from 8% to 9%. For the Tier 2ratio, we ended the quarter with 4.7% for the total BIS ratio of 13.2%, above the regulatory threshold of 9%.

The slide number 13 shows the return on assets and return on equity of the Bank. The return on equity of the quarter was15.2% and return on asset was 1.5%. The return on equity rebounded is anticipate after the improvement in NIM and NII, this quarter marked more normalization of profitability keeping in mind the oncoming headwinds after rest of the year. We expect to continue growing the net income although at a moderate pace while maintaining solid solvency indicators for the rest of the year and improving profitability. Our target of return on equity for this year will in between 13% to 14% while the medium term target continues to stay at the level 16%.

After presenting these results to you, wish to reaffirm two main goals for the future, first, our focus on profitability. This will come from a combined effect of growing of our lending business and sustain a development of our portfolio services. The lending business should benefit from higher volumes and better margins as well as an optimal diversification and risk management criteria. And second, our focus on efficiency. This is a necessary condition to sustainable and profitability. Our efforts in digital transformation, increased popularity of our channel and process optimizations will contribute to this initiative and will permit the business to continue delivering value to our shareholders.

After presenting these slides and discussing our second quarter results, I would like to invite our audience to ask any questions you may have and we are gladly to take it from there. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions]

And our first question comes from Ernesto Gabilondo from Bank of America/ Merrill Lynch

Ernesto Gabilondo

Hi, good morning, and thanks for taking my call. After the recent increase in interest rates, the re-pricing on loans, and that the economic growth is slowing, how do you perceive to create demand in the coming quarters and next year? And just another question about the asset quality. We saw an improvement in NPLs but some deterioration in the cost of risk. I think mainly that was due to the consumer segment. So I just want to know to what extent should we expect this ratio to continue trending up. Or what are the reasons behind to expect stable behavior?

Jose Humberto Acosta

Okay. Thank you, Ernesto. Regarding your question the asset quality. We at the beginning of the year we talked about that our cost of credit will be at around 1.7%, today is currently 1.7%. We saw as you mentioned deterioration in the loan portfolio but we don’t expect a huge deterioration. We believe that at the end of this year our cost of credit will be between 10.7% — 1.7%, 1.8% cost of credit. Obviously because of the economic cycle we foresee any specific deterioration basically in consumer loans. What happens in our operation was deterioration in the Panama operation that we have right now under control. So just to give an answer, we don’t expect a major deterioration in the loan portfolio in the second quarter. And we believe that we will be at around 8.8% of the cost of credit. Regarding your first question, we took advantage of the high interest rate, high shelter of Central Bank, we that we will be able to sustain it in the second quarter, the challenge will be focused basically on the cost of funding. So the NIM we are expecting to sustain the NIM in the second quarter and we will be focused our effort on the funding cost. That’s the idea. As a credit demand, yes, regarding the credit demand, yes, we believe that the credit demand we aligning at a level of 10%. We saw an increase in the first quarter and then we see a reducing pace of growth in the second quarter and that third and fourth quarter will be — we see exactly a same trend. So we don’t expect a major increase in loan portfolio, neither we don’t expect a drop in the number. We are expecting as you probably hear from our chief economist meanwhile the economic is growing at a level of pace of 2.4, we are growing at a different pace of time because of typically growth in those countries are different level. So meanwhile the loan growth in Colombia would be 8% to 10%. We see for example in Panamanian operation growing at pace of 10%. Guatemala growing at a pace of 8% to 9%. So as a combination of that we will see ups and downs but at the end of day 10% would be the number at the end of this year.

Operator

Our next question comes from Thiago Batista from ITAÚ BBA.

Thiago Batista

Yes, hi, guys. Thanks for the opportunity. I have two questions. The first one on fees. You posted a material expansion in the bancassurance fee. Could you give us a little more color on your strategy on the bancassurance business? And the second one, just a follow-up on your answer about loan growth. You just said that you were expecting a loan growth of 8% to 10%. If I’m not wrong, in the first half of the year your loan book expanded by almost 1% or around 0%. Is it feasible to see this big improvement in the loan portfolio expansion during the second half of the year?

Jose Humberto Acosta

Okay. Regarding your second question the loan growth, the situation is as follows. Remember, that we have almost 65% of our loan portfolio is in local peso. The local peso is behaving at pace of 10% to 11% growth in the last 12 months. In the US dollar track we are not growing. We are growing only 1%. And that situation is explained mainly by the loan book in US dollars in Colombia. What happens in Colombia is a corporate trade demand for US dollar shift from US dollar to local currency. So we are experiencing a decrease in the US dollar loan book in Colombia. Meanwhile the order loan books in the offshore, in the international operation is growing at a good pace but with the combination of factors it lead only growing 1%. What we expect for the rest of the year. We are expecting same in both currencies, maintaining the growth in local currency in peso to align 10% and to maintain the loan growth in US dollar outside in between 5% to 10%. Regarding your first question, fees, what’s going on with bank insurance is we are the number one dealer of insurance for Suramericana for example. So we are penetrated in our consumer segment with those bank assurance and the numbers are growing at a pace CAGR in the last three years at around 20%. What we expect the next coming months? We are expecting same level of growth because we are promoting the use of insurance in our branches. Remember, that we have more than 6 million clients here in Colombia. Although, it is a very successful business in our operation in Agricola and in Salvador, we are growing also at a pace of 20% to 25%. Obviously, the number is still very low but we are promoting the use of insurance and it is reflected because our new composition of the society, people are beginning to realize that the buying insurance it is a very good business. So it’s sustainable fee income at least for the next two years in the same numbers our growth of 20%.

Operator

Our following question comes from Tito Labarta from Deutsche Bank.

Tito Labarta

Hi, good morning and thanks for the call. My question is on net interest margin, following up a little bit more. I understand you said you expect it to remain kind of stable for the rest of the year. But — so that means you don’t see any more increase in spreads? We saw some good performance this quarter. So I just want to make sure you’re thinking that, that you can increase the spreads more. But also on the funding side, I understand you feel comfortable with your loan-to-deposit ratio but we have seen deposits fall now for two quarters. Do you think that could add some more pressure on the funding side that maybe then could negatively impact the margin? And then also I understand you expect rates to remain stable for the rest of the year. But if rates were to rise some more, where do you think you would feel more pressure, on the asset side, where you can increase spreads again or would that at more pressure to your funding costs, particularly with the loan-to-deposit ratio where it is? I just want to get a little bit more color on your outlook for margins.

Jose Humberto Acosta

Thank you, Tito. Yes, what we expect the second half of the year is we took advantage of the momentum of first half increase the interest rate and DTF will increase as well. The second half of the year we expecting a flat interest rate in terms of DTF and we expect that minimum increase of the Central Bank interest rate so for that reason we are not expecting on the asset side up an indicator of NII. We are expecting to maintain steady indicator of NII. As you said what is the challenge. The challenge is to maintain the funding cost under control and that will be very challenging again because obviously the cost of funding is increasing. So what we did is try to pre fund and re opt back of our funding. Remember, one third of our funding structure is timed to CDs, so we already locked part of them. We will take advantage of that. So we believe that the third and fourth quarter we would try to maintain funding cost under control. And this is basically because as we mentioned in the speech, half of our deposit is now price sensitive because it’s retail business. So again the guidance here is to sustain the NIM at the same level. The challenge will be 2017 because priority if inflation change and the interest rate goes down and because we are asset sensitive we will be feel pressure on the NIM but that will be the second — the first half of next year. Regarding your second question that interest rate will remain stable, again, the structure of funding, we are funding basically from what happen with loan to deposit ratio is in the operation in Panama we are growing at a pace of 10%. But on the liability side we are not growing at the same space. We are growing at a pace of 7% to 8%. So we are covering that gap with medium term loans from international bank. That is why the number of loan to deposit ratio changed. But again in our Colombian operation we have a ratio of loan to proceed at around 100%. The situation is in our international operation because it’s mainly driven in US dollars and we have to use the international facilities. That’s the reason why we went to the market with BCM and we raised money for Banagricola last year ago and raised money for Banco Agromercantil two years ago.

Operator

Following question comes from Nicolas Riva from Citigroup.

Nicolas Riva

Thanks, Jose Humberto, for taking my questions. My first question is on capital. Your Tier 1 increased 30 basis points quarter-on-quarter; now it’s 8.5%, which is the midpoint of your guidance of 8% to 9%. And the increase seemed to be driven by a reduction in the risk-weighted assets, which were around 2% quarter-on-quarter. Now I know that loan growth was quite low quarter-on-quarter only 1%, however I wanted to know what was the reason really for the reduction in the risk weighted assets on a quarter-on-quarter basis. And then my second question on taxes. The structured income tax has been quite well in recent quarters, 49% in the first quarter, 32% in the second quarter. And overall this year has been a quite substantially from last year which was 20%. So I wanted to ask what’s driving the volatility in the structured income tax rate and also what’s the guidance for the tax rate for the second half of this year? Thanks.

Jose Humberto Acosta

Thank you, Nicolas. Yes, the reason why the risk weighted asset reduce is because the VIR, remember that we are locate — our liquidity — 7% of our assets are located in the investment portfolio of mostly in sovereign treasury so we are using less VIR and that’s the reason why the number increases in terms of Tier 1, which implies that we are using our capital in the best possible way and try to allocate in the best possible way. And you will see that try to maintain that number again 8% to 9%. The second question regarding taxes, remember, in the first quarter we were impacted because of appreciation the FX rate came from 3,150 pesos to 3,000 peso that was appreciation of currency, very important that affect in terms of taxes. So for the year the guidance as we are expecting tax rate base of 38% assuming that the FX will be a kind of stable, which means we believe us – our chief economist say that the interest tax rate will be at the end of the year at a level of 3,000 pesos. If it is what it is 3,000 pesos the tax rate base will be 37%. But if something happens in terms of appreciation of depreciation that will change tax interest rate.

Operator

Following question comes from Catalina Araya from JPMorgan.

Catalina Araya

Hi, yes. Thank you. Just my quick question is following up on consumer lending. I was surprised by the increase in the acceleration of consumer loans, which this quarter grew around 19% year-on-year versus only 8% year-on-year in the first quarter. You said at the beginning of the call that in terms of risk you’re being conservative, especially in the consumer segment; but we see this huge — or accelerating in growth and NPLs increasing 20 basis points. So I want to know, understand, where this growth is coming from. And then my second question, just following up on bancassurance, you talked about 6 million clients in Colombia. How many of these clients have insurance products? Thank you.

Juan Carlos Mora

Thank you, Catalina. Regarding your first question, what happen with consumer loan is we decided to go to the high income individuals. And we use new tools inside a bank which is analytics and we were right now very efficient in the pre approval process with those population. So as a result of that we increased the level of loan portfolio for those individuals. And also we are offering them more tenure instead of lending for one year we are lending for two or three years but as you mentioned Catalina mostly focused on high income individuals in order to avoid deterioration of the loan portfolio. And remember that the deterioration of the loan portfolio part of is seasonal, the other part is because of the Panamanian operation and other part is because some corporate clients, is not related mostly to the consumer business. It is related for the whole range of business that we are operating. So the answer is we are very focused with high income individuals and we try to take advantage of that and to lend them more money.

Juan Carlos Mora

Jose Humberto Let me, Catalina, let me precise a little bit what are our expectations around a loan growth. As we said we expect our book to grow around 10%. How do you divide that growth? Mortgages are going to grow 12% so that’s going to be the leading part of portfolio. Commercial loans will grow around 8% to 10% and as we mentioned they are from corporate projects, infrastructure in Colombia and other corporates in country so that part of the book will grow between 8% and 10%. On retail is going to grow around 5% to 6%. So we are expecting that retail part of the business is going to grow at a pace that is going to be lower for the next year.

Jose Humberto Acosta

And also remember, Catalina, that 58% of our loan book is basically commercial loans. So we are talking about that loan growth will be basically of that segment. Regarding your second question of bancassurance, out of the 6 millions clients we have right now 800,000 are clients using bancassurance, so you see a huge potential in growth and that’s the reason why we believe that the number of growing at a pace of 20% will be sustainable at least for the next two years.

Juan Carlos Mora

And let explain little bit on that. We have been building a strategy of around insurance for the last three to four years and it’s a business that is growing at a very good pace. Insurance penetration in our country is very low. But we have customers and we have a very — a distribution network that is very powerful. So we are taking that product on our distribution network and the results had been very good. And we expect that pace to continue since we see a very good demand for this kind of product not just in Colombia but as we mentioned before in the other countries that we are present.

Operator

[Operator Instructions]

Our next question comes from Neha Agarwala from HSBC.

Neha Agarwala

Hi, congratulations on the results, and thank you for taking my question. I would like to go back to the tax rate for the year. You started the year with tax guidance for the year of 26% to 28% so now that has changed to 38%. I just want to clarify that. And given that the statutory rate for this year is 40% and next year it’s going to increase to 42%, would we expect a similar increase in the effective tax rate for the years going forward as well? Thank you so much.

Jose Humberto Acosta

Thank you. The reason why are moving from 26%, 27% of tax rate to 37% is because of combination of factors. First, the number of operation is growing in Colombia. We are obtaining gains because of the operations. So that we imply more taxes. Second because remember then we have our tax reforms two years ago in which we are assuming tax is growing 9% margin, this year will be growing 11% margin, so that’s the reason why the number jumps through 37%. And your second question would you please repeat? Remember the second question was —

Neha Agarwala

Yes, the incentive statutory rate for this year is 40%, and your effective tax rate you are guiding for the year is around 38%. Next year the statutory rate would increase to 42% under the tax reform. So what should we increase — a similar increase in the effective tax rate as well? And what is the expectation for the years going forward?

Jose Humberto Acosta

Yes. I am sorry about. Probably next year we will talk about that from 37% to 39%. Obviously all of that depends of FX condition because the variation affects us in terms of tax but the answer is we would go from 37% this year to 39% in 2017.

Operator

Our following question comes from Sebastian Gallego from Credicorp Capital.

Sebastian Gallego

Hi. Good morning, everyone. Thanks for the question. Just following up on the NIM side, but going to 2017. First, what’s Bancolombia’s view on any potential hike rate by the Fed? And how is this going to affect also the cost of funding and the NIM potentially, seeing also lower interest rates in Colombia by the Central Bank? Thanks.

Jose Humberto Acosta

Yes. We talked about the local situation, we talk about what happen with inflation and what will happen again with inflation next year that will depended the interest rate of the Central Bank. Again, if the interest of the Central Bank goes down, the re-pricing of the assets will be faster than the re-pricing of our liability and we will feel like kind of compression of any for at least the whole year of 2017. But as always happen also we will be benefit because of the marginal funding cost also would be reduced. So at the end of the day in terms of local currency, we are expecting to sustain the NIM at a level of 6% to 6.1% at the current level. We are not expecting neither goes up because interest rate hike is done but we are not expecting to go down because we will do the best effort to maintain funding under control. On the US dollar universe, obviously if interest rate goes up again will happen exactly as saying the LIBOR will be up, the spreads will be maintained and we will do exactly as same on liability side. So it is not a function what happen in terms of the rate in the US, it is a function that the way we will structure the funding to attend the business in both currencies in local and US dollars.

Juan Pablo Espinosa

Jose, if I can add something about that is that actually we expect that the tightening cycle in Colombia is going to be ending soon. And we actually believe that there is going to be pace in timing which monetary policy will remain stable because basically we have still very high inflation reading so we don’t foresee that a change in cycling, the monetary policy will occur any time soon. So I mean that downward trend in rates in our opinion will take a while to occur.

Operator

We have time for one more question. Natalia Casas from Ultraserfinco.

Natalia Casas

Hi; thank you for the call. I would like to know a little bit more about the efficiency ratio. And what do you expect about the rest of the year? It will be under 50% again?

Juan Carlos Mora

Okay, Natalia, regarding efficiency ratio, well, obviously it is a function of not only expenses also the income ratio. And this behaving very well. You see the expenses growth were 20%, out of the 20%, 7% were Banco Agromercantil, a new operation that we started in Guatemala. And if you do the math the other expenses 40% are US dollar, with valuation of 12% during the last year, we are talking about 5% because of FX variation that means that we are in the growing of expenses at a level of 8% to 9%. And this is our guidance and we are doing our effort internally to maintain the number 8% under control. How we are doing that? Basically try to for example in terms of business using in a more efficient way the distribution channels, different branches as Juan mentioned at the beginning of the speech. Maintaining and the control the number of projects we are not growing the branches. We are trying to move forward using different channels with the lower cost. And because of that I’d say that we will be able to sustain that number 8% expenses growth this year.

Operator

At this time, we have no further question. I’d like to turn the call back to Juan Carlos Mora for closing remarks.

Juan Carlos Mora

I’d like to thank you for take the time to hear our conference call and to be with us. We reaffirm that we are very happy with the quarter results and that we keep working on maintaining the profitability and the results of the bank. If you have further questions, don’t hesitate to contact our IR team. And hope you see in our third quarter conference call results. Thank you very much. And have a good day.

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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